Practice Questions
Available here.
(A) Robinson in solitude
If I begin talking about trade between two countries, your first image is likely to be Americans losing factory jobs, unable to compete against cheap Chinese imports. Much of this image is correct, but while you will initially perceive it to be a bad thing I argue it represents economic progress. After all, didn't the horse and wagon industry lose jobs to the automobile industry?
Trade is just an exchange of goods and/or services between people. Those people could be you and your brother, you and your boss, Oklahoma and Texas, Chicago and Seattle, or the U.S. and China. The essence of trade can be illustrated with two people or two nations, and because the former is much simpler, we will start there.
Even if you have not read Daniel Defoe's Robinson Crusoe1, you probably know it is about a solitary man stranded on an island, much like Tom Hanks in the movie Cast Away. By imagining ourselves in permanent solitude we can best think about the world without trade. All alone, every single thing Robinson consumes he must produce. Not surprisingly, he can't produce much, but he does learn enough skills to survive. Let's pause here and imagine what your life would be like if you could only consume things made by you and you alone. What if you became a modern-day Robinson Crusoe, alone on a small Pacific island? Given twelve hours of work each day for five years, what will you be able to make for yourself?
Figure 1—Tom Hanks in Cast Away (2000)
Do you want an iPod? Well, can you physically make an iPod? Then no iPods for you. What about a refrigerator, or decent shoes, or penicillin, or a comfortable pillow?
Carefully think about how little you could produce on Crusoe's island, and then think about all you are able to consume now when you are not stranded alone on an island—when you are a member of a large society with whom you can freely buy from and sell to. Of all these things you currently consume, you could make only a small, small fraction for yourself on that island. Not even in three decades would you provide for yourself a nice dwelling with refrigerators and cable television and computers and a comfortable bed with a comfortable pillow and wireless phones—don't forget soap and water, ibuprofen, and heart transplants.
Human life is constituted by the harmonious exchange of benefits, and is held fast in a pact of mutual assistance not by fear but by mutual affection.
—Seneca, Lusius Annaeus (4 BC – 65 AD), a Stoic philosopher. On Anger. From Anger, Mercy, Revenge. 2010. The University of Chicago Press. Translated by Robert A. Kaster.
It warrants repeating: even if you are among the poorest of Americans, you have access to goods and services you could never make own your own. What you have access to in one day you could not make for yourself in a hundred years. This illustration, first made by Bastiat(B1) in the nineteenth century, is an irrefutable proof of the benefits of trading with others. It not only shows why you should trade with others by living in a society; it shows why the U.S. should trade with China. Trade is good. Ask Robinson Crusoe.
(B) Robinson Meets Friday
After more than twenty-five years of solitude, a group of primitive islanders visited Crusoe's island with the intent on cannibalizing two prisoners. One of the prisoners escaped and ran straight to where Robinson was hiding. The prisoner would have been captured if Robinson had not intervened, and by saving the prisoner Robinson gained himself a loyal friend. All of this happened on a Friday, so Robinson named his new friend "Friday".
Figure 2—Robinson Meets Friday
The presence of another person enhanced Crusoe's life considerably, as he remarked, "Now my life began to be so easy that I began to say to myself that could I but have been safe from more savages, I cared not if I was never to remove from the place where I lived."(D1)
Let's think about the ways in which Robinson could benefit from the presence of another person, and do think of this other person as a trading-partner. For every benefit we can ascribe to Friday's presence we can also ascribe to U.S. trade with other countries.
Trade benefits both parties because it allows them to:
(B.1) Acquire new goods, heretofore unavailable—Perhaps Friday is able to spear a particular type of tasty fish Robinson cannot. With Friday, Robinson has access to a new, tasty food—just like America cannot acquire bananas at a reasonable price unless we trade with countries like Costa Rica. However, as we will see, two parties can benefit from trade even if both are efficient producers of all goods that are traded.
(B.2) Acquire more stuff through comparative advantage—Even if there are multiple things both Robinson and Friday can produce, their skills will make each better at some things than the other, and they should concentrate on what they are best at. The term "best at" has a very specific meaning in the context of trade. Consider fish and goat milk. Suppose you ask both Friday and Robinson go catch one fish and bring it back to their camp. When both have returned, ask them, "In the time it took you to catch this one fish, how many gallons of milk could you have obtained?" Whoever gave up the most gallons of milk has a comparative advantage in milking and should milk instead of fish. After all, they left more milk "on the table" to catch that one fish.
