Saturday, February 21, 2009

Why gains from trade need to be absolute

Economists have often noted that because the gains from trade are diffused but its losses focused, those against free trade are more likely to prevail in order to protect their potential losses. One notable problem with the arguments for free trade is that it does not bring down absolute prices but relative prices as explained by Dani Rodrik:

Daniel Drezner has some nice things to say about me and my blog, but then takes me to task for understating the gains from free trade in a recent entry. He writes:

In focusing strictly on the employment effects, however, Rodrik elides the biggest gain from trade -- lower prices.

Since Drezner’s point reflects a common misunderstanding about the effects of trade, it is worth some explication.

When a country opens up to trade (or liberalizes its trade), it is the relative price of imports that comes down; by necessity, the relative prices of its exports must go up! Consumers are better off to the extent that their consumption basket is weighted towards importables, but we cannot always rely on this to be the case.

Unfortunately, the misunderstanding about lower prices reflects that perhaps not only the gains from trade diffused, but those who purportedly gain from trade (consumers) don't even recognize the gains from trade! Unless prices are lower in absolute terms, consumers will not be rejoicing, unlike Fey Accompli (Via MR) or Silly