Domes of trade

By Gregory F. Rehmke

Trade is simply voluntary exchange, and it is everywhere in the economy. When we purchase an ice cream cone, we trade money for ice cream, and when we go to work at Baskin and Robbins, we trade our labor preparing ice cream cones for money. International trade is merely the extension of voluntary exchanges to include individuals in different countries.

Unique in the world is America's wide geographical scope for voluntary exchange. Across 3.5 million square miles of territory, the United States is the world's largest free-trade zone. So strong was U.S. growth in the 1980s that protectionist European countries tried to copy it by forming a free-trade zone in Europe. Then, in response to the planned European free trade zone, U.S., Canadian and Mexican officials began planning and later passed a North American Free Trade Zone (NAFTA).

Trade, and the markets that the freedom to trade creates, organize the economy, encouraging efficient use of raw materials and machines, and productive tasks for people. Few realize that voluntary exchange creates value whether it's between neighbors, individuals in neighboring cities, neighboring states, or neighboring countries.

Protectionists argue in favor of trade restrictions hoping they will protect companies and jobs here in America. Tariffs are taxes on imported goods while quotas are limits on the number of a particular good that can be imported. Tariffs and quotas already exist for a wide range of goods, and protectionists recommend higher tariffs and imported goods. Protectionists bitterly opposed the North American Free Trade Agreement (NAFTA) because they opposed bringing the people of Mexico into the existing U.S./Canada open trade agreement. But if protectionist arguments were valid for opposing trade between countries, they should be valid for trade between states and cities as well.

Twilight trade zone

Let us begin with a "thought experiment" that might make an educational Twilight Zone episode. Sometime soon, on a dark and stormy night, with lightning flashing and thunder roaring, an eerie glimmer appears high above an American town. Silently descending in the dark, a transparent dome drops down like a clear plastic lid over a giant serving tray. The dome's outer rim drives deep into the ground.

The mysterious dome is clear so that moonlight passes through, and it isn't discovered until morning. Our thought experiment begins with 10,000 people locked under the dome. What will life be like for them?

What sort of work would they soon be forced into? It sounds a bit like a riddle: if there are only 10,000 people in your whole world, what is your occupation? The answer is "farming."

Any American town or city cut off from the outside for even a few days will begin to run out of food. In our domed world, all available land, from highways to rooftops would probably be used to grow food.

Few people think it odd that they don't live on a farm. Yet it is odd, by historical standards. Only in recent decades has farming become a relatively rare occupation. The reason is the vast improvement in agricultural productivity, due to improvement in farm equipment and technology, and new grains, fertilizers and pesticides. In 1830, 70% of the American labor force were farmers, dropping by 1900 to 50%, by 1930 to 21%, by 1950 to 12%, by 1960 to 6%, and by 1980 to just 2.2%. Now about 98% of Americans have jobs outside of farming.

For those under the dome, the machines and other products used in everyday life would break down and wear out. Clothes would begin to fray with no textile mills under the dome to weave new fabric and no computer-controlled machines to rapidly stitch new jeans and shirts. Even if there were, they too would break down for lack of replacement parts from the outside world.

A few might escape from farming, or at least from full-time farming, by producing some of the other necessities of life. Gradually, weaving would again become a family enterprise, with rough handlooms turning out a few yards of fabric each day. Cobblers would painstakingly assemble shoes, and blacksmiths would hammer out a few farm tools in a day.

This invisible dome would push those caught inside it backward in time, backward to the days when each isolated medieval village produced nearly all its own goods and services. The modern world would soon fade from memory or at least from daily reality.

It is not so obvious how the invisible dome would make people so poor so quickly. Even with thousands of capable and well-educated people within the dome&emdash;scientists, technicians, and expert mechanics&emdash;even with tons of sophisticated equipment and machinery under the dome, living standards would rapidly drop. Our material world is maintained by markets that draw together the individual knowledge and actions of millions of people. The dome would make us poor simply by cutting the scope of trade.

It is easy to take material things for granted in a modern economy. Someone said: "The world does not lack for wonders, it lacks for wonder." How many of us are amazed by the thousands of things for sale in an average supermarket? Former Soviet and Eastern European visitors were first speechless and confused by supermarkets.

