Free trade versus protectionism
Long held and deep-seated beliefs are hard to change. Open competition is an example where much of the dialogue is ill-informed. Virtually every economist will tell you that free trade beats protectionism any day. Yet arguments for anti-globalisation (protectionism) continue in political and social discourse.
Over 200 years ago, Adam Smith, the father of modern economics, espoused the benefits of free markets in his magnum opus, The Wealth of Nations. Smith argued that it is irrational to produce at home that which can be imported more cheaply. He criticised the idea that protectionist tariffs serve the economic interests of a nation by protecting local industries.
Another legendary economist, David Ricardo, built on the work of Smith and developed the most important concept in international trade – the theory of comparative advantage. According to Ricardo, nations should specialise in making goods they can produce most efficiently (their area/s of comparative advantage) and trade for goods they make less well.
To be clear, free trade is the unrestricted purchase and sale of goods and services between countries without the imposition of constraints such as tariffs, duties and quotas. Protectionism, on the other hand, is the deliberate restriction of international trade by means of government policies designed to shield domestic industries and jobs from foreign competition.
The belief that protectionism can preserve jobs in the long-run is an illusion. The prime example of this is the Australian car industry. Over the past decade, Ford has received an estimated $1.1bn in government subsidies. Notwithstanding this taxpayer funded assistance, Ford is leaving Australian shores in 2016 which will result in the axing of 1200 manufacturing jobs.
Announcing the closure, the head of Ford in Australia said: “Our costs are double that of Europe and nearly four times Ford in Asia. The business case simply did not stack up, leading us to the conclusion that manufacturing is not viable for Ford in Australia in the long-term”. Holden, which has received around $1.8bn in government handouts, is also battling for survival.
It’s blindingly clear that Australia does not enjoy a comparative advantage when it comes to car manufacturing. So, at what stage do we embrace this reality and write the car industry’s obituary? Throwing good money after bad will not make the car industry self-reliant and sustainable. No amount of protectionism can force consumers to “buy Australian”.
Consumers behave as economic models predict in that they acquire what they want, for the best price. Federal Treasurer, Joe Hockey, made this observation last year saying: “People are not buying Australian-made cars because they don’t want to buy Australian-made cars, and the cars are not meeting their demands as consumers”.
I suspect that there would be riots in the streets if the government told Australians they could no longer buy imported goods. Free trade provides the cheapest goods and services for consumers. (Note: Japanese consumers pay five times the world price for rice because of import restrictions protecting Japanese farmers.)
The harsh reality is that protectionism costs more jobs than it saves. Protectionist laws that reduce consumer spending power actually end up destroying jobs. Free trade, on the other hand, creates more jobs than it eliminates since it allows countries to specialise in the production of goods and services in which they have a comparative advantage.
Over recent decades, Australia has transitioned from a highly protectionist economy to one open to foreign investment and exports from around the world. The creation of this open and competitive economy has led to 22 years of recession-free economic growth. This transition, of course, has not been seamless or uniformly welcomed.
While job losses in one sector are always painful, local production should not be defended from imported competition. Australia operates in the 21st century which is why we can’t continue to protect 20th century industries. As the 19th century English philosopher, John Stuart Mill, wisely noted: “Trade barriers are chiefly injurious to the countries imposing them”.
Posting Date: 28 October 2013
Who controls the economy?
Politicians do a lot of huffing and puffing about their economic credentials and claim to be able to control the economy. In reality, governments have some influence and, therefore, only some impact on economic activity, but it matters a lot less than people think.
The global economy can be likened to a vast ocean. Each nation-state is free to steer its own ship and set its own course in open waters. But each vessel has to deal with similar headwinds, like the Global Financial Crisis, which cross national borders.
The fate of domestic economies is impacted significantly by what blows in from offshore. No economy is immune from higher oil prices, movements in exchange rates and other seismic changes. Which is why the fate of most economies is largely determined by global conditions, not domestic ones.
In Australia’s case, our recent resources sector boom led to a surge in national income from exports. But the government can’t take credit for this boom cycle as it was driven by the voracious demand from developing nations in Asia, particularly China, for our raw materials.
Our central bank has more influence over the economy than the government. The Reserve Bank of Australia is independent of the government and has total autonomy over interest rate setting. Monetary policy directly impacts the demand for credit and consumer sentiment.
Interest rates go down when times are tough and go up when things are overheating. It is ironic, therefore, that glory-seeking governments take the credit when interest rates fall (a sign of a weak economy) and nit-picking oppositions are critical when interest rates rise (a sign of a strong economy).
As noted by author, Albert Alla, not only do politicians have no say in the rise and fall of interest rates, they cannot create jobs in the private sector. Moreover, they are unable to force companies to invest in declining industries and can’t micro-manage workers in order to increase productivity.
Consumption by consumers, investment by businesses and government spending are the three major parts of an economy. In Australia, personal consumption is the main driver of the Australian economy and represents more than 50 per cent of our nation’s GDP.
Personal consumption represents you and me. Collectively, we have more influence on the economy than the government. Ronald Reagan quite rightly noted that “a government can’t control the economy without controlling people” and no democratic government seeks to control the populace.
The Australian Government does not interfere in personal economic choices. We are best able to decide our wants and needs. As a result, the government can’t stop us living beyond our means. Nor can it force us to spend or compel us to save (except superannuation savings).
We operate an open market economy where people are free, within the bounds of the law, to engage in commerce at their will and their peril. All markets have rules (the term “free market” is an oxymoron) and governments play an important role in setting industry standards.
With regard to economic competition, the Federal Government is the rule-maker, the referee and the umpire – it regulates markets, ensures a fair playing field and enforces the law. Importantly, it also invests in infrastructure.
In short, the government’s job is to improve the functioning of the marketplace and not play a direct role in markets. While government interventions to improve market infrastructure such as roads are necessary and welcomed, over-regulation is not and can be counter-productive to the workings of a capitalist society.
It can be seen that our economy is based on the market forces of supply and demand and the economic interactions between millions of people. Our politicians have little control over most things that actually affect the economy. Yet we unfairly hold them responsible for short-run ups and downs.
The way forward is clear: We should stop blaming politicians