The other person has a comparative advantage in fish, and should concentrate on fishing. No one person will ever have the comparative advantage in everything. At the end of the day, one brings back milk and the other brings back fish, and they share. By concentrating on their comparative advantage both Robinson and Friday can consume more milk and fish than they could without sharing. This is true even if Friday could produce more fish or milk than Robinson in a single day. It doesn't matter how much one party can make, but how much of another good they give up making it.
Technically, we say one party has a comparative advantage in the production of a good if they can produce it at lower opportunity cost.
Video 1—Comparative Advantage in 60 Seconds (OpenLearn @ BBC)
This story can be extended from Robinson Crusoe to modern nations. Consider America and Costa Rica, where both nations can produce sugar and wheat. There is no debate that America can produce more wheat per labor hour. It is also [almost certainly] true that America can produce more sugar and wheat per hour of labor than Costa Rica in any given year, due to American mechanization in sugar beet farming. Yet, if free trade in sugar were permissable, Costa Rica would probably export sugar to America, and America would export wheat to Costa Rica—both nations becoming richer in the process.
Figure 3—Which Milking System Is More Productive?
(B.3) Acquire more stuff through division-of-labor and economies-of-scale—Two different systems for milking goats are shown in Figure 3, a modern, automated system on the left and a primitive system of hand milking on the right. Which one do you think is more productive, allowing one to milk more goats per hour? The system on the left, of course. Now let me ask you which farm is more likely to use the automated system: a farm with 1,000 goats or a farm with two goats? The large farm, of course. Installing automatic milkers requires a considerable investment, a cost too high when the herd size is two. The larger farmer can spread the cost of investment over many goats, though, and can thus afford it, allowing him to reap economies-of-scale, where the per unit cost of production falls the more milk that is produced.
Video 2—Corn Farmers Getting Bigger and Bigger (from documentary, King Corn)
On his island, Robinson milks his few goats by hand, but suppose that hundreds of other people join Robinson on the island. Now Robinson can invest in expensive capital that improves milking efficiency, after which he enlarges his herd size and milks many goats at a relatively low cost. As the farm grows both Robinson and Friday only produce goat milk, and exhibit a division-of-labor whereby Robinson concentrates solely on milking the goats and Friday concentrates on feeding and caring for the goats. They could have both fulfilled the roles of milkers and herdsmen, but they decided to separate their duties so that each could specialize in one aspect of production and hone their skills.
This division-of-labor is a simpler form of the assembly line which has made both cars and meat affordable even to the poorest of American. As Robinson and Friday produce large amounts of inexpensive milk they sell it to the other islanders and use the money to buy all the other things they need—the other things they used to produce for themselves. The key insight from this story is that trade enlarges the potential size of a market. The ability to sell to many customers allows division-of-labor and economies-of-scale necessary for all the island to drink milk at low prices. Before, Robinson and Friday produced everything they consumed, but produced it inefficiently. Now they can produce only one good but become brutally efficient at it. All the other islanders do the same, but for different goods. Eventually, the more populous island is brutally efficient at everything, which means more wealth is created, and the island prospers.
And now let us see how our city will be able to supply this great demand: We may suppose that one man is a husbandman, another a builder, someone else a weaver — shall we add to them a shoemaker, or perhaps some other purveyor to our bodily wants?
Quite right.
The barest notion of a State must include four or five men.
Clearly.
And how will they proceed? Will each bring the result of his labors into a common stock?— the individual husbandman, for example, producing for four, and laboring four times as long and as much as he need in the provision of food with which he supplies others as well as himself; or will he have nothing to do with others and not be at the trouble of producing for them, but provide for himself alone a fourth of the food in a fourth of the time, and in the remaining three-fourths of his time be employed in making a house or a coat or a pair of shoes, having no partnership with others, but supplying himself all his own wants?
Adeimantus thought that he should aim at producing food only and not at producing everything.
Probably, I replied, that would be the better way; and when I hear you say this, I am myself reminded that we are not all alike; there are diversities of natures among us which are adapted to different occupations.
Very true.
And will you have a work better done when the workman has many occupations, or when he has only one?
When he has only one.
—Plato (424-348 B.C.) in The Republic. Book II: The Individual, The State,
And Education. A conversation between Socrates and Glaucon, and perhaps some
others.
This quote from Plato shows how long the concept of division-of-labor has been around. It is truly one of the more remarkable observations in science, for one could argue that the division-of-labor is the primary source of wealth creation. Technological innovation is important of course, but such innovation allows for new forms of the division-of-labor to take place. For instance, technological progress in robotics has allowed robots to take workers' place in the assembly line, releasing workers to be used in other areas, like those who build robots. The division-of-labor is a manifestation of technological progress and human creativity.
