A High School Economics Guide

Supplementary resources for high school students

Definitions and Basics

A barrier to trade is a government-imposed restraint on the flow of international goods or services.

The most common barrier to trade is a tariff—a tax on imports. Tariffs raise the price of imported goods relative to domestic goods (goods produced at home).

Another common barrier to trade is a government subsidy to a particular domestic industry. Subsidies make those goods cheaper to produce than in foreign markets. This results in a lower domestic price. Both tariffs and subsidies raise the price of foreign goods relative to domestic goods, which reduces imports.

Yet another barrier to trade is an embargo—a blockade or political agreement that limits a foreign country’s ability to export or import.

Barriers to trade are often called “protection” because their stated purpose is to shield or advance particular industries or segments of an economy. From an economic perspective, though, the costs to the economy almost always outweigh the benefits enjoyed by those who are protected.

Protectionism, from the Concise Encyclopedia of Economics

The fact that trade protection hurts the economy of the country that imposes it is one of the oldest but still most startling insights economics has to offer. The idea dates back to the origin of economic science itself….

Free Trade, from the Concise Encyclopedia of Economics

For more than two centuries, economists have steadfastly promoted free trade among nations as the best trade policy. Despite this intellectual barrage, many practical men and women of affairs continue to view the case for free trade skeptically, as an abstract argument made by ivory-tower economists with, at most, one foot on terra firma. Such people “know” that our vital industries must be protected from foreign competition….

In the News and Examples

If economists are so convinced of the benefits of free trade, why are there so many arguments against it in the press?

Many fallacies and myths have persisted for centuries, tracing back to an old idea called Mercantilism, which advocated promoting exports over imports (a positive Trade Balance). Even though Adam Smith, founder of modern economics, turned mercantilism on its head in 1776 with the publication of The Wealth of Nations, the errors continue. Below are some light, humorous readings confronting just a few of the most common logical errors, emphasizing how to answer when you hear those mistakes being made.

Popular myth: Trade barriers are good for the economy. Economic reality: Trade barriers benefit some people—usually the producers of the protected good—but only at even greater expense of others—the consumers. See this satire on lobbying: “A Petition”, by Frédéric Bastiat (pronounced bas-tee-AH). Chapter 7 in Economic Sophisms, first published 1845 in France.

From the Manufacturers of Candles, Tapers, Lanterns, Candlesticks, Street Lamps,….

To the Honorable Members of the Chamber of Deputies….

You are on the right track. You reject abstract theories and have little regard for abundance and low prices. You concern yourselves mainly with the fate of the producer. You wish to free him from foreign competition, that is, to reserve the domestic market for domestic industry….

We are suffering from the ruinous competition of a foreign rival who apparently works under conditions so far superior to our own for the production of light that he is flooding the domestic market with it at an incredibly low price; for the moment he appears, our sales cease, all the consumers turn to him, and a branch of French industry whose ramifications are innumerable is all at once reduced to complete stagnation. This rival, which is none other than the sun,…

Reciprocity. Popular myth: If we remove a trade barrier, shouldn’t we require our trade partners to reduce theirs? Economic reality: Unilateral reduction of trade barriers is better than no reduction at all. See Reciprocity, by Frédéric Bastiat. Chapter 10 in Economic Sophisms, first published 1845 in France. See also, “Commercial Reprisals are a Mistake,” by Pedro Schwartz.

There are people (a small number, it is true, but there are some) who are beginning to understand that obstacles are no less obstacles for being artificial, and that we have more to gain from free trade than from a policy of protectionism, for precisely the same reason that a canal is more favorable to traffic than a “hilly, sandy, difficult road.”

But, they say, free trade must be reciprocal. If we lowered the barriers we have erected against the admission of Spanish goods, and if the Spaniards did not lower the barriers they have erected against the admission of ours, we should be victimized. Let us therefore make commercial treaties on the basis of exact reciprocity; let us make concessions in return for concessions; let us make the sacrifice of buying in order to obtain the advantage of selling….

Saving and investment: Popular myth: If we keep running a trade deficit, won’t we run down our economy, eating into our savings by continuing to buy more than we sell? Economic reality: Those who buy those foreign goods are not fools—they are searching world markets for the best deals. See also

Importing is the same as buying something—it just happens to be from a foreigner. (Similarly, exporting is the same as selling—it just happens to be to a foreigner.) Some things that are bought are used for current consumption; and other purchased things are used for investment.

If the citizens of the country running the trade deficit truly squander all the imports, or solely use them for current consumption year after year, then yes, the economy would be run down. To pay for the expenditures, capital—that is, saving and investment—would ultimately have to be eaten into, reducing future opportunities. But no one has an incentive to behave that way. Plus, the trade deficit is merely the symptom, not the cause of such spendthrift behavior; and reducing the trade deficit will not address the underlying problem.

