I often preface my posts on economics by saying “I’m not an economist” – I also often have discussions with my friend Ben – who is an economist – and based on his uni results and work history, a good one, before posting things. Today, rather than rehashing his comments on protectionism and the economics involved I’ll just reproduce them verbatim.
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Okay, you have a bunch of people working in for an Australian company in Australia. They get $20 and all profits remain in Australia. Assume a competitive industry so they receive the fair market price for their goods.
Compare with an overseas producer, who has labour costs of $5 a unit. There are arguments that offshore employees are less productive than domestic workers, but I don’t know about that. Anyway, they also have export costs of $2 to transport the items to Australia.
Thus, per unit the offshore company is always going to make $13 more per unit. In a competitive market, the price should come down to the opportunity cost of producing the item. Given as many offshore competitors should be able to enter the market as they want, the price of the item at market value will be somewhere around $15. There is no way that this item can be sold at a rate covering the value of the labour in Australia.
What does this mean? Well, most likely the level of protectionism we have isn’t just keeping shirt prices high, but also wages. If there were true globalisation, that should extend to a worldwide labour market, and a close level of parity of wages.
If the company went overseas, it would increase demand for labour upwards, and labour costs would go up to $6 per unit. Some Australians would now not be able to find employment at the same level, and would take jobs at $19 an hour.
So those are the first degree effects. If the market was always competitive, this shouldn’t have much effect on the market price of the good. if the level of protectionism inflated the market price, then there should be some drop in the price of item. In the current situation in Australia, the latter is the case, and there should be a drop in prices.
The idea of free trade is that people displaced from employment would move elsewhere, generally to industries that the nation has a comparative advantage in.
Let’s explain comparative advantage.
Country A:
wheat costs 2 units to produce
computers costs 5 units
country B:
wheat costs 10 units to produce
computers costs 50 units
In this situation, country A can produce both wheat and computers for less resources than country B. However, thought of differently,
country A:
wheat costs 2/5 unit of computers
computers cost 2.5 units wheat
country B:
wheat costs 1/5 unit of sugar
computers costs 5 units of wheat
Country A has a comparative advantage in producing computers, B in producing wheat.
now, for 100 resources:
A could make 50 wheat or 20 computers. B could make 10 wheat or 2 computers.
A focuses on making its comparative advantage, computers. It makes 20 computers. It trades 3 computers and gets 10 wheat. It now has 17 computers and 10 wheat, which it could not have produced before. And country B has 3 computers, which it couldn’t have obtained before. Any linear combination between A trading 0 and 4 computers for wheat can result in both countries obtaining a different level than otherwise obtainable.
So I guess that is the basis for why trade benefits all countries.
You mentioned farmers in your post. And in particular rice. Here is my comparative advantage of rice production for Australia vs. the world:
Australia
Rice costs 1000 units to produce
all other goods (a basket of other good) costs 10 units
Rest of world
Rice costs 1 unit to produce
all other goods costs 8 units.
Work through that example. Australia should never produce rice.
One good thing about free trade is our rice industry should take a dive, which is fair enough. I still think our farming industry retains inefficiencies due to our ridiculous farm protection policies. I think when you think farm protection, you are thinking maintaining farms. I think it would just result in a shift in farming to more efficient products/farming techniques.
But back to my point, and I touched on this in my thesis, when people nearing retirement lose their manufacturing jobs, they don’t really shift into other industries. There is less incentive for employers to retrain them given they only have a few years of working left, and the workers have low incentive for a range of reasons (including the fact they are angry hold men). And this grudge remains well into retirement, leaving a group of people who will always be anti-free trade.
I also don’t buy the whole ethical argument suggesting they are exploiting offshore labour. I think this is generally used as an emphatic argument that carries little weight but often thrown against companies who source labour overseas. The first point alone doesn’t make much sense, that the workers don’t get a lot of money for their work. On so many levels. If they weren’t getting much money they wouldn’t be working. True, their conditions may be worse than ours, but better than their current standard. Allowing full free trade should resolve this issue, as noted above. It’s only when trade trickles to these countries that their progress in workplace development is stunted. those people might not be getting a “fair” wage, but then you have to extend that argument to domestic matters, where it would appear the workers much by mirroring the argument also not be getting a “fair” wage (but a greatly inflated one). The “loss of traditional skills” argument I don’t think is relevant, again refer to the comparative advantage deal, and if it’s a free labour market there should still be a required allocation to the relevant markets. I don’t like to use analogy, but in the western world, the proportion of people today compared to prior to the industrial revolution, not many now know how to tend the fields, hustle cattle, build cottages, etc. why the developing world needs to be further stunted for the argument of losing traditional skills just seems like a kick in the face.
Comments
Hi Ben,
Many thanks for your article. I’m not an economist, but I’m interested. Perhaps you can answer a few of my questions for me.
Firstly, having grown up on a rice farm and with relatives still in that business, I had considered the level of government subsidy to be extremely low and the efficiency of the Australian rice industry second to none in the world (though America is slowly closing in). In some cases (like Japan though they are quite the example) their farmers are subsidised more per tonne than Australian farmers can sell their rice for!
So I guess my first question is, where have you got your rice statistics from?
Secondly, it would have been good to have had a discussion regarding the effect of market forces when one single nation or even just a couple produce a good for the rest of the world. Normally than sends prices sky high. I guess oil would be an example of this. But it can happen in industries that take years to reestablish too. Are we naive to think that this won’t happen?
Furthermore, doesn’t one also need to take into consideration the effect of a natural disaster or other issue when we rely on just one or a few nation. By relying on one or few suppliers who then become adversely effected by a single disaster local economies are severely effected as prices for simply things like rice shoots for the stars.
Just finally, what impact should the observation that free trade is never free trade have on our thinking? i.e. someone always has power in a relationship, and can extract a better price. The result is that poorer nations always get a dud deal when dealing with bigger nations. Do you have any suggestions for how we might address this problem in a fully free market situation?
Many thanks
Mike
Hi Mike,
Thanks for commenting – I’ve passed your comment to Ben because he very rarely ventures onto my blog (he prefers to have my posts emailed to him).
The natural disaster point I guess is particularly interesting given that Myanmar (formerly Burma) is currently experiencing a massive rat plague wiping out most of their rice crops.
Will let you know if I get a reply from Ben.
Nathan – you should have warned people replying to this that once you start Ben on this argument it will never end!
I swear I got grey hair from the last debate Tim and I had with him about this.
Here’s Ben’s unedited reply…
That raises many good points. i could write for days discussing this stuff. its a very interesting topic.
Your point about a natural disaster is a good point i think. from a world view, allowing vital goods to be produced in one location would be poor foresight, and i dont think is likely to occur. placed in context of rice though im not sure it is realistic. especially when australia’s rice production is so volatile and so small (relative to teh world market). if we are in a position that we can’t import rice, the world would be in a drastic position.
The prior point I guess is akin to the arguement if war broke out we would need to maintain all necessary industries incase we didn’t have access to them anymore. many ppl disregard the issue these days, that countries should preserve a wide range of industries incase they need them for a rainy day. I guess you would have to say the modern ideology towards this issue is an assumption that world relations have improved and we are approaching a global economy with complete free trade. Keeping industries incase we lose access to them is a good point, but at the same time not allowing trade keeps poor countries poor. not allowing free trade is actually a factor in creating hostilities, poor conditions in deprived countries, etc etc. this i think is a somewhat valid arguement for protection, but in the case of Australia’s rice industry is a bit unrealistic, keeping a small rice industry “just incase” seems like a bit of a luxory.
i find it odd you focused on the rice industry, given the current situation in our manufacturing industry a more upfront example of this point. but lets ride with it as it has been an interesting topic of mine for a few years now.
I don’t think i reported any rice statistics, the example was to demonstrate how the concept of comparitive advantage works, and the numbers were made up. However, I will point you to certain sections of the latest ABARE Australian Commodities report (rice isnt my forte, its a smaller industry i don’t usually pay much attention to, another person here bought it up, but ABARE is generally the base source for most of the agriculture data I use, even though i have some questions over its accuracy),
“The availability of irrigation water remains a critical issue for irrigated broadacre and dairy farms in 2008-09. Many irrigated farms continue to operate with allocations of water significantly lower than licensed entitlements. Some improvement in water storage levels in 2008-09 has resulted in an increase in the area planted to cotton and rice, but the area planted is still historically low.”
