Why do we trade?

Wednesday February 08, 2017 Konrad Hurren

The first article in this series briefly explored who trades, noting that it is individual people and firms who trade, not nations. This article continues my description of trade from a fundamental perspective by exploring why individual people and firms trade.

It is important to remember that everyone trades: traditional employment is trading one’s skills and time for other goods and services (facilitated by money), this is the export activity in the context of one’s personal economy. Shopping is the second step in this process, it is the importing activity, and we import goods and services into our household. This comparison serves to illustrate that distinguishing between what is normally called “trade” (usually referring to one country trading with another) and everyday commerce is only arguing semantics, the two are equivalent.

In short, we trade in order to consume, either presently or in future. We, voluntarily, exchange something we value for something we value more. Because each party in trade gains more value than they otherwise would have, we can say that voluntary trade is wealth creating.

We can say with certainty that individual people and firms are gaining from voluntary trade, because if they weren’t then trade would not occur. A key to this argument is the idea that value is subjective. Each person makes their own assessment of what a car, auditing service or USB memory stick is worth to them. Additionally, each person makes their own assessment of what their skills and time and tools are worth to them.

Identifying that the desire to trade comes from the desire to consume illustrates a powerful argument in how trade should be assessed by outside observers. When any trade occurs, what the person receives (or imports) is the benefit of trade to that person, what they give (export) is the cost. Any insistence or coercion from a party outside the transaction that an individual person or firm give (export) more than they otherwise would have for any good is wealth destroying. This coercion is usually justified in order to “protect” the “losers from trade”, in my next article I address this issue.

Clearly, trade involves a lot of work (waking up on a Monday to migrate and export your services doesn’t always sound appealing). So why do it?

Trade is actually less work than not trading. We have limited (scarce) resources such as time for labour and capital like tools which means we cannot produce all the things we possibly want.

Take, for example, a car. If you wanted a car you would need mechanical skill and knowledge, thousands of labour hours, steel, plastic and many more commodities even to produce an unroadworthy curiosity piece. Clearly, building such a vehicle would come at no small cost for the vast majority of New Zealanders.

Luckily, each of us possesses a combination of labour and capital (often in the form of skills or human capital) which is uniquely suited to a subset of tasks. This combination means that we can perform a subset of tasks more efficiently than some other subset of tasks. This is referred to as our comparative advantage. Consider those people who are particularly good at the tasks involved in raising dairy cattle, these individuals (through many trade interactions) eventually sell the milk they harvest to an individual or firm in another country. The value of dairy exports (as receipts of NZD) is shown in the figure below. For the 2016 December year these exports totalled 3,033 million tonnes at a total value of $11 million NZD. For some context, the total value of exports is also shown next to this figure. The total amount of NZD received by people in New Zealand from exporting goods and services was around $46 bn NZD


dairy export receipts


total export receipts


These individuals who are quite uniquely suited to raising dairy cattle are highly unlikely to be so well endowed with skill and labour hours that they are also uniquely suited to producing their own cars. Instead, they use the currency they received in exchange for their milk to buy cars from individuals or firms in other countries. The total number of motor vehicle imports is shown in the figure below. For the December 2016 year the total number of motor vehicles imported was 4,792,784 at a value of $7.7 bn NZD.


motor export receipts


It should be noted that because these vehicles are being produced by people who are uniquely well suited to producing motor vehicles they are of superior quality.

When we perform tasks we are good at and trade the fruits of our labour with people who are also performing things they are good at we unlock the power of specialisation. And we each get goods and services produced in the most efficient (using least amount of resources) way.

Voluntary trade not only creates wealth, it does so efficiently – using the least amount of (scarce) resources. We get more, for less. In this way trade is exactly like innovation, which is generally celebrated as wealth enhancing.

What is true of trade in general – that it is wealth enhancing through the division of labour, is no less true because it happens to be between individuals in different countries. At a fundamental level some people are trading milk for cars. Facilitated by money in the form of fiat currency. This does not change if the person used shiny rocks or the blockchain. Nor does it change if the local currency shifts in value in terms of the foreign currency. People still exchange things they value, for things they value more.

The next article in this series will examine the most commonly cited reason to fear trade: what are often called “the losers from trade” – those people who find themselves unemployed due to patterns of trade.

We live in a world where the ideal free trade isn’t politically feasible and such barriers as tariffs (e.g. the 4.4c per KG of beef importers in the US pay for beef from New Zealand) exist to steer the patterns of trade. Other, non-price barriers also can include quotas, certification and specification requirements among other complex regulations preventing free trade.

Future articles will address optimal policy responses to the erection of trade barriers by other nation states.