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The benefits of free trade

History has shown that trade can be a powerful engine of economic growth. Despite this, the number of protectionist policies adopted around the world has increased.

This is due to a growing tendency to view commerce as a competition rather than a cooperative enterprise. For proof, consider the ongoing trade war between China and the United States, which has impacted everything from electronics to soybeans.

The economic costs of this dispute are well documented. In 2019, Moody’s Analytics found that the trade war had cost 300,000 jobs in the United States. In 2020, the Federal Reserve concluded that American companies had lost $1.7 trillion market capitalization due to the introduction of new tariffs.

In this infographic from the Hinrich Foundation, the first in a three-part series on global trade, we explain the theory of free trade and explore a powerful body of evidence that refutes the rationale for protectionist policies.

Why do we trade?

The main reason countries trade is to specialize their production. This is when the people of a country can focus on what they do best. For example, consider Germany’s expertise in automobiles or America’s leadership in technology.

These countries use their comparative advantages to generate a greater surplus than if they produced all their needs alone. Through exchange, they can exchange their excess production (exports) for the production of others (imports).

Imports are what facilitate the benefits of trade. These are goods that people consume without having to produce, and they can help reduce costs, catalyze greater competition and even spur innovation.

A new era of de-globalization

Between 2001 and 2008, trade increased enormously. In dollars, it went from $15.6 trillion to $40.7 trillion, an increase of 160%. More importantly, as a share of global GDP, it fell from 47% to a peak of 64%.

Year Trade (export + import) World GDP (USD) Trade (% of GDP)
2001 $15.7 billion $33.4 billion 47%
2002 $16.4 billion $34.7 billion 47%
2003 $19.1 billion $38.9 billion 49%
2004 $23.2 billion $43.9 billion 53%
2005 $26.6 billion $47.5 billion 56%
2006 $30.5 billion $51.5 billion 59%
2007 $35.4 billion $58.1 billion 61%
2008 $40.7 billion $63.7 billion 64%
2009 $32.5 billion $60.4 billion 54%
2010 $38.6 billion $66.1 billion 58%
2011 $45.6 billion $73.5 billion 62%
2012 $46.2 billion $75.2 billion 62%
2013 $47.5 billion $77.3 billion 61%
2014 $48.5 billion $79.5 billion 61%
2015 $43.2 billion $75.2 billion 57%
2016 $42.3 billion $76.4 billion 55%
2017 $46.6 billion $81.3T 57%
2018 $51.3 billion $86.3T 59%
2019 $50.5 billion $87.6 billion 58%
2020 $45.1 billion $84.7 billion 53%

Since then, the number of protectionist trade policies has increased by 663%. This includes customs duties, which are taxes on foreign goods, and import quotas, which are limits on the quantity of imported goods.

These measures seem to have a significant effect on trade. As a percentage of GDP, it never returned to its 2008 peak, and in 2020 it fell an alarming five percentage points.

The fallacy of us Vs. Their

A growing number of governments view trade as a competition between “us” and “them”. This could be because the costs of trade are visible, while the benefits are largely invisible.

Consider a company struggling to compete with low-cost foreign producers. It puts an end to its activities, leading to job losses and an abandoned factory. These are the visible costs of trade, and when covered by the media, trade is portrayed in a bad light.

So what exactly are the benefits? For starters, consumers benefit from the availability of cheaper products. Not only can they buy the same things for less, but they also have more money to buy other goods and services. This additional spending will then contribute to growth in other sectors of the economy.

“The benefits of trade are the resources that become available for investment in promising new businesses and industries. It is by making better use of resources that we increase the standard of living and wealth.
– Daniel Ikenson, economist

To see if these benefits outweigh the costs, we analyzed the economic performance of the United States from 1975 to 2019. In the vast majority of those years, GDP moved in the same direction as imports. This means that in years when imports increased, GDP also increased.

However, this does not mean that an increase in imports will directly increase GDP. On the contrary, GDP increases when the additional spending that has been freed up is allocated efficiently. The same positive relationship is observed between imports and employment, which challenges the belief that imports lead to a net loss of jobs. Indeed, imports increase when an economy grows, and an expanding economy creates more jobs.

The case for trade liberalization

When it comes to free trade, domestic politics and geopolitical struggles seem to take center stage. Consider the medical equipment shortages seen in the early stages of the COVID-19 pandemic – this was partly due to harmful tariffs that disrupted the free flow of goods.

This is problematic because the most powerful benefits from trade are realized through imports. These cheaper goods give consumers greater purchasing power, which benefits other sectors of the economy.

In the next part of the Hinrich Foundation sponsored series on global trade, we will explore digital commerce and its impact on the global economy.