III A Free-Trade Area

A Free-Trade Area .EUROPEAN unification movements are in unanimous agreement that national economies with their numerous market divergencies should be unified, and that men, goods, and capital should be allowed to move as freely within the union as in each member economy. The two preceding sections of this book show that hope for such a union must be in vain as long as there is government intervention in economic life. There cannot be a union where there are welfare states with a multiplicity of restrictive or protective measures. The several unification movements also agree that the government of a European union should afford protection for particular industries within the union from competition by producers outside the European area. As has been stated repeatedly in preceding sections, this hope must also be in vain because no agreement can conceivably be reached among the various member nations as to which industry shall be protected and who shall bear the sacrifice which such a protection logically imposes upon the others. While it is comparatively easy to persuade a nation that it should protect certain of "its" industries, it is virtually impossible to persuade different nationalities to bear sacrifices favoring certain producers of another nationality in the union.

There is but one way to unify Europe. Nations eager to unify must abandon their government welfare and socialist ideologies and return to policies of individual liberty and free trade. All restrictive and protective measures within the union, as well as toward the outside world, must be abandoned. Where only free trade and individual liberty exist, there are cooperation and union. The theory of international trade forms one of the most complicated subject matters of economic theory. In this age of utter 300 A FREE-TRADE AREA 301 disregard for economics the theory of international trade is rejected because it conflicts with the basic tenets of the ideology of government welfare and socialism. Foreign trade or trade among nations, as it is commonly called, is trade among individuals separated by national boundaries. The motivating forces leading to foreign trade are identical with those leading to domestic trade: they are the increase of utility and value resulting from exchange. That is to say, the value of the good received is, or at least is expected to be, greater than the sacrifice made for obtaining it. It is obvious that there would be no exchange if both parties were not expecting to benefit from it. The same holds true in foreign trade. The value of imports is, or at least is expected to be, greater than that of the goods exported in exchange. Exports merely are sacrifices of value given in exchange.

Imports enable the individual to procure commodities which he and his fellow citizens are unable to produce themselves. Imports also enable him to obtain commodities which he and his fellow citizens cannot produce with the same facility. It is technologically feasible, for example, to produce bananas in greenhouses in Alaska. But the costs of such a production by far exceed the costs for obtaining bananas by means of international exchange. Imports also enable the individual and his fellow citizens to employ their natural abilities and their land and capital in those fields of production which offer the best chance for high returns. The efficiency of every producer and instrument of production is increased if they specialize in the production of those goods for which natural abilities and conditions are most favorable. It is the essence of the division of labor that every participant produces what he is most suited to produce, either because of his natural abilities or external conditions determining and influencing production. The territorial division of production is merely an aspect of the general principle of the division of labor. Just as an individual earns highest returns by employing his inborn abilities in an occupation requiring his special skill, producers, in order to earn highest returns, must specialize in the production of those commodities for which the existing conditions such as climate, land, capital, and labor markets are most favorable.

The elemental fact of foreign trade, as well as domestic trade, is a discrepancy in the existing conditions of production. Commodities are exchanged in voluntary division of labor because the conditions of production differ as to climate, land, capital, and labor services. However, an important difference between domestic trade and for302 AN ALLIANCE OF FREEMEN eign trade must here be mentioned. While the discrepancies in the domestic conditions of production tend to stay at a minimum because of the mobility of the factors of production, the discrepancies in the international conditions of production are of more serious nature because of the relatively greater immobility of production factors. Under existing conditions of government interventionism and socialism, capital and labor cannot migrate from countries with less favorable conditions of production to countries where conditions are more favorable. Thus discrepancies in the conditions of production are added by numerous institutional obstacles to the natural discrepancies such as climate and land. This knowledge gained by simple reasoning clearly reveals the relative importance of foreign trade as compared with domestic trade. It indicates that the volume of foreign trade should tend to grow with growing discrepancies in the international production conditions. If we compare this principle of economic theory with the actual state of affairs, we begin to realize the detrimental effects of "welfare" doctrines and policies on the international division of labor. The foreign trade of welfare and socialist nations often amounts to less than a trifle of domestic trade.