A villager wandering from a medieval town through a time warp and into a modern supermarket would go crazy trying to comprehend the unimaginable wealth it represented. All that selection and all the wealth we take for granted, derives from the scope of trade, and from the accumulation of knowledge and capital or tools.

The larger the scope of trade, the greater the division of labor and division of knowledge. People specialize. Michael Dell and the thousands of people, who work with him at Dell Computer in Austin, Texas, specialize in making personal computers. When Michael Dell started building computers as a University of Texas undergraduate, he sold them only in Austin. But it is costly and time-consuming to make computers a few at a time.

Michael Dell was able to expand his computer enterprise, because his scope of trade was the entire United States. He was able to take advantage of economies of scale. He could build a large factory, hire people to build computers for Texans and for export to other states. When Dell ramped up production he had market of over 200 million people to advertise and sell to.

If Mr. Dell's factory were caught under the invisible dome, he would probably plant wheat on the factory roof, and grow mushrooms in the dark interior. The computer market inside the dome would be far too small for the size of his firm, and he would no longer be able to buy the parts that go into his computers.

There simply would not be enough people under the dome to create the complex goods we use in our modern lives, nor maintain the quality of health care and other services. It's hard to comprehend how little any one of us knows about the goods and services we consume. We don't have to know how to make a car to drive one--we don't even have to understand how it works. We just twist a key and push a pedal. Few of us can sew our own clothes or grow our own food. We don't have to sew and grow food, so we have time to learn more specialized skills.

Wealth and the scope of trade

To see how a greater scope of trade increases wealth, consider how a single trade creates wealth. We often think that people trade, or exchange, things of equal value, but that is not quite right. People exchange things they value less for things they value more. When a cobbler trades a pair of shoes for a bag of rice, it is because he values the rice more than the shoes. Both the cobbler and the rice merchant must value each other's goods more than their own, otherwise they wouldn't trade. Trade moves material goods from people who value them less to people who value them more. Each trade, therefore, increases the total value or wealth of the world.

Value is not an objective thing--it is instead subjective. The gleam in the eye of the beholder is the first measure of an object's worth. A good is valued by what buyers are willing to offer in exchange.

In the modern world we trade a couple hours of our labor for dollars, and then trade those dollars for what we want. Trade allows the division of labor. Instead of one person working for 4 hours to produce a shoe, 50 people can specialize in different parts of the process and make shoes far faster. Even further, 200 people can concentrate on designing and fabricating a shoe-making machine which can crank out shoes by the thousands.

Expanding the Dome

What happens in our thought experiment when the invisible dome is somehow expanded? Blasting the dome outward so that it surrounds 100,000 people instead of just 10,000 will cause economic and political consequences. The scope of the market expands to include 100,000 people with 100,000 levels of skill, of knowledge, and of desire for goods and services. The new dome is bad news for the 90,000 people newly covered by it because their scope of trade is drastically reduced. But the new larger dome is good news for those locked under the smaller dome--their scope of trade is increased.

Not everyone from the smaller dome benefits equally from new trade, however. Everyone benefits as consumers, since more goods will be available at lower prices with 100,000 producers, than with just 10,000. But as producers, many will suffer from new competition from larger more specialized firms. People can either buckle down to the disagreeable but necessary shifts in production and jobs and adapt to the new competition, or they can try to protect the "old ways."

Change in the scope of trade is disruptive. Think of those who make shoes within the smaller dome. Many that prospered producing for that limited population will be driven out of business by more efficient producers on the outside.

Again, as consumers, everyone benefits from lower prices, but as producers, the owners and employees of some companies will bear the heaviest burden from new, more efficient outside competitors. Is it fair that Mr. Jones, the shoemaker, should be thrown out of work by cheaper imported shoes?