In fact, the division-of-labor is not a concept reserved for humans. Some scientists now believe life evolved from single-celled to multi-celled organisms in order to benefit from the division-of-labor.(G1) We owe the division-of-labor our existence!
(C) Pilgrim distillers
The American pilgrims loved alcohol. When they first arrived in the New World they were accustomed to drinking very weak beer, partly because beer was safer to drink than water. They had trouble making their own beer, though, because the Old World grains did not grow well on the eastern coast. They could import grains, but they were not cheap. What was cheap was rum, made from the by-product of sugar processing, sugar molasses. Eventually the colonists learned they could import the sugar molasses even cheaper and make the rum themselves, and as the population grew and the ingenuity of the colonists was applied to rum production, the northeast became a major rum producer. At one point, rum constituted 80% of its exports. In case you are unaware, cane sugar absolutely will not grow in the northeastern U.S.
Think about what that means. In an area where sugar cannot be grown a major rum industry emerges and thrives, exporting rum all over the world. Sometimes, what a region exports has absolutely nothing to do with the region's climate and resources. When large populations and zones of trade allow economies-of-scale and division-of-labor, a region can benefit by producing and exporting a good it is naturally unsuited to making.(S1)
(D.1) You say we can gain from trade, but will we?
This article has focused on how trade can produce more wealth for everyone, but how do we know people will trade in this manner? Could they mistakenly trade in a matter that makes both parties worse off, or allows one party to benefit at the expense of the other? A similar question might be: how do we know a factory will be profitable? How do we know someone will find a good job after graduation? How do we know parents will make a good decision about whether their sick child needs surgery? So long as they have economics freedom, people are generally good at taking advantage of opportunities when they arise, and that's all trade is: an opportunity for a better life.
Video 3—Why We Trade (Learn Liberty video)(Y1)
(D.2) So what's stopping us?
If the case for trade is as powerful as economists say, then why have nations always imposed trade barriers, and to this day have trouble passing free trade agreements between countries?
- One answer is special interests. The sugar program is a prime example. The U.S. government protects American sugar producers from cheaper sugar imports, causing prices in the U.S. to be double the world price. This trade restriction allows a few sugar producers to become very rich, and they express their gratitude for the trade restrictions in the form of campaign contributions. Politicians thus erect trade barriers to help them raise money to help them get reelected.
- Also, most people simply don't know much about economics, and are hesitant to just take economists at their word.
- Some people may believe trade is good overall, but will harm them personally, and thus oppose trade liberalization schemes that might cost them their job.
- Finally, the anti-globalization movement opposes free trade between countries not because of economic arguments, but political concerns. They believe that when free trade is allowed big, multinational corporations will invade developing countries, using its power to control the local government and oppress the workers in that country. If there were no large corporations, there would not be an anti-globalization movement.
(F) Gains from trade in the animal world
Even different species of animals have learned to gain from trade. The video below shows a Giant Moray Eel and a Grouper hunting together. Grouper are fast in open waters; they are the Cheetah of the sea, but they can't hunt in small spaces. The Moray is the opposite able to slide through small, meandering tunnels and cracks, but not fast in the open water.
The two species have learned to combine their distinct talents to become a formidable team. Grouper actively seek out Moray when it has found prey hiding in tunnels, asking the Moray come help by shaking its body. The Grouper then escourts the Moray to the hidden prey, doing a headstand and shaking its head to indicate where the prey hides. The Moray then enters where the Grouper cannot. If the prey is cornered then the Moray is able to get a free meal, but if the prey is hiding in a tunnel with an exit then the Moray flushes the prey out where it is quickly caught by the Grouper.
This is an example of comparative advantage. The Grouper and Eel hunt the same food, but have different skills that can be executed to catch it. By combining their differing skills, both get more prey than they could hunting alone.
Video 4—Gains From Trade: Under The Sea(Y1)
References
(B1) Bastiat, C. F. 1850. Economic Harmonies. The Bastiat Collection. Second Edition. Ludwig von Mises Institute.
(D1) Defoe, Daniel. 1719. Robinson Crusoe.
(G1) Goldsby, Heather J., Anna Dornhaus, Benjamin Kerr, and Charles O'fria. August 7, 2012. "Task-switching costs promote the evolution of division of labor and shifts in individuality." PNAS. DOI:10.1073/pnas.1202233109
(S1) Standage, Tom. 2006. A History of the World in 6 Glasses. Walker Publishing Company: NY, NY.
(Y1) Yong, Ed. April 24, 2013. "Groupers Use Gestures to Recruit Morays For Hunting Team-Ups." Phenomena [blog]. National Geographic.
