Bite Size Advice. Paul J. Thomas

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       Posting Date: 30 September 2013

       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 21^st century which is why we can’t continue to protect 20^th century industries. As the 19^th century English philosopher, John Stuart Mill, wisely noted: “Trade barriers are chiefly injurious to the countries imposing them”.