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{733}—at the same time when jobs were increasing by the millions in the United States.{734} Both countries saw an increase in their international trade, with especially sharp increases in those goods covered by NAFTA.{735}
The basic facts about international trade are not difficult to understand. What is difficult to untangle are all the misconceptions and jargon which so often clutter up the discussion. The great U.S. Supreme Court Justice Oliver Wendell Holmes said, “we need to think things instead of words.”{736} Nowhere is that more important than when discussing international trade, where there are so many misleading and emotional words used to describe and confuse things that are not very difficult to understand in themselves.
For example, the terminology used to describe an export surplus as a “favorable” balance of trade and an import surplus as an “unfavorable” balance of trade goes back for centuries. At one time, it was widely believed that importing more than was exported impoverished a nation because the difference between imports and exports had to be paid in gold, and the loss of gold was seen as a loss of national wealth. However, as early as 1776, Adam Smith’s classic The Wealth of Nations argued that the real wealth of a nation consists of its goods and services, not its gold supply.
Too many people have yet to grasp the full implications of that, even in the twenty-first century. If the goods and services available to the American people are greater as a result of international trade, then Americans are wealthier, not poorer, regardless of whether there is a “deficit” or a “surplus” in the international balance of trade.
Incidentally, during the Great Depression of the 1930s, the United States had an export surplus—a “favorable” balance of trade—in every year of that disastrous decade.{737} But what may be more relevant is that both imports and exports were sharply lower than they had been during the prosperous decade of the 1920s. This reduction in international trade was a result of rising tariff barriers in countries around the world, as nations attempted to save jobs in their own domestic economies, during a period of widespread unemployment, by keeping out international trade.
Such policies have been regarded by many economists as needlessly worsening and prolonging the worldwide depression. The last thing needed when real national income is going down is a policy that makes it go down faster, by denying consumers the benefits of being able to buy what they want at the lowest price available.
Slippery words can make bad news look like good news and vice versa. For example, the much-lamented international trade deficit of the United States narrowed by a record-breaking amount in the spring of 2001, as BusinessWeek magazine reported under the headline: “A Shrinking Trade Gap Looks Good Stateside.”{738} However, this happened while the stock market was falling, unemployment was rising, corporate profits were down, and the total output of the American economy declined. The supposedly “good” news on international trade was due to reduced imports during shaky economic times. Had the country gone into a deep depression, the international trade balance might have disappeared completely, but fortunately Americans were spared that much “good” news.
Just as the United States had a “favorable” balance of trade in every year of the Great Depression of the 1930s, it became a record-breaking “debtor nation” during the booming prosperity of the 1990s. Obviously, such words cannot be taken at face value as indicators of the economic well-being of a country. We will need to examine more closely what such words mean in context.
THE BASIS FOR INTERNATIONAL TRADE
While international trade takes place for the same reason that other trades take place—because both sides gain—it is necessary to understand just why both countries gain, especially since there are so many politicians and journalists who muddy the waters with claims to the contrary.
The reasons why countries gain from international trade are usually grouped together by economists under three categories: absolute advantage, comparative advantage, and economies of scale.
Absolute Advantage
It is obvious why Americans buy bananas grown in the Caribbean. Bananas can be grown much more cheaply in the tropics than in places where greenhouses and other artificial means of maintaining warmth would be necessary. In tropical countries, nature provides free the warmth that people have to provide by costly means in cooler climates, such as that of the United States. Therefore it pays Americans to buy bananas grown in the tropics, rather than grow them at higher costs within the United States.
Sometimes the advantages that one country has over another, or over the rest of the world, are extreme. Growing coffee, for example, requires a peculiar combination of climatic conditions—warm but not too hot, nor with sunlight beating down on the plants directly all day, nor with too much moisture or too little moisture, and in some kinds of soils but not others. Putting together these and other requirements for ideal coffee-growing conditions drastically reduces the number of places that are best suited for producing coffee.
In the early twenty-first century, more than half the coffee in the entire world was grown in just three countries—Brazil, Vietnam, and Colombia. This does not mean that other countries were completely incapable of growing coffee. It is just that the amount and quality of coffee that most countries could produce would not be worth the resources it would cost, when coffee can be bought from these three countries at a lower cost.
Sometimes an absolute advantage consists simply of being located in the right place or speaking the right language. In India, for example, the time is about 12 hours different from the time in the United States, which means that an American company which wants round-the-clock computer services can engage a computer company in India to have Indian technicians available when it is night in the United States and day in India. Since many educated people in India speak English and India has 30 percent of all the computer software engineers in the world, {739}this combination of circumstances gives India a large advantage in competing for computer services in the American market. Similarly, South American countries supply fruits and vegetables to North American countries when it is winter in the northern hemisphere and summer in the southern hemisphere.
