The raid on trade

Why doesn’t somebody call Trump’s bluff in trade pacts?

A decade ago, a Hong Kong firm hired poor youths to play fantasy games on the computer all day, earning such cyber perks as magic swords. Their boss banked these credits, selling them for cash to game-players with more money than time on their hands.

A key figure in this business, Stephen Bannon, is now the chief strategist to US President Donald Trump. So if nothing else, someone at the White House understands the argument for free trade: If you sell whatever you have in abundance, for something that you lack, you will gain. For example, Internet Gaming Entertainment sold hours for cash.

That’s the principle of comparative advantage, and the Trump administration plans to unplug it. Americans have a forte in skilled labor, so the principle says they should exchange high-tech goods for low-tech ones. Trumpists protest that this will wipe out low-tech jobs in the US. That it will, but it will also cut prices in the US for sugar and blue jeans. American families would gain so much purchasing power that they could more than compensate US sugar farmers and textile workers with aid and retraining. In theory, no one need lose from free trade.

Here's a simple example. The table below shows how many oil barrels or cars that a typical worker can produce per week. For example, an American worker can provide eight barrels or four vehicles. (Yes, the numbers are ridiculously simple, but humor me: The principle’s the thing.)

The American worker has so much machinery that he can produce more oil and autos than the Kazakhstani. Economists say the Yank has an absolute advantage in both industries. Even so, he will gain by trading. Suppose that he sells one car for three barrels. Had he produced the barrel himself, he would have had to give up making one-half of a car, because he would have been obliged to move from the auto factory to the oil derricks. If he instead trades with Kazakhstan, another barrel would cost him only one-third of a car. (That is, he trades one-third of a car for one barrel.) One-third is less than one-half, so the Yank gains by trading rather than by producing everything for himself.

The Kazakhstani gains, too. He sells three barrels for one car. Had he produced the car himself, he would have had to give up four barrels. So trade gives him a car more cheaply than self-production could.

Yankee go trade!

What’s going on here? Well, the US has a comparative advantage in cars: One auto costs only two barrels there but four barrels in Kazakhstan. Similarly, KZ has a comparative advantage in oil: A barrel costs only a fourth of a car here but one-half of a car in the US. We should produce whatever we can make more cheaply than other countries – and trade for the rest.

Worker’s product	Oil	Autos
US	8	4
Kazakhstan	4	1

Is this example too simple? Yes. It assumes away transport costs. Suppose that shipping a car from the US to Kazakhstan costs the equivalent of two barrels. Then to import a snazzy set of wheels at the current exchange rate, Kazakhstan would have to pay five barrels (three for US production, two for transport).  It could produce cars more cheaply  for itself, since this would cost only four barrels.   


Yes, since the US can manufacture a car for as few as two barrels, it could lower its exchange rate to one car for four barrels (two for production, two for transport). But even at this rock-bottom price, Kazakhstan is merely indifferent between trading for the car and producing it for itself; in either case, the car would cost it four barrels. And higher transport costs – say, three barrels for one American car – would make it too expensive for Kazakhstanis. 
  


Another possibility is that the amount that another worker can produce depends on the number of workers or labor hours. My example assumes that the typical Kazakhstani worker can produce one car per week (instead of four barrels) regardless of his depth of experience. But suppose that by producing autos, Kazakhstanis learn so much that they lower the cost of assembling a car to one barrel. At that point, they should export cars and import oil -- say, at the exchange rate of one vehicle for one and a half barrels.

So the debate over trade between Kazakhstan and the US should weigh technical issues – but it doesn’t. In the US, there is next to no debate. The media is obsessed with tweets and spies (probably a healthy obsession), and Congress can’t get past health care, much less the debt ceiling. On protectionism, Trump may get a free pass. After all, trade between the two countries is puny.  In 2016, Kazakhstan’s exports to the US were $618 million (just 1.7% of all KZ exports), and imports from the US were $1.27 billion (5%). 

Hmm.  Maybe Kazakhstani kids should play computer games after all. – Leon Taylor tayloralmaty@gmail.com

Good reading

Paul Krugman, Maurice Obstfeld and Marc Melitz. International economics: Theory and policy. Tenth edition. Addison-Wesley. 2015.

References

Shawn Boburg and Emily Rauhala. Bannon’s days at control of firms aided gaming cheats. Washington Post. August 6, 2017.

National Bank of Kazakhstan.  Kazakhstan: Balance of payments and external debt for 2016.  May 2017.  www.nationalbank.kz