International Trade | Basic Economics by Thomas Sowell | Ch. 21

Today, we’re now moving on from talking about the national economy to the international economy as we dive right into the 21st chapter of Thomas Sowell’s Basic Economics. In this chapter, we begin by talking about international trade.

If you haven’t read my previous summaries and analyses on this book yet, please click here. Otherwise, let’s get to it!

Chapter Summary

In discussing international trade, we must always remember that it’s not a “zero-sum” game, nor is it a “winner vs. loser” dynamic. In trade, all sides wish to benefit from the agreement, or it wouldn’t make sense to continue to trade, since they can just continue to do their own internal trading.

Additionally, we need to remember that all economies rise as buying increases, since jobs are created for workers to produce those additional goods and services. There is no “fixed” number of jobs. Instead, the idea of “a rising tide lifts all boats” applies as countries’ economic prosperity means an increase of jobs on all sides.

Of course, politics often gets in the way of it all. As Sowell explains:

“The basic facts about international trade are not difficult to understand. What is difficult to untangle are all the misconceptions and jargon which so often clutter up the discussion.”

The wealth of a nation consists of the goods and services it provides. Often, the political rhetoric is centered around surpluses and deficits in trade balance, but the reality is that denying consumers the ability to buy things at the lowest prices they want is what hurts an economy. So how does this factor into trade?

The Basis for International Trade

There are three ways countries gain from international trade: absolute advantage, comparative advantage, and economies of scale.

Absolute Advantage is the advantage one country has over another in the production of some kind of good or service. For example, in tropical areas, it is much easier to produce tropical fruits than in colder climates. This advantage means that the production of that good is much cheaper and easier, and thus less costly.

Comparative Advantage is more relative. Because a focus to produce one product often means less focus to produce another product, it’s not always about how much it costs to produce something, but also the trade-off in choosing not to produce as much of something else. This means that even if a country is better than another at producing anything, it can still trade with that other country. In the event this happens, the more productive country can specialize on producing one kind of product while the other specializes in another product, thus benefitting each other immensely. It’s only when one country can produce everything more efficiently that there wouldn’t be any point in trading.

This is a pretty important point. For example, while while Great Britain has been able to provide enough food for all of its people, it does not actually produce the majority of its food. Instead, it produces manufacturing, shipping, and other services, and then buys food from other nations. This gives the British the ability to feed its people far better than attempting to grow the food on their own ever could.

Economies of Scale, as discussed in Chapter 6, is the ability to increase the amount of production or service in a specific area. It is also an important part of international trade, because there are some things, such as car manufacturing, that just aren’t cost effective until you’re making a lot of them at a time. A lot of this depends on how large a population is in a given country, as well as how efficiently it can trade with others.

A key part of participating in economies of scale is when a country attempts to restrict its people’s ability to produce, thereby inflating prices. When such a country begins to trade, its internal small businesses often experience a crash, as their small scale is forced to reckon with the massive production of other countries.

International Trade Restrictions

Thus, a key component of international economics is realizing that, like other kinds of economic activity, it can quickly displace inefficient methods of production and service for more efficient ones, no matter where in the world a country is. Politically, this often ends up with locals calling their government to protect them from foreign competition. And so, let’s look at some of the fallacies that are often brought out to argue against it.

The High-Wage Fallacy is the idea that countries with higher average wages can’t compete with those with lower ones. It might sound correct, but this is false when we understand the complexity of cost. To begin, wage rates, labor costs, and total costs are different things. Wage rates are related to each hour one works. Labor costs are related to each unit of output. Total costs includes labor costs, but also includes things like raw materials, cost of capital, transportation, and things that are needed to bring a product or service to the market.

Thus, the reality of high wages in a prosperous country is that, more often than not, those high wages reflect higher output, which means it actually has lower labor costs. Another way to think about it is that a more prosperous country has a better ability to make labor cost less, even if individuals are paid more wages. Remember, a free market incentivizes the reduction of costs, including paying more wages. However, an employer must pay a wage high enough to retain workers, and experienced workers who stay around are far more efficient than high-turnover workers.

But what about all those jobs like telemarketing and programming in the United States lost to countries like India? While certainly it can be argued that some jobs are shifting around to different countries, this doesn’t mean that there is a net loss of jobs overall in a higher wage country (in this case, the United States). After all, while the programming can be done in India, you would still need international managers, good team builders who can work cross-culturally, and even translators—jobs which are created in the higher wage country because of such shifts in economic activity.

Of course, the reality of this may still hurt those who suffer from the jobs that did go overseas. But the answer IS NOT to restrict domestic or international markets, as that actually often reduces both new job creation and prosperity in the long term, which further hurts those who suffer from the shift in jobs landscape. While it is politically convenient to pitch a story of “us vs. them“, the reality is that the only people who gain from such a pitch are domestic special interest groups. Everyone one else loses.

This is especially pertinent when politicians propose or are pressured to save jobs as a key component in dealing with international trade. Such a thing usually happens through restricting trade. By increasing tariffs on imports, it is more often the case that unemployment actually increases, and exports in the same industry suffer as well. This is because, in a free market, if it is truly more efficient and less costly to produce something elsewhere, restricting doing such things is enforcing less efficient and more costly methods on the market. This economic fact doesn’t change just because politicians or the public want to help people. Thus, as time goes on, a national market that is forced to be less efficient and more costly must compete on the international stage, and its disadvantage eventually decreases employment for that nation, and other countries buy less of its products as well.

