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And this doesn’t just apply to local situations, either. This principle of allowing the market to make production ever more efficient – even if it means accepting some creative destruction along the way – applies at every level of the economy, including at the transnational scale. And that leads us into one of the last major topics I want to cover here: international trade. Commentators often treat international trade as its own separate sphere, with a completely different set of rules from the domestic economy. But everything we’ve been talking about here so far, about the importance of increasing efficiency via division of labor and improved technology and so on, is just as applicable at the international scale. In fact, as Wheelan points out, foreign trade might be regarded as the greatest efficiency-boosting “technology” of all:

Imagine a spectacular invention: a machine that can convert corn into stereo equipment. When running at full capacity, this machine can turn fifty bushels of corn into a DVD player. Or with one switch of the dial, it will convert fifteen hundred bushels of soybeans into a four-door sedan. But this machine is even more versatile than that; when properly programmed, it can turn Windows software into the finest French wines. Or a Boeing 777 into enough fresh fruits and vegetables to feed a city for months. Indeed, the most amazing thing about this invention is that it can be set up anywhere in the world and programmed to turn whatever is grown or produced there into things that are usually much harder to come by.

Remarkably, it works for poor countries, too. Developing nations can put the things they manage to produce—commodities, cheap textiles, basic manufactured goods—into the machine and obtain goods that might otherwise be denied them: food, medicine, more advanced manufactured goods. Obviously, poor countries that have access to this machine would grow faster than countries that did not. We would expect that making this machine accessible to poor countries would be part of our strategy for lifting billions of people around the globe out of dire poverty.

Amazingly, this invention already exists. It is called trade.

If I write books for a living and use my income to buy a car made in Detroit, there is nothing particularly controversial about the transaction. It makes me better off, and it makes the car company better off, too. That’s [basic Economics 101] kind of stuff. A modern economy is built on trade. We pay others to do or make things that we can’t—everything from manufacturing a car to removing an appendix. As significant, we pay people to do all kinds of things that we could do but choose not to, usually because we have something better to do with our time. We pay others to brew coffee, make sandwiches, change the oil, clean the house, even walk the dog. Starbucks was not built on any great technological breakthrough. The company simply recognized that busy people will regularly pay several dollars for a cup of coffee rather than make their own or drink the lousy stuff that has been sitting around the office for six hours.

The easiest way to appreciate the gains from trade is to imagine life without it. You would wake up early in a small, drafty house that you had built yourself. You would put on clothes that you wove yourself after shearing the two sheep that graze in your backyard. Then you would pluck a few coffee beans off the scraggly tree that does not grow particularly well in Minneapolis—all the while hoping that your chicken had laid an egg overnight so that you might have something to eat for breakfast. The bottom line is that our standard of living is high because we are able to focus on the tasks that we do best and trade for everything else.

Why would these kinds of transactions be different if a product or service originated in Germany or India? They’re not, really. We’ve crossed a political boundary, but the economics have not changed in any significant way. Individuals and firms do business with one another because it makes them both better off. That is true for a worker at a Nike factory in Vietnam, an autoworker in Detroit, a Frenchman eating a McDonald’s hamburger in Bordeaux, or an American drinking a fine Burgundy in Chicago. Any rational discussion of trade must begin with the idea that people in Chad or Togo or South Korea are no different from you or me; they do things that they hope will make their lives better. Trade is one of those things. Paul Krugman has noted, “You could say—and I would—that globalization, driven not by human goodness but by the profit motive, has done far more good for far more people than all the foreign aid and soft loans ever provided by well-intentioned governments and international agencies.” Then he adds wistfully, “But in saying this, I know from experience that I have guaranteed myself a barrage of hate mail.”

It’s true that this topic of trade tends to stir up a lot of controversy. But Krugman is right in his claim that it has been one of the most tremendous forces for good in the world. Despite all the ardent anti-globalist arguments saying that trade exploits poor countries, the countries that have been willing to participate in free trade have consistently outperformed those that haven’t. And despite all the alarmist predictions here in the US that free trade will cause all our jobs to be shipped overseas, and that it will lead to skyrocketing unemployment rates across the country, these dire outcomes have never actually materialized. True, many jobs have been shipped overseas, but even more jobs have been created in their stead; and the result has been a steady rise in prosperity, both here and abroad. As Sowell writes:

When discussing the historic North American Free Trade Agreement of 1993 (NAFTA), the New York Times said:

Abundant evidence is emerging that jobs are shifting across borders too rapidly to declare the United States a job winner or a job loser from the trade agreement.

Posing the issue in these terms committed the central fallacy in many discussions of international trade—assuming that one country must be a “loser” if the other country is a “winner.” But international trade is not a zero-sum contest. Both sides must gain or it would make no sense to continue trading. Nor is it necessary for experts or government officials to determine whether both sides are gaining. Most international trade, like most domestic trade, is done by millions of individuals, each of whom can determine whether the item purchased is worth what it cost and is preferable to what is available from others.

As for jobs, before the NAFTA free-trade agreement among the United States, Canada, and Mexico went into effect, there were dire predictions of “a giant sucking sound” as jobs would be sucked out of the United States to Mexico because of Mexico’s lower wage rates. In reality, the number of American jobs increased after the agreement, and the unemployment rate in the United States fell over the next seven years from more than seven percent down to four percent, the lowest level seen in decades. In Canada, the unemployment rate fell from 11 percent to 7 percent over the same seven years.

Why was what happened so radically different from what was predicted? Let’s go back to square one. What happens when a given country, in isolation, becomes more prosperous? It tends to buy more because it has more to buy with. And what happens when it buys more? There are more jobs created for workers producing the additional goods and services.

Make that two countries and the principle remains the same. Indeed, make it any number of countries and the principle remains the same. Rising prosperity usually means rising employment.

There is no fixed number of jobs that countries must fight over. When countries become more prosperous, they all tend to create more jobs. The only question is whether international trade tends to make countries more prosperous.

Mexico was considered to be the main threat to take jobs away from the United States when trade barriers were lowered, because wage rates are much lower in Mexico. In the post-NAFTA years, jobs did in fact increase by the millions in Mexico—at the same time when jobs were increasing by the millions in the United States. Both countries saw an increase in their international trade, with especially sharp increases in those goods covered by NAFTA.

And Wheelan expounds further:

Trade makes us richer. Trade has the distinction of being one of the most important ideas in economics and also one of the least intuitive. Abraham Lincoln was once advised to buy cheap iron rails from Britain to finish the transcontinental railroad. He replied, “It seems to me that if we buy the rails from England, then we’ve got the rails and they’ve got the money. But if we build the rails here, we’ve got our rails and we’ve got our money.” To understand the benefits of trade, we must find the fallacy in Mr. Lincoln’s economics. Let me paraphrase his point and see if the logical flaw becomes clear: If I buy meat from the butcher, then I get the meat and he gets my money. But if I raise a cow in my backyard for three years and slaughter it myself, then I’ve got the meat and I’ve got my money. Why don’t I keep a cow in my backyard? Because it would be a tremendous waste of time—time that I could have used to do something else far more productive. We trade with others because it frees up time and resources to do things that we are better at.

Saudi Arabia can produce oil more cheaply than the United States can. In turn, the United States can produce corn and soybeans more cheaply than Saudi Arabia. The corn-for-oil trade is an example of absolute advantage. When different countries are better at producing different things, they can both consume more by specializing at what they do best and then trading. People in Seattle should not grow their own rice. Instead, they should build airplanes (Boeing), write software (Microsoft), and sell books (Amazon)—and leave the rice-growing to farmers in Thailand or Indonesia. Meanwhile, those farmers can enjoy the benefits of Microsoft Word even though they do not have the technology or skills necessary to produce such software. Countries, like individuals, have different natural advantages. It does not make any more sense for Saudi Arabia to grow vegetables that it does for Tiger Woods to do his own auto repairs.

