These days many people talk about free trade. In this essay, I will cover some background about free trade and show how government introduces many problems into free trade.
Free Market is the free flow of goods and services between different people in the society. Free trade is the free flow of goods between political jurisdictions. The free market benefits the consumer because it makes multiple producers compete to offer goods and services offering the consumer the best possible price. Free trade expands the market to include foreign producers as well as the domestic ones. Free market benefits the consumers and the efficient producers and punishes the inefficient producers. Producers who don’t offer good value end up shutting down and freeing their resources such as capital and labor for other uses in the economy and this creative destruction ensures the proper distribution of resources.
On the long run countries in a free trade system will specialize in certain products that they produce more efficiently. The same way individuals specialize in the areas of production they are the best fit for according to their comparative advantage. On the short run, there may be a trade imbalance between different countries but on the long run, any trade imbalances will be resolved through currency relative prices. For example, if country A exports less than it imports that means that its trading partners will end up with a surplus of country A currency. This surplus can be used by the trading partners either to invest in country A assets, keep the currency as a reserve, or they will trade that currency out. If the trade partners sold their access country A currency, this would push the currency relative price down and the raise the price of imports for country A which will on the long run forces it to consume less imported goods and create a trade balance.
Free trade works like the free market when we let the market process work and respect the outcomes. The role of government in the market should be limited to protecting property rights and resolving disputes between private parties. Problems arise when the government expands its role and select winners and losers.
The first problem is that the inefficient producers don’t go down quietly, instead, they use the political system to gain protection. They ask for tariffs and restrictions on imports to protect them against the foreign competition. This is similar to anti-trust laws on the national level that mainly protect the inefficient producers and penalize efficient ones. These laws end up creating inefficiencies in the market and protecting the well-connected companies and sectors and leaving other sectors out.
The second problem is that free trade exposes the problems with each country’s economic, legal and regulatory systems. If these systems impose extra costs on some or all areas of the economy these areas will be at a disadvantage against foreign competition from countries that don’t have similar costs. If country A has regulations that cause cars to be 25% more expensive, then equivalent foreign cars that don’t suffer the same regulation cost will be cheaper as long as they are priced less than the domestic producer even if they are not cheaper without the regulation overhead. These producers will have several options:
- Work for a political solution to reduce government-imposed overhead through tax, regulation, and legal reform.
- Join the inefficient producers and lobby the government for protection.
- Relocate their production to foreign countries and import their products afterward to their home country.
The third problem is the whole notion of a trade agreement. Governments pretend that the only way to have free trade is through complicated agreements that include 2 or more countries. Free trade doesn’t require complicated agreements, a commitment to remove tariffs or reduce them to the same level on all products should be enough. By looking at NAFTA or TPP as examples, we can see that all of these trade agreements come with thousands of pages of tariff schedules, exceptions, procurement rules, and regulation mandates. These agreements are examples of corporate welfare where connected firms get their products access to foreign markets or prevent foreign competition through exceptions and quotas.
Free trade, like the free market, has a very limited role for government and any deviation from this role cause imbalances and negatively affect the whole market. Government overreach cannot be solved without citizens holding the politicians accountable and vote them out of office for crossing the boundaries. We have made the mistake of relying on electing free market advocates to government and hoping to make a change. The better approach is to work on spreading true economic knowledge and expand the liberty movement to more people and only then we can hold the politicians accountable and turn the country around.
Think about a product or a service you bought recently and why you paid that price for it. For example, if you are a Netflix subscriber you pay about $7.99 every month to have access to that service which means that you value having this subscription more than you value $7.99. If Netflix increased its price to $11.99 people who value the service more than $11.99 will continue to subscribe but if Netflix increased the price to $100 a month they will definitely lose a lot of users. People decide to buy a product or a service if they value it more than they value its price that’s why interactions in the free market are all win-win interactions. People won’t voluntarily enter a transaction they don’t think it will make them better off. The decision to buy a product or a service has nothing to do with the cost of production, but it depends on the subjective value the customer puts into that product or service. Economists call this the Subjective Theory of Value.
A producer sets the price of his product or service to what he thinks will attract enough customers to make up for his business costs and get a profit. If a business cannot make a profit it has to make a change such as optimizing its process to save on costs or increasing its prices and hoping to keep enough customers to get profits. If a business couldn’t make a profit it will eventually just shutting down. When a new business enters a market it competes by offering similar value to existing offerings with less price, offering a better value with higher or same price or offering a less value product at a less price point to attract customers who weren’t part of that market. The free market and the different value different people assign to the same product or service allow different options of products and services to suit most customers.
In the free market, a producer cannot ask for a higher price than what the customers value his product while a customer cannot pay less price than what the producer is willing to offer. Some customers and producers try to force outcomes that cannot be achieved via the free market using government coercion. They influence the government to make it interfere in the market by setting prices of certain products or services. Usually, government intervention causes the exact opposite of what the government aimed to achieve:
- Price Ceilings: the government decides that the price of some product or service is high so it sets a ceiling on that price. This leads to increase the demand for that product or service because the low price is less than the value more people place on it. But because it is harder to make the profit under that price many producers will either leave the market or lower the quality of their offerings. Rent Control is a classic example, it leads to increase in the demand for apartments in the city that enacts it and a reduction in the supply of rental units and quality deterioration of the existing units because landlords cut on maintenance.
- Price Floors: the government decides that the price of a certain product or service is low so it sets a floor for the price. This raises the price above what many people value which drives them out of that market leaving much of that product or service unsold. Minimum Wage is a classic example, the government sets the hourly rate of unskilled workers at a rate higher than what many business owners value they don’t higher those workers leaving many of them unemployed.
Politicians use government coercion to interfere in the market to achieve political goals. Although they fail to achieve their stated economic goals, they win the support of voters who wish to buy a product for less than its market price or sell a product for more than its value. The more deviation from the free market they achieve the more problems happen affecting everyone in the economy.