Episode 35: Why do countries restrict trade?

In Episode 34, we saw that the practice of
free trade according to comparative advantage results in lower buying prices, higher selling
prices, and greater global production, all of which means improved living standards.
Do you know how many countries in the world are engaged in trade? Every single one — there’s
not one country in the world that’s completely self-reliant. And do you know how many countries
around the world practice completely free trade? None. Not one single country practices
trade free of any restrictions. So if free trade is so fabulous, then why do all countries
put restrictions in place? Perhaps it’s best to take one step backwards
and ask: who has the power to put trade restrictions in place? That would be each country’s government.
Why would the government put such restrictions in place? The government places trade restrictions
in order to protect domestic industries from foreign competitors. Now ask yourself this:
which domestic producers would seek such protection? Surely not all of them; some domestic producers
already have a natural advantage in production over the foreign competitors. This is the
key; the only domestic producers who would need protection are those who would be driven
out of business under free trade — those who have a comparative disadvantage in production.
So what arguments could the weak, disadvantaged producers make to the government to convince
it to provide protection in the form of trade restrictions? Well, there are several. First, there’s the domestic jobs argument:
if some type of trade restriction, say a tax or a quota, is placed on incoming foreign
goods, then consumers will have to purchase domestic goods instead, right? And if the
demand for domestic goods is higher, then the need for workers to produce those goods
is higher. Look at the US steel industry: with protections in place, more US steel is
purchased, and more US steel workers have jobs. The domestic jobs argument is pretty
persuasive with politicians, because voters with jobs are happy voters. Here’s the rub,
though; while trade barriers mean more jobs in the protected industry, they actually cost
jobs in other industries. Think again about the US steel industry: historically, taxes
(called tariffs), have been imposed on imported steel, so the US producers don’t have to compete
at such a low price. But this means that steel will cost more to consumer. Who buys steel?
The auto industry, perhaps? Construction firms? Steel drum manufacturers? Any industry that
uses steel is a resource will face rising costs, which will lead to decreased supply,
which means fewer jobs in all of those industries. So while steelworkers may have more jobs,
workers and all the downstream industries, like auto workers and construction workers,
will lose jobs. On net, especially in a country like the United States where disadvantaged
areas tend to be oh, raw materials are low-end materials, this will result in a net loss
of jobs. Argument for production number two: level
playing field. The logic here is that the foreign producer has some unfair advantage
over the domestic producer, and the trade restriction would just… even things up a
bit. An unfair advantage might be if, say, the foreign producer was receiving subsidies
from its own government, such that costs were reduced, and the foreign producer’s product
could be sold very cheaply in our market. But what happens if the foreign producer just
has an advantage — are all advantages unfair? In 1997, the collapse of the Thai baht kicked
off a wholesale financial collapse in Southeast Asia. As Asian currencies lost most of their
value, becoming very cheap, Asian products became cheap. Suddenly US steel producers
were facing extremely cheap Asian steel, and went to the US government to seek protection.
The question I have is this: did the Asian producers have an unfair advantage? Did they
deliberately plan for their currencies to lose over 90% of their value, just so they
could sell more steel? The term “fair” is a slippery thing, somewhat subject to interpretation.
The other difficulty here is that one country may dispute the “fairness” of another’s
restrictions, and retaliate with restrictions of its own, eventually escalating into a trade
war. A third argument for trade restrictions is
that they can raise additional revenue for the domestic government. A tariff (or a tax
on imported goods) would generate added dollars, as would revenue from the sale of quota licenses.
But in a country like the US, where only a very small percentage of government revenue
comes from traded goods (remember we saw in the budget episode about 90% of federal revenues
come from income tax, payroll tax and corporate tax), does it makes sense to harm consumers
by making imported goods more expensive? The government revenue argument is likely to be
more compelling for governments of poor nations, where there isn’t much income to tax; the
only place to squeeze additional revenue is from businesses, especially internationally. A fourth argument used in favor of trade restrictions
is the national defense argument. If an industry is critical to the national defense, we should
protect it in peacetime to make sure that it’s still around in times of war. Some industries
may spring to mind immediately as being critical to the national defense: tanks, guns, munitions,
aircraft, shipbuilding… but then, what about the metal used in all of these industries?
Shouldn’t that be protected? What about our food supply, or uniforms for our troops? Or
the producers who make buttons for the uniforms? You can see where this is headed — it becomes
difficult to draw a hard and fast line separating industries that are critical to the national
defense from those that are not. This becomes compounded when you realize that in recent
years, the argument has been broadened from “critical to the national defense” to
“critical to the national interest.” For example, some countries have restricted the
amount of US entertainment and publications, like movies and magazines, that are allowed
in, because they feel it would not be in their country’s national interest to allow their
own cultural identities to be swallowed up by US pop culture. The infant industry argument is number five
on our list; this says we should protect and support new industries until they’re mature
enough to compete on their own. I can understand this; in the town where I grew up there was
an economic incubator. If you had an idea for new business, you could put in a proposal.
If you were successful, you’d start up your business in the incubator building, enjoying
lower rent and immediate access to business consultants. After a designated period of
time, your business would move out and someone else would move in. Here’s the drawback with
federal support for a new industry: who is in the best position to know when the industry
is ready to “leave the nest”? The industry is. So if the government goes to the industry
and says, “Hey, you ready yet? Can we take the restrictions away?”, what’s industry
going to say? “Sure, go ahead”? More likely the response would be, “No, not yet. Ask
us again a couple of years.” In the past, some countries would protect these “infant”
industries for decades. In the US, at least, the international Trade Commission (or ITC)
places time limits on protection, and usually weans the industry off by progressively decreasing
the level of restrictions over that time period. There is one more method that goes against
the natural flow of free trade, but it’s less about protecting a weak domestic producer
from foreign competition than it is about giving your domestic producer an artificial
boost into other countries’ markets by subsidizing them, so they can take over market share abroad.
This method of creating international dominance is, of course, squarely in the arena of “unfair
advantage” (see argument number two), and is really an open invitation for other countries
to retaliate against you with restrictions of their own. In this episode I went over many reasons why
government might agree to protect the economic interests of its domestic producers, even
though they have comparative disadvantage in production. Next time, I’ll show you in
more detail how the government can protect domestic producers by using tariffs, quotas,
voluntary export restraints, or nontariff barriers to trade. NEXT TIME: Types of trade restrictions