Okay, but what about countries that don’t do anything particularly well? After all, countries are poor because they are not productive. What can Bangladesh offer to the United States? A great deal, it turns out, because of a concept called comparative advantage. Workers in Bangladesh do not have to be better than American workers at producing anything for there to be gains from trade. Rather, they provide goods to us so that we can spend our time specializing at whatever we do best. Here is an example. Many engineers live in Seattle. These men and women have doctorates in mechanical engineering and probably know more about manufacturing shoes and shirts than nearly anyone in Bangladesh. So why would we buy imported shirts and shoes made by poorly educated workers in Bangladesh? Because our Seattle engineers also know how to design and manufacture commercial airplanes. Indeed, that is what they do best, meaning that making jets creates the most value for their time. Importing shirts from Bangladesh frees them up to do this, and the world is better off for it.

Productivity is what makes us rich. Specialization is what makes us productive. Trade allows us to specialize. Our Seattle engineers are more productive at making planes than they are at sewing shirts; and the textile workers in Bangladesh are more productive at making shirts and shoes than they are at whatever else they might do (or else they would not be willing to work in a textile factory). I am writing at the moment. My wife is running a software consulting firm. A wonderful woman named Clementine is looking after our children. We do not employ Clemen because she is better than we are at raising our children (though there are moments when I believe that to be true). We employ Clemen because she enables us to work during the day at the jobs we do well, and that is the best possible arrangement for our family—not to mention for Clemen, for the readers of this book, and for my wife’s clients.

Trade makes the most efficient use of the world’s scarce resources.

This is the same concept of comparative advantage that we were discussing earlier with regard to humans vs. machines (or more accurately, humans who don’t own a bunch of machines vs. humans who do). In some cases, two different parties will have absolute advantages in two different areas, so it’s obvious that they’ll be able to mutually benefit from trade. But as it turns out, even in areas where one party is better than the other at literally everything in absolute terms, trade can still be mutually beneficial for both parties for the simple reason that neither of them is capable of doing everything at once. Several of the economists I’ve been quoting throughout this post have had insightful things to say on this subject, so I’ll just include a few more excerpts from them here. (And some of them, I realize, are repeating many of the same points, but I think each one also adds enough extra insight to still be worth including – and besides, the points they do repeat are important enough to bear repeating.) Let’s start with Harford:

Comparative advantage is the foundation of the way economists think about trade. Let’s picture it this way: who is the better economics writer, me, or E. O. Wilson? Professor Wilson is “one of the twentieth century’s greatest thinkers” and “considered to be one of the world’s greatest living scientists” according to the jacket of his book Consilience. His chapter on social science was written after interviewing some of the world’s greatest economists; the result was an insightful explanation, which introduced me to plenty of things I didn’t know about economics. The truth is that E. O. Wilson is probably a better economist than I am.

So I know when I’m beaten. Why write a book about economics when Professor Wilson could write a better one? The answer is comparative advantage. Because of comparative advantage, Professor Wilson hasn’t written a book about economics, and I’m fairly confident he never will.

We owe the idea of comparative advantage to the [19th-century economist] David Ricardo. If Wilson and I shared David Ricardo as an agent, he might advise us as follows: “Tim, if you write biology books you are unlikely to get more than one sale per year of writing—the one your wife buys. But your economics is passable, and we predict sales of twenty-five thousand books for every year you spend writing. Professor Wilson, your economics books will probably sell five hundred thousand copies for every year you spend writing: but why not stick to the biology books and sell ten million?”

E. O. Wilson is twenty times as good an economics writer as I am, but, advised by David Ricardo, he sticks to writing biology, a subject at which he is ten million times more accomplished than I. On a personal level, Ricardo’s advice is plain common sense: E. O. Wilson should choose his vocation not with reference to what he does better than I do, but with reference to what he does best. Meanwhile, I would be well advised to make a living as an economics writer, not because I am the best economics writer in the world but because economics writing is what I do best.

Ricardo’s advice becomes more controversial when it comes to trading with the Chinese. “Chinese wages are so much lower than ours,” cry the protectionists. “They can make televisions and toys and clothes and all kinds of things much more cheaply than we can. We should protect our domestic producers with a tax on Chinese products—or perhaps an outright ban.” And so we do. The United States defends the interests of American companies (but not the American people) by blocking Chinese imports through “antidumping” laws. Dumping, according to these laws, is selling products cheaply. But the truth is that this is not dumping, but competition. Who benefits when, for example, Chinese furniture is blocked because it is “unfairly” cheap? American furniture manufacturers, perhaps. Certainly not the average American who wants to buy furniture. Many Europeans, meanwhile, cannot afford large, high-definition television screens because the European Union is trying desperately to prevent their arrival from China. Steel, which China now produces more than the United States and Japan combined, was recently subject to illegal tariffs imposed by the United States. Agriculture is even more highly protected.

Isn’t this necessary to stem what would otherwise be a flood of cheap foreign products under which our domestic industry would drown? It is not. The United States ought to produce goods and services not by asking what it does more cheaply than China but by focusing on what the United States does best.

Ricardo’s insight is that trade barriers—whether they are subsidies to our farmers, regulations on textiles, or taxes on televisions— make both us and the Chinese worse off. It does not matter if the Chinese really are better than we are at making everything: they should stick to producing whatever their economy is most efficient at turning out. Meanwhile, we, despite (apparently) being worse at everything, should stick to producing what we are least bad at producing. The argument is the same as one the spirit of David Ricardo gave to me and E. O. Wilson: I may be worse at everything, but I should still produce the economics books while E. O. Wilson sticks to biology. Yet barriers to trade are also barriers to this common-sense arrangement.

An example may help to persuade the unconvinced. Let’s say an American worker could produce a machine drill in half an hour, or a flat-screen TV in an hour. A Chinese worker could produce a machine drill in twenty minutes or a flat-screen TV in ten. The Chinese worker is evidently the E. O. Wilson of manufacturing. (Incidentally, the productivity numbers in this example are not only fictional but fantastical. Sadly for the Chinese, workers in developing countries are far less productive than workers in developed countries. They are able to compete only because they are paid much less; in fact, the relationship between lower wages and lower productivity is an extremely close one.)

If China and America do not trade, it takes ninety minutes work to produce a flat-screen TV and a drill to mount it on the wall in the United States. In China the TV and drill can be made in half an hour. If the protectionists get their way, then that is how things will stay.

If there are no trade barriers, we can trade with each other and both be better off. The Chinese worker makes two televisions, which take her twenty minutes, and the American makes two drills, which take him an hour. Trade one drill for one television and both are better off than when they started, having saved a third of their time. Of course, being more efficient the Chinese worker can quit work earlier, or earn more; but that does not mean the American worker has lost because of trade. Quite the reverse.

It’s true that if the Chinese worker put in a bit of overtime, she could do her own job and also do the same work as the American would have achieved all week. But why would she be so extraordinarily generous? The Chinese do not export televisions to the United States out of the goodness of their hearts; they do so because we send something in exchange—even if, as with our hypothetical machine drills, the Chinese are better at making them, too.

Contrary to popular belief, it is simply not possible for trade to destroy all of our jobs and for us to import everything from abroad and export nothing. If we did, we would have nothing to buy the imports with. For there to be trade at all, somebody in America must be making something to sell to the outside world.

This should be obvious, but somehow it isn’t. Think of American workers in, say, Pittsburgh, producing those machine drills. The workers are paid in dollars. The factory is rented in dollars. The heat and light and telephone bills all come asking for payment in dollars. But the drills are exported to China and sold locally or used to make goods in the Chinese currency, the renminbi. The costs of production are in dollars, the revenues are in renminbi. Somewhere renminbi have to be “turned into” dollars to pay the Pittsburgh workers’ salaries, but of course there is no process of magically turning dollars into renminbi. The only thing that will work is for an importer in the United States to provide dollars in exchange for renminbi, which he will use to buy imports. Exports pay for imports.

Economics, surprisingly to some, is about the interconnectedness of things: goods and money do not just appear and disappear. Nobody outside the United States would accept dollars in payment if the United States was not exporting things that the dollars could be used to buy.

In a more complex world the dollars and renminbi, drills and televisions, will not be directly exchanged for each other. We sell drills to the Saudis, the Saudis sell oil to the Japanese, the Japanese sell robots to the Chinese, and the Chinese sell televisions to us. We can borrow money temporarily—the United States is currently doing this—or we can produce assets like machine drill factories and sell the factories rather than the machine drills. But the circular flow of currencies will balance out completely in the end. The United States can afford imports only if we eventually produce exports to pay for them, and the same is true for every country.