What about temporarily applying economic restrictions to protect infant industries in the interest of fostering growth? While many economists agree this may be a good idea in theory, in practice, most infant industries aren’t really cared for enough by politicians to get protection in the first place. Instead, old inefficient and quickly obsoleting industries often do have the political clout to receive subsidies and favorable legislation, often at the expense of the public and market.

National Defense is another area in which international trade is restricted. Such restrictions are not necessarily due to political shenanigans, but because it’s typically unwise to buy munitions and weaponry from another nation you may be in conflict with in the future. However, many things are done in the name of national defense, though the products being restricted may have very little to do with such things. But when done correctly, both economists and politicians actually agree that the export of domestic military-based products and technologies should be restricted.

Many accuse non-domestic countries of dumping products at prices below cost in order to drive domestic businesses out and allow the foreign market to take over. Of course, it’s pretty difficult to calculate the real cost of production, with all the differing circumstances and environments with which one can produce different goods and services. But again, reality comes to a fore in that, if a company is producing something below cost, it will quickly find itself unable to sustain in the long run (as discussed in chapter 8). Thus, even if such a thing were true, as long as governments aren’t subsidizing these affairs, in the short term there may be some domestic losses, but the market will always rebalance itself out, and those selling under cost will soon be out of business themselves.

In all this, it’s important to distinguish the kinds of restrictions that can be imposed on an economy, especially in an international sense. Tariffs are taxes on imports, and effectively raise cost of imports to help domestic businesses compete. Import Quotas limit the amount of a specific good that can come from a given country. Both generally raise prices. However, a quota makes the cost of an import more obscure to the public, and so people are less aware of its effects. Thus, the effect of quotas often raise domestic prices far more than tariffs, but are just as easily passed by political officials because of the ambiguity of such laws.

Changing Conditions

Just as in national and local economics, we must remember that, over time, things change. The centers for production of various goods and services shift from country to country over time, and industries rise and fall.

A great example is the digital technology and computing industry, which began in the United States, but slowly made its way around the world. As the hardware became easier to produce en mass, computer components went from being mainly made in the US to mainly made in Asia. Similarly, the software industry grew in the United States, and is now making its way around the world. During the rise of the technological era, it was common to see headlines which talked only about the masses of lay-offs happening in the tens of thousands in American industries. Yet, millions of new jobs were being created across the country.

In the current climate, many are in outcry at the “outsourcing” of American jobs overseas. Yet, as given before, when looking at jobs, it’s important to look at the net number of jobs, not just what’s in decline. If the number of jobs created outgrows the number of jobs lost, then it doesn’t matter if outsourcing is happening. In fact, outsourcing could actually produce better economic results and job growth, as there’s plenty of evidence that the outsourcing of jobs actually also lead to newly created domestic jobs.

As Sowell explains, this is why most economists are very positive about free trade internationally, though in the political arena, there is much support for protectionism, and against ‘globalization’. Of course, that term ‘globalization’ is a loaded term, and not all of it has to do with free trade in the international arena.

My Thoughts

The idea of comparative advantage, especially as it relates down to the individual, is a very interesting way to look at economics. I come from a background which admires a ‘self-made’ person. In other words, the more you are able to do-it-yourself, the more respect you generally have (even if it’s just self-respect). But comparative advantage understands that the delegation and specialization of tasks is not about whether you can do-it-yourself, but the economic advantage you gain by not doing everything yourself.

Of course, this all sounds great until you try to rely on others, and those others fail to follow through. I’ll write a blog on this in the future, but such dependencies, and the failure of those dependencies, is a lot of the problem with businesses in general. In today’s modern era, entrepreneurship has been romanticized into this idea of creating a start-up with a brilliant original idea that will take over the world. But the fact is that most businesses are “middle-management” businesses. In other words, they serve to provide expertise in a small field that is interconnected with other things. Rather than being the whole chain, it is just a link in the system.

I would venture to guess that the businesses which thrive are the ones that find that niche (even if it is one with a few competitors), and do really really well in them.

Maybe this is why a lot of non-DeFi cryptocurrency businesses fail. Most crypto projects, like EOS, Tezos, and others want to be the whole caboodle. Not only do they want to create their own digital currency, but they want to innovate the tech as well, in addition to wanting to be the dominant force in the crypto world, as well as disrupting the current financial system, as well as creating a better Facebook, or Twitter, or something else. Very few ‘disrupter’ crypto projects build on the back of another cryptocurrency that already exists.

I think that’s part of the reason why the Ethereum ecosystem is successful, despite its current flaws in energy consumption and high gas fees. The projects based in Ethereum are built on an already well-known and well-functioning chain which is being actively worked on. Thus the exchange of coins and software coding platform is already taken care of.

But some projects even on Ethereum have the same problem.

Currently, the Brave project is torn between being a good browser and providing a good, stable digital token platform. Visiting their subreddit is a good place to get discouraged from trying their products, as it’s easy to find many posts talking about the problems with BAT. They have issues sending out tokens to all users, issues with browser bugs, issues with getting advertisers to hop in on the project, etc. While I’m not one to tell anyone what to do with their businesses, this idea of doing everything yourself may be the reason why many of these crypto projects fail. They attempt to tackle too much in the beginning, instead of being really good at one thing first, before venturing on.