Managing Trade's History

John Nye from the February 1997 issue

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The general reader may well wonder why, if free trade is so good, its adoption has been so exceptional. The short answer is politics. While Irwin's book is unimpeachable on the normative theory of trade--that is, a careful discussion of what state-of-the-art economic theory has to say for and against free trade--it is disappointing to see so little discussion of the politics of trade, particularly the work in public choice.

Few nations pursue free trade, and those that try often deviate from the theoretical ideal. Furthermore, as is now apparent, the most common forms of real-world protection do little to promote the general good. Modern public choice theory has abandoned the utopian assumption of an all-knowing, benevolent state seeking to maximize social benefit. It now studies policies as enacted by politicians responding to lobbying and the need to win elections. We need not assume corruption or venality. Rather, the incentives facing the typical politician are sufficiently skewed so that even the most well-meaning tend to promote the interests of the few at a cost to the many. We need to learn why governments that are subject to manipulation distort their domestic markets, and how persistent misinformation has ensured that even the educated classes remain ignorant of the most elementary notions of comparative economic advantage.

The gap between hypothetical instances when some protection may enhance the public good, and the policies actually implemented in the name of theory, is never more clear than in dealing with newer, "infant" industries. The claim is that newer companies competing with internationally established giants need time to develop behind tariff walls from which they will eventually emerge. In practice, protection merely encourages inefficient production, and in most cases temporary protections drag on indefinitely.

John Stuart Mill first made this idea widespread, but the strongest 19th-century advocate of the "infant industry" critique of free trade was the German Friedrich List, an inspiration to such modern-day nationalists as Buchanan. But even List never abandoned the goal of worldwide free trade, and he advocated protection only as a temporary measure for countries catching up with advanced industrial nations.

Yet more often than not, protectionism is used to protect not infant industries, but geriatric ones such as steel, textiles, and automobiles. List's name is also used to defend protections that contribute more to the stagnation than to the development of Third World nations, by keeping their industries bloated, technologically backward, and uncompetitive.

In the end, Irwin does us a great service in demonstrating that the theoretical argument against free trade boils down to the following three cases:

• First, those situations in which protection may be helpful if precisely targeted, such as temporarily aiding infant industries. (We would still be better off, however, keeping trade free and subsidizing such infant industries directly.)
• Second, situations involving industries with a large number of peculiar characteristics--such as significant returns to scale or huge spillover effects or winner-take-all effects--that may dictate counterintuitive strategies, such as selling at a loss for a very long time. The industries involved have to be so delicately poised that the first companies to enter a market reap all the rewards and no catch-up is feasible. Most important, one must assume ineffective capital markets that cannot foresee these problems, while postulating a government agency that can.
• Finally, purely political or distributional considerations that have little to do with promoting the nation's wealth. This case is the most intractable since the winners may well outnumber the losers, but the losers are so important to the government--or the public feels such sympathy for their plight--that political or emotional considerations about short-term job loss, or profit erosion, dominate the policy debate. But here too, free trade combined with direct assistance is a more efficient and humane policy.

  For anyone familiar with the history of economic thought, it ought to be clear that free trade remains the best practical policy involving the fewest complications and the greatest overall gain. Hypothetical exceptions only strengthen the soundness of this fundamental prescription. So it is extremely useful to have at hand such a scrupulous and lucid guide to the history of modern thought on the subject. It is also worth bearing in mind that the theory will continue to evolve and that scholars will continue their debate, but that in the end any successful exceptions to the norm of free trade will depend on state authorities having penetrating insight, superior knowledge, and extraordinary benevolence. This, unfortunately, will rarely be the case, no matter now sophisticated our scientific knowledge becomes.