A more extreme example may clarify things further. Think of a country whose government is very keen on self-sufficiency. “We need to encourage our local economy,” says the Minister for Trade and Industry. So the government bans all imports and patrols the coast to prevent smuggling. One effect will be that a lot of effort will be devoted to producing locally what was once imported: this certainly is encouragement to the local economy. But another effect is that all of the export industries will quickly shrivel and die. Why? Because who would want to spend time and money exporting goods in exchange for foreign currency, if nobody is allowed to spend the foreign currency on imports? While one part of the local economy is encouraged, another is crippled. The “no imports” policy is also a “no exports” policy. And indeed, one of the most important theorems of trade theory, the Lerner theorem, named after the economist Abba Lerner, proved in 1936 that a tax on imports is exactly equivalent to a tax on exports.

Lerner’s theorem tells us that restricting imports of Chinese televisions to protect American jobs in television manufacturing makes as much sense as restricting exports of American machine drills to protect American jobs in television manufacturing. In fact, the American television manufacturing industry is not really competing against the Chinese television manufacturing industry at all; it is competing against the American machine drill industry. If the machine drill industry is more efficient, the television manufacturing industry will not survive, just as surely as E. O. Wilson’s promising career as an economic journalist never got off the ground in the face of his superior skills as scientist.

This certainly makes us look at trade barriers in a new light. But it doesn’t prove that trade barriers cause any harm: after all, mightn’t the benefit of trade barriers to the American television manufacturing industry outweigh the harm to the American machine drill industry? David Ricardo’s theory of comparative advantage tells us that the answer is no. As we know, under free trade, both Chinese and American workers can quit work earlier than they could under restricted trade, having produced the same amount as before.

The commonsense answer based on practical experience is also no: compare North Korea with South Korea, or Austria with Hungary. To take a very rough guide to how much better it is to have an open, liberal economy than a closed one, simply note that in 1990, just after the fall of the Berlin wall, the average Austrian was between two and six times richer than the average Hungarian (depending on how you measure it). The average South Korean is wealthy while the average North Korean is starving. North Korea is so isolated that it’s hard to get any measurement of quite how poor the country is.

Trade barriers will always cause more harm than good, not just to the country against which the barrier is erected but also the country that erects the barriers. No matter if other countries choose to inflict trade restrictions on themselves, we’re better off without. The great economist Joan Robinson once quipped that just because others throw rocks into their harbor, that is no reason to throw rocks into our own. As the Zwin silted up, the citizens of Bruges were no doubt realizing the same truth centuries before.

None of this is to say that free trade is good for everybody. Competition from cheaper or better foreign products cannot put all of our domestic industries out of business, because otherwise we couldn’t afford to buy the foreign products. But it can alter the balance of our economy. To go back to the example of machine drills and televisions, although in our example the Chinese are better at producing both machine drills and televisions, we still produce machine drills when trading with the Chinese. In fact, we produce twice as many machine drills as we did before, but our television manufacturing industry has been wiped out. Good for the machine drill industry, bad for the television manufacturing industry. People will lose their jobs. They will have to try to learn new skills and get reemployed in the machine drill sector, which may be easier said than done. Overall, the United States is better off, but some people will lose out, and the losers will curse free trade and demand restrictions on imported televisions, although we know now that they could equally demand restrictions on exported machine drills.

Even the most casual historian will be reminded of the Luddite rebellion in Britain. Luddism began in 1811 in the English midlands, a desperate response by skilled textile workers to competition from the latest technology: stocking and shearing frames. The Luddites were well-organized, destroying mills and machines (“frame-breaking”) and protesting against the new economic system. Contrary to the modern stereotype of an unimaginative thug, the Luddites were responding to a real threat to their livelihoods.

So did technological change hurt some people? Without a doubt. Did it impoverish Britain as a whole? A ridiculous notion. Without minimizing the genuine suffering to those who lost their livelihoods along the way, it’s obvious that technological progress made us far better off.

Trade can be thought of as another form of technology. Economist David Friedman observes, for instance, that there are two ways for the United States to produce automobiles: they can build them in Detroit, or they can grow them in Iowa. Growing them in Iowa makes use of a special technology that turns wheat into Toyotas: simply put the wheat onto ships and send them out into the Pacific Ocean. The ships come back a short while later with Toyotas on them. The technology used to turn wheat into Toyotas out in the Pacific is called “Japan,” but it could just as easily be a futuristic biofactory floating off the coast of Hawaii. Either way, auto workers in Detroit are in direct competition with farmers in Iowa. Import restrictions on Japanese cars will help the auto workers and hurt the farmers: they are the modern-day equivalent of “frame breaking.”

The solution, in a civilized but progressive society, is not to ban new technology or to restrict trade. Neither is it to ignore the plight of those people put out of work by technology, trade, or indeed anything else. It is to allow progress to continue while helping support and retrain those who have been hurt as a result.

Perhaps that sounds callous. After all, even one person who wants a job and cannot find one is suffering a personal tragedy. Yet the interest groups who oppose free trade for their own profit have vastly overblown the effects of trade. Between 1993 and 2002, almost 310 million jobs were lost in the United States. Over the same period, more than 327 million jobs were created. Nearly 18 million more people had jobs in 2002 than in 1993. Each of the 310 million times somebody lost a job, that person was entitled to sympathy and to help, whether or not foreign competition had anything to do with it. Trade or no trade, a healthy economy loses jobs all the time, and creates them as well.

Despite the downsides that come with any form of creative destruction, it’s clear that trade can provide massive benefits to the countries that participate in it, because it allows them to make the best use of their different capabilities. In fact, as it turns out, it isn’t just beneficial to countries with wide disparities in their capabilities; as Taylor points out, even when it seems like two countries are so economically similar that they’d hardly have anything to gain from trade, the benefits can actually be substantial:

Both absolute and comparative advantages are about trade between countries with different productivity levels selling different products. However, well over half of world trade happens between countries that are fairly similar. I’m thinking particularly here of the high-income economies of the world, such as the United States, Canada, Japan, Australia, and countries of the European Union. Much of the trade between these countries involves buying and selling very similar products. The United States imports cars from Europe and exports cars to Europe; Japan exports computers to the United States and imports computers from the United States; and so on. Moreover, the high-income countries that are trading with one another have, in a big-picture sense, roughly similar wages.

How can this kind of trade of very similar goods benefit the economies of both countries? A first advantage is that it allows even smaller countries to take advantage of economies of scale. If a medium-size economy such as the United Kingdom had a whole bunch of car companies and no international trade, each company would need to be fairly small, because there are only so many British car buyers. Such companies would be unable to take advantage of economies of scale—that is, the fact that large car companies can produce at a lower average cost. However, when a few large auto production plants in the United Kingdom can produce for both domestic consumption and exporting, they can take advantage of economies of scale.

A second advantage of this kind of trade is a gain in variety. Again, imagine that in a small economy such as the United Kingdom’s, one big car plant can provide all the cars the country demands in a year. But because of economies of scale, that one big plant may be able to do only one thing really well—say, producing small, efficient city cars. If the British market wants lots of different kinds of cars—city cars, family cars, sports cars, SUVs, what have you—it could get that variety through international trade.

A third advantage: trading similar goods allows a greater degree of specialization within industries. This is sometimes called “breaking up the value chain.” For example, a car is made from many separate pieces. There are low-tech pieces, such as the fabric covering the seats; there are higher-tech pieces, such as the computers and the engines; and there is an assembly process. When trade occurs between similar countries, some pieces of the car are made in one country, some are made in other countries, and the car may be assembled in still another country. If this process allows each party to focus on specific, specialized tasks, they can all be more productive.

A fourth advantage: trade in similar goods can encourage a flow of knowledge and skills. Several decades ago, Japanese companies invented something called just-in-time inventory management, in which inventories were kept very low and supplies were delivered to the factory only as needed. It turns out that in a number of industries, this is a very effective way of organizing manufacturing. The United States learned this idea from Japan and adopted it. There was a flow of ideas, not just of goods and services.

Finally, trading similar goods across national borders provides greater competition for domestic producers. As we know, competition provides better incentives for low prices and innovation.