The detrimental effects to the nations themselves are easily discerned. The protectionists object to freedom of international trade because a country's conditions of production may be less favorable in many or most respects than the conditions in other countries. What happens to these countries, they ask, whose production conditions are so unfavorable that they cannot stand the competition of the more fortunate countries? What choice do they have but to restrict imports from countries with more favorable conditions? Government control and restriction of imports is said to be a vital necessity for countries producing under disadvantageous conditions. The fallacy of this protectionist notion becomes apparent immediately if we observe two individuals, one greatly gifted and industrious, the other one inferior in all his performances. The president of a corporation who began his career as an errand boy and who served his corporation through many years as clerk, accountant, foreman, salesman, treasurer, manager, etc., is probably more industrious and talented than his many fellow workers and competitors. And yet, when he reaches the presidency, he does not discharge a clerk, accountant, or manager because he, the president, is more talented in filling all these positions. Obviously it would be foolish for the president to waste his time doing a clerk's job even though he can do it more efficiently than his clerk can.

A FREE-TRADE AREA 303 But this is precisely what the protectionists are recommending to our governments. Let us illustrate the fallacy of their advices in the following example dealing with two different countries: Let us assume that conditions are such that in the United States the production of an automobile and a family cruiser require the expenditure of 1000 working hours each and that in England an automobile requires 3000 hours and the family cruiser 2000 working hours. Now the protectionists maintain that because English production conditions are less favorable for both commodities, foreign trade would be harmful to England. This is a serious fallacy. If each country turns toward the production of that commodity for which conditions are most favorable seen comparatively, the division of labor achieves a higher productivity of labor in both countries. If American producers turn toward the production of cars exclusively and English businessmen toward the production of boats, both countries will benefit from this division of labor. Though America has superior facilities for the production of both commodities, it is expedient for American producers to produce only cars, and for English producers to produce only family cruisers. If there were no interchange, 1000 working hours in both American branches of production would yield one car and one boat respectively. The same working time in England would produce % of a car and % of a boat, the total of both countries thus being iy3 of a car and F/2 of a boat, or 2% units. But if each country confines its production to that commodity in which it has the greatest comparative advantage, the total will be 2 cars produced in the United States and 1 boat produced in England, or 3 units altogether. While England benefits from this division of production inasmuch as she can obtain one American car at a sacrifice that is smaller than her own production costs, America benefits from this division of production inasmuch as it can obtain an English boat at a sacrifice of less than a car, which is more favorable than its own ratio of 1:1.

Let us compare the prices. Let us assume that the American cars and boats costs $3000. The price for the same car in England is the equivalent of $3600 and that of a boat $2400. Of course, the English wage rates must be considerably lower than the American rates because of the lower marginal productivity of English labor. Now if each country specializes in the production of that commodity for which it has the greatest comparative advantage, American producers will build cars and English producers will specialize in boats. The advantages of this division of production and labor are obvious. But according to your premise, somebody may object, the condi304 AN ALLIANCE OF FREEMEN tions of production for both commodities are more favorable in the United States. That is correct. Our price illustration does not conflict with the assumption that only 1000 American working hours are required for the construction of a boat, while it costs 2000 working hours in England. The lower marginal labor productivity in England determines a low rate of wages. Prices are determined by the demand and supply situation on the English market and expressed in terms of pounds sterling. On the whole, they equal American prices in accordance with the principle of purchasing power parity of the media of foreign exchange.