62 Replies to “Episode 35: Why do countries restrict trade?”

  1. Thank you for posting this! Your voice is really clear and your drawings are really helpful visual aids. I understand macro so much clearer with these videos.

  2. It's true that I sometimes skip around while making these, but did you watch episode 34, comparative advantage & trade? It's about the gains from trading freely according to one's comparative advantage.

  3. this vidoe knows very little putting resetictionns on other countrys goods requires buyers to buy there countrys goods to keep jobs

  4. @Houshalter I suppose I can't argue about Somalia without data, but to my knowledge (based on info such as the Index of Economic Freedom), Hong Kong & Singapore are the closest thing to free markets. I try to stay away from discussions about morality – it's very slippery ground.

  5. @Houshalter Hmm. You aren't actually a trained economist, are you? We fastidiously avoid terms like "better," and "moral grounds," and tend more toward "net balance of costs and benefits . . ."

  6. @Houshalter I'm not disagreeing – just saying that most economists have that way of thinking beaten out of them! That's why law schools love students who've majored in Econ.

  7. Lets apply this logic to the global labor markets. North Americans presently enjoy artificially high wages within a consumer driven economy. If foreign workers, with less consumption habits and lower lifestyle expectations can out-compete North american workers, then they would have a comparative advantage. North American industries could open branch plants off-shore to reap this comparative advantage. In fact, maintaining income disparity could prove quite profitable.to multinational industries

  8. @mjmfoodie i think you are a genius,,, im not an economist, not even close to be that, but watching your video i realised something, im from argentina, where government subsidize many manufacturers so that they will be more competitive overseas, and everyone is happy because they do better, but, doesnt that mean that argentineans are paying part of the product's costs? to be more clear, my country is giving away my money to foreigners? maybe im wrong i would love to know what you think 😀

  9. @mjmfoodie i think you are a genius,,, im not an economist, not even close to be that, but watching your video i realised something, im from argentina, where government subsidize many manufacturers so that they will be more competitive overseas, and everyone is happy because they do better, but, doesnt that mean that argentineans are paying part of the product's costs? to be more clear, my country is giving away my money to foreigners? maybe im wrong i would love to know what you think 😀

  10. @guilletuck Sounds like the Argentinean taxpayers pay, to the benefit of the Argentinean producers, cheap prices for foreign consumers (as long as THEIR governments don't retaliate with extra taxes on imports), and to the detriment of foreign producers.

  11. This video has further solidified my thinking that the Theory of Comparative advantage is as bad Keynesian economics.

  12. your videos are amazing and very helpful… thanks a lot for uploading them… i am an IB student and i study with the help of your videos… i have economics HL and i have a debate in school about protectionism to be for or against … unfortunately i have got to be with free trade.. can u please help me with some points which will be strong and can appose your points in episode 35… thank you

  13. @kanishkmalhotra1994 Actually, if you pay careful attention, I give the opposing points on each argument, as well as the argument itself.