There is a strong empirical correlation between countries that expand their international trade and countries that have good economic growth. What’s more, there are literally zero examples of countries that have gotten very rich without expanding trade. The World Bank published a study several years ago on this subject. They split the world economy into two groups: globalizers, countries whose ratio of exports to GDP doubled in the 1980s and ’90s; and nonglobalizers, whose ratio of exports to GDP declined in that period. Globalizers included China, India, Mexico, and most of the high-income countries of the world, for a total of three billion people. Among globalizers, per capita GDP rose 5 percent per year in the 1990s. Among nonglobalizers, including much of Africa, the Middle East, and Russia, per capita GDP declined an average of 1 percent per year in the 1990s.

Heath provides still more insight into why free trade is so beneficial to the countries that partake in it, and why comparative advantage plays such a big role in the whole dynamic:

Even the most sympathetic observer must admit that over the past few decades, the apostles of neoliberalism, globalization, and free trade have done a terrible job of marketing their brand. The more they try to make people feel better about international trade, the more suspicious everyone becomes. The problem can be traced back to one stock phrase, which they repeat like a mantra: “international competitiveness.” What are you going to do when the Bangalore call-center workers come for your job? How are you going to compete? The specter of millions of diligent, educated, overachieving Asian workers coming online in the next decade is invoked, like a “scared straight” program, as a remedy for Western decadence. General Motors chairman Rick Wagoner summed up the anxiety perfectly when he complained that the U.S. economy was in danger of becoming “uncompetitive in everything.” There’s only one problem with all this: It’s not possible for an economy to be uncompetitive in everything, and even if it were possible, it wouldn’t matter, because, fundamentally, trade is not a competitive relationship. Competitions have a winner and a loser. Trade, on the other hand, is a cooperative relationship. Both parties benefit—otherwise they wouldn’t do it. There is, of course, competition on either side of the exchange, among the sellers and among the buyers, and there are external effects. But there is no competition between the sellers and the buyers. In this respect, all competition is domestic competition. We do not compete with China, India, or Mexico when we trade with them, nor do we compete with firms in those countries. If you look at the economics textbooks, the key concept in international trade is not “competitive advantage,” but rather “comparative advantage.” These are entirely different things. Furthermore, comparative advantage is an unintuitive and poorly understood concept, one that—it would seem—cannot be explained too many times. Yet rather than making the case for international trade through reference to its win-win structure, many of international trade’s most ardent defenders have inadvertently chosen to undermine the case by framing it as a type of competition. This just reinforces the idea that globalization is a zero-sum game, in which the winners benefit at the expense of the losers.

Why would the apostles of free trade sabotage their own case in this way? Part of it has to do with a simple failure to realize how much this rhetoric feeds into the left-wing critique of globalization. Saying that trade creates both winners and losers is just another way of saying that trade is exploitative, which gives aid and comfort to the old-fashioned Marxist view that there is extraction of “surplus value” in these exchange relations. Furthermore, if trade is competitive, what chance does a poor African nation have against the big bullies of the West? Aren’t we supposed to be giving them a helping hand, rather than trying to beat them down?

Apart from this unintended side effect, there is also an intended consequence of the “competitiveness” rhetoric: It serves to advance a domestic right-wing agenda. Some people find it politically expedient to describe us as being in competition with our trade partners, even though it isn’t true, because it allows them to push for tax cuts, wage reductions, deregulation, and lax environmental standards. The basis for this rhetoric is usually a false analogy between the competitiveness of countries and the competitiveness of businesses. The New York Times columnist Thomas Friedman, for instance—long-time cheerleader for globalization—has probably done more damage to the cause through this sort of rhetoric than have any of its most ardent critics. He makes a point of using the words “company” and “country” interchangeably. “If you are going to deal with a system as complex and brutal as globalization, and prosper within it, you need a strategy for how to choose prosperity for your country or company,” he writes. This is in a section of The Lexus and the Olive Tree entitled “Does your country’s or company’s management get it and can you change management if they don’t?”

This faulty analogy is used to suggest that government needs to become “leaner,” more businesslike, perhaps even be downsized. We must learn to “shoot the wounded,” as Friedman puts it. Taxation rates, labor standards, environmental regulations—these are just overhead expenses, all of which must be reduced in order to promote competitiveness. The welfare state is a luxury, a frill, an expensive perk that we’re going to have to learn to live without. This isn’t a choice, it’s an inevitability: “Many of the old corporate and government safety nets will vanish under global competition in the flat world,” Friedman writes in his follow-up work, The World Is Flat. While he does make an effort to talk about comparative advantage, he keeps slipping back into the rhetoric of competitiveness. We’ve got to pull up our socks, straighten our ties, and stop taking lunch breaks! We need to get serious, get educated, and get back to work, otherwise we’ll be crushed!

In fact, we don’t have to do anything of the sort. Countries are not companies, and they shouldn’t try to act as though they are. In fact, it’s tempting to call this analogy the “Lexus and the olive tree” fallacy, in honor of Friedman’s relentless conflation of the two. Companies compete with one another; countries do not. Getting mixed up on this point is a recipe for enormous confusion.

—

International free trade is one of the few economic policy questions that has the capacity to become a major election issue. In Canada, the attempt to implement the Canada-U.S. free trade agreement in 1988 actually forced the government to call a general election (after the Senate refused to pass the necessary legislation). The campaign that ensued was fought almost entirely on this question. Like many Canadians my age, I voted against the government. I did so because I was convinced that the free trade agreement would be a disaster for the country. And the reason I was convinced of this had a lot to do with the fact that I didn’t understand basic economics. In this respect, I was in good company. Indeed, most of Canada’s left-wing intelligentsia (especially writers and artists) spoke out against the free trade agreement, and in the process managed to reveal a scandalous lack of economic literacy. Scanning through these documents with the benefit of hindsight, it is safe to say that pretty much the entire left-wing establishment in the country did not understand international trade.

As it turned out, we were all completely wrong about the effects of free trade. (It is a useful measure of intellectual honesty to see how many are willing to admit this, two decades later. Of course, that’s easy for me to say, since I was only an undergraduate at the time.) Who would have thought that Ontario would soon eclipse Michigan as the largest automobile manufacturing center in North America? (And who would have thought that Canada’s universal health care system, an expensive government safety net, would be a crucial variable in the decision of various Japanese manufacturers to locate their operations in Ontario rather than Detroit?) Who would have imagined that there would be street protests in Hollywood among film workers, complaining about the massive relocation of movie and television production to Toronto and Vancouver? (And who would have imagined that the alien worlds in science fiction programs, which had traditionally borne a suspicious resemblance to southern California, would soon start to look like the rain forests of British Columbia?)

People had all sorts of reasons for objecting to the free trade agreement. One of the arguments that showed up again and again involved a version of the so-called pauper labor fallacy. John Ralston Saul provided a nice example of this back in 1988: “No European nation could succeed in open competition against a Korea or a Thailand, which both maintain nineteenth-century labour conditions. The countries of the European Economic Community therefore limit that competition to their definition of the word by the use of regulations, which include tariffs.” The suggestion was that Canada would be crazy to open its borders up to competition with countries where the cost of doing business is lower across the board. In order to “compete” effectively, a country must have costs of production that are, at least in some cases, absolutely lower—and as a result, a rich nation cannot possibly benefit from trade with a nation of “paupers.”

This seductively mistaken argument got even more play when the free trade zone was expanded to include Mexico, and Ross Perot made his famous remark about “a giant sucking sound” coming from south of the U.S. border. The basic idea in both cases was quite simple. Initially it had been thought, how can Canada possibly compete with South Carolina, with its low wage rates and almost nonexistent level of unionization? Now the thought became, how can Canada (and the United States) possibly compete with Mexico, where workers are paid pennies instead of dollars?

In the background here is the following sort of picture: Imagine two bakeries, across the street from each other. One of them is on the rich side of the street, and so pays its workers $10 per hour. The other is on the poor side of the street, and so pays its workers $1 per hour. All other expenses are the same, and both bakeries have access to the same equipment and technology. Workers are not allowed to cross the street, but customers are. So how can the “rich-side” bakery possibly compete with the “poor-side” bakery? It seems obvious that it cannot—everything on sale there is going to cost more. Thus the rich-side bakery will have to either lower wages or pick up sticks and move to the poor side.