Historically, persistent trade deficits have in fact been associated with the periods of greatest economic investment and development. (U.S. example: the development of the railroads. The Marshall plan rebuilt Europe, but meant massive trade deficits for Europe during that time.) Individuals have budget constraints and ultimately know that they cannot spend without paying for their purchases now or working harder or saving to pay in the future. Businesses buy investment goods wherever they can get them cheapest in the world, paying dollars in return. The government borrows to finance its spending wherever it can do so most cheaply in the world. For the most part, citizens make these decisions somewhat intelligently because they have incentives to do so. And in the long run, when those dollars we spend abroad are spent back by foreigners to buy our goods, trade will balance out anyway.

The fundamental principle is that people trade because trade benefits both parties. Apart from location, international trade is economically the same as domestic (within-country) exchange.

Exports, imports, and the trade balance. The term “trade deficit” has a negative connotation, but this can be misleading, like saying, “We’re getting killed on trade.” See “The ‘Trade Deficit’: Defective Language, Deficient Thinking,” by Daniel B. Klein and Donald J. Boudreaux.

Notice that if imports exceed exports, as they have done for decades in the United States, then, on net, more dollars leave the United States by Americans’ purchases of imports than come in by Americans’ sales of exports. Such a situation is termed a current-account deficit, or “trade deficit.” But the terminology could just as well be formulated the other way around, in a framework of husbanding stuff. Then, under the same condition of imports exceeding exports, the focus is on the stuff that, on net, is flowing into the United States. Now we view the exact same world but see a surplus. Instead of looking at matters as the conventional language does, we might call this new view the in-kind account. What in the conventional view is a “trade deficit” is in the in-kind view an “in-kind surplus.”

Jobs. Popular myth: Protectionism saves jobs. See Free Trade, by Alan S. Blinder.

A slogan occasionally seen on bumper stickers argues, “Buy American, save your job.” This is grossly misleading for two main reasons. First, the costs of saving jobs in this particular way are enormous. Second, it is doubtful that any jobs are actually saved in the long run….

Many estimates have been made of the cost of “saving jobs” by protectionism. While the estimates differ widely across industries, they are almost always much larger than the wages of the protected workers….

But the situation is actually worse, for a little deeper thought leads us to question whether any jobs are really saved overall. It is more likely that protectionist policies save some jobs by jeopardizing others. Why? First, protecting one American industry imposes higher costs on others. For example, quotas on imports of semiconductors sent the prices of memory chips skyrocketing in the eighties, thereby damaging the computer industry. Steel quotas force U.S. automakers to pay more for materials, making them less competitive….

Aren’t there any arguments left in favor of barriers to trade and protectionism? Don’t exports create jobs? What about the painful relocations and retraining when whole industries lose their comparative advantage? What about new businesses—don’t infant industries and startups deserve a chance to compete in world markets? What about agriculture? oil?—don’t we have to have domestic farm and domestic oil industries so we can be self-sufficient in the event of war? Shouldn’t we support industries that are vital to national defense? What about government revenue—won’t reducing tariffs reduce government revenue and increase the budget deficit? What about market failures—don’t government subsidies sometimes correct for market failures, perhaps making the loss of the benefits from importing worth the cost?

Of these arguments, only the last one holds up, and even then, only in very specific circumstances. The conclusion is that most arguments in favor of trade barriers cannot be supported on economic grounds because the costs inevitably outweigh the benefits. Other, non-economic, grounds (political, emotional, etc.) have to be involved if you want to argue against free trade.

Does National Security Justify Tariffs? by Jon Murphy at Econlib.

The concern about relying on foreign sources of war materials is that they could be unreliable or disrupted. In a world of shifting alliances, geographical concerns, and logistical issues, as in the 18th century Britain of Adam Smith, this fear might be justified. However, in 21st century America, it is less plausible.

National defense is often stated as a justified exception to a policy of free trade, and it may well be the most reasonable exception. Indeed, national defense is vital to economic prosperity. However, it is a plausible exception, not necessarily a probable one. Many of the tariff arguments presented under the “national defense” guise are flimsy. Given the negative impact of tariffs on wealth, when they are proposed, even under the national defense justification, they should be carefully examined to see if there is a true national defense issue or if domestic firms are merely justifying tariffs for protection from competition.

 

Do international trade agreements serve to reduce barriers to trade? It depends. See Free Trade and TPP, by Pierre Lemieux at Econlib.

Trade agreements between national governments, however, are not really free trade, but managed trade. Free international trade doesn’t require complex treaties any more than trade between California and Maine does; what is needed is no anti-trade ban or regulation. A national government could simply declare unilateral free trade—that is, allow its citizens to import at will—and this would achieve many, if not most, of the benefits of multilateral free trade Other countries, after exporting, would have to import or use their foreign currencies to invest in the countries to which they exported: otherwise, what would they do with the foreign currencies they have gained.