  14. The companies that seek protection from foreign competition are the ones that suck and would get wiped out because they don't want to stop sucking. The free market doesn't proetect people who suck. I'll take a mercedes over a sucky GM car any day.

  15. Yea let's do look at the US steel industry. I wonder if you know why the name of the football team in Pittsburgh is steelers? It's because when the US had a free market they made a junkload of steel. Do they anymore…? No.. China does =).

  16. @panzerkilla Actually, I grew up in upstate NY, just 20 minutes from PA, so yes, I'm quite familiar with the US industry that started as the world powerhouse, and then became stagnant as other countries started up their own industries with newer equipment & methods.

  17. I understand economics when I watch your videos. When I read my textbook, I get very confused. Perhaps it's because the authors use fancier words and, unlike you, they don't provide real, solid examples. Should I even bother reading my textbook?

  18. I had a similar situation in college. The professor would explain in laymen terms, but thew test was based on the wording in the tewxtbook. I learned to take careful notes and match up what she said with what eas said in the textbook. It is important to learn the proper terminology otherwise it will catch up to you later.

  19. 7:05……classic, thanks for your videos, I really appreciate the time you have taken to make them – they really have helped me.

  20. Other countries didn't just "start up their own industries" but first protected their domestic steel market and licensed or stole the "newer equipment and methods" and began dumping their steel in the U.S. until they drove U.S. makers out of business.

    How else could "other countries" who had no domestic steel industry or technical know-how come out of nowhere and drive out of business the "world powerhouse."

    Merchantilism works, that's why Asia is growing and the "free trade" west is dying.

  21. yes, because china is renowned for its free trade virtues. If you people were to look at some actual reading or evidence then you would swiftly see that it is keynesian economics that succeed. There's no such thing as the free market and there never will be.

  22. *Mercantilism

    Also, Asia is renowned for its free trade. As N. Gregory Mankiw points out in "Principles of Economics", the countries in Asia that have prospered the most have concurrently been the ones that have liberalized the most. Even China's current upsurge is largely attributed to the liberalization policies commenced by Deng Xiaoping in the 1970s.

  23. Sweden had mercantilism until the 1840s, when the libertarians/liberals took power and freed up the economy from guild-based operations and introduced modern free market principles. In just 50 years, real wages rose by 170%, infant mortality plummeted and Sweden went from a poor nation to one of the wealthiest in Europe.

    Free trade did that, not mercantilism.

  24. Given that free-trade has been tried for over 30 years now, it's essentially safe to say that it has been a colossal failure. It's time to go back to soft-protectionism.  

  25. Suppose Iran figured out a way to make nuclear weapons more cheaply than we can. I guess we should just buy ours from them and deploy our nuclear weapons capital in some more efficient way.

  26. America has a comparative disadvantage in supplying low and middle-skilled labor because the American worker's advantage over his Chinese counterpart is shrinking but his salary expectations are not. It is not politically feasible (fortunately) to pay Americans a dollar an hour. Economically it makes sense to outsource jobs where possible. You can't outsource nurses or bartenders but you can outsource a wide range of skills, including computer programming and much legal work, so American wages should sink toward equilibrium with offshore workers. Meanwhile American capitalists are doing very well. So, unless we want social upheaval, we need to find a polite way to divert domestic capital gains into domestic wages.

  27. mjmfoodie just want to thank you for all the work you have put into these videos. I love them. Also I love the illustrations because believe it or not they make the concept come alive. Great job and thanks again.

  28. This is so much rubbish. No country has ever climbed the economic ladder of success by using free trade—certainly not Great Britain, the U.S. or Germany. The benefits of free trade, in history, shows it to be a myth (Paul Bairoch, Economic & World History). Free trade destroys the middle class.

    Karl Marx signed onto free trade because he believed it would hasten the Communist revolution. in a speech Karl Marx presented in 1848 he said, "the protective system of our day is conservative, while the free trade system is destructive. It breaks up old nationalities and pushes the antagonism of the proletariat and the bourgeoisie to the extreme point. In a word, the free trade system hastens the social revolution. It is in this revolutionary sense alone. . . . that I vote in favor of free trade."

  29. Are there any good videos someone could recommend me against free trade? Seems like it's tough to find economists that aren't for it, but protectionism has existed for centuries for a reason and I want to hear both sides.

  30. Protectionism punishes productive industries by making the less productive industries cost more for consumers thereby more money goes to the less productive industries and less to more productive ones.

  31. I don't get it.
    Always I read that tariffs and protectionism (deadweight loss etc) are bad, but why do all countries do it?
    Its not possible that simply "everyone is stupid". Its a Game Theory/prisioners dilemaI thing where if someone does one thing, you have to do same in order not to lose?
    I think there must be more to this then those oversimplified explanations…

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