Who Competes with Who?

President Trump (and other protectionists) like to frame international trade as a context: the domestic nation is competing with foreign nations and that imports must necessarily harm and exports necessarily help.  Aside from the numerous logical and mathematical issues with this interpretation, it is economically incorrect from the perspective of competition.

International trade represents the exchange of goods and services across political borders by individuals.  More simply put, it involves buyers on one side of an arbitrary line and sellers on another.  The fact this is buyers and sellers matter for a simple reason: buyers and sellers do not compete with one another.  They cooperate.

Buyers compete against other buyers.  Sellers compete against other sellers.  Buyers and sellers do not compete with one another.  The seller must offer a price acceptable to the buyer.  The buyer must offer a price acceptable to the seller.  The two will cooperate to make the exchange happen (or else they go their separate ways and other buyers and sellers step in).  What this indicates for international trade is this: when foreign producers are harmed, either through tariffs or quotas, they are not the only ones harmed: their domestic customers are harmed as well.  When Trump mentions “punishing” foreign companies for having the gall to offer Americans the best possible deal, what he is actually talking about is punishing Americans by reducing their options and preventing their cooperation with other people.

If we are to use the (highly misleading) language of nations trading with one another, this means that international trade is not a competition but rather cooperation.  It is impossible for one nation to be losing at trade because there is no competition!  Buyers and sellers cooperate.  When two nations trade, they cooperate.

Trade is Not Zero-Sum

On this post on Cafe Hayek, Per Kurowski writes in the comments:

Trade deficits per se do not worry me as much as a wrongly structured trade deficit. If current trade conditions permit other countries better chances to develop 1st class robots and the smartest artificial intelligence than mine, then I do fret for the future of my grandchildren. Let us not forget the “Arsenal of Democracy”

Mr. Kurowski makes a common mistake regarding trade: trade is not zero-sum.  If other countries are developing 1st class robots and smarter artificial intelligence, it does not necessarily follow that the domestic nation is made worse off by such innovations.  Indeed, the domestic nation stands to gain from such innovations.  A wealthier nation has more to offer the world.  More to trade means more trade.  More trade fosters more growth for both parties.  Even if a nation loses an absolute advantage in robotics or AI or something (as Mr. Kurowski postulates), it still becomes wealthier because of the Law of Comparative Advantage.

Mr. Kurowski also seems to insinuate that such gains by trading partners would pose a threat to national security.  I’ve written on the “protectionism for national defense” argument before, but it bears repeating that trade fosters peace, not violence.  There are two main ways to get what one wants: through cooperation or coercion; through trade or violence.  When trade is encouraged, peaceful cooperation takes hold.  Goods and services can cross borders, making all better off.  Since this trade is mutually beneficial, both nations face higher costs of breaking off those ties.  Even if the two nations get wealthier and can afford more expensive military equipment, the costs of war will rise quicker and the benefits of war fall.  With rising costs and falling benefits, the likelihood of conflict drops (we have seen this pattern take hold over the past few decades as trade liberalized).

If Mr. Kurowski is concerned about the future of his grandchildren, then he should welcome deeper trade ties among nations and not be concerned about trade deficits.  This would mean a wealthier and more peaceful world.  A move to protectionism would mean a poorer and more violent world.

Cooperation, Coordination, and the Law

Markets, by definition, rely on cooperation and coordination.  Buyers must cooperate with sellers in order to exchange; the seller must offer something the buyer wants and the buyer must offer something the seller wants.  Only through this cooperation can a trade occur.

Likewise, buyers and sellers must coordinate.  The buyer must be in the same place as the seller*.  A coordinating agent (ie a middleman) may sometimes be used to bring buyers and sellers together (think, for example, a realtor that brings home buyers to the home seller).  Similar to cooperation, buyers and sellers must coordinate on what to exchange and what their expectations are.

Cooperation and coordination are vital to the market process.

Economic texts tend to focus primarily on the coordinating and cooperation aspects of the market process, as they rightfully should, but a key factor is left out of the equation; that factor is the law.

Law here refers to the “rules of the game.”  Law is both written and unwritten; it is the set of rules, customs, norms, etc that develop through people’s interactions with one another.  Law, while shaped by peoples’ interactions, also shapes those interactions.

Law provides a useful form of coordination: who can sell what, what/how promises should be kept, what remedies exist for lawbreaking, that sort of thing.  Without law, and especially property rights, the coordination necessary for the market process would break down.

Consider, for example, property rights.  Property rights are a form of law; they may be formal (in the case of a deed registered at a local governmental authority) or it may be informal.  Property rights allow the market process to occur by defining who can trade what.  In other words, who owns the right to the use of a piece of property.  Ultimately what is being traded in any situation is a bundle of property rights.  If these are not clearly defined, then folks cannot know how to trade.  There cannot be coordination nor cooperation in this case.

Clearly-defined property rights are important to market transactions, but no property right will always and everywhere be perfectly clear.  We live in a world of “incomplete contracts.”  Not all possible situations can be anticipated and to write and understand property rights that take into account all possible conflicts is both physically impossible and economically wasteful (marginal cost exceeds marginal benefit).  In these ambiguities is where law also helps the market process.  Law, preferably by drawing on established rules of adjudication and precedent, can resolve these conflicts and allow the market process to function better (this was one of the great insights of Ronald Coase).

Law, of course, can have its own problems.  Just like any institution (including the market), it can be abused.  But it is vital to the coordination and cooperation functions of the market process.  Without law, trade cannot exist.  Only war.

*This place need not be physical