Revisiting the Case for Free Trade

By Jon Murphy. 

"Back in 2018, I wrote an Article for EconLib entitled “Does National Security Justify Tariffs?”  In that piece, I argued against the national defense justification for protectionist tariffs.  My main argument was tariffs on goods vital to national defense were unnecessary for the United States given our stable allies and that any supply disruptions would be short-lived as producers adjust.

But here it is in 2022.  For nearly two years, the US and the world have been dealing with chronic shortages of goods and services.  Many items needed for national defense and consumer demand, such as computer chips, are very difficult to procure.  The idea of tariffs to protect domestic supply chains are becoming vogue again, with none other than a prominent former Federal Reserve chair floating the idea.  My predictions seem to have failed.  Now seems to be the perfect time to revisit the case for free trade.

First, let me discuss why my predictions failed.  I did not foresee the events of the past two years.  They are unprecedented.  Never in human history has the entire world essentially closed up and gone home.  Global trade fell 25% and domestic producers were shut down or severely curtailed.  Even in my most pessimistic thoughts, I could not imagine such a collapse in trade.  In my 2018 article, I assumed trade flows would remain fairly stable, if only over land.  But that assumption did not apply to the policy responses to the COVID pandemic.

Additionally, I assumed a well-functioning price mechanism.  Prices would rise for needed goods, encouraging more quantity supplied.  During the COVID pandemic, prices were not allowed to function.  Price controls were slapped on all sorts of goods in the early days.  Firms faced rapidly increasing costs, coupled with decreased labor productivity, and the inability to raise prices.  Naturally, this would combine to reduced quantity supplied.  Add in forced closures and “work from home” orders, and firms could not increase productivity to meet rising demand.

The predictions I made in my 2018 article did not come true.  But does that imply that there is a case for protectionist tariffs after all?  Does the pandemic prove free trade is wrong?  I do not think so for two reasons:

First: Protectionism would not have helped in 2020.  It is true that other nations were shutting their borders and cutting off trade, but domestically the US was shutting down factories, too.  No amount of protectionism is going to help if workers cannot work.

Second: People respond to incentives.  Since costs 1) take place in the future and 2) depend on the realizable alternatives each person face, expectations play a large role.  Prior to March 2020, no one had expectations of a major forced global shutdown of economic activity.  But now, in 2022, expectations have changed.  Producers now must expect some probability of such behavior going forward. 

 Consequently, they face new costs and new benefits of global supply chains and “just-in-time” production networks.  How producers will respond to these new costs and benefits is anyone’s guess, but I suspect we will see more “near-shoring,” at least in the near term.  Market interventions only make sense if there is some reason for why the market fails to provide “proper” incentives.  But that is not the case for firms in 2022.  They do not need incentives from the government; markets have provided that for them.

One of the advantages to free trade is it allows people the leeway they need to make decisions given the costs and benefits they face.  As a rule, it is solid.  If society is to be truly progressive and forward-looking, we need general rules that are also forward-looking.  To impose protectionist tariffs based off the events of 2020 and 2021 would be reactionary, not proactive.  It would be binding, not freeing."