James Murray

This blog entry is about the following pair of articles:

• "Leaders Go Left, But Economists Get Back To Basics," by William Easterly, Forbes Magazine, January 30, 2009.
  
  
• "Nations Rush To Establish New Barriers To Trade," by John W. Miller, Wall Street Journal, February 6, 2009.
  

The first is a commentary by New York University economics professor Dr. William Easterly pointing out that while economists are finally agreeing that the United States and much of the world is experiencing an economic recession, economists are also agreeing that putting up legal barriers to conduct commerce will make problems worse. Economists that are free market advocates are typically not hard to come by, but Dr. Easterly also cites a Harvard University economist, Dr. Dani Rodrik, an academic who describes his own views of economic development and globalization as unconventional. Dr. Rodrik has openly critiqued some proposed benefits of international trade, but in his December 31, 2008 blog he warned that the costs of raising barriers to international trade are especially large given the current state of the economy. Dr. Easterly also cites a group of economists that includes people with all sorts of political and academic ideologies that signed a formal statement warning world leaders of the negative consequences of undoing market deregulation laws that have allowed markets to operate more freely in the past couple decades. Some have suggested that these deregulation polices have made our economy more susceptible to volatile swings and market failure, but economists are suggesting these have allowed for more economic growth, and shutting down such policies will reduce production and consumption possibilities, worsening the recession.

The recent actions of world leaders, described in the Wall Street Journal (WSJ) article by John Miller, suggest that many economists' advice are falling on deaf ears. The economic stimulus package signed by President Obama includes "buy American" clauses. These clauses say in many instances, those receiving assistance from this new legislation must buy American made products, even when imported goods provide less expensive alternatives. The European Union (EU) has barred imports of Chinese screws and bolts, arguing that China is dumping them below cost to drive out European producers out of the market. The EU has also recently restricted imports on U.S. chicken and beef. In retaliation, he U.S. said it plans to increase tariffs on Italian water and French cheese. Russia has introduced 28 new measures to raise tariffs and increase subsidies on its own exports, arguing that the measures are necessary to allow Russian companies to survive the recession.

The WSJ article points out that, tempting as it may be, it is not yet time to be making comparisons with the great depression and the Smoot-Hawley tariff act, which raised tariffs to 60% on almost one third of U.S. imports, creating an average tariff of 20%. Many have argued that putting up this incredible barrier to trade caused the United States to sink deeper into the Great Depression. The WSJ article talked to Fredrik Erixon, director of ECIPE, a trade policy think tank in Brussels. Mr. Erixon said that world leaders will not go to these measures again. He said that policy makers now understand that such actions are "illegal and immoral".

I think many economists would actually disagree with Mr. Erixon. Protectionist trade policies may illegal, but laws can be free to change. Moreover, economists are not saying preventing free trade is immoral, they are saying such policies cause more harm than good to the countries that enact them. It is not a question of ethics, it is a question of intelligent economic policy. When the U.S. puts a tax on Italian water and French cheese, it not only hurts Italian water makers and French cheese makers, it hurts U.S. consumers who want to buy water and cheese. It even hurts U.S. consumers who are currently buying American-made cheese. The tax on French cheese reduces the supply of cheese in the U.S. Facing the same demand, this causes an increase in the price of cheese. This is the detrimental effect of trade barriers: when a country enacts these policies (presumably to help its struggling economy), it makes goods sold in the country more expensive, and causes the consumer's dollar to not go as far as it could. This is particularly painful when there is a recession with incomes down and unemployment up.

Moreover, even the threat of raising trade barriers reduces international trade and therefore increases the prices consumers pay for goods. The article mentions that Italian water companies have spent millions of dollars in the United States to get FDA and Kosher certification for their products. If tariffs are imposed on imported Italian water, then Italian water companies will not see the returns they expected on this investment. Now the general movement across the world to raise tariffs threatens all international trade, even among goods that are currently trading without legal barriers. The possibility that the U.S. government will impose future tariffs is preventing current investment by foreign companies in the United States. This reduction in supply again causes prices to increase, even for American made goods.

It is not hard to find pointing fingers in the news for the cause of the current economic downturn. Popular choices are financial institutions that took excessive risks providing mortgages, homeowners that took larger mortgages than they should have, low interest rates in 2003 that made this possible, new types of assets that made getting rid of these investments easier, lack of regulation that made these assets possible, imperfect information and economic uncertainty that caused credit markets to freeze among these problems, and the list goes on and on. While there is a lot of disagreement about what caused our troubles, what has never been seriously blamed is openness to international trade. Trade is instead like the bloodstream of a global economy, allowing for growth and a healthy movement of goods, services, and assets around the world. Cutting off the blood flow is no better a prescription for economic policy makers than it is for doctors.

Labels: gains from trade, recession, trade