These are all examples of what economists call “absolute advantage”—one country, for any of a number of reasons, can produce some things cheaper or better than another. Those reasons may be due to climate, geography, or the mixture of skills in their respective populations. Foreigners who buy that country’s products benefit from the lower costs, while the country itself obviously benefits from the larger market for its products or services, and sometimes from the fact that part of the inputs needed to create the product are free, such as warmth in the tropics or rich nutrients in the soil in various places around the world.
There is another more subtle, but at least equally important, reason for international trade. This is what economists call “comparative advantage.”
Comparative Advantage
To illustrate what is meant by comparative advantage, suppose that one country is so efficient that it is capable of producing anything more cheaply than a neighboring country. Is there any benefit that the more efficient country can gain from trading with its neighbor?
Yes.
Why? Because being able to produce anything more cheaply is not the same as being able to produce everything more cheaply. When there are scarce resources which have alternative uses, producing more of one product means producing less of some other product. The question is not simply how much it costs, in either money or resources, to produce chairs or television sets in one country, compared to another country, but how many chairs it costs to produce a television set, when resources are shifted from producing one product to producing the other.
If that trade-off is different between two countries, then the c
ountry that can get more television sets by foregoing the production of chairs can benefit from trading with the country that gets more chairs by not producing television sets. A numerical example can illustrate this point.
Assume that an average American worker produces 500 chairs a month, while an average Canadian worker produces 450, and that an American worker can produce 200 television sets a month while a Canadian worker produces 100. The following tables illustrate what the output would be under these conditions if both countries produced both products versus each country producing only one of these products. In both tables we assume the same respective outputs per worker and the same total number of workers—500—devoted to producing these products in each country:
With both countries producing both products, under the conditions specified, their combined output would come to a grand total of 190,000 chairs and 90,000 television sets per month from a grand total of a thousand workers.
What if the two countries specialize, with the United States putting all its chair-producing workers into the production of television sets instead, and Canada doing the reverse? Then with the very same output per worker as before in each country, they can now produce a larger grand total of the two products from the same thousand workers:
Without any change in the productivity of workers in either country, the total output is now greater from the same number of workers, that output now being 100,000 television sets instead of 90,000 and 225,000 chairs instead of 190,000. That is because each country now produces where it has a comparative advantage, whether or not it has an absolute advantage.
Economists would say that the United States has an “absolute advantage” in producing both products but that Canada has a “comparative advantage” in producing chairs. That is, Canada sacrifices fewer television sets by shifting resources to the production of chairs than the United States would by such a shift. Under these conditions, Americans can get more chairs by producing television sets and trading them with Canadians for chairs, instead of by producing their own chairs directly. Conversely, Canadians can get more television sets by producing chairs and trading them for American-made television sets, rather than producing television sets themselves.
Only if the United States produced everything more efficiently than Canada by the same percentage for each product would there be no gain from trade because there would then be no comparative advantage. Such a situation is virtually impossible to find in the real world.
Similar principles apply on a personal level in everyday life. Imagine, for example, that you are an eye surgeon and that you paid your way through college by washing cars. Now that you have a car of your own, should you wash it yourself or should you hire someone else to wash it—even if your previous experience allows you to do the job in less time than the person you hire? Obviously, it makes no sense to you financially, or to society in terms of over-all well-being, for you to be spending your time sudsing down an automobile instead of being in an operating room saving someone’s eyesight. In other words, even though you have an “absolute advantage” in both activities, your comparative advantage in treating eye diseases is far greater.
The key to understanding both individual examples and examples from international trade is the basic economic reality of scarcity. The surgeon has only 24 hours in the day, like everyone else. Time that he is spending doing one thing is time taken away from doing something else. The same is true of countries, which do not have an unlimited amount of labor, time, or other resources, and so must do one thing at the cost of not doing something else. That is the very meaning of economic costs—foregone alternatives, which apply whether the particular economy is capitalist, socialist, feudal, or whatever—and whether the transactions are domestic or international.
