From the Wikipedia article on the Theory of Comparative Advantage
David Ricardo developed the classical theory of comparative advantage in 1817 to explain why countries engage in international trade even when one country’s workers are more efficient at producing every single good than workers in other countries. He demonstrated that if two countries capable of producing two commodities engage in the free market, then each country will increase its overall consumption by exporting the good for which it has a comparative advantage while importing the other good, provided that there exist differences in labor productivity between both countries. Widely regarded as one of the most powerful yet counter-intuitive insights in economics, Ricardo’s theory implies that comparative advantage rather than absolute advantage is responsible for much of international trade.
This insight is one of the fundamental arguments for free trade. “Increasing overall consumption” is econ-speak for “have more stuff” which correlates with well being. So if Country A does everything better, faster, cheaper than Country B you’d think that Country A would have no reason to trade with B. But Ricardo demonstrates that this is not true, and by having free trade both countries will be better off. Country A will buy things where Country B has a comparative advantage, even if Country B has an absolute disadvantage. You have to do read the article to see why this is true. If not, just take it as a given.
But not everyone in both countries will be better off, and there’s the problem. Let’s suppose that Country B sells product X to country A–either because of a comparative advantage or an absolute advantage. Everyone in Country A will be better off–except for the people in Country A who make product X–the people who have businesses making X, and the people who work in those businesses. They’d like tariffs to protect their businesses and jobs. See Wikipedia on Tariffs.
Consider Trump’s tariff on steel. Tariff or no tariff there are winners and losers. With a tariff, the winners are the companies and people who make steel. The losers are the consumers who buy things made out of steel–their costs go up; the companies that make end-products containing steel to sell domestically–since prices are higher they sell less; the companies that make end-products containing steel to export–since prices go up they are less competitive and sell less. And since steel is used to build machinery, the cost of machinery goes up and every product that’s made using machinery ultimately costs more and the companies that sell it sell less. But it gets worse.
Suppose a company imports foreign steel and builds an end-product for sale in the United States. Its choices: raise the price of the end-product, suffer a decline in sales and a loss in jobs; or move its entire operation offshore, import the end-product, maintain its sales (and profits) lay off all its workers. It makes no sense for a small company to do that; and there’s a large one-time cost to make the change. But for a large company (with lots of jobs) it could make sense.
Anyway, fun to be had on Monday.
A couple of articles
Trump says he’s going to apply the tariffs “flexibly” — which cynical people might interpret as a signal that the people who make the “flexible” decisions could be induced–some say “bribed” to make exceptions. Fortunately, I’m not a cynic.
See you Monday.