The Advantages of Free Trade
By Eugenio Marí
Removing restrictions on international trade has positive effects in terms of efficient resource management, consequently generating aggregate gains to human welfare. The advantages that are normally cited are increased returns to scale, increased competition, and the traditional welfare gains from voluntary exchange.
However, in this case, I would like to draw attention to two other positive effects: the first based on the changes of expectations of business owners, and the second based on the exchange of information.
Often overlooked is the fact that, at the microeconomic level, trade liberalization and market expansion reduces volatility in demand. Since companies plan their production levels according to their costs, reduced volatility in sales will lead to decreases in average costs in the industry. This in turn then leads to increases in the quantity of goods produced for a given price.
What does this mean? In an autarchy, or completely closed economy, a firm that produces cars, for example, can only sell them in the domestic market. Its output is therefore determined by the evolution of its local sales. In a country with high income volatility, business owners seek to amortize their investments more quickly, which increases average costs.
If this is not clear enough, consider the following example: If the car factory has a machine that costs US$1,000 and produces 10 cars per year, the average cost of the machine per year will be $100, if they expect to sell 10 cars per year for 10 years. However, the cost will be $1,000, if they only expect to sell 10 cars in one year (the company will amortize the machine after one year, since it will no longer be used). Once again, stability in this example has reduced average costs, while volatility forces them to increase.
Trade liberalization diminishes volatility, as it allows companies to sell their products in other markets. Let’s go back to the car factory: if the same machine is used, and 10 cars were sold in the domestic market, and another 10 were sold abroad every year for 10 years, the average cost of the machine is now down to $50.
Should a domestic economic crisis affect local demand, the manufacturer can still sell 10 cars abroad for 10 years, maintaining the average cost of the machine at $100.
While average costs doubled in an open economy in this example, they would have increased tenfold in an autarchy. This gain is always positive, except in cases when the revenues of both countries involved in trade are perfectly correlated, which does not happen in practice.
Free trade also leads to an increase in the variety of products available on the market, improving the capacity for consumer choice. Furthermore, if we think of each product and each exchange as a package of information, the increase in the number of transactions and the diversity of goods leads to an increase in the total amount of information.
Therefore, producers can learn new management techniques and new technologies, among other things, just by interacting with other companies and buyers. Entrepreneurs will then innovate and create new products based on information they would have otherwise not gained were it not for trade.
The benefits of free trade at the aggregate level are unquestionable. However, free trade does generate adjustments in the domestic economy that benefits some sectors more than others. Industries that may be negatively affected by free trade are usually concentrated, and have a greater ability to lobby.
Meanwhile, the consumers that stand to benefit the most are usually scattered, and are therefore less likely to organize and influence the government’s decisions.
Eugenio Marí is an Argentinean economic analyst with the Fundación Libertad y Progreso. He holds a bachelor’s degree in economics from Ucema and he is pursuing his masters degree. Follow @Eugenio_Mari.
A Secret That Will Cost Us Dearly
By Vladimir Garay
Español“The future is in the Pacific,” say the optimists with a penchant for clairvoyance. For Latin-American countries eager to achieve development, this means economic prosperity and the benefits that come with it. That is why it’s not surprising that the governments of Chile, Peru, and Mexico have favorably received the invitation to be part of the Trans-Pacific Partnership (TPP).
These three nations have joined the United States, Canada, Japan, Brunei, Australia, New Zealand, Malaysia, Singapore, and Vietnam in the negotiation of an agreement which, they say, represents about 40 percent of the world’s economy, and will set tomorrow’s standards in international trade.
In this light, the TPP seems like a great opportunity. Of course, these things are never that simple.
Throughout the five years of negotiation, diverse groups such as labor unions, internet activists, environmental organizations, consumer-advocacy groups, and health-care providers have raised the alarm on the dire consequences that this treaty will have for the citizens of the 12 countries involved. Nobel Prize-winning economists Joseph Stiglitz and Paul Krugman have also voiced these same concerns.
The first major criticism of the TPP is the manner in which it has been negotiated: in total secrecy. Not even the members of the national parliaments of each country have had access to the text of the agreement, undermining the democratic principles of these nations.
The question is obvious: If the TPP is so beneficial, why can’t we openly discuss it?
In its 29 chapters, the TPP covers a wide range of vitally important issues, from state investments to environmental regulations. Of these chapters, only three have been made public, thanks to Wikileaks. And what we’ve seen has been disturbing.
How could the TPP affect us? The agreement would extend pharmaceutical patents and discourage the production of generic drugs. This would subsequently diminish the scope of health policies in Latin-American countries.
The TPP would also impose draconian intellectual-property regulations, similar to those the controversial Stop Online Privacy Act (SOPA) would have established in the United States had it not been defeated. Those same provisions are now being resurrected thanks to the secrecy behind the TPP negotiations.
Moreover, the TPP would give companies the ability to file lawsuits against national governments that establish policies that run counter to their economic interests, such as food-labeling laws or legislation aimed to reducing smoking, to name just a few.
The worst part is that once these conditions are accepted, there is no turning back: the multilateral nature of the agreement makes it virtually impossible to alter any commitments in the future. Furthermore, the certification process awards the United States the exclusive ability to reject regulatory changes that the other member countries are forced to enact to fulfill the agreement, undermining national sovereignty.
The more we know about the TPP, the less it looks like a door to the future, and more like a rope around our necks.