Free Trade vs Fair Trade

A protectionist shibboleth

Photo by Ian Taylor on Unsplash

My last post on why tariffs are bad prompted a good comment from a reader, who said:

You say free trade is good. No issue there. But not all free trade is fair. And fair trade is just as good as free trade. Unfair free trade is harmful.

Example, using eggs since I eat them daily. Say a foreign country subsidizes its egg exports. Tax rebates, shipping subsidies, energy bill discounts, etc. That country wants to dominate the egg market. Their strategy: dumping cheap, but still good enough quality product into a given market. Their goal: to put that market’s egg producers out of business.

Once this is done, egg prices creep back to normal levels, then above normal. Domestic egg production is gone. A foreign country controls the egg market it went after.

Free trade? Yes. Fair trade? No. End result? No domestic egg jobs and high egg prices, both of which one should avoid.

This is a common refrain. Many people, organizations, and government officials support trade between nations, but only if it is done “fairly”. The commenter above does an excellent job laying out the fair trade argument. Some governments heavily subsidize selected industry. Especially in agriculture, producers will get tax rebates, subsidized energy, and occasionally will just be paid by the government for simply existing. This creates an advantage. If you are producing carrots in Japan and the government is giving you free water and buying your carrots and inflated prices, you don’t have to worry about foreign competition. Not only that, but those carrots can then be sold abroad at a price that carrots farmers in other countries can’t compete with. Thus, if we have free trade between two countries, but one country is subsidizing an industry, the trade isn’t really free. Just as putting tariffs on foreign goods constitutes non-free trade, so too should foreign subsidized production, as both result in the same price imbalance.

This is not an academic concern. Every nation has favored industry that is subsidized, with agriculture usually being one of the largest beneficiaries. How did the Central Valley in California become one of the most productive agricultural regions in the world? Because the US government spent billions and billions of dollars rerouting countless rivers and watersheds there. Farmers in the Central Valley are sold water at a fraction of the true cost. The result? Almost all US almond production, as well as 82 percent of the world's almonds, one of the most water-intensive crops in existence, is grown in a desert. Other countries subsidize chosen firms in heavy industry. China and other countries simply have their government start companies, so-called state-owned enterprises (SOEs).

All these subsidies have led to proponents pushing “fair trade”. That is, trade without tariffs should only be allowed by countries that are letting the free market reign. Once a country starts subsidizing production and selling the resulting goods abroad, a process known as “dumping”, the reciprocal countries are not only justified in instituting tariffs but should do so to protect local industry from unfair competition. The logic makes sense. The problem is that the conclusion doesn’t follow from the premise.

First and foremost, it’s important to recognize that dumping isn’t generally harmful to the receiving country. If the Japanese government wants to indirectly give American consumers access to cheap carrots, great! If China is subsidizing their garment factories and American consumers can buy more clothes, wonderful! I’m fully in favor of foreign governments helping out the American economy. Why would I be against foreign taxpayers picking up the tab for American consumers? The fact is it doesn’t matter why China can make cheaper plastic toys than the US can. Regardless of whether it’s because their costs or lower or because the Chinese government is subsidizing the industry, the effect on the American economy is the same; cheaper goods.

That isn’t to say there aren’t losers. Domestic producers absolutely suffer because of the lower prices. American carrot farmers will be driven out of business if Japan engages in large-scale carrot dumping.¹ As both economic research and mountains of evidence show, however, the benefits to consumers outweigh the cost to producers, resulting in a net benefit. It doesn’t matter why foreign goods are cheaper than domestic goods when calculating the cost-benefit of allowing trade. The reason doesn’t change any of the calculations in economic well-being.

Proponents of fair trade will often yield this point. The typical response is, “Well yes, sure. As a supporter of free trade, I understand that lower prices help domestic consumers more than they hurt domestic producers. That, however, is only in the short run. What about the long run? Once these artificially cheap imports destroy the domestic industry, the foreign government can stop subsidizing the industry. The price of the foreign goods will then rise. Since all the domestic producers were driven out by the formerly cheap imports, domestic production doesn’t increase in the face of higher prices. Instead, in the long run the economy is left with no domestic industry and high prices.”

Again, all this sounds sensible. The problem is it doesn’t happen, either in theory or in reality. Let’s say Japan attempts to do this with carrots. The Japanese government spends billions subsidizing carrot production and then sells those carrots for next to nothing in the United States. Consumers benefit, while American carrot farmers are forced out of the market. Then, once all the American competition is destroyed, Japan increases the price of carrots so that it is significantly higher than they were originally. American consumers are stuck paying high prices and the American carrot industry has been decimated.

Hopefully, you see why this isn’t the end of the story.

If the price of carrots rises above the original price, a price that American farmers were competing with before trade began, they are going to notice… and start planting carrots again! Thus leading the price of carrots to fall back to its original level. It doesn’t make sense to claim that once American producers leave a market they will never reenter. Of course they will. And that’s why the second part of the story, the sharp price increase after domestic producers are driven from the market, doesn’t happen.

This is most obvious when considering clothing. An overwhelming 98 percent of American apparel is imported. A century ago hardly most was produced domestically. In the intervening 100 years the entire American garment industry was gutted. Under the claim of fair trade proponents, once the garment industry left the United States, foreign producers should have raised their prices to take advantage of the production-bereft consumers. Far from it, the opposite happened. Clothes continued to become cheaper. In the 1950s, the typical American household spent 12-14 percent of its income on clothing. Today, it’s around three percent. The cost of apparel fell through the floor and has stayed low, despite foreign subsidies and lack of domestic production. Today Americans purchase an unfathomable amount of clothing. Amounts that were only for the very rich only a few generations ago.

That isn’t to say foreign production hasn’t changed. It has dramatically. When clothing production first started going abroad in the second half of the 20th century, one of the leading producers was South Korea. Then, as South Korea evolved from a poor country to a rich one, garment production moved to Southeast and South Asia. If prices rise there in the future, the clothing industry will likely move to Africa. The point is there’s no mechanism by which a foreign economy can destroy domestic production and then keep prices high until the rapture. The world economy will take note of high prices and fill the gap.

When presented with this conundrum, fair trade proponents will have other arguments. They will bring up industries like steel, claiming that we need to protect domestic industry in case World War Three breaks out. They will bring up international labor standards, and claim that it's unethical to consume goods that are made by people making only a few dollars a day. This is nothing more than shifting the goalposts. Are there a few industries that should be protected under national security concerns? Sure. But these are far and few between (read: not steel). As far as ethics, if foreign producers are using slave labor or other coercive measures, trade should be restricted. But this is the exception, not the norm.

Ultimately, when people argue that they are in favor of free trade, but only if foreign governments aren't dumping, allowing imports could be disadvantageous during wartime, or because other nations have lax safety standards, they aren't in favor of free trade. These constant arguments show what fair trade proponents really seek: protectionism. Don’t fall for it. Trade is good.

1. If any readers are starting a college improv group, I humbly suggest considering “carrot dumping” as the name.