David Ricardo, who first expounded these advantages of foreign trade known under the name of "Law of Comparative Cost," presented it in a simple analogy. He said: "Two men can both make shoes and hats, and one is superior to the other in both employments; but in making hats he can only exceed his competitor by one-fifth, or 20 per cent, and in making shoes he can excel him by one-third, or SSy3 per cent. Will it not be for the interest of both that the superior man should employ himself exclusively in making shoes, and the inferior man in making hats?"* We may add: if two countries can both produce cars and boats, will it not be for the interest of both countries if both produce what they can produce comparatively best? The higher productivity of labor achieved under the division of labor serves the interests of all participants. Collaboration of the more talented, more efficient, and more industrious with the less talented, less efficient, and less industrious benefits both. Why should this fundamental principle of the division of labor lose its validity when individuals are separated by political boundaries?

Why should a border policeman make all the difference for the effects of human association and the consequences of the division of labor? Of course, all such contentions are untenable and fallacious. The law of comparative costs is based on one assumption: that only commodities are freely mobile and that capital and labor are hindered from crossing political borders by government restriction and intervention. When only commodities are freely mobile, the law of comparative costs applies. When capital and labor also enjoy free mobility, they migrate to those places on the earth where natural conditions of production are most favorable and where the productivity of labor is highest. People and capital tend to leave countries and places that are unsuited for production and settle at places where higher incomes and returns are obtained. Industries produci Ricardo, David, Works (ed. J. R. McCuUoch), London, 1881, p. 77.

A FREE-TRADE AREA 305 ing under costly and unfavorable conditions are abandoned, the least fruitful land is left untilled, and immobile factors of production are abandoned or employed in more extensive processes of production. Thus capital and labor are distributed according to the natural opportunities affording highest productivity. If the European nations really desire unification and the advantages and benefits which such a unification affords, the following steps must be taken on the road to unity. First, all government favors and privileges must be unconditionally abolished; policies of interventionism and socialism must be abandoned; the numerous divergencies in the national structures of production must be allowed to be corrected and evened out by the forces of the market economy. Second, commodities, capital, and labor must be allowed to move as freely within the union as in each member state. In the absence of government restrictions imposed upon the individual by socialist and welfare governments, men and the mobile factors of production will migrate to those places within the union where the natural conditions for their employment are most favorable. Third, inasmuch as non-European governments would continue to impose restrictions upon the mobility of their own and European citizens and capital funds, the European governments must conduct unconditional policies of free trade with the outside world. European trade with foreign countries must be governed by the Law of Comparative Costs.

But someone may object that the communist economic bloc and other collectivist economies may disturb the market economies at will through transactions motivated by political considerations. Should a government not endeavor to protect the economy from malicious dumping of commodities by a communist government which is attempting to create political difficulties Many excellent economists are inclined to answer this question in the affirmative.2 We must reject their inference and advice on grounds of the following consideration. The powers of protection given to government can be used so abusively as to far outweigh any success it may have in combating a minor evil. It opens the way for the whole camp of protectionists to demand protection for their products from bothersome competition. And who could truthfully make the statement, "This is malicious dumping." A communist economy lacks all means of calculation, inasmuch as the market economy with its determination of costs and 2 E.g., Wilhelm Ropke, International Ordnung-heute, Zurich, 1954, p. 318 et seq.

306 AN ALLIANCE OF FREEMEN prices has been abolished. It must be guided through comparison with the price structure of the world market. Furthermore, we should bear in mind that sales below cost are always a heyday for consumers. The lower the commodity price, the higher is the standard of living. Communist dumping of commodities in the capitalist markets would enrich the latter at the expense of the former. In the market economies only the specific industry exposed to foreign dumping would suffer and then only temporarily. Businessmen would have to readjust to the new condition. But this is their very entrepreneural function. They incessantly have to cope with readjustments and fluctuations. They know it infinitely better than politicians and policemen. Some industries, though "unprotected," undoubtedly cope with great risks and fluctuations even today. They would and could also manage the risk of dumping. This inference is all the more conclusive when we realize that the market economies constitute an interrelated world market which would absorb and evenly distribute all quantities offered. Thus the effects of communist attempts to disturb the national markets would be negligible and need not be feared.