Some people find this sort of argument so compelling that they regard it as a decisive refutation of the case for international trade (or, at the very least, they consider it proof that globalization serves the interests of bakery owners, not bakery workers). In fact, it is an example of the pauper labor fallacy. The problem is that it is predicated upon a false analogy between companies and countries. Companies typically compete with one another in order to transact with a third party, namely, their customers. Yet in the case of international trade, there is no third party, no outside customers. Countries trade with one another. Of course, Canadian firms compete with firms in Mexico to sell to third parties, but that has nothing to do with the issue of free trade. Putting tariffs on Mexican goods does nothing to make Canadian goods more attractive to people in other countries. What trade barriers do is make it more difficult for people in Canada to trade with people in Mexico, and the question is whether there is any advantage to be had from such a policy.

In order to make the bakery scenario properly analogous, one would have to imagine an arrangement under which the bakeries can trade with one another. For example, suppose that customers on both the rich and the poor side of the street are given vouchers to shop with, which are redeemable for baked goods only on their own side of the street. Customers from the rich side of the street can wander over to the poor-side bakery and try to buy something, but the only thing they have to offer by way of payment is rich-side bakery vouchers. The question is, if you are the poor-side bakery, why would you accept rich-side vouchers as payment? What good are they, since the only place you can exchange them for anything useful is at the other bakery? And since the rich-side bakery is paying its workers 10 times more than you are, wouldn’t you be better off just making everything yourself, rather than buying it from the rich side? To put the same idea in somewhat different terms, by accepting rich-side vouchers, which are intrinsically worthless, as payment for its goods, the poor-side bakery is essentially committing itself to buying something at the rich-side bakery. How could that be of benefit to them? Isn’t the rich-side bakery “uncompetitive in everything”?

It is here that one can see the flaw in the argument, and an opportunity to rehearse David Ricardo’s now somewhat old-fashioned point about comparative advantage. Suppose that workers at the rich-side bakery are particularly skilled at making bagels, while workers over on the poor side are much better working with pastry. This means that the relative cost of a bagel, compared to a tart, will be different on either side of the street (the absolute magnitude of these two prices cannot be compared from one side of the street to the other, since they are each denominated in terms of the “local” voucher). For concreteness, suppose that on the poor-side tarts cost half as much as bagels, while on the rich side tarts cost twice as much. This means that the poor-side bakery could improve its earnings by making a few extra tarts, selling them to customers from the rich side, then using the accumulated vouchers to buy the bagels that it sells to its poor-side customers. If they are able to get one bagel in this way for each tart that they sell, then they will be able to halve the amount of time spent supplying the bagel needs of their customers.

Here is another way of thinking about it. The poor-side bakery has two ways to make bagels. One is to do it in-house. The other is to make tarts, sell them to people from the rich side, then run across the street and buy bagels with the proceeds. Whether or not the second way is better than the first will depend entirely upon how good people on the poor side are at making bagels and tarts, compared to how good people on the rich side are. Thus the benefits of trade arise from the comparative advantages of the trading parties, not from any sort of competitive advantage. The fact that the wage rate is higher on the rich side of the street is completely irrelevant.

Of course, poor-side customers might get wind of this, and so instead of buying their bagels on their own side, they might go across to the rich-side bakery and try to buy them directly. The rich-side bakery will be happy to accept their vouchers, because they can use them to run across the street and buy tarts. The exchange is necessarily reversible, because both parties have to benefit in order for it to be worthwhile.

Thus the two bakeries have an interest in exchanging with each other: They can offer the same range of products to their customers at lower cost through trade, despite the disparities in their wage rates or overall costs of production.

—

The introduction of “vouchers” into the example above is not accidental. Much of the confusion over international trade arises from the way money obscures the nature of the underlying transactions. To see how this can happen, consider the following scenario. Suppose the two bakeries get tired of handling two types of vouchers, not to mention running back and forth across the street all the time, and so the poor-side bakery decides to stop accepting rich-side vouchers and to stop making bagels, while the rich-side bakery stops accepting poor-side vouchers and stops making tarts. From this point on, anyone on the rich side who wants tarts will have to buy poor-side vouchers from someone, in order to use them at the poor-side bakery. The way to do this, of course, will be to find someone on the poor side who wants to buy bagels, then exchange vouchers. Thus a currency exchange will develop, with a rate of exchange that reflects the ratio of bagel-to-tart productivity on the two sides of the street. People will buy vouchers from one another, then go to the bakery that specializes in the baked good that each wants to buy.

What is the difference between this scenario and the earlier one? In the first case, the bakeries are exchanging tarts and bagels with each other. In the second case, consumers are exchanging vouchers with one another. Yet the latter characterization is potentially misleading, since the vouchers have no intrinsic value; they are simply a stand-in for the goods that can be purchased with them. What’s really going on in the second case is the same as in the first: Tarts are being exchanged for bagels. The money illusion threatens to obscure that fact. Whether the two bakeries trade goods or the customers trade vouchers, the underlying economic transaction is the same.

This is important to remember in the case of international trade, because national currencies are basically just vouchers. Euros, as such, can only be spent in the euro zone, and thus represent a voucher for European goods. Holding currency is in this respect much like asking for a refund and getting a store voucher, or getting a gift certificate for Christmas. I can remember on many occasions wandering the aisles of a big-box hardware or clothing store with a gift certificate that I didn’t really want, trying to find something, anything, that might be of use to me. The experience is not all that different from looking through the gift shop at an international airport, trying to get rid of some foreign currency before boarding a flight home.

It is tempting to think that when we import goods from abroad, we pay for them with money, just as we do when shopping at the corner store. Yet it is important to remember that our money is worthless, as such, to foreigners. They can’t use it to pay their rent, for example, as the owner of the local corner store can. It’s only useful to them if they can cash it in on this side of the border for something they want (or exchange it with someone else who wants to cash it in, on this side of the border, for something). When we import a million dollars’ worth of goods from China, the best way to think about the transaction is to imagine a bunch of Chinese people subsequently wandering around the country thinking, “Gee, is there anything here I want? Maple syrup? Wheat?”—much like a shopper wandering through the hardware store with a gift card, thinking, “Do I need a table saw?”

Of course, this isn’t realistic, since some Chinese people have probably done their shopping in advance, picking out the items they want prior to selling us their goods. Because here’s the crucial point: If there isn’t anything on this side of the border that someone in China wants, then they won’t accept our money as payment. We will not be able to import anything from them, because we don’t have anything of value that we can use to pay them with. (So if the “uncompetitive in everything” scenario were possible, it wouldn’t manifest itself in the form of trade deficits. If no one wanted to buy anything from us, then no one would be willing to sell to us either, because we wouldn’t be able to pay them.)

No problem, you say—if they don’t want to accept our money as payment, all we have to do is go out on the currency markets and buy some of their money, and use that to pay for the imports. But this just pushes the problem back a step. What are we going to use to pay for their money? Our money. And why would anyone want to buy our money? They’re only going to want it if they can cash it in, on this side of the border, for something that they want.

Of course, the Chinese may not actually want anything from us but may earn our money in order to exchange it for some other currency. Again, this just pushes the problem back a step. People holding that other currency will be willing to sell it for ours only if there is something that they want in our country. Unless, of course, they can find someone else who is willing to buy our money … But the buck has to stop somewhere. Imagine a Web site where people who got gift certificates that they didn’t really want could get together to exchange them with one another. No matter how complex a web of transactions may develop, the fact remains that the only way you’ll be able to get rid of that Ikea gift certificate is if someone, somewhere, wants to buy Ikea merchandise.

Finally, if there is really nobody anywhere who wants anything that we make, then people holding our vouchers will start wanting to unload them, and so may begin to sell them at a discount. Their value will decline until someone, somewhere, starts thinking that our goods are becoming attractive at that price.

Currency is thus an incredibly important mechanism when it comes to regulating international trade. Yet all of these complexities should not be allowed to obscure the fundamental fact that in international trade, all imports are ultimately paid for with exports. This is an immediate consequence of the fact that trade is a system of exchange. China doesn’t just give us stuff; they also expect something in return. Of course, they may not demand repayment immediately (and by “repayment,” I mean payment in real goods, not paper money). They may choose to park their money in the country for a while, by buying government bonds or some other form of investment. This is what makes it possible for a country to show a trade deficit. When imports exceed exports, it means only that this year imports exceeded exports, because foreigners are now holding more of our currency (or debts denominated in our currency) than they were in the past. Eventually, by hook or by crook, they will have to be repaid with exports. After all, they’re not stupid. They don’t want our money: They want our goods.

So when a factory closes down in the United States and the owners relocate production to China, there is not necessarily any net loss of jobs to Americans. Americans will stop producing whatever it is that this factory used to produce, but they are going to have to start producing more of something else in order to pay the Chinese for the goods that are now being imported. This process may cause all sorts of disruption, and it may exacerbate social inequality within the United States. The people who get the new jobs, created to pay for imports, will almost certainly not be the same people who lost their jobs when the decision was made to offshore production. Thus a narrow argument against trade liberalization, focused upon this precise point, has considerable force. Critics of international trade, however, often just ignore the fact that the loss of jobs caused by offshoring will be offset by an increase in domestic production elsewhere. Jobs do not simply disappear domestically. To say that the country is “exporting jobs rather than goods” cannot be correct. Jobs are reallocated within the economy—if this weren’t the case, then we would have no way of paying for the goods that we are hoping to import.

Heath also provides an important clarification to one of Wheelan’s points made earlier. Wheelan had been explaining why America’s high levels of development and productivity enable its workers to earn more than workers in countries like Mexico and Vietnam; but as Heath points out, this might easily be read as implying that American workers therefore need to maintain higher absolute productivity levels in order to “outcompete” these poorer countries – and that’s not actually true:

It is worth observing that so far I have not said anything at all about productivity. This is unusual, in that defenders of globalization and international trade often try to console those who worry about losing their jobs by saying, “Don’t worry, you’ll be fine—you’re much more productive than those workers in Mexico (or China, or Bangladesh, or wherever).” Moreover, the need to improve productivity in order to maintain competitive advantage is a central theme in the “time to pull up our socks” lecture that people like Thomas Friedman never tire of delivering.

[…]

But there is [a] fundamental problem with the appeal to productivity as a way of comforting those who are concerned about international trade. Consider the way Charles “The Naked Economist” Wheelan deploys the argument:

Why wouldn’t a firm relocate to Mexico when the average Mexican factory worker earns a fraction of the wages paid to American workers? The answer is productivity. Can American workers compete against foreign workers who earn half as much or less? Yes, most of us can. We produce more than Mexican workers—much more in many cases—because we are better-educated, because we are healthier, because we have better access to capital and technology and better public infrastructure. Can a Vietnamese peasant with two years of education do your job? Probably not.

Wheelan is an economically sophisticated guy, but what he’s saying here is wrong. Or at least, it sounds like he’s saying something completely wrong. Because what it sounds like he’s saying to American workers is, “Even though we’re paying you more, that’s okay, because most of you produce a lot more, and so our operation is still competitive.” In other words, it sounds like he’s saying that domestic jobs are safe even though the wage rate being paid is higher, because the “piece rate” being paid (the amount that is paid per unit of output) is in fact lower. This is cold comfort for a number of reasons. First of all, it’s very seldom true, and people can sense that. After all, how useless could people in these underdeveloped countries be? When General Motors moves an assembly plant to Mexico, their workers get the same training and access to exactly the same equipment as workers in the United States. Superior education may help workers in United States churn out a few more cars per hour, but 10 times more? Americans aren’t that well educated.

The problem with Wheelan’s argument is that it encourages the reader to believe that wealthy nations need to have absolute advantage in order to remain competitive (that “we” must “produce more than Mexican workers” in some objective sense). This in turn serves to promote an artificial panic about our need to “stay competitive.” After all, if our high wages depend upon workers in Mexico being somehow incompetent at car assembly, we can hardly expect them to stay that way for long. This suggests that we need to keep working harder and harder in order to stay ahead of the game, and even to avoid any erosion in our absolute standard of living. And this is completely false.

Productivity is important, but it’s only relative productivity within a particular national economy that matters. Autoworkers in the U.S. get to keep their jobs (insofar as they do get to keep their jobs) because they’re highly productive compared to other Americans, not compared to Mexicans. In other words, the United States has (or had) comparative advantage in automobile production. More generally, wealthy nations typically have comparative advantage in high-productivity sectors, because of the relative abundance of capital and technology and because of the quality of infrastructure. Poor nations have comparative advantage in sectors that require lots of low-skilled labor. This is why trade often results in a gain in employment in capital-intensive sectors in the wealthy nation combined with a gain in employment in labor-intensive sectors in the poorer nation. It has nothing to do with high-productivity workers “outcompeting” their third-world rivals.

In this respect, American automotive workers are like bagel-makers on the rich side, rather than pastry chefs. (The reason they don’t lose their jobs as a result of increased trade with Mexico is that some other groups of Americans will. Defenders of globalization tend not to dwell upon this fact.) Americans would be willing to pay Mexicans to build their cars only if it were cheaper to do it that way than it would be to build them domestically. Yet as it turns out, Americans are better at building cars for themselves than they are at producing things that Mexicans happen to want in exchange for cars.

Of course, market conditions are always shifting and changing, so comparative advantages are never fully set in stone. A country that has a comparative advantage in automobile manufacturing in one generation might see its comparative advantage shift to some other industry in the next. And Heath is right to note that when this kind of changeover happens, it can often be incredibly disruptive for the workers who (from their perspective) seem to have “lost their jobs to foreign competition.” Nevertheless, this kind of creative destruction – whether it be the result of domestic trade or foreign trade – is a necessary part of growth and development for any functional economy. If no jobs were ever made obsolete, it would mean that we were no longer making progress or becoming more productive as a society. Finding ever more efficient ways of producing goods and services, after all, is what allows our standard of living to keep improving over time. But as Sowell points out, the only way that can happen is if the less efficient ways of producing those goods and services are done away with:

Over time, comparative advantages change, causing international production centers to shift from country to country. For example, when the computer was a new and exotic product, much of its early development and production took place in the United States. But, after the technological work was done that turned computers into a widely used product that many people knew how to produce, the United States retained its comparative advantage in the development of computer software design, but the machines themselves could now be easily assembled in poorer countries overseas—and were. Even computers sold within the United States under American brand names were often manufactured in Asia. By the early twenty-first century, The Economist magazine reported, “Taiwan now makes the vast majority of the world’s computer components.” This pattern extended beyond the United States and Taiwan, as the Far Eastern Economic Review reported: “Asian firms heavily rely on U.S., Japanese and European firms as the dominant sources of new technology,” while the Asian manufacturers make “razor-thin profit margins due to the hefty licensing fees charged by the global brand firms.”

The computer software industry in the United States could not have expanded so much and so successfully if most American computer engineers and technicians were tied down with the production of machines that could have been just as easily produced in some other country. Since the same American labor cannot be in two places at one time, it can move to where its comparative advantage is greatest only if the country “loses jobs” where it has no comparative advantage. That is why the United States could have unprecedented levels of prosperity and rapidly growing employment at the very times when media headlines were regularly announcing lay-offs by the tens of thousands in some American industries and by the hundreds of thousands in others.

Regardless of the industry or the country, if a million new and well-paying jobs are created in companies scattered all across the country as a result of international free trade, that may carry less weight politically than if half a million jobs are lost in one industry where labor unions and employer associations are able to raise a clamor. When the million new jobs represent a few dozen jobs here and there in innumerable businesses scattered across the nation, there is not enough concentration of economic interest and political clout in any one place to make it worthwhile to mount a comparable counter-campaign. Therefore laws are often passed restricting international trade for the benefit of some concentrated and vocal constituency, even though these restrictions may cause far more losses of jobs nationwide.

The direct transfer of particular jobs to a foreign country—“outsourcing”—arouses much political and media attention, as when American or British telephone-answering jobs are transferred to India, where English-speaking Indians answer calls made to Harrod’s department store in London or calls to American computer companies for technical information are answered by software engineers in India. There is even a company in India called TutorVista which tutors American students by phone, using 600 tutors in India to handle 10,000 subscribers in the United States.

