Andrew Leigh

Free trade is hard but better than the alternative

The Daily Telegraph, 27 October 2017

In February, President Trump gave a speech at a Boeing factory, lauding the launch of the newest model Dreamliner. He told the crowd: ‘This plane, as you know, was built right here in the great state of South Carolina. Our goal as a nation must be to rely less on imports and more on products made right here in the USA.’

But the Dreamliner wasn’t just made in America. Sections of the fuselage are Italian and Korean. Parts of the wings are Australian and Japanese. The landing gear is British, the cargo doors are Swedish, and the passenger doors are French. Four out of five Dreamliners will be exported and all will be used for international travel. The Dreamliner is of the world, by the world, and for the world. Few products better epitomise globalisation.

World trade is just another form of comparative advantage, letting countries specialise in what they do best. Look at any individual transaction, and you will see benefits to both the importer and the exporter. After all, unless both buyer and seller were better off, the sale wouldn’t happen. Just as your hairdresser doesn’t defeat you when you get a haircut, Japan doesn’t defeat you when you buy a PlayStation. Sellers aren’t vanquishing buyers – both are benefiting from specialisation.

What are the risks of protectionism? On the campaign trail, President Trump repeatedly threatened to impose tariffs as a way of discouraging firms from moving manufacturing production to countries such as Mexico. Thankfully, the United States has not yet implemented these threatened 45 per cent tariffs. But we can get some insights into what the effects might be from the contrasting experiences of Argentina and Korea.

In around 2010, under President Cristina Kirchner, Argentina imposed import restrictions on several key manufactured goods, and insisted that producers instead build them in Argentina. One company that complied was BlackBerry, which produced the first ‘Made in Argentina’ smartphone in 2011. There was just one problem: the device cost twice as much and used outdated technology. It wasn’t long before cheaper and better phones were being smuggled into Argentina. Two years later, the final Argentinian BlackBerry ran off the production line. Protectionism, combined with huge subsidies for firms that manufactured locally, failed to increase the share of Argentinians working in manufacturing. A closed-economy attempt to ‘Make Argentina Great Again’ led to rising unemployment, double-digit inflation, increasing budget deficits, and sluggish growth.

Then there is South Korea. In the early 1960s, under Park Chung-hee, Korea opted to focus on a strategy of trade-led growth. Initially, tariffs were eliminated on imports if the product was then used to produce goods for exports. This was followed by a gradual succession of tariff cuts across the economy. From the 1960s onwards, Korea’s manufacturing sectors grew rapidly. From steel to ships, cars to televisions, a reduction in protectionism helped spur growth. In 1960, Korea’s income per person was about one-tenth of the United States – similar to many countries in Africa. Today, its income level is about half that in the United States. Korea is a rare example of a nation that has managed to make the leap from developing to developed country in not much more than a generation.  According to one study, about one-fifth of this can be explained by its tariff cuts.

The stories of Argentina and Korea can be seen in more fine-grained analyses of protectionism and growth. Lowering trade barriers tends to lead to more investment in the economy and more rapid rates of economic growth. Conversely, a protectionist backlash is likely to harm economic growth. If countries cannot specialise in what they are best at, then they are likely to be less productive – just as most of us would be less productive if we were forced to grow our own food, cut our own hair, and fix our own cars. Because imports tend to be cheaper than locally made substitutes, protectionism would also mean higher inflation. For households, higher tariffs would mean that the household budget does not stretch as far.

The other risk of protectionism is that countries get into a cycle of punishing each other. Even governments who recognise the benefits of open markets would invariably come under pressure to retaliate. This mercantilist approach is no smarter than it would be to destroy your airports because another country has torn up its runways. But the history of past trade wars is littered with examples in which nations have responded to a tariff with a tariff.

As economist Paul Krugman warns: ‘If we treat the rules with contempt, so will everyone else. The whole trading system would start to unravel, with hugely disruptive effects everywhere.’ Modelling by the Productivity Commission estimates that a 1930s-style upsurge in protectionism would cost the typical Australian household $1500 per year, and cause 100,000 people to lose their jobs.

This is an edited extract from Choosing Openness, published this month by the Lowy Institute and Penguin Random House Australia.