A green zealot v free trade
Gerard Jackson
Dr Clive Hamilton, executive director of The Australia institute, seems to have been getting quite a bit of favourable publicity of late. Nonetheless, there are some who are disturbed by his institute's extreme views and its open contempt for the material and social aspirations of ordinary people.
So just how good is Hamilton's economic analysis? Not very, in my opinion. I consider him to be a green zealot with a loathing of the free market. Like most critics of the market, he is totally ignorant of sound economic theory and market processes. This fact was brought home to me several years ago by his inept defence of the Buy Australian campaign.
Hamilton had been offended by the Centre for Policy Studies (CPS) because it had correctly pointed out that such campaigns are economically counter productive. The centre had apparently argued that encouraging Australians to buy domestic goods would force up the exchange rate and thus increase unemployment by making some industries uncompetitive.
Hamilton reversed the logic and declared that not buying Australian would drive the exchange rate down thereby expand foreign demand for Australian goods thereby expanding our export industries. From this he concluded that all advertising by Australian firms is "pernicious" because it raises the exchange rate by persuading Australians to buy Australian goods.
In this respect Hamilton is right. Exchange rates are not determined by trade balances or capital flows: what basically determines them in a free market is purchasing power parity. (I am using the more sophisticated Misesian view of purchasing power parity instead of the cruder Casselian one that is used by most economists). However, Hamilton went on to argue that there is "considerable logic to the Buy Australian campaign".
Unfortunately for his argument none of the logic was economic. Sneering at free market economists he asserted that the Buy Australian campaign is in keeping with economics textbooks because it raises welfare by providing consumers with additional information that will allow them to better express their preferences. This is complete and utter clap trap.
It is abundantly clear to anyone who has seriously studied economics that what is meant by "additional information" is that which better informs market participants. In short, the information must be accurate, or at least honestly presented. 'Information' that is dishonest, i.e., designed to mislead the consumer about the nature of the product, will patently lower consumer welfare.
If, for example, a company falsely claims that its product cures baldness, then that company is clearly guilty of fraud. Those who bought the tonic in anticipation of having their hair restored will suffer only disappointment. The same holds for the Buy Australian campaign.
Therefore, when people only buy Australian goods in the erroneous belief that they are making Australia better off they are keeping company with the victims of snake-oil merchants. If any company engaged in the kind of misleading practices that the Buy Australian campaign has used it would quickly find itself in court, and rightly so.
The campaign was based on three fundamental lies: a) imports cause unemployment, b) tariffs cut unemployment, c) tariffs also expand real per capita national income. People need to be continually reminded that imports are a benefit that has to be paid for and that the real price of imports is exports. It is exports that pay for imports.
All Australian exports are really demands for foreign goods. (It is a sad reflection on the educational level of most businessmen and 'journalists' that such a fundamental fact needs to be constantly repeated).
The relationship between exports and imports would be perfectly transparent in a barter economy but unfortunately money acts as 'veil' when it comes to exchange, giving the false impression that goods exchange against money instead of other goods. Simply put, exports are the price of imports. Foreigners obtain Australian dollars by selling us their goods; the dollars are then used to buy Australian goods. It can be easily seen that any measures that reduce imports must reduce the demand for Australian exports. This is a fundamental fact that the protectionists at the Australia Institute dishonestly ignore.
Failure to comprehend the true nature of foreign exchange has made the layman easy prey for protectionist snake-oil merchants. In The Wealth of Nations (1776) Adam Smith stressed the absurdity of a doctrine that preaches people will become wealthier by reducing their purchasing power. And this is the essence of the tariff doctrine.
Of course, no Australian would dispute the irrationality of trying to grow bananas in Iceland in order to curb imports, raise employment and expand investment. It would be self-evidently stupid. Yet the same Australian might very well support tariffs for our foreign-owned car manufacturing companies on the same grounds, despite the fact that it might be the equivalent of growing bananas in Iceland.
The reason that laymen cannot see that both situations are, economically speaking, fundamentally the same is because they have no understanding of the law of comparative advantage. David Ricardo was the first person to publicly explain why it pays a country to trade with others even though it can produce goods more cheaply, a paradox that many had already observed (Principles of Political Economy and Taxation, 1817).
What became known as the law of comparative advantage has never been refuted. All competent economic arguments for free trade ultimately rest upon this law. It follows that all arguments against free trade ultimately rest on this law's refutation — something that has never been accomplished.
Several things must be made clear about the law of comparative advantage: Regardless of what some critics claim, the law does not depend on everyone practising free trade. It clearly demonstrates that free trade is beneficial for a country even though its trading partners have imposed tariffs. The tariffs will naturally reduce overall welfare, but retaliating with tariffs will only succeed in reducing welfare further.
Neither is the law based on the assumption of constant returns, nor does it assume fixed natural endowments or immobile factors of production. Assertions by anti-market 'journalists' like Brian Toohey of The Australian Financial Review that rapidly changing technology and mobile capital have invalidated the law of comparative advantage are therefore complete bilge.
The invariable refrain of every call for tariffs or "buy domestic" is "save jobs". Two things: 1) free trade does not cause unemployment and 2) tariffs cannot cure unemployment. The effect of free trade is to direct labour, land and capital into more efficient lines of production. It does not, regardless of tariff propaganda to the contrary, reduce the volume of unemployment.
It should now be clear that the benefits of free trade come from the specialisation of labour and capital which in turn increase total output. Tariffs and "Buy Homespun" campaigns have the reverse effect and that is why economists oppose them. Defenders of protectionists do not deny any of the preceding, they just ignore it.
In the final analysis, if Buy Australian campaigns raise economic welfare so do tariffs. And no amount of weaselling can alter that conclusion. The likes of Hamilton can only be right if the law of comparative advantage has been refuted. If it has, perhaps Hamilton will kindly provide Brookes' readers , as well as the economics profession, with proof of his refutation.
Further reading:
Growth, greens and living standards
Pro-Saddam Greenpeace blockades P.M. Howard's residence: now lets look at Greenpeace' KGB links
Gerard Jackson is Brookes' Economics Editor
BrookesNews.Com
Wednesday 23 July 2003