May 2018

10 Flagrant Fallacies about Free Trade

By Willem Buiter

Trade Wars are a threat to the global economy – of that there is no doubt. But like any threat with global implications it tends to attract a lot of wild assertions and misinformation. Here are 10 of the most common.

  • Trade surpluses and exports are good; trade deficits/imports are bad - As a general rule, imports are good and exports a regrettable necessity to obtain Imports. Boosting exports is one way to boost demand for domestically produced goods and services and thus to promote employment and capital utilisation. But specifically boosting exports or discouraging imports makes sense only if the rest of the world is overheating.
  • Import controls increase the trade surplus - Import controls discourage not just imports, they discourage trade – imports and exports. They have no unambiguous effect on the trade balance.
  • Foreign predatory practices (“dumping”) increase our trade deficit - Dumping does not necessarily increase the trade deficit of the dumper.
  • Trade surplus countries stand to lose more in trade wars than trade deficit countries - In general, countries with trade deficits stand to lose more in a trade war than countries with trade surpluses. The only exception is when boosting the trade surplus is the only way to tackle deficient aggregate demand.
  • Exports of services are less valuable than exports of tangible goods - Exports of tangible goods are not more valuable, economically, socially or environmentally, than exports of services.
  • Depreciation of a currency improves competitiveness - With ‘pricing to market’, a weaker currency raises the relative price of exports to imports, i.e., weakens competitiveness, lowers export demand and increases the demand for imports.
  • An improvement in competitiveness increases the trade surplus - Regardless of how responsive export demand and import demand are, a real exchange rate depreciation need not increase the trade surplus.
  • A devaluation of the currency boosts the trade surplus - A weaker currency increases the trade surplus only if (1) the responsiveness of import and export demand to competitiveness is high enough; (2) there is no ‘pricing to market’ and (3) only demand matters – we live in a Keynesian, effective-demand-constrained equilibrium.
  • Imposing import tariffs and subsidising exports will improve competitiveness – A given percentage subsidy on exports and the same percentage tariff on imports have no effect on anything that matters, including competitiveness. The real exchange rate will appreciate to undo any competitive advantage. The same applies to Border tax adjustment.
  • Unilateral free trade makes a country better off – Trade liberalisation or free trade doesn’t make everyone better off, even though the size of the national pie is likely to increase. Active trade adjustment assistance policies – (re)training, encouraging mobility – and preferably a full ‘flexicurity’ approach are necessary to ensure freer trade benefits for all.

Willem is a Special Economic Advisor to Citi

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