Opinion & Commentary
Protectionism’s ‘Barren Truth’
The Bracks review of the automotive industry supported the current timetable for reductions in car tariffs to five per cent by 2010. In so doing, it effectively sides with the Productivity Commission on the question of the terms of trade argument for tariff protection.
Commission Chairman Gary Banks, in his Colin Clark lecture, was critical of the use of this argument in economic modelling commissioned by the Victorian government and the car industry in support of continued tariff protection.
The argument maintains that when tariffs reach low levels, further reductions can have adverse implications for the terms of trade that outweigh the efficiency gains from lower tariffs.
Dartmouth economist Douglas Irwin notes that the terms of trade argument ‘remains the most widely acknowledged and generally accepted restriction to free trade admitted by economic theory.’
The idea has its origins in the work of the 19th century economist Robert Torrens and the British tariff debates of the 1840s. It was subsequently formalised by John Stuart Mill and F. Y. Edgeworth.
Yet the 19th century formulators of the terms of the trade argument for tariff protection were also among its most scathing critics.
In his essay ‘Of the Laws of Interchange between Nations,’ Mill argued that the circumstances in which the argument would hold ‘are of a nature so imperfectly ascertainable, that it must be almost impossible to decide with any certainty, even after the tax has been imposed, whether we have been gainers by it or losers.’
Edgeworth said that ‘direct use of the theory is likely to be small. But it is to be feared that its abuse will be considerable. It affords to unscrupulous advocates of vulgar protection a peculiarly specious pretext for introducing the thin edge of the fiscal wedge.’ Edgeworth said of its advocates, ‘Let us admire the skill of the analyst, but label the subject of his investigation poison.’
Nassau Senior declared that the terms of trade argument was ‘one of those barren truths from which no practical inferences can be drawn.’
Fast forward to the 21st century, and the fears of the 19th century economists remain relevant.
Gary Banks noted that it is not difficult to demonstrate a loss to the terms of trade from reductions in tariffs, given the right assumptions. The Productivity Commission’s work on the car industry readily concedes such a loss, but notes this is more than outweighed by the income gains from improved domestic resource allocation and increased investment from lower car prices.
The argument over tariff protection is a broader one that the net costs of a specific tariff to the Australian economy. The economists of the 19th century were also concerned that the terms of trade argument was a beggar-thy-neighbour policy.
The improvement in the terms of trade is only secured at the expense of trading partners, while lowering the volume of world trade. Such restraints on trade invite retaliation, damaging the international trading system and ultimately our own welfare.
The terms of trade argument can be admitted as a theoretical exception to the national efficiency case for free trade, although its applicability is limited, especially for a small economy like Australia, which generally lacks pricing power in world markets.
But it still fails in terms of the cosmopolitan case for free trade, which argues that we should oppose restraints on trade as potentially damaging to the broader international trading system, even when we think they might advantage us.
Mill argued ‘if international morality, therefore, were rightly understood and acted upon, such taxes, as being contrary to the universal weal, would not exist.’ John Maynard Keynes would later write that ‘we should hold to Free Trade as a principle of international morals, and not merely as a doctrine of economic advantage.’
As a small, open economy, Australia is an enormous beneficiary of global free trade and it is ultimately in our interest to promote a liberal international trading system. We undermine that system when we impose restraints on trade, especially when they are explicitly based on a beggar-thy-neighbour view of trade policy.
The recent collapse of the Doha round of trade talks highlights the flaws inherent in a multilateral trade liberalisation process held hostage to a zero-sum view of trade policy, based on reciprocal trade concessions.
As Gary Banks argued in his Colin Clark lecture, ‘the latest multilateral WTO “failure” should if anything reinforce the good sense of Australia pressing on with its own reforms. Apart from its international implications, action to the contrary could signal domestically a policy shift on tariffs that could end up undermining our economy’s future productivity performance.’
Dr Stephen Kirchner is a Research Fellow at the Centre for Independent Studies
