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COMPARATIVE ADVANTAGE: The economic argument for trade is the concept of comparative advantage — or that every country should be better at producing something than anyone else when accounting for cost of production.

Economics vs. politics in trade discussions

Policy Report: While it's not surprising that NAFTA is being revisited after 25 years, it's somewhat surprising that the free trade agreement has become such a political firestorm.

The United States, Canada and Mexico are in the midst of renegotiations of the North American Free Trade Agreement. That the countries should revisit trade rules ratified more than 25 years ago is not particularly surprising. That the existing agreement and the current deliberations have become such a political firestorm is somewhat surprising and certainly disheartening to most economists and agricultural interests.

Economics of trade
The economic argument for trade is the concept of comparative advantage, a central tenet of the entire economic discipline. The theory of comparative advantage simply states that everyone (or every country) is relatively better at producing something than anyone else when accounting for the economic cost of production, including the opportunity cost of not producing something else.

It isn't just those that are more efficient than others that benefit from trade. Even those that are less efficient benefit from specialization in production of the products for which they forego the least other opportunities. Trading with each other creates gains for both, allowing both to consume more in total than they could individually without trade. These gains from trade are the same in concept whether talking about two people in a relationship, two states, or two or more countries.

The same economic arguments and graphs that readily explain the gains from trade can also explain the difficult politics of trade. The graph below is a classic three-panel diagram of trade, where you have an exporting country and an importing country, with individual supply-and-demand curves as a function of their individual resources, productivity and consumer preferences.

In the absence of trade, markets equate supply and demand separately in those two countries with price differences as a result. Opening the markets to trade allows supply and demand to reach a global equilibrium (in the middle panel) with a global price signal and production, consumption, and trade flows that follow in each country (transportation costs, transaction costs and other policy constraints excluded for simplicity).

The exporting country responds to the higher price signal by expanding production. Domestic consumption actually shrinks somewhat as prices go up, and the excess production is marketed globally. Economists can analyze the graphs and data further to calculate changes in welfare or economic well-being. On net, the gains to producers exceed the losses to consumers, and the exporting country wins as a whole.

In fact, the losses to consumers in this one market may be more than offset by the increase in total income (producers are consumers, too) and overall increases in consumption across multiple markets and products.

In the importing country, it is consumers that respond to the lower price by increasing consumption while production falls. Importing country producers lose as production and prices fall, but consumers gain more from falling prices and increased consumption such that the country as a whole gains.

The three-panel diagram is a fundamental illustration of the gains from trade that allow both countries to benefit from specialization and trading of products (or services, capital, etc.). While the diagram shows gains from trade in both countries, it also shows that the benefit is not shared equally by all people or groups in both countries.

Politics of trade
While the overall economic gains from trade seem clear, the politics of trade are largely driven by producer interests. Given the relative ability of producer groups to organize and the dispersed impacts on consumers, it is producer groups that tend to speak most loudly on trade policy.

Not surprisingly, U.S. producers of commodities with export potential such as grains, oilseeds and meat are generally strong advocates of trade and have been vocal about protecting the current benefits of NAFTA for agriculture in any renegotiation. At the same time, producer groups in importing countries face challenges from increased global competition and trade, and engage in similar political efforts to protect their interests from trade.

We can see that clearly in agriculture with the difficulty of reducing barriers to trade that were negotiated in the now-defunct Trans-Pacific Partnership agreement with important customers such as Japan. Instead of reducing tariffs on U.S. meat imported to the country under proposed TPP language, the United States is now facing increased tariffs from Japan due to additional duties imposed by the country to protect domestic producers. At the same time, Australia and now the European Union begin to enjoy increased access to the country for meat trade.

We can also recognize that for many products, the United States is the importing country, whether it be for certain specialty crops or other agricultural commodities or for various manufactured goods. As producer groups tend to speak more loudly than consumer groups, we are hearing from producers of some crops and livestock, as well as many manufactured goods producers (manufacturers as well as manufacturing workers), that trade does not work or that certain protections and terms need to be negotiated into any new agreements.

Current outlook
The current trade outlook has certainly been challenging on the policy front. One of the first acts of the current administration was to withdraw from the TPP agreement that was awaiting ratification. Additional calls to withdraw from NAFTA until reports of the intervention of the secretary of agriculture led to calls for renegotiations have left agricultural interests concerned about trade prospects. There have been wins on trade as well with several country-by-country agreements to increase access for U.S. agricultural goods, but the rhetoric surrounding the current NAFTA renegotiations is again casting doubts about trade prospects. Negotiations focused on increased exports as the measure of success feeds into the producer groups driving trade politics, but satisfying all producer groups is impossible in any negotiation that will demand both give and take to achieve trade gains for all countries as a whole.

Keeping vigilant to trade policy news and negotiations, and engaging in the process will be critical for agricultural producers and ag policy stakeholders to ensure current benefits from trade are not sacrificed for the sake of other sectors and interests. Trade negotiations are difficult. The only thing more challenging than engaging in the process may be adjusting to the aftermath if not engaged.

Lubben is an Extension policy specialist at the University of Nebraska-Lincoln.

 

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