The Free Trade of Goods … And Bads

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Both Canada and Europe expect to benefit from the new free trade agreement.

Canada and the EU have made a sweeping free trade agreement, and Stephen Harper is exultant: “This is a big deal,” he told the press in Europe, after concluding the negotiations. “Indeed, this is the biggest deal our country has ever made. This is a historic win for Canada.”

The Prime Minister’s claim is barely an exaggeration. The general removal of barriers to the cross-Atlantic exchange of goods and services, or free trade, will almost certainly mean hundreds of billions of dollars to the economies of Canada and the European Union over the next few decades. There are few informed people who disagree. In fact, nearly 100% of economists support free trade.

Uncertainty surrounds free trade, however. Recent polls of Canadians find 40% who endorse free trade with Europe, 16% who oppose it and, surprisingly, around 44% of Canadians who have no opinion, perhaps because they do not fully understand what it means to have free trade. Most issues debated in government have a more transparent moral or partisan character.

Because of the economic significance of trade policy, and its relative intuitive simplicity, it is worth explaining free trade in a general way.

Every government in the world charges some level of tariffs on goods and services purchased from foreign sellers. When consumers pay tariffs on goods they import, the tariffs are normally called duties. Most tariffs, however, are levied on businesses, who pass much of the burden of the tariff on to consumers.

When a Canadian confectioner imports sugar from Latin America, for example, it may pay up to $30 per tonne of sugar in duty. Canadian shoe retailers pay up to 20% of the purchase price on footwear imported from Asia or Europe. Foreign governments likewise impose tariffs on Canadian imports.

Canada has concluded agreements to drop tariffs with 14 countries, and there are a few pending agreements that will soon take effect. The new agreement with the EU, which will be fully ratified within a few years, brings the number of such countries to 42. As part of the deal, 98% of existing tariffs between the two economies will be removed. Consumer prices will fall on a variety of goods, and sellers in each economy will have effective access to a much larger market.

The benefits of free trade are even better than low prices or more exports, however, and this is something that Stephen Harper understands.

One of the earliest insights of modern economics was that free trade nearly always leads to a total increase in wealth for all involved countries. Crucially, this is true even for countries whose productive capacity is inferior to their trading partners’ in every industry. This argument, which hinges on the principle of “comparative advantage”, is actually quite subtle, so it is best illustrated by an unrealistically simplified example.

In a hypothetical economy that involves only two countries and two goods, imagine that producers in France are able to produce both cheese and olives more cheaply than are producers in Canada. However, while the cost of growing olives in Canada is extremely high, Canadian cheese is only moderately expensive. So while it would be cheaper to produce cheese in France than in Canada, it would actually be even cheaper to both countries if France only grew olives and Canada produced only cheese. Canada would then trade some of its cheese for French olives. In this case, while France has an “absolute advantage” in both goods, Canada has a comparative advantage in cheese. By means of free trade, Canada is able to obtain its olives by producing cheese, rather than by inefficiently growing them. And because Canadians are willing to pay quite well for olives, the French are left better off as well.

The empirical and intuitive cases for free trade are strong, but there are of course reasons to oppose the policy, at least in particular circumstances. Certain Canadian industries would shrink or vanish if exposed to foreign competitors, and jobs in those industries would be lost. The dairy industry, for example, will probably see falling profits now that Canadians can buy European cheese more cheaply. This is a reason for political caution, but experience teaches us that the benefits of free trade outweigh its costs.

The unambiguous and very large benefits of free trade sometimes tempt policymakers and pundits to become over-enthusiastic, and to forget that there are important reasons to be selective in our trade policy. It is common sense that we do not, for example, liberalize the international market for handguns, explosives or non-medicinal drugs.

Perhaps one of the best publicized effects of the new free trade deal, however, is that the market for wine and spirits will be liberalized, leading to more varieties of alcohol and likely to lower prices. But while Canadians will be freer than before to indulge, we can be almost certain that more people in Canada will die as a result of lower prices, many of them teenagers (the leading preventable cause of teenage death in Canada is alcohol). The number of deaths caused by alcohol shows a surprisingly significant connection to the price of the drug. Whether we are examining drug policy or trade policy, lowering the price of alcohol should probably be our last priority.

Despite the missteps that often accompany good policy, we can be confident that a policy of free trade with Europe is sensible and well justified by experience. We can look forward to the increased prosperity that follows free and open markets. With respect to value created, the agreement may indeed be one of the most significant accomplishments of Mr. Harper’s premiership.

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