Economic Perspectives – No. 95 [21-2-21] – see also EP 14

“Back to Basics” – International Trade

TRADE SURPLUSES AND DEFICITS

Any country’s trade balance is the difference between the totals of its exports and imports respectively, as measured in its own currency. To the extent that its exports exceed its imports, its balance of trade will be in surplus, while an excess of imports over exports will show a deficit. Easy!

But the arguments persist – in particular the notion that a trade deficit is something any sensible government would wish to avoid; and hence, by its own logic, exports must be a “good thing” while deficit-prone imports are harmful.

Speaking of reason, since it is logically impossible for every country to have a trade surplus, how can exports and imports be thought of as “good” and “bad” respectively? Yet the Queen’s Award for Enterprise is sub-titled “Exports”. Why is there no Queen’s Award for Imports?

Actions based on a fallacy

During the Brexit debate much was made of the fact that Britain’s trade with the EU gives rise to an annual current account deficit, which is the amount by which the cost of our imports of goods and services from Europe exceed the amount we receive for our exports to EU countries. But the patent irrationality of the “exports-good-imports-bad” mindset doesn’t prevent trade ministers from acting on it. This usually means discouraging imports by adopting policies to protect local businesses and industries from overseas competition, such as levying tariffs on imported goods; while granting subsidies to selected home enterprises to make them more competitive, and thereby encouraging exports.

“exports good, imports bad” mythology

 

At this point it is helpful to remember Say’s* Law: we produce in order to consume. Say’s Law also provides the economic explanation of the division of labour. As no one is self-sufficient, individuals tend to specialise and focus on what they do best, and the same applies to businesses. The more successful the particular specialism, the greater the resulting wealth – not only for the producers, but for the entire community.

Say’s Law, being a law, applies on every level. In our present context it applies to individual countries whose particular features bestow an advantage – whether climatic, topographical, geographical or, simply, possession by its citizens of a talent, tradition or powerful work ethic, giving rise to nations’ specialisms. Hence, we can apply Say’s Law to international trade: “We export in order to import”.

[*Jean-Baptiste Say, 1767-1832]

Enter ‘protectionism’

From this standpoint it is obvious that obstacles to the free flow of goods and services between any two nations will be harmful to the citizens of both those nations, not just the citizens of one of them, since trade entered into willingly is beneficial to all trading partners. Now, there can be few obstacles more harmful to trade than tariffs on imports, grants of discriminatory subsidies and protectionist regulations – such as those being attempted right now by the Brussels establishment, in a fit of post-Brexit pique, against the UK’s financial services industry.

tit-for-tat protectionism

It is astonishing that the same old tit-for-tat protectionist arguments are still raised at the very mention of tariffs or subsidies, despite the fact that they are so palpably self-defeating.

Why are they self-defeating? Let’s spell it out

1 – Advocates of protective tariffs are, in effect, urging their government to force citizens to pay higher prices for imported goods so that protected domestic producers can maintain their revenues.

“unfair” subsidies

 

2 – The protectionists argue that competing foreign producers are unfairly subsidised by their own governments. Again, this can only mean that domestic consumers (that’s us!) are receiving a gift of lower-priced goods from foreign producers. It is surely not our government’s role to make us poorer by preventing us from accepting that gift.

3 – Protectionists warn that if we fail to retaliate against the import of “artificially” low-priced widgets from abroad, their overseas producers, once granted a foothold in our market, will bankrupt our domestic widget manufacturing industry and replace it with a foreign monopoly. What they miss, of course, is that widgets are available for purchase from dozens of countries worldwide and there is no realistic risk of nurturing a foreign-owned monopoly: importers will always seek out the best products at the lowest prices, regardless of where sourced.

4 – Protectionists view trade economics through an upside-down prism. It is the function of consumers to consume, not to serve the interests of producers; while the raison d’etre of producers is to serve consumers. The fact that consumers may choose to spend their money in ways that don’t please domestic widget-makers does not justify their lobbyists’ demand for state intervention, using the standard emotive word-play: “protect our workers”, “we want a level playing field”, “let’s play by the same rules”, “end unfair competition”, and the rest.

with unilateral free trade there’s no need for trade agreements

 

5 – As we can see, protectionist policies may grant a short-term advantage, but in the long run they are destructive and never work; whereas a policy of unilateral free trade would obviate the need for bilateral or multilateral trade agreements entirely!

Settling foreign debt

A current account deficit is simply a label for accumulated foreign debt, which must be repaid. If the deficit country is creditworthy the foreign holders of that debt will not be concerned, particularly when the deficit country is using its borrowings to finance the acquisition of capital assets that will work towards reducing the deficit.

A British firm importing German goods must pay for them in euros. For that purpose the UK firm (or its agent) will acquire euros from a German bank, and after settling the bill the German exporter (or its bank) is now a holder of British pounds. What will they do with them? In all probability they will use them to buy British goods, or they can exchange them for a different currency – but if, instead, they just sit on them indefinitely they will, like the retailer who never cashes your cheque, be handing the importer a free gift!

An importer’s currency must be acceptable to the exporter

The only legitimate concern for those whose trading partners use a different currency relates to the relative strength of the currencies concerned. No exporter will accept payment for his goods in a currency he does not trust – due either to its volatility and instability in terms of purchasing power, and consequently will not be trusted by his other trading partners either. For example, when the US dollar was widely respected for having all the virtues of a “reserve” currency, traders in smaller exporting countries all over the world would insist that payment for their produce, raw materials and manufactures should be denominated in dollars.

protection…of currencies!

 

Protecting our currencies is therefore the real issue underlying much of the debate on current account surpluses and deficits which, after all, are inherent features of international trading relations. The most important favour that trading entities can seek from their own governments is to desist from destroying the exchange value of their currency.

This is now the real issue given that central banks everywhere are inflating their currencies into oblivion – a veritable race to the bottom!

Possession of a weak currency may be may be considered good for exporters at a point in time, but that advantage is counterbalanced by a disadvantage to the non-exporting sector. Furthermore, the deliberate action by a government’s central bank of favouring exporters by weakening the currency merely causes prices to rise, which eats into the exporters’ margins – until the next round of currency debasement. And so on.

In this foolhardy see-saw there can be no winners.

[EMILE WOOLF, 27-2-2021]