World production of Rice is a bit over 400 megatonnes, of which australia has produced up to 1000 kilotonnes in the most recent good years, however more recently (and forecast for coming years) production is to be negligible. The area of rice planting has declined from a recent peak of about 100 thousand hectares to only a few hundred thousand in recent years (all sourced from ABARE). put in context, the total area of grains and oilseeds planted is about 22000 thousand hectares in Australia, so rice is not a very big land-eater. if a natural disaster takes out other rice producing nations, i dont think many ppl will be eating rice if they are relying on australia (and we will probably be exporting all ours due to the higher returns).
Subsidisation of industries is important in maintaining industries which are not profitable. that is not really relevant to the rice industry. ABARE suggest that the world price of rice is to remain strong over coming years, with export earnings to improve, so I think profitability should remain high. In isolation, i think most industries would be profitable. its the bigger picture when trying to maximise total utility where certain industries look more dour.
I am not sure what exactly you mean by efficiency, but at a guess you are refering to the farming techniques used by australian farmers, which one would have to assume would be amoungst the highest in the world. The issue here is more of opportunity cost and comparitive advantage. the rice farm may be profitable, but if it is in the place of 20 times the area of wheat farms, is it still a good move? I am not sure how easy it is for rice farms to rotate crops, but the dependence on rice produciton on water availablity (as cliched as the arguement may seem) suggests that if farms find it difficult to rotate these kinds of crops, then the current drop in rice plantings becomes even more of a concern if it means some resources are idle at present that may have been used more efficiently (as in efficient resource allocation) otherwise.
I am not sure what your point with Japan was, but if their rice industry isnt viable, then I’m not sure if that makes Australia’s any more viable.
Next up, a market price is affected by the supply. a single nation could only maintain being the sole supplier to the entire world if they have some form of protection/monopoly. rice isnt one such object. if one nation produced enough rice for the entire world, and there was free trade, the market price would be confirmed by simple supply/demand forces (ie would be a fair market price). if the country decided to set prices above the market price, everyone else would start making it. this situaiton isnt viable. more countries would start producing rice until the opportunity cost leveled out. there are no bars to entering the rice market. not every country has oil to extract from the ground, but every country could attempt (to varying degrees of success) to grow rice. some ppl might argue that if we give up the rice industry now and we need it back, we won’t be able to do that. it may be difficult to re-develop a rice industry, however i don’t think it is impossible. but for a s!
ingle country to be the sole producer of rice would take a pretty drastic turn of events anyway, but since a single nation can’t realistically continually control supply of rice its not a realistic situation. If supply is low, relative to demand there will be a period of higher rice costs (which we are in a sense experiencing at the moment). but this again doesnt directly address the question of whether australia should maintain a rice industry. you would think given our position of a tiny producer of rice, at the will of world market forces, there isn’t really much reason for australia to be concerned with maintaining the industry from this standpoint.
the final point is a huge question. the fall in commodity prices recently has been well documented. i think it demonstrates how forcefully the market can reacte to changing conditions. i am not sure i agree with the point free trade is never free trade. i agree fully that many markets are distorted for a wide range of reasons. im not sure poorer nations get a dud deal when dealing with bigger nations, especially not in commodity prices. smaller nations are pretty much at the will of the market price. the additional costs they are often exposed to are exchange rate movements, shipping (which is an internal cost) and tariffs (which are also set internally so would only hurt themselves).
when it comes down to it, rice over the past few years has pretty much succumbed to itself due to the fact it isnt an overly viable product. farmers in australia are themsleves moving away from it, which is probably the best indicator of all that it is not a good fit.
“The “loss of traditional skills” argument I don’t think is relevant, again refer to the comparative advantage deal, and if it’s a free labour market there should still be a required allocation to the relevant markets. I don’t like to use analogy, but in the western world, the proportion of people today compared to prior to the industrial revolution, not many now know how to tend the fields, hustle cattle, build cottages, etc. why the developing world needs to be further stunted for the argument of losing traditional skills just seems like a kick in the face.”
I don’t entirely agree with you here, because I think Western society has gone too far the wrong way in NOT having these sorts of skills, particularly in basic ‘farming’. I think we need to be more responsible for growing our food, as the agricultural practises in place to provide for millions who don’t know how to grow food, or for who there isn’t a local market gardener etc, are unsustainable and unhealthy.