 

A Little History: Primary Sources and References

A Brief History of International Trade Policy, by Douglas A. Irwin on Econlib

The theory of international trade and commercial policy is one of the oldest branches of economic thought. From the ancient Greeks to the present, government officials, intellectuals, and economists have pondered the determinants of trade between countries, have asked whether trade bring benefits or harms the nation, and, more importantly, have tried to determine what trade policy is best for any particular country….

Has there ever been a period in history characterized by free trade? Briefly. The repeal of the Corn Laws in the United Kingdom sparked such a brief era, which lasted only a few decades. See Unilateral Commercial Disarmament, by Pedro Schwartz on Econlib.

One of the causes of the political resistance to unilateral free trade is the general presentation of international trade theory in terms of advantage and disadvantage and then insensibly formulated in terms of national power. The ‘Wealth of Nations’ became ‘The Wealth of States’. Bismarck’s move and those of his rivals and imitators was a symptom of the illness that affected Western politics in the years leading to World War I: to wit, putting the productive capacity of capitalism at the service of nationalism, imperialism, and welfarism.

The Balance of Trade, by Frederic Bastiat. Selected Essays on Political Economy, originally published in 1845.

The Myth of Free-Trade Britain, by John V.C. Nye on Econlib

In the two and a half centuries since Adam Smith first articulated the basic case for free trade, no event has been more significant than the British conversion to open markets in the nineteenth century. In the fable that is now conventional wisdom, nineteenth century Britain turned its back on protection and chose to open its markets to the world….

Did the Smoot-Hawley tariff contribute to the Great Depression? Great Depression, from the Concise Encyclopedia of Economics. See also Rustici on Smoot-Hawley and the Great Depression at EconTalk.

In contrast, economist Charles Kindleberger, in The World in Depression, 1929-1939, sees the depression as a global event caused by a lack of world economic leadership. According to Kindleberger, Britain provided leadership before World War I. It fostered global trade by keeping its markets open, promoted expansion by making overseas investments, and prevented financial crises with emergency loans. After World War II the United States played this role. But between the wars no country did, and the depression fed on itself, Kindleberger argues. No country did enough to halt banking crises, and the entire industrial world adopted protectionist measures in attempts to curtail imports. In 1930, for example, President Herbert Hoover signed the Smoot-Hawley tariff, raising tariffs on dutiable items by 52 percent. The protectionism put an extra brake on world trade just when countries should have been promoting it….

Of Restraints upon the Importation from Foreign Countries of such Goods as can be Produced at Home, by Adam Smith. Book IV, Chapter 2 in the Wealth of Nations

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 taylor 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 taylor. 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 neighbours, 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…. [par. IV.2.11]

 

 

Advanced Resources

Some Aspects of the Tariff Question, by Frank Taussig on Econlib

[Influential study of the infant-industry argument—the idea that a fledgling industry might warrant protection till it gets started. Taussig started off believing in the idea but by the end of his research concluded that the argument was deeply flawed on both logical and empirical grounds. (Historical sidenote: Frank Taussig’s daughter, Helen, is known as the founder of pediatric cardiology for her contributions to solving the mystery of “blue baby” syndrome.)]

Protectionism and the labor market. Protection or Free Trade, by Henry George on Econlib. Particularly see Chapter XXII, The Real Strength of Protection.

One needs but to talk with the rank and file of the supporters of protection in such a way as to discover their thoughts rather than their arguments, to see that beneath all the reasons assigned for protection there is something which gives it vitality, no matter how clearly those reasons may be disproved.

The truth is, that the fallacies of protection draw their real strength from a great fact, which is to them as the earth was to the fabled Antæus, so that they are beaten down only to spring up again. This fact is one which neither side in the controversy endeavors to explain—which free traders quietly ignore and protectionists quietly utilize; but which is of all social facts most obvious and important to the working classes—the fact that as soon, at least, as a certain stage of social development is reached, there are more laborers seeking employment than can find it—a surplus which at recurring periods of industrial depression becomes very large. Thus the opportunity of work comes to be regarded as a privilege, and work itself to be deemed in common thought a good….

Free Trade and Other Fundamental Doctrines of the Manchester School. Francis Hirst, editor.

A Lecture on Free Trade: In Connexion with the Corn Laws by Thomas Hodgskin, on Econlib.

Related Topics

Benefits of Trade and Comparative Advantage

Trade, Exchange, and Interdependence

Balance of Trade and Balance of Payments

Roles of Government

Consumers

Government Failures and Public Choice Analysis