A Case Against Free Trade

I'm generally for allowing trade to occur between entities with as little interference from government(s) and others as possible.  I'm pretty vocal about that, so people are often very surprised when they learn that I'm NOT for completely free international trade.

Let's start with a specific definition for Free Trade found by typing "Free Trade Definition" into Google:

free trade noun

noun: free trade; modifier noun: free-trade 

1. international trade left to its natural course without tariffs, quotas, or other restrictions.

I'll focus on tariffs because that's my preferred way of "restricting" trade.  A tariff is just a tax.  Taxes are required for governments to operate.  Even radical libertarians think that at least a minimal government is required for civilization to flourish and therefore, taxes of some sort (or multiple sorts) need to be collected from somewhere.

I've yet to see a good argument why the tariff sort of tax is less legitimate than any other sort of tax such as the sales tax, income tax, real estate tax, estate tax, capital gains tax, health tax, etc.  To the extent that revenues from tariffs can replace those other taxes, I don't think that tariffs are any more onerous for an economy and society than any of those other taxes.  In addition, tariffs are a fairly efficient tax in that there are a limited number of ports where goods can enter the country, as opposed to income tax where 300,000,000 individuals in the United States alone have to file.

Trade enables specialization.  Specialization leads to efficiency and innovation and enhanced wealth creation, leaving the trading entities better off overall, potentially far better off.

But I think that the incremental advantages of trade diminish as the scale increases.  Two people trading with each other are much better off than each doing everything for himself, 100 people better off than 2, a million better off than 100, etc., but it may break down at some point.  500 million may be better off trading with each other compared to restricting trade within groups of 50 million, or maybe not.

How about 5 billion versus a half a billion?

My guess is no.

Consider the approximately half billion people in the North America Free Trade Area (NAFTA).  It contains labor from first and third world countries, at least some of nearly all natural resources required for any economy, and extensive diversity of people and geography. I think that NAFTA and the trade that occurs within it is a good thing and very beneficial for the countries that are members.

But I think that if we expand beyond NAFTA, the adverse effects of the chaotic nature of trade will begin to overwhelm the benefits of specialization and economies of scale provided by trade.  As a result, I think that NAFTA should impose across-the-board, uniform tariffs on all goods coming into it and that the Eurozone and other free-trade areas should do the same.

A description of the chaotic nature of markets is provided by Professor David Ruelle in his book Chance and Chaos:

A standard piece of economics wisdom is that suppressing economic barriers and establishing a free market makes everybody better off.  Suppose that country A and country B both produce toothbrushes and toothpaste for local use.  Suppose also that the climate of country A allows toothbrushes to be grown and harvested more profitably than in country B, but that country B has rich mines of excellent toothpaste.  Then, if a free market is established, country A will produce cheap toothbrushes, and country B cheap toothpaste, which they will sell to each other for everybody's benefit.  More generally, the economists show (under certain assumptions) that a free market economy will provide the producers of various commodities with an equilibrium that will somehow optimize their well-being.  But, as we have seen, the complicated system obtained by coupling together various local economies is not unlikely to have a complicated, chaotic time evolution rather than settling down to a convenient equilibrium.  (Technically, the economists allow an equilibrium to be a time-dependent state, but not to have an unpredictable future.) Coming back to countries A and B, we see that linking their economies together, and with those of countries C, D, etc., may produce wild economic oscillations that will damage the toothbrush and toothpaste industry.  And thus be responsible for countless cavities.  Among many other things, therefore, chaos also contributes to the headache of economists. 

Let me state things somewhat more brutally.  Textbooks of economics are largely concerned with equilibrium situations between economic agents with perfect foresight.  The textbooks may give you the impression that the role of the legislators and government officials is to find and implement an equilibrium that is particularly favorable for the community. The examples of chaos in physics teach us, however, that certain dynamical situations do not produce equilibrium but rather a chaotic, unpredictable time evolution.  Legislators and government officials are thus faced with the possibility that their decisions,  intended to produce a better equilibrium, will in fact lead to wild and unpredictable fluctuations, with possibly quite disastrous effects.  The complexity of today's economics encourages such chaotic behavior, and our theoretical understanding in this domain remains very limited.

A graphical example of "tipping" points in a chaotic system is shown by the bifurcations in the following graph:

The system is perfect stable for r < 3, enabling a false sense of security and ability to predict the system response for other values.  By r = 3.6, the system has become completely unstable and unpredictable with rapid further increases in instability as r increases from there.

There are many real-world physical examples of this such as turbulent versus laminar flow of a fluid in a pipe where linear increases of pump pressure lead to more-or-less linear increases in flow rate until a certain flow rate is hit, after which the flow becomes turbulent and massive increases in pump pressure give little or no increase in flow rate. Eventually the pipe will burst from the pressure.

In the economy, chaotic effects are manifested in things like shifting comparative advantages between regions leading to the collapse of whole industries and sub-economies.  Examples include: steel shifting to Asia, gutting the U.S. steel industry and leaving the badly damaged rust-belt in its wake; and accelerated devastation of Appalachia from the changing economic viability of coal and farming.  Each of these examples were exacerbated by rent-seeking unions, government and environmental regulations, less than optimal management, technological innovation, and foreign subsidies, but the chaotic nature of markets still played a significant role and these other factors are an inherent part of the chaotic global political economy.

As the chaotic effects increase, investment risk also increases.  It's easier to get investment for a venture that can provide a positive ROI and an exit strategy in a short time frame than for ventures that have a longer time horizon.  This is partly inherent in the risk assessment and its effect on the subjective discount rate used in Net Present Value calculations which penalize longer time horizons.  However, a substantial part of the risk analysis takes the chaotic nature of markets into account.

I have personally experienced this sort of effect.  I may have a high degree of confidence that I'm the only one working on a certain innovation in a given region, but I'm unable to predict the status of this innovation world wide.  Investors, however, want to know if there's a chance they'll be blindsided by some competing group in India, or Israel, or Ireland, or Italy, etc. and if so, will be far less likely to invest.  I think that part of slowing of worldwide investment is partly due to this sort of phenomenon.  There's a lot money sitting, doing nothing, with nobody willing to pull the trigger to invest that money, because that money will be wasted if competing entities are working on the same thing.

Resilience is affected by chaos as well.  In March 2011, an earthquake and tsunami damaged a portion of the northeast coast of Japan and this affected the global supply of motor vehicle parts:

Located in the disaster region and adversely affected by these forces are a number of manufacturing facilities which are integral to the global motor vehicle supply chain. They include plants that assemble automobiles and many suppliers which build parts and components for vehicles. Some of the Japanese factories that were forced to close provide parts and chemicals not easily available elsewhere. This is particularly true of automotive electronics, a major producer of which was located near the center of the destruction.

While efficiency is increased by global trade, the above example shows that resilience is not.  Concentrating manufacturing in one or a handful of facilities to benefit from economies of scale leaves the world economy more vulnerable to natural and man made disasters.

Trade and fluid flows have similarities.  When fluid flows become turbulent, backing off the pressure helps. In a more complex fluid system, adding baffles can help.  Tariffs are essentially baffles in this context.  A 20% across the board tariff would enable redundant manufacturing of various products in different and independent regions, reducing chaos, increasing resilience.  While possibly somewhat less efficient, if the manufacturing is shut down in one region due to an earthquake, tsunami, meteor strike, political unrest, invasion, war, etc., the impact on the rest of the world economy will be mitigated.

In summary, I think there are issues of scale when it comes to free trade. I see no reason why tariffs are any more onerous than other types of taxes, and the chaotic and fragility effects are reasons to use across the board tariffs to restrict international trade.