Protectionism: A guest post

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.

Protect and serve?

Discussion is ongoing on yesterday’s post about protectionism and misguided “buy local” campaigns. I didn’t mention the “sustainability” side of that debate – which is probably valid. It doesn’t make sense for major grocery stores to ship produce from North Queensland to warehouses in Victoria then back to North Queensland for sale – at that point I will join the brotherhood of sustainability and cry foul (fowl if we’re talking about chickens…). I didn’t mention it because it’s not the problem I have with “buy local” campaigns – which is that they don’t do what they claim to do, namely “protect local jobs”.

Buying local works to protect Australian farmers. There’s no denying that. But the insidious campaigns stretch further than the farm gates But we have plenty of other primary producers whose cause is harmed by drops in demand for our resources overseas (which are in part due to drops in demand for all sorts of product on a global level – particularly from the US).

But that’s just rehashing the point I’d already made yesterday. In a slightly more coherent form.

There were a couple of points raised in the comments that are worth rehashing – particularly if you haven’t read them.

“Buying coffee grown in Australia at a local coffee store, rather than coffee grown in Costa Rica at Starbucks.” – Stuss.

Ahh, a subject close to my heart. The argument I’d make at this point is that Australian made doesn’t necessarily guarantee quality. You might feel nice paying three times the price you’d pay for foreign grown produce for local stuff – but in some cases you’re paying more for an inferior product. Coffee is a great example. If you want premium quality Australian coffee you’ve got to pay a premium price – and it still won’t be as good as stuff grown in the ideal conditions.

Her next point in a subsequent comment touches on the whole fair trade debate.

“There are ethical implications in buying goods made elsewhere. A big reason why companies shift that manufacturing off shore is that it can be done cheaper. Much, much cheaper. Which means the people doing the manufacturing aren’t getting a lot of money for the job. On one hand, it is good that some of these people are getting the employment at all. But on the other hand, sometimes these people are being exploited, and not receiving a fair wage. Or they are coming away from their villages and subsistence farming lifestyle to work in the factories and losing traditional skills. Which one outweighs the other?”

Those sweatshops employing and exploiting workers for the sake of fashion are a different matter, that’s an ethical question not a question of economics – and therefore not within the scope of this rant.

I don’t see how buying local and doing these overseas people out of the jobs they’ve won that are often literally putting food on the table – particularly when following through the argument using coffee farmers as an example – is doing the coffee farmer a service. In the case of agriculture – and particularly for argument sake the case of coffee – we’re not talking about farmers leaving subsistent living, we’re talking about third and fourth generation farmers who have been exporting coffee since coffee exporting began. Aussie Joe who decides to plant his coffee plantation in Atherton – where conditions aren’t as good as conditions elsewhere and thus the coffee flavour isn’t as rich – is doing a disservice both to the palate and to the global coffee market.

The fundamental economic principle of supply and demand means that if there’s an oversupply of a poor quality version of a particular variety of product and a largely uneducated audience the price of the good stuff either has to significantly alter or die out (or become an “exclusive” product for the rich and famous). Throwing in a “buy local” campaign artificially inflates the price of local coffee and punishes the foreign growers. It’s not a level playing field. And it’s an incentive for businesses that should probably fail. Because their product is inferior.

Amy made a similar point about rice but from a sustainability rather than quality standpoint in the comments on the last protectionism post…

“I don’t think it is okay to buy Australian grown rice, because rice is totally unsuited to our environment and therefore needs far more resources than an imported product.”

I wonder what the typical elements in the purchase equation are? You could no doubt express it as a funky Venn diagram – in fact I’m sure it’s already been done somewhere… but I’d say price, sustainability, ethics, and quality are all in the mix. Are there any others?

Protect us from ourselves

I got this email today, from a colleague.

“Joe Smith started the day early having set his alarm clock ( MADE IN JAPAN ) for 6am . While his coffeepot ( MADE IN CHINA ) was perking, he shaved with his electric razor (MADE IN HONG KONG ). He put on a dress shirt ( MADE IN SRI LANKA ), designer jeans ( MADE IN SINGAPORE ) and tennis shoes ( MADE IN KOREA ). After cooking his breakfast in his new electric skillet ( MADE IN INDIA ) he sat down with his calculator ( MADE IN MEXICO ) to see how much he could spend today. After setting his watch ( MADE IN TAIWAN ) to the radio (MADE IN INDIA ) he got in his car ( MADE IN GERMANY ) filled it with Petrol from Saudi Arabiaand continued his search for a good paying Australian JOB At the end of yet another discouraging and fruitless day checking his Computer (MADE In MALAYSIA ), Joe decide to relax for a while.. He put on his sandals ( MADE IN BRAZIL ) poured himself a glass of wine (MADE IN FRANCE.! ) and turned on his TV ( MADE IN INDONESIA ), and then wondered why he can’t find a good paying job in … Australia….. “

Is it just me or is protectionism so hot right now? “Buy local” campaigns are the new economic black. I think A Current Affair is running a story (or they have already run it) encouraging their legion’s of viewers to buy Australian made. It’s odd. And pretty stupid. In fact I think it’s just clever marketing and a nice, easy PR campaign to boot. Who’s not going to cover a story about keeping locals in jobs. It seems the first thing advertisers do in a recession is call for protectionism – buy local campaigns etc…

Magnetic Island is in the midst of a protectionism row at the moment after a local operator missed out on a tender to a Sydney based comments. This operator’s comments to the local paper that these fly by night Sydney operators would “be crucified” if they tried setting up on the island no doubt does our region a world of good as we try to attract investment and tourists. Here’s a message to you new businesses from the businesses on Magnetic Island… “die or we’ll kill you”. Nice.

The campaign to reverse the Townsville City Council’s incredibly above board tender decision took on new legs over the weekend with a protest group carting around signs that said “Beach Hire is un-Australian” and “local jobs for locals”… Apparently coming from Sydney is un-Australian now. Basically this guy thought the job was his by right – and barely even scraped together a tender (and submitted it after the closing date). He lost. That’s life. Move on.

I like to preface these pretty broad posts by saying “I’m no economist but” so here’s the standard disclaimer. I’m no economist but in the face of a global financial crisis it doesn’t make sense to be acting in the national not global interest – because to me, the bigger problem for Australian jobs is the rapidly collapsing resource sector. A collapse fuelled by slowing demand from overseas. That’s right. We export this stuff. So we need other countries to be in a financial position to buy our stuff.

This is why I think the fact most of the stimulus package being spent on things produced overseas is a good thing. Sure, buying local is good. But buying foreign made is ok. And why should we value employment in our prosperous country with better than adequate social security over jobs in other countries with non-existant unemployment payments?

I’ve had a few conversations with a few people who “don’t want the money from K-Rudd” on principle. That’s fine. Give it to me. I’ll spend it wisely.

These conversations go along these lines:

1. We should be helping big business that’s how to fix the economy
2. We should be investing in infrastructure that’s how to help the economy – we need to be ready for the next resources boom…
3. This money is only going to keep retail employees in jobs – and most of it will go overseas to China.
4. It’s a big debt that we can’t afford to pay now – and it will be a burden on future generations.

From my very, very laymans meta-analysis of the current economic situation the downturn in Chinese production fueled by the lack of demand for their products seems to me to be a pretty prime factor in our resource prices tanking.

Pouring money into Chinese manufacturers is a good thing because not only will it give us access to technology as they develop it to suit demand, it will also stimulate demand for our resources – there won’t be another resource boom if other countries don’t want to grow and develop.

Sure, we could have a locally driven resource boom. But then the Greens would get angry that we’re chopping down trees to pave paradise for multi-storey car parking.

The debt thing is an issue – but once we’ve decided to spend money saving the economy rather than letting it tank completely and picking up the pieces the solution is going to require spending money, and governments are really the only entities in a position to borrow.

So here’s the response I sent to my colleague… some of the points are a stretch – but I wish sometimes people would think a little bit past the obvious “that money’s going to support a Chinese person not an Australian person” bias.

“Joe Smith started the day early having set his alarm clock ( MADE IN JAPAN – using Nickel from Townsville) for 6am . While his coffeepot ( MADE IN CHINA (using aluminium mined in Australia) – (with coffee grown on the Atherton Tablelands ) was perking, he shaved with his electric razor (MADE IN HONG KONG ) (using technology developed in Australian universities). He put on a dress shirt ( MADE IN SRI LANKA – using cotton grown in Australia ), designer jeans ( MADE IN SINGAPORE – also using Australian cotton) and tennis shoes ( MADE IN KOREA using Australian leather ). After cooking his breakfast in his new electric skillet ( MADE IN INDIA from Australian steel ) he sat down with his calculator ( MADE IN MEXICO using components made from Australian resources ) to see how much he could spend today (based on Australian research). After setting his watch ( MADE IN TAIWAN using Australian components and sold to him by an Australian salesman ) to the radio (MADE IN INDIA and installed, repaired and serviced by Australian technicians ) he got in his car ( MADE IN GERMANY – sold in Australia by a local dealer who employs local mechanics – unless the locals are so lazy that he has to bring in workers from overseas ) filled it with Petrol from Saudi Arabia (shipped to Australia by an Australian company, transported by Australian truck drivers) and continued his search for a good paying Australian JOB (he wasn’t looking hard enough) At the end of yet another discouraging and fruitless day checking his Computer (MADE In MALAYSIA ), Joe decide to relax for a while.. He put on his sandals ( MADE IN BRAZIL – That is unAustralian – he should have been wearing pluggers) poured himself a glass of wine (MADE IN FRANCE.! – again, there’s plenty of good Australian wine) and turned on his TV ( MADE IN INDONESIA filled with Australian content), and then wondered why he can’t find a good paying job in … Australia….. probably because nobody wants to buy our resources anymore because we’ve stopped buying stuff, or he’s too lazy to do anything he considers “menial” or beneath him…”