Real world trade domes

In the real world, what and who can pass through an invisible trade dome is determined by legislation passed by Congress. The list of goods fully or partially restricted by the invisible dome fills a foot-thick book, and changes all the time. Special interest groups lobby for more protection from outside trade. President Bush recently signed off on additional restrictions on steel imports and timber from Canada. Car companies push to restrict imports of foreign cars, textile companies restrict foreign textiles, and sugar producers make sure sugar imports are blocked. Even imports of clothespins and roses face restricted.

Nifty or nasty NAFTA?

The larger the geographical range of free trade, the more opportunity there is to reap the benefits of specialization in all corners of the free trade region. Bananas, coconuts and mangoes from the tropical lowlands, coffee from the tropical highlands, wheat from the temperate plains, minerals from scattered deposits, and so forth, all criss-cross through the free-trade regions along with thousands of specialized manufactured goods and services. In a free-trade zone, trade is only limited by the transportation cost of moving goods from one region to another. It might be cheaper to bake bricks in Bolivia, but they are too heavy to ship to Texas. Trading, based on geographical advantages and natural resources, supplements trade based on specialization in crafts and industry.

We accept the idea of free trade across the wide range of the 50 United States, and from Canada. Why not adopt a free trade policy with the entire continent?

First, free trade agreements between countries cannot be made unilaterally. All governments have to sign off on the agreement, which means special interest groups in all countries have to somehow be placated. The political battle over the North America Free Trade Agreement almost brought the then-current Canadian government down.

Why the resistance in Canada? Mostly for the same reasons as in the trade dome thought experiment: those hurt by trade are concentrated, easily organized, and highly motivated to protect themselves. The vast majority who benefit from trade are spread out, unorganized, and not so strongly motivated.

The specific benefits of free trade are not known ahead of time. There is always uncertainty about just who will benefit and by how much. Prices of many goods will fall, but it will not always be clear that freer trade was the cause. There is much less doubt about who will be hurt. Less efficient industries protected by tariffs will be the first hit by competition, and managers, workers, and investors in these industries will suffer, at least at first. After restructuring, an industry may emerge sounder and more profitable than it was when protected by tariffs. But some industries may not emerge at all.

America's sugar industry, for example, might not survive if we had a free-trade policy for sugar. Quotas restrict foreign sugar, and Americans pay roughly twice world prices because of these restrictions. Only in America is Coke made with corn syrup instead of sugar because high domestic sugar prices make corn syrup cheaper.

Trade & the environment

Some environmental organizations and unions opposed NAFTA. They argued that lower wages would result from the free trade agreement, and that companies would relocate in Mexico in order to escape burdensome environmental regulations in the U.S.. And many did after NAFTA was passed. But the benefits of the broader scope of trade across North American overwhelmed the costs. Far more companies were founded or expanded in the U.S. that left or shrank due to NAFTA. And increasing wealth in Mexico from new higher-paying manufacturing and service jobs means millions more customers for U.S. goods and services.

Environmental organizations were split over NAFTA Some, like the Environmental Defense Fund, favored NAFTA because they believed the environmental benefits will outweigh the costs. NAFTA would raise Mexican environmental standards just by generating new wealth for the people of Mexico. Worldwide surveys indicate that a yearly income of $5,000 is about the point where people become interested in cleaning up the environment. Below that income level they are just too poor to focus beyond food and shelter for their families. NAFTA has lifted living standards in Mexico despite the deep corruption endured under the long-ruling PRI politicians and bureaucrats.

The vocal few or the silent majority

Lower costs for American consumers have been a more significant benefit to more Americans than job losses and wage declines that hurt some. Freer trade with Mexico after NAFTA had the initial effect of bringing more high-wage jobs to the U.S. and at the same time increased lower wage jobs in Mexico. Why? Simply because America has a more highly-trained and productive work force.

As long as some companies benefit from protectionism, however, the public will hear protectionist arguments ranging from thoughtful and clever to emotional and nationalistic. But protectionism is one of the few subjects uniting almost all economists. Trade creates wealth and generates strong incentives for improvement and progress. Protectionism leads soon to stagnation and decline.

Economists would like to see the invisible dome of trade now pushed to the outside borders of Canada, the United States, and Mexico pushed still further to the far reaches of North and South America. And after that pushed further, perhaps to some distant galaxy.