Issues

Benefits from trade – a fundamental perspective

Friday December 02, 2016 Konrad Hurren

The United States has elected Trump, Britain has Brexited with talks of exiting from the Common Market, and an agreement between the EU and Canada looks shaky. Clouds gather on the world of free trade as people express concern over international trade and nationalist sentiment rises.

 

The strategies of those elected in New Zealand seems very different from this world trend: broadly, politicians are negotiating expansions to the agreement with China, continuing negotiations with India and musing on such an agreement with Russia. With an election year looming it is clear that these agreements will receive particular focus, given the TPPA is floundering, if not completely dead in the water.

 

In anticipation of the upcoming political debates regarding trade, to prepare our readers to participate in informed discussion I begin the first article in a series addressing trade. This series takes the perspective from fundamental economic reasoning rather than a modern textbook approach, to shed light on the issues in a more robust way and facilitate deeply informed discussion.  I concede that the real world is unimaginably complicated. But in understanding the fundamentals, we can get a better insight into how engaging in trade offers us benefits.

 

This first article focuses on how trade works and who, exactly, is involved in trade. Further articles will explore arguments against trade and the risks of economic nationalism increasing. 

 

What is trade?

 

Trade is the exchange of something of value for something else of value. For example, Company Inc. may value Mr Person’s skills, Mr Person values other goods and services. Each day he or she migrates and exports their skills to their employer in exchange for money which allows them to indirectly trade their skills for other goods and services.

 

I’ll take this opportunity to emphasise that trade is always goods and services for other goods and services but is mediated by money. Money, then, serves only to facilitate that trade and is of no value except to the extent that it facilitates present or future consumption – the ultimate economic goal of individuals.

 

In future I will describe the role of money more in depth but for now, suffice to say that only relative prices matter: If Mr Person’s wage is $10 an hour and the local café offers coffee for $5 then it is correct to say that a coffee is priced at 30 minutes of Mr Person’s labour. Keep an eye on the BERL website for this upcoming series where I will discuss the role of money from a fundamental perspective, how it came about and where it is likely headed.

 

Who trades?

 

It is often said, and we are guilty of this at BERL, that New Zealand trades. We tell a story of New Zealand selling close to $50 billion worth of goods to other countries and buying a very slightly higher value of goods, at least on average. Our data shows that New Zealand trade (both imports and exports) is increasing over time.

 

total exports receiptsimports annual totals

 

What these figures mask, in quest for simplified exposition, is that New Zealand does not trade; trade is between individual people and firms, not nations. These individuals trade with each other by going to work each day, or by displaying groceries on shelves. In contrast, a nation is an aggregation of all the individuals in an arbitrarily defined geographic area and cannot, as an aggregation, engage in trade.  One may argue that centrally planned nations engage in trade, this is true, however it is the individual people and firms in the country who engage in the activity of trade, although they are coerced into doing so.

 

Imagine we draw a line around a small number of people who live at the same address and call them a household. In terms of economic logic applied to this household the aforementioned transactions represent; exporting services (and often migration) when an individual goes to work each day and importing goods when an individual shops at the supermarket for the week’s necessities and luxuries. This description introduces us to the distinction between domestic and international trade – in economic reality, there isn’t one. Individuals in other lands exchange things they value with individuals in New Zealand for things they value more. What is “other lands” and what is New Zealand depends only on figurative lines, not economic ones.

 

Much like transactions between one household and a firm involve money, so too do transactions between individual people and firms in other lands and individuals in New Zealand. The exchange rate represents the value of resources in one place in terms of resources in another. Only relative prices matter and so it follows that, from a fundamental economics perspective, international and domestic trade are the same phenomenon.

 

The next article in this series will explore fully why we trade. Following that, the third article will discuss how buying goods from individuals in other lands is argued to harm the domestic economy and why arguing this harm is a fallacy. The final article in this series will address the fallacies of economic nationalism and begin to assess the risks of a world retreating to nationalist positions.  Later BERL articles will explore how this fundamental perspective can be muddied by market and policy failures.