Trade Deficits and other Disasters – 2

This is  a continuation of a previous post which was in response to points that Mallikarjuna asked about trade deficits and Chinese exports to India.

First let’s understand trade. Voluntary trade is good for both parties. This is true in the case of individuals trading among themselves within a region, for obvious reasons. If both parties didn’t gain something from the trade, it would not happen since by definition the trade is voluntary. For less obvious reasons, in general voluntary trade across political borders also leads to gains.

We have discussed an important theoretical concept called “comparative advantage” in this class. In the context of international trade, even if country A has a lower productivity in every activity compared to country B (meaning A has no “absolute advantage” over B), both countries would have an “comparative advantage” in some activity.

For example, the USA may have a higher productivity both in producing wheat and in producing cars compared to India but India could still have a comparative advantage in producing wheat and the US could have a comparative advantage in producing cars. In that case, if the US exports cars and imports wheat from India, both the countries would benefit.

Notice that I am talking of aggregates here — the whole of the US and the whole of India — and the net benefit to the economy arising from international trade. Indian imports of American cars would benefit Indian car buyers, and US imports of Indian wheat would benefit American wheat consumers. But Indian imports of American cars would hurt Indian car manufacturers (and therefore workers in Indian car companies), and American imports of Indian wheat would hurt American wheat farmers.

International trade nearly always hurts some domestic industries, even if there are net benefits to countries from international trade. That’s also true for domestic trade, if you think about it.

If Biharis buy cheap shoes made in Delhi, Bihari shoe manufacturers would suffer. The reason this happens is because Bihari shoe makers are not as good at making shoes as those in Delhi. Meaning either the Bihari shoe makers become better at making shoes or get into some other line of work in which they are comparatively better than the people of Delhi.

Here I am making quite simple and sweeping claims. Real life is more complicated, of course. If the theory of international trade was so simple, trade theorists wouldn’t dedicate decades to figure things out. (Just BTW, my minor in grad school was international trade. I enjoyed the subject enormously.)

Now in real life, nearly all governments impose trade restrictions for various reasons. Tariffs on imports add to government revenue, while at the same time provide protection to favored domestic producers from foreign competition. The favored domestic producers often turn around and bribe the politicians who favor them. That’s “crony socialism.”

But in general, tariffs and other trade barriers hurt domestic consumers and favor domestic producers of the imported products. That also means that trade barriers hurt the producers of export products.

Suppose cars are the import product and wheat is the export product. Barriers to car imports help the domestic car companies, and hurt the domestic wheat producers and the consumers of cars.

Alright, let’s simplify this a bit. Suppose there are only two sectors in an economy: the agricultural sector and the manufacturing sector. If a country imposes import restrictions on manufactured goods, it is an implicit tax on the agricultural sector. Why? Because following the restriction, manufactured goods will cost more than it would have had imports been allowed. So the terms of trade (how much farmed goods would trade for how much manufactured goods) would turn against the agricultural sector.

This happened in India. Cars and other manufactured good were not allowed to be imported (without heavy duties.) So Indian cars (there were two models) were shoddy and very expensive. That was an implicit tax on farmers that transferred money from rural India to urban India.

Now I am ready to address Mallikarjuna’s points. I repeat them here for reference:

Trade deficits are bad. China runs huge trade surplus for itself with almost every other country. That is killing the local industries (silk producers, primarily.)

And

Cheap/Cost-Effective Exports with malware (USA Printers in mid-east, telecom & electrical equipment by Chinese) … How to get over this? Is it beyond economics?

The primary reason why China is able to produce goods at lower costs is  because the Chinese government allows Chinese producers to produce at a lower cost. The Indian government imposes costs on Indian producers that make Indian producers lose out. China does not dictate how Indian producers do their business; the Indian government dictates the burden that Indian producers bear.

The local Indian industries that are being killed are being killed by the Indian government, not by the CCP and their policies. The “trade deficits” are not unrelated to Indian government policies.

Blaming China is understandable — and wrong. The Indian government handicaps Indian industry, not China.

Economics explains why and how markets work. It also explains why the Indian government does what is not in the interest of Indian producers. Specifically, public choice theory explains why the people in government do what create barriers to prosperity: it benefits those in positions of power.

China will continue to do what is in its best interest. China will export malware because their products are cheaper than can be produced by the importing countries. The importing countries will not be able to compete with China because the governments of importing countries like India will impose costs on their producers that make them uncompetitive in the global marketplace.

The silk producers in India have the Indian government to blame, not the Chinese government. In a very real sense, the Indian government is in cahoots with the Chinese government to keep India backward and poor. We need to understand this because otherwise we could be barking up the wrong tree.

Author: Atanu Dey

Economist.

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