My wife and I felt the need to have a break from the national election contention by taking short-term asylum in Montreal. I was interested as I went window-shopping today that one of my favorite shirts is now made in Canada.
A little over a century ago, England-based cloth maker Viyella became the first company in the world to brand its cotton-wool-blend cloth. Since then, the company has evolved into a clothing manufacturer and maker of good-quality casual shirts.
Many years ago, when I first bought a Viyella shirt, it was made in the USA. Some years later, I noted that fabrication had migrated to Hong Kong. More years passed, and manufacturing moved to mainland China. The new shirt I bought this week proudly proclaims, “Fabrique au Canada.”
Shirt makers, as well as other business concerns, move production around the globe in search of greater profits. For corporate shareholders, this is a good thing. But what about consumers and factory workers? Does this also work for them?
International trade increases national income. This is one of the central themes of economic trade theory. For those who may doubt this, an example can be helpful.
But first, by way of review, last week we noted that the standard of living within a nation is determined by the quantity of goods and services its population can consume in a given period of time. New labor-saving innovations allow the same basket of products to be produced by fewer workers. This in turn permits laborers, who have been freed up from their former employment, to go forth and produce new products. This is growth in a nutshell.
International trade works in a similar way, but with many additional benefits, which we will leave for another day. (Some readers may find my numerical example tedious. To be honest, I found it tedious to write. But others might perceive a glimmer of illumination. For those who want to skip or skim the example, the conclusion is simple: when we buy things from another country at lower prices than our domestic cost of production, we free up local labor as if we had just invented a new method of production. The labor we save can be redeployed to produce other things, quite analogous to our growth expose last week.)
Now for the tedious example. Imagine that to produce 100,000 shirts in the U.S., 150,000 hours of garment-worker labor is required at a cost of $36 per hour, or $54 per shirt. Now assume that Mexico can produce the same shirt for $18, i.e., one third the cost in the U.S.
Further assume that Mexico is unable to manufacture at reasonable cost the specialized computer chips we make here. For simplicity, imagine that each chip requires 20 hours of the same $36-per-hour labor, or $720 per chip. At this point, we can look at two possibilities: first, we produce our own chips and shirts; second, we build chips and exchange them for shirts with Mexico.
Let us begin with the first scenario, that we build our own stuff in the U.S. In this case, if we want 100,000 shirts and 10,000 computer chips, we will use 150,000 plus 200,000 hours of labor, for a total of 350,000 hours to generate the goodies.
Alternatively, if we choose to exchange chips for shirts with Mexico, we have a different mix. Mexico produces shirts at $18 per shirt. Thus, to purchase 100,000 shirts from them, we will need to deliver to them $1,800,000 worth of chips. At $720 per chip, we must produce an extra 2,500 chips to send south of the yet-to-be-built wall.
At this point we can begin to see how trade helps increase national income. If we stop producing shirts in the U.S., we free up 150,000 hours of labor. But to pay neighbors to the south for these, we are required to use a mere 50,000 hours of additional labor (20 hours per chip times 2,500 chips) to manufacture the extra chips. This leaves us with a net savings of 100,000 hours of labor.
Whether we trade with Mexico or not, we can enjoy our basket of 100,000 shirts and 10,000 chips. But in the case of trade, we employ 250,000 hours of labor versus 350,000 without trade.
Some readers might be inclined to point out that we have now lost 100,000 hours worth of jobs. In our example, trade with Mexico certainly has decimated our garment industry. However, it has also freed up a huge amount of labor which can be deployed to make other things.
Specifically, prior to trading with Mexico, we needed 350,000 hours of labor and now only 250,000 to enjoy the same basket of goods. That represents a huge savings. When we deploy those furloughed workers into the production of alternative products, we will enjoy the fruits of their labor, which represents an additional 100,000 hours worth of goods and services. Through free trade with Mexico, we have, in essence, gone from consuming 350,000 hours of goods to 450,000 hours of goods.
That is a huge jump in the standard of living made possible simply by opening up free trade. Several studies have been made to estimate the effect on household income arising from foreign trade. As I have glanced over the literature, it would seem that average household income today is at least 10 percent higher than it would be without the level of trade we enjoy at this time. Take away free trade, and, after the severe recession that will certainly follow, households will be significantly poorer. Reducing access to foreign markets is akin to outlawing labor-saving innovations.
Yet despite the benefits of free trade, not all is quite as simple and glorious as the model. As is often said in economics, “the map (model) is not the terrain (actual economy).” Next week we will examine why free trade is, at times, controversial.
(Marcus Hutchins is a former economist, treasury-bond arbitrage trader, and hedge fund manager. He retired to Southport in 1997, where he resides with his wife, Andrea, and youngest daughter, Abbey. He welcomes feedback at email@example.com.)