The benefits of comparative advantage are particularly important to poorer countries. Someone put it this way:
Comparative advantage means there is a place under the free-trade sun for every nation, no matter how poor, because people of every nation can produce some products relatively more efficiently than they produce other products.{740}
Comparative advantage is not just a theory but a very important fact in the history of many nations. It has been more than a century since Great Britain produced enough food to feed its people. Britons have been able to get enough to eat only because the country has concentrated its efforts on producing those things in which it has had a comparative advantage, such as manufacturing, shipping, and financial services—and using the proceeds to buy food from other countries. British consumers ended up better fed and with more manufactured goods than if the country grew enough of its own food to feed itself.
Since the real costs of anything that is produced are the other things that could have been produced with the same efforts, it would cost the British too much industry and commerce to transfer enough resources into agriculture to become self-sufficient in food. They are better off getting food from some other country whose comparative advantage is in agriculture, even if that other country’s farmers are not as efficient as British farmers.
Such a trade-off is not limited to industrialized nations. When cocoa began to be grown on farms in West Africa, which ultimately produced over half of the world’s supply, African farmers reduced the amount of food they grew, in order to earn more money by planting cocoa trees on their lands, instead of food crops. As a result, their increased earnings enabled them to live off food produced elsewhere. This food included not only meat and vegetables grown in the region, but also imported rice and canned fish and fruit, the latter items being considered to be luxuries at the time.{741}
Economies of Scale
While absolute advantage and comparative advantage are the key reasons for benefits from international trade, they are not the only reasons. Sometimes a particular product requires such huge investment in machinery, in the engineering required to create the machinery and the product, as well as in developing a specialized labor force, that the resulting output can be sold at a low enough price to be competitive only when some enormous amount of output is produced, because of economies of scale, as discussed in Chapter 6.
It has been estimated that the minimum output of automobiles needed to achieve an efficient cost per car is somewhere between 200,000 and 400,000 automobiles per year.{742} Producing in such huge quantities is not a serious problem in a country of the size and wealth of the United States, where each of the big three domestic automakers—Ford, General Motors, and Chrysler—has had at least one vehicle with sales of more than 400,000, as did Toyota, while the Ford F-Series pickup truck has had more than 800,000 annual sales.{743} But, in a country with a much smaller population—Australia, for example—there is no way to sell enough cars within the country to be able to cover the high costs of developing automobiles from scratch to sell at prices low enough to compete with automobiles produced in much larger quantities in the United States or Japan.
The largest number of cars of any given make sold in Australia is only about half of the quantity needed to reap all the cost benefits of economies of scale.{744} While the number of automobiles owned per capita is higher in Australia than in the United States, there are more than a dozen times as many Americans as there are Australians.{745}
Even those cars which have been manufactured in Australia have been developed in other countries—Toyotas and Mitsubishis from Japan, and Ford and General Motors cars from the United States. They are essentially Australian-built Japanese or American cars, which means that companies in Japan and the United States have already paid the huge engineering, research, and other costs of creating these vehicles. But the Australian market is not large enough to achieve sufficient economies of scale to produce original Australian automobiles from scratch at a cost that would enable them to compete in the market with imported cars.
Although Australia is a modern prosperous country, with output per person higher than that of Great Britain, Canada or the United States, its small population limits its total pu
rchasing power to one-fifth that of Japan and one-seventeenth that of the United States.{746}
Exports enable some countries to achieve economies of scale that would not be possible from domestic sales alone. Some business enterprises make most of their sales outside their respective countries’ borders. For example, Heineken does not have to depend on the small Holland market for its beer sales, since it sells beer in 170 other countries. Nokia sells its phones around the world, not just in its native Finland. The distinguished British magazine The Economist sells three times as many copies in the United States as in Britain.{747} Toyota, Honda, and Nissan all earn most of their profits in North America, {748}and Japanese automakers as a whole began in 2006 to manufacture more cars outside of Japan than in Japan itself.{749} Small countries like South Korea and Taiwan depend on international trade to be able to produce many products on a scale far exceeding what can be sold domestically.
In short, international trade is necessary for many countries to achieve economies of scale that will enable them to sell at prices that can compete with the prices of similar products in the world market. For some products requiring huge investments in machinery and research, only a very few large and prosperous countries could reach the levels of output needed to repay all these costs from domestic sales alone. International trade creates greater efficiency by allowing more economies of scale around the world, even in countries whose domestic markets are not large enough to absorb all the output of mass production industries, as well as by taking advantage of each country’s absolute or comparative advantages.
As in other cases, we can sometimes understand the benefits of a particular way of doing things by seeing what happens when they are done differently. For many years, India encouraged small businesses and maintained barriers against imports that could compete with them. However, the lifting of import restrictions at the end of the twentieth century and the beginning of the twenty-first century changed all that. As the Far Eastern Economic Review put it: