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Review Question

Barriers to Trade

If the gains from free trade are clear theoretically, why are there tariffs and quotas? One important reason is that the costs of tariffs are defused and hard to see, whereas the benefits are concentrated and easy to see. A tariff or quota raises the price of a product. This will harm consumers of the product, but will benefit the domestic producers of the product. If the harm done to consumers is spread over a great many people, and if the exact amount of harm done to each is unclear and small, they may do little lobbying to protect themselves. (Remember the rationally ignorant voter.) If the benefits to producers are clear and concentrated on relatively few, the producers will lobby for protection. Thus, the pressures that political leaders face may not reflect the ratio of total costs and benefits of the action.

However, the fact that there are both winners and losers to any change in tariffs and quotas raises a problem. The nature of this problem can be illustrated with a numerical example. The table below gives three distributions of four fish and seven coconuts between Crusoe and Friday, and the value Crusoe and Friday put on another coconut or fish. The condition of exchange efficiency indicates that distribution A is not efficient. Friday places much more value on another fish than he places on coconuts, whereas Crusoe considers them of equal value. Both Friday and Crusoe can gain from trade.

Three Distributions of Goods
Value of fish in terms of coconuts



3 fish
3 coconuts

1 fish = 1 coconut


1 fish
4 coconuts

1 fish = 5 coconuts



2.3 fish
4 coconuts

1 fish = 2 coconut


1.7 fish
3 coconuts

1 fish = 2 coconut



3.3 fish
5 coconuts

1 fish = 2 coconut


0.7 fish
2 coconuts

1 fish = 2 coconut

Distributions B and C are both exchange-efficient. In both distributions, Crusoe and Friday consider fish twice as valuable as coconuts. No rearranging of fish and coconuts can take place without harming one.

Moving from distribution A to distribution B is a move from an inefficient distribution to an efficient one, which might happen with voluntary exchange. In distribution A, Crusoe thinks fish and coconuts have the same value, so he should be willing to give up .7 fish to get another coconut. In distribution A, Friday thinks fish are five times as valuable as coconuts, so he should be willing to give up one coconut to get .7 fish. After the trade, the law of diminishing marginal utility would change valuations. Crusoe has less fish, so he values another unit of fish more; and he has more coconuts, so he values another unit of coconuts less.

A move from distribution A to distribution C is also a move from an inefficient to an efficient distribution. However, this move would not take place voluntarily. Crusoe's well-being is improved, but Friday's has decreased. This is the sort of change that occurs when a tariff is removed. (Imposing a tariff involves a move similar to a move from distribution C to distribution A.) A person claiming that distribution C is better than distribution A implies that the gain to Crusoe is of greater value or importance than the loss to Friday. This seems arbitrary. To make it seem less arbitrary, some economists have suggested that if the gain to Crusoe is large enough so that he could pay Friday enough to reimburse him for his loss, then the change was desirable even if payment is not made.

This problem of change harming some and helping others is not confined to the issue of tariffs and quotas. Any non-trivial change involving an outward shift in the production-possibilities curve in a complex social system will aid some and harm others. The development of the automobile harmed those who produced buggies. The development of the electronic calculator harmed those who produced slide rules and mechanical calculators. In England between 1811 and 1820, organized bands of craftsmen called "Luddites" protested the threat of new techniques by smashing textile machinery that was displacing them. The list of examples of changes harming some and helping others is very long. The destructive nature of change was captured in the phrase that Joseph Schumpeter used to describe the most noteworthy aspect of capitalism: "the process of creative destruction." Because so many changes involve both groups that are harmed and groups that are helped, the concept of economic efficiency is of little use in making policy judgments unless one is willing to make some interpersonal comparisons.

One could argue for tariffs and restraints on trade by acknowledging that a few will be helped and many harmed, and arguing that the well-being of the few should be given more importance than the well-being of the many. But no one ever publicly argues for protection in this way. Most public arguments for protection are simply wrong because they do not acknowledge that anyone will be hurt. However, there are a few special cases in which an appealing and logically correct argument for protection can be made.

One such argument is the "infant industry" argument. A country may have a comparative advantage in a product once the industry is established, but it may need protection to build up to the point at which it can successfully compete. Though sound on paper, this argument is subject to considerable abuse in practice. It is difficult to forecast which industries will actually be able to compete successfully when mature, and hence many unneeded tariffs may be enacted. Further, once a tariff is in place, it may be difficult to repeal even when it is no longer needed for "infant" protection. No one gives up government favors without a fight.

Two other arguments rely on a division of the world into us-them categories, a division that political borders encourage. People do make these divisions--most people find that news about disasters affecting one's countrymen are more distressing than the same disasters affecting foreigners, even though both are complete strangers. Though economics rarely incorporates these divisions into its analysis, politicians respond to them.

The first of the us-them arguments is a national defense argument. If foreign competition threatens a skill or industry that would be necessary during wartime, the government may decide that protecting the skill or industry is necessary. The second argument notes that though the total harm to transactors will exceed the amount of revenue that a tariff brings to the government as tax revenue, the harm is borne both by domestic buyers and foreign sellers. Under certain conditions, the foreign sellers may bear enough of the harm so that the loss to the domestic buyers is less than the amount that the government collects. In this case, it may be in the country's (though not in the world's) interest to establish a tariff. However, this type of situation may be relatively uncommon in the real world because it requires that the nation imposing the restrictions buy or sell a great proportion of the item that is restricted.

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Copyright Robert Schenk