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Comparative Advantage/Free Trade (Vol. 54)

Updated: Feb 7, 2023

analyticsbox | Jun 01, 2022


Free Trade Handhsake

Tariffs and Quotas are Bad Economic Policy

Last week we discussed Comparative Advantage and what that means. To summarize, it is the simple notion that individual countries or businesses may be the most efficient producers of a given good or service - they have a Comparative Advantage.

Why does this matter? It matters because the world and every country is better off buying from the most efficient producer. And the most efficient way for international trade to be conducted is freely trading among countries with no quotas.

Tariffs and quotas are usually a result of trying to protect some industry from foreign competition to ‘save jobs’ or trying to reduce a deficit in the balance of trade. This has a negative effect on international trade and drives up the cost to consumers by making the products more expensive. Tariffs are simply a tax collected by the government and paid for by consumers, not the sellers or the importers. The net result is that a small number of companies get an unearned advantage at the expense of all of the users of the product. This is an inflationary tax by another name.

When we import goods from other countries, they are able to then buy some of our goods. Or invest the funds here that they received from us in other ways. There may be a deficit in the balance of trade, but economically that is a good thing. It frees up resources here to be used where we are more efficient. And we are getting goods cheaper as a result of this, which has actually been a key factor in holding down inflation here as we buy cheaper products from other countries.

And the ‘jobs saved’ are usually offset by ’jobs lost’ in other industries as they will not be able to buy from us with the money they got by selling to us. We need to remember that a lot of our imports are for businesses. They are the pieces and parts that go into making or finishing goods sold to consumers. So any increase in the cost of imports also very likely raises the costs for American businesses making it harder for them to hire workers and sell their goods.

A prime example of tariffs gone wrong was when we passed the Smoot-Hawley tariff in 1930. This raised tariffs on thousands of products up to 52%. This harmed U.S. production and employment. And, on top of that, other countries reciprocated and international trade plunged , and everyone was worse off as a result. This was a major contributor to the Great Depression of the 30's.

BUT, there is a risk. When we are no longer able to produce certain goods in adequate quantities, we become reliant on others for these items. That is ok until it is not ok. What happens when international relations cause a disruption, as we are experiencing now with some countries. Some trading partners may not be our friends and if problems occur and trade stops, both countries have a problem and are harmed. That is a risk when we become dependent on foreign sources especially for critical commodities.

BOTTOM LINE

Generally tariffs and quotas are harmful to an economy, as they reduce total output and hurt consumers. They benefit few at a cost to many. Free trade among countries is the best way to expand economic output and the standard of living for all.

However, this must be tempered with security issues for critical items. This means there are tradeoffs that must be made to get the right balance.

LEARN ECONOMICS, THEN VOTE SMART.

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