Those who decry the numbers of jobs transferred to another country almost never state whether these are net losses of jobs. While many American jobs have been “outsourced” to India and other countries, many other countries “outsource” jobs to the United States. The German company Siemens employs tens of thousands of Americans in the United States and so do Japanese automakers Honda and Toyota. As of 2006, 63 percent of the Japanese brand automobiles sold in the United States were manufactured in the United States. The total number of Americans employed by foreign multinational companies runs into the millions.

How many jobs are being outsourced in one direction, compared to how many are being outsourced in the other direction, changes with the passage of time. During the period from 1977 to 2001 the number of jobs created in the United States by foreign-owned multinational companies grew by 4.7 million, while the number of jobs created in other countries by American-owned multinational companies grew by just 2.8 million. However, during the last decade of that era, more American jobs were sent abroad by American multinational companies than there were jobs created in the United States by foreign multinationals. Not only is the direction of outsourcing volatile and unpredictable, the net difference in numbers of jobs is small compared to the country’s total employment. Moreover, such comparisons leave out the jobs created in the economy as a whole as a result of greater efficiency and wealth created by international transactions.

Even a country which is losing jobs to other countries, on net balance, through outsourcing may nevertheless have more jobs than it would have had without outsourcing. That is because the increased wealth from international transactions means increased demand for goods and services in general, including goods and services produced by workers in purely domestic industries.

Free trade may have wide support among economists, but its support among the public at large is considerably less. An international poll conducted by The Economist magazine found more people in favor of protectionism than of free trade in Britain, France, Italy, Australia, Russia, and the United States. Part of the reason is that the public has no idea how much protectionism costs and how little net benefit it produces. It has been estimated that all the protectionism in the European Union countries put together saves no more than a grand total of 200,000 jobs—at a cost of $43 billion. That works out to about $215,000 a year for each job saved.

In other words, if the European Union permitted 100 percent free international trade, every worker who lost his job as a result of foreign competition could be paid $100,000 a year in compensation and the European Union countries would still come out ahead. Alternatively, of course, the displaced workers could simply go find other jobs. Whatever losses they might encounter in the process do not begin to compare with the staggering costs of keeping them working where they are. That is because the costs are not simply their salaries, but the even larger costs of producing in less efficient ways, using up scarce resources that would be more productive elsewhere. In other words, what the consumers lose greatly exceeds what the workers gain, making the society as a whole worse off.

Hazlitt summarizes the fundamental argument:

Since The Wealth of Nations appeared more than two centuries ago, the case for free trade has been stated thousands of times, but perhaps never with more direct simplicity and force than it was stated in that volume. In general Smith rested his case on one fundamental proposition: “In every country it always is and must be the interest of the great body of the people to buy whatever they want of those who sell it cheapest.” “The proposition is so very manifest,” Smith continued, “that it seems ridiculous to take any pains to prove it; nor could it ever have been called in question, had not the interested sophistry of merchants and manufacturers confounded the common-sense of mankind.”

From another point of view, free trade was considered as one aspect of the specialization of labor:

It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy.

The tailor does not attempt to make his own shoes, but buys them of the shoemaker. The shoemaker does not attempt to make his own clothes, but employs a tailor. The farmer attempts to make neither the one nor the other, but employs those different artificers. All of them find it for their interest to employ their whole industry in a way in which they have some advantage over their neighbors, and to purchase with a part of its produce, or what is the same thing, with the price of a part of it, whatever else they have occasion for. What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom.

But whatever led people to suppose that what was prudence in the conduct of every private family could be folly in that of a great kingdom? It was a whole network of fallacies, out of which mankind has still been unable to cut its way. And the chief of them was the central fallacy with which this book is concerned. It was that of considering merely the immediate effects of a tariff on special groups, and neglecting to consider its long run effects on the whole community.

—

An American manufacturer of woolen sweaters goes to Congress or to the State Department and tells the committee or officials concerned that it would be a national disaster for them to remove or reduce the tariff on British sweaters. He now sells his sweaters for $30 each, but English manufacturers could sell their sweaters of the same quality for $25. A duty of $5, therefore, is needed to keep him in business. He is not thinking of himself, of course, but of the thousand men and women he employs, and of the people to whom their spending in turn gives employment. Throw them out of work, and you create unemployment and a fall in purchasing power, which would spread in ever-widening circles. And if he can prove that he really would be forced out of business if the tariff were removed or reduced, his argument against that action is regarded by Congress as conclusive.

But the fallacy comes from looking merely at this manufacturer and his employees, or merely at the American sweater industry. It comes from noticing only the results that are immediately seen, and neglecting the results that are not seen because they are prevented from coming into existence.

The lobbyists for tariff protection are continually putting forward arguments that are not factually correct. But let us assume that the facts in this case are precisely as the sweater manufacturer has stated them. Let us assume that a tariff of $5 a sweater is necessary for him to stay in business and provide employment at sweater-making for his workers.

We have deliberately chosen the most unfavorable example of any for the removal of a tariff. We have not taken an argument for the imposition of a new tariff in order to bring a new industry into existence, but an argument for the retention of a tariff that has already brought an industry into existence, and cannot be repealed without hurting somebody.

The tariff is repealed; the manufacturer goes out of business; a thousand workers are laid off; the particular tradesmen whom they patronized are hurt. This is the immediate result that is seen. But there are also results which, while much more difficult to trace, are no less immediate and no less real. For now sweaters that formerly cost retail $30 apiece can be bought for $25. Consumers can now buy the same quality of sweater for less money, or a much better one for the same money. If they buy the same quality of sweater, they not only get the sweater, but they have $5 left over, which they would not have had under the previous conditions, to buy something else. With the $25 that they pay for the imported sweater they help employment—as the American manufacturer no doubt predicted—in the sweater industry in England. With the $5 left over they help employment in any number of other industries in the United States.

But the results do not end there. By buying English sweaters they furnish the English with dollars to buy American goods here. This, in fact (if I may here disregard such complications as fluctuating exchange rates, loans, credits, etc.) is the only way in which the British can eventually make use of these dollars. Because we have permitted the British to sell more to us, they are now able to buy more from us. They are, in fact, eventually forced to buy more from us if their dollar balances are not to remain perpetually unused. So as a result of letting in more British goods, we must export more American goods. And though fewer people are now employed in the American sweater industry, more people are employed—and much more efficiently employed—in, say, the American washing-machine or aircraft-building business. American employment on net balance has not gone down, but American and British production on net balance has gone up. Labor in each country is more fully employed in doing just those things that it does best, instead of being forced to do things that it does inefficiently or badly. Consumers in both countries are better off. They are able to buy what they want where they can get it cheapest. American consumers are better provided with sweaters, and British consumers are better provided with washing machines and aircraft.

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Now let us look at the matter the other way round, and see the effect of imposing a tariff in the first place. Suppose that there had been no tariff on foreign knit goods, that Americans were accustomed to buying foreign sweaters without duty, and that the argument were then put forward that we could bring a sweater industry into existence by imposing a duty of $5 on sweaters.

There would be nothing logically wrong with this argument so far as it went. The cost of British sweaters to the American consumer might thereby be forced so high that American manufacturers would find it profitable to enter the sweater business. But American consumers would be forced to subsidize this industry. On every American sweater they bought they would be forced in effect to pay a tax of $5 which would be collected from them in a higher price by the new sweater industry.

Americans would be employed in a sweater industry who had not previously been employed in a sweater industry. That much is true. But there would be no net addition to the country’s industry or the country’s employment. Because the American consumer had to pay $5 more for the same quality of sweater he would have just that much less left over to buy anything else. He would have to reduce his expenditures by $5 somewhere else. In order that one industry might grow or come into existence, a hundred other industries would have to shrink. In order that 50,000 persons might be employed in a woolen sweater industry, 50,000 fewer persons would be employed elsewhere.

But the new industry would be visible. The number of its employees, the capital invested in it, the market value of its product in terms of dollars, could be easily counted. The neighbors could see the sweater workers going to and from the factory every day. The results would be palpable and direct. But the shrinkage of a hundred other industries, the loss of 50,000 other jobs somewhere else, would not be so easily noticed. it would be impossible for even the cleverest statistician to know precisely what the incidence of the loss of other jobs had been—precisely how many men and women had been laid off from each particular industry, precisely how much business each particular industry had lost—because consumers had to pay more for their sweaters. For a loss spread among all the other productive activities of the country would be comparatively minute for each. It would be impossible for anyone to know precisely how each consumer would have spent his extra $5 if he had been allowed to retain it. The overwhelming majority of the people, therefore, would probably suffer from the illusion that the new industry had cost us nothing.

