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Tire Trade Tirade

October 12, 2009

Tags Corporate WelfareFree MarketsGlobal EconomyInterventionism

In 2002, President George W. Bush helped make us poorer by signing off on higher steel tariffs. In 2009, President Barack Obama helped make us poorer by signing off on higher tire tariffs. Is this supposed to be change we can believe in?

Economic analysis shows that trade creates wealth. The law of comparative advantage demonstrates that when we specialize and trade, we produce more wealth using the same resources. Preventing trade means that we use more resources to produce less wealth.

A simple example illustrates the essential logic of comparative advantage. Suppose Amy can produce either one hundred oranges or ten tires in a day while Chen can produce either ten oranges or two tires in a day. At first glance, it doesn't look like they have anything to gain from one another: Amy is much more productive than Chen.

When we compare their opportunity costs, however, a different story emerges. The opportunity cost is what you have to give up to get something else. To produce one hundred oranges, Amy gives up the opportunity to produce ten tires. Her opportunity cost of an orange is one tenth of a tire, and her opportunity cost of a tire is ten oranges. Chen's opportunity cost of an orange is one fifth of a tire, and her opportunity cost of a tire is five oranges.

In terms of tires, it is cheaper for Amy to produce oranges because she only gives up one tenth of a tire to produce an orange while Chen has to give up one fifth of a tire. In terms of oranges, it is cheaper for Chen to produce tires because he only gives up five oranges to produce a tire while Amy gives up ten oranges to produce a tire.

They can both have more oranges and more tires if they specialize and trade. Suppose Chen offers Amy one tire in exchange for seven oranges. Chen would be better off because he would get seven oranges in exchange for one tire, whereas he would only get five oranges in exchange for one tire if he produced them himself.

So if Chen is better off, Amy has to be worse off, right? Wrong. This is an attractive deal for Amy too, because she can get a tire for only seven oranges, which is fewer than the ten oranges she would have to give up if she produced tires herself. At any "orange price" of tires between five and ten, Amy and Chen are both better off.

Economists have shown that the same logic applies to trade between countries as well. Simply replace "Amy" with "the United States of America" and "Chen" with "China," and you can easily see that both countries are better off if they can specialize and trade.

This law of comparative advantage is one of the most important and most poorly understood ideas in economics. It is also an anvil that has worn out many hammers. In spite of repeated objections from noneconomists and even a few theoretical counterexamples from economists, the law of comparative advantage remains robust.

Tire protectionism has other unintended but predictable consequences as well. Since we are poorer, we have fewer resources to invest in education, health care, and innovation. Also, higher tire prices means that some people will drive on worn-out tires longer than they otherwise would, which increases accident risk and will likely lead to more highway deaths.

There is another effect that goes beyond simple economics 101. In addition to an introductory course, I also teach courses in economic history and the history of economic ideas. In these classes, I focus on the role of institutions, ideas, communities, and secure private property rights in historical economic change.

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"Preventing trade means that we use more resources to produce less wealth."

The president's capitulation to special interests tells people that they can expect the government to take care of them when things do not go their way. It encourages people to invest resources in picking others' pockets rather than producing wealth. History is littered with the dry bones of civilizations that encouraged Peter to get rich by robbing Paul. Protectionism is a step toward the dustbin of history.

The salutary effects of trade are sometimes hard to see, but they are very real and very important. By embracing protectionism, President Obama has adopted a policy that works against his supposed concern for Americans' well-being by reducing innovation, destroying wealth, perverting incentives, and encouraging destructive nationalism. Protectionism gives politicians an opportunity to appease special interests, but we're all worse off for it.

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