In real life, we don’t have to persuade people to trade or exchange goods and services. Since ancient times, people have sought to exchange the products of their labor. Markets and bazaars have always been crowded places, and numerous wars have been fought for access to trade routes.

However, the logic that tells people to trade and specialize, that is, not to produce all goods, but only some of them and secure the rest of goods and services they needed through trade, sometimes doesn’t work when it comes to international trade.

Although few people try to question the advantages of specialization within a country, the idea of a nation’s full self-sufficiency may have a lot of supporters, especially among people in power.

To achieve economic self-reliance, some governments start hindering international trade by introducing tariffs on foreign goods or imposing other restrictive measures aimed at putting domestic producers at an advantage over foreign ones.

And this is where professionals such as economists come in. They are the ones who often urge politicians not to hamper international trade.

Over the last two hundred years, economists have largely succeeded in that, since trade barriers have dropped significantly. Liberalization of international trade moved forward particularly fast after the Second World War.

Nevertheless, there are quite a few advocates of protectionism, a policy aimed at protecting domestic manufacturers from external competition. And the worse an economic situation in their country is, the more vocal about the necessity of imposing protectionist measures the advocates become.

Who loses from international trade?

Where does strong opposition to such a great undertaking as international trade come from? The point is that the entire nation is not one person but many people, so by enhancing the well-being of a country as a whole, trade may aggravate the situation of its individual citizens.

Imagine that a country A has a comparative advantage when producing textiles, and a country B has a comparative advantage when manufacturing confectionary products. That’s why the country A benefits from giving textiles to the country B and getting confectionary products in exchange.

Nevertheless, the same cannot be said for manufacturers of confectionary products and consumers of textiles living in the country A.

The disgruntled producers of confectionary products based in the country A might want to request their government to ban the trade of goodies with the country B in order to shield domestic producers from international competition.

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The arguments they will make for imposing trade protection measures may be as follows:

1) job losses in their production sector;
2) the loss of the country’s self-sufficiency and hence the weakening of defense capacity;
3) reduction in government revenues.

Let’s try to refute each of those arguments. For this purpose, we can put forward the following counterarguments:

1) Undoubtedly, the closure of enterprises unable to withstand international competition entails the dismissal of employees that work for those enterprises. However, it means that the laid-off workers will be able to get jobs in other sectors in which their labor will be more productive, for example, the sectors in which their country has a comparative advantage. Labor force is exactly the resource that trade distributes effectively.

2) People always face a choice. You can’t have it all. You can either increase the production possibilities of a nation by participating in the international division of labor or have a self-sufficient economy, that is, be able to produce goods required in the event of forced isolation.

Some states choose to reduce their current consumption in order to always be ready for war in which they will be fully isolated from the rest of the world and won’t have a single ally. But what are the chances that the disaster for which they prepare will actually happen?

Different countries may have varying views on the likelihood that such a situation will arise. None the less, it should be understood that trade and commercial interest contribute to the spread of new skills and technologies, and they are better at it than any spy network. For this reason, nations that abandon international trade soon begin to experience a technology gap, which, of course, doesn’t facilitate the increase in a nation’s military capacity for self-defense.

3) Budget revenues are a part of an “economic pie” that a country’s citizens transfer to their governments for them to distribute the revenues and spend them on shared needs.

Income to a government budget provided by enterprises that are forced to close down due to trade liberalization will be more than compensated for by revenue growth provided by those industries that benefit from international trade.

This indicates that budget revenues won’t be reduced, and the size of the “economic pie” will only increase.

Why don’t all goods manage to cross the border?

Imagine that the country A and country B mentioned above are very distant from each other. In this case, both of those nations will have to spend a lot of money on the transport of their goods to the other country, and hence the costs that arise from the transaction will exceed the benefits that come with it. Most likely, those states won’t trade.

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Costs incurred in carrying out a transaction such as transport, performance guarantee and negotiation expenses are called transaction costs. In economics, those expenses are akin to friction in the physical world.

If you don’t attach importance to those costs, then even a perfectly designed mechanism, be it an economic system or a car engine, may be stalled.
Just as there are lubricants enabling to reduce friction of the components of an engine, there are ways of reducing transaction expenses in international trade.

Actually, to carry out lucrative trade, the following conditions are required:

1) Opportunity costs of the production of goods that traders are going to exchange should be different for each party to a transaction.
2) Transaction costs shouldn’t exceed the gain from the deal the parties make.

As you can see, transaction costs of carrying out trade deals reduce the benefits of trade and decrease the volume of trade. Hopefully, technological progress successfully fulfils the task of lowering the costs arising from the transport and storage of goods, and economists successfully combat those who are associated with the protectionist activity of government bodies.

A glaring example of a success in combating protectionism is the founding of the WTO. Let’s find out why this institution was established.

The creation of the World Trade Organization

Throughout the 1930s, the world was swept up in the Great Depression, a strong decline in economic activity following the stock market’s collapse in 1929.
Many enterprises came to a standstill, which put many people out of jobs and left them destitute.

At the lowest point of the crisis in 1932, an industrial output in the US was only half of the pre-crisis level. The world, which just started emerging from the devastating First World War, was overwhelmed in despair.

A dire economic situation in Germany, where one in four of the population was out of work in 1932, contributed to the coming to power of the Nazi regime that started the Second World War.

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One of the main reasons of the economic and political disaster was that governments started creating trade barriers seeking to protect domestic producers and working places from external competition. Nevertheless, a trade war is never a one-sided phenomenon: if one country closes its border to foreign goods, then the foreign states return the favor.

As a result, international trade, which had enabled a more effective way of the distribution of resources belonging to society at the expense of the international division of labor, almost ceased to exist.

By 1932, the volume of international trade declined by half from the pre-crisis level. It was tantamount to technological degradation: production possibilities diminished, people became significantly poorer than they had been in the past.

So as not to repeat the mistakes of the Great Depression and prevent the disintegration of the international division of labor, which may potentially spell disaster for many nations, leading world powers opted for the liberalization of international trade in the post-war period.

Numerous negotiations commenced as early as 1947 within the framework of the General Agreement on Tariffs and Trade (GATT) and aimed at regulating trade relations laid the foundation for the establishment of the World Trade Organization in 1995.

Today, almost all countries are part of this organization. The task of The WTO is to ensure the uniform application of international trade regulations, eliminate trade barriers, settle trade disputes and carry out other activities leading to the cost reduction of the movement of goods and services between countries.

The presence of rules that are binding on all citizens and the existence of a court whose function is to deal with conflict situations significantly reduce the cost of doing business in a WTO member country and facilitate its development.

Likewise, the availability of an international body recognized by almost all countries of the world and the presence of common rules regulating international trade enables to reduce the risk and cost of negotiations.

That’s pretty much all we wanted to tell you about the dangerous consequences of protectionism and the positive effect of international trade on the economy of any state.

Now you know why economic liberalization can do some good for any country and why a nation’s economic gain from international trade exceeds the loss incurred by its individual domestic manufacturers whose goods and services aren’t able to compete with those of foreign producers.

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