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It is important to notice that the new tariff on sweaters would not raise American wages. To be sure, it would enable Americans to work in the sweater industry at approximately the average level of American wages (for workers of their skill), instead of having to compete in that industry at the British level of wages. But there would be no increase of American wages in general as a result of the duty; for as we have seen, there would be no net increase in the number of jobs provided, no net increase in the demand for goods, and no increase in labor productivity. Labor productivity would, in fact, be reduced as a result of the tariff.

And this brings us to the real effect of a tariff wall. It is not merely that all its visible gains are offset by less obvious but no less real losses. It results, in fact, in a net loss to the country. For contrary to centuries of interested propaganda and disinterested confusion, the tariff reduces the American level of wages.

Let us observe more clearly how it does this. We have seen that the added amount which consumers pay for a tariff-protected article leaves them just that much less with which to buy all other articles. There is here no net gain to industry as a whole. But as a result of the artificial barrier erected against foreign goods, American labor, capital and land are deflected from what they can do more efficiently to what they do less efficiently. Therefore, as a result of the tariff wall the average productivity of American labor and capital is reduced.

If we look at it now from the consumer’s point of view, we find that he can buy less with his money. Because he has to pay more for sweaters and other protected goods, he can buy less of everything else. The general purchasing power of his income has therefore been reduced. Whether the net effect of the tariff is to lower money wages or to raise money prices will depend upon the monetary policies that are followed. But what is clear is that the tariff—though it may increase wages above what they would have been in the protected industries—must on net balance, when all occupations are considered, reduce real wages—reduce them, that is to say, compared with what they otherwise would have been.

Only minds corrupted by generations of misleading propaganda can regard this conclusion as paradoxical. What other result could we expect from a policy of deliberately using our resources of capital and manpower in less efficient ways than we know how to use them? What other result could we expect from deliberately erecting artificial obstacles to trade and transportation?

For the erection of tariff walls has the same effect as the erection of real walls. It is significant that the protectionists habitually use the language of warfare. They talk of “repelling an invasion” of foreign products. And the means they suggest in the fiscal field are like those of the battlefield. The tariff barriers that are put up to repel this invasion are like the tank traps, trenches and barbed-wire entanglements created to repel or slow down attempted invasion by a foreign army.

And just as the foreign army is compelled to employ more expensive means to surmount those obstacles—bigger tanks, mine detectors, engineer corps to cut wires, ford streams and build bridges—so more expensive and efficient transportation means must be developed to surmount tariff obstacles. On the one hand, we try to reduce the cost of transportation between England and America, or Canada and the United States, by developing faster and more efficient planes and ships, better roads and bridges, better locomotives and motor trucks. On the other hand, we offset this investment in efficient transportation by a tariff that makes it commercially even more difficult to transport goods than it was before. We make it a dollar cheaper to ship the sweaters, and then increase the tariff by two dollars to prevent the sweaters from being shipped. By reducing the freight that can be profitably carried, we reduce the value of the investment in transport efficiency.

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The tariff has been described as a means of benefiting the producer at the expense of the consumer. In a sense this is correct. Those who favor it think only of the interests of the producers immediately benefited by the particular duties involved. They forget the interests of the consumers who are immediately injured by being forced to pay these duties. But it is wrong to think of the tariff issue as if it represented a conflict between the interests of producers as a unit against those of consumers as a unit. It is true that the tariff hurts all consumers as such. It is not true that it benefits all producers as such. On the contrary, as we have just seen, it helps the protected producers at the expense of all other American producers, and particularly of those who have a comparatively large potential export market.

We can perhaps make this last point clearer by an exaggerated example. Suppose we make our tariff wall so high that it becomes absolutely prohibitive, and no imports come in from the outside world at all. Suppose, as a result of this, that the price of sweaters in America goes up only $5. Then American consumers, because they have to pay $5 more for a sweater, will spend on the average five cents less in each of a hundred other American industries. (The figures are chosen merely to illustrate a principle: there will, of course, be no such symmetrical distribution of the loss; moreover, the sweater industry itself will doubtless be hurt because of protection of still other industries. But these complications may be put aside for the moment.)

Now because foreign industries will find their market in America totally cut off, they will get no dollar exchange, and therefore they will be unable to buy any American goods at all. As a result of this, American industries will suffer in direct proportion to the percentage of their sales previously made abroad. Those that will be most injured, in the first instance, will be such industries as raw cotton producers, copper producers, makers of sewing machines, agricultural machinery, typewriters, commercial airplanes, and so on.

A higher tariff wall, which, however, is not prohibitive, will produce the same kind of results as this, but merely to a smaller degree.

The effect of a tariff, therefore, is to change the structure of American production. It changes the number of occupations, the kind of occupations, and the relative size of one industry as compared with another. It makes the industries in which we are comparatively inefficient larger, and the industries in which we are comparatively efficient smaller. Its net effect, therefore, is to reduce American efficiency, as well as to reduce efficiency in the countries with which we would otherwise have traded more largely.

In the long run, notwithstanding the mountains of argument pro and con, a tariff is irrelevant to the question of employment. (True, sudden changes in the tariff, either upward or downward, can create temporary unemployment, as they force corresponding changes in the structure of production. Such sudden changes can even cause a depression.) But a tariff is not irrelevant to the question of wages. In the long run it always reduces real wages, because it reduces efficiency, production and wealth.

Thus all the chief tariff fallacies stem from the central fallacy with which this book is concerned. They are the result of looking only at the immediate effects of a single tariff rate on one group of producers, and forgetting the long-run effects both on consumers as a whole and on all other producers.

(I hear some reader asking: “Why not solve this by giving tariff protection to all producers?” But the fallacy here is that this cannot help producers uniformly, and cannot help at all domestic producers who already “outsell” foreign producers: these efficient producers must necessarily suffer from the diversion of purchasing power brought about by the tariff.)

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On the subject of the tariff we must keep in mind one final precaution. It is the same precaution that we found necessary in examining the effects of machinery. It is useless to deny that a tariff does benefit—or at least can benefit—special interests. True, it benefits them at the expense of everyone else. But it does benefit them. If one industry alone could get protection, while its owners and workers enjoyed the benefits of free trade in everything else they bought, that industry would benefit, even on net balance. As an attempt is made to extend the tariff blessings, however, even people in the protected industries, both as producers and consumers, begin to suffer from other people’s protection, and may finally be worse off even on net balance than if neither they nor anybody else had protection.

But we should not deny, as enthusiastic free traders have so often done, the possibility of these tariff benefits to special groups. We should not pretend, for example, that a reduction of the tariff would help everybody and hurt nobody. It is true that its reduction would help the country on net balance. But somebody would be hurt. Groups previously enjoying high protection would be hurt. That in fact is one reason why it is not good to bring such protected interests into existence in the first place. But clarity and candor of thinking compel us to see and acknowledge that some industries are right when they say that a removal of the tariff on their product would throw them out of business and throw their workers (at least temporarily) out of jobs. And if their workers have developed specialized skills, they may even suffer permanently, or until they have at long last learnt equal skills. In tracing the effects of tariffs, as in tracing the effects of machinery, we should endeavor to see all the chief effects, in both the short run and the long run, on all groups.

As a postscript to this [discussion] I should add that its argument is not directed against all tariffs, including duties collected mainly for revenue, or to keep alive industries needed for war; nor is it directed against all arguments for tariffs. It is merely directed against the fallacy that a tariff on net balance “provides employment,” “raises wages,” or “protects the American standard of living.” It does none of these things; and so far as wages and the standard of living are concerned, it does the precise opposite. But an examination of duties imposed for other purposes would carry us beyond our present subject.

Nor need we here examine the effect of import quotas, exchange controls, bilateralism and other means of reducing, diverting or preventing international trade. Such devices have, in general, the same effects as high or prohibitive tariffs, and often worse effects. They present more complicated issues, but their net results can be traced through the same kind of reasoning that we have just applied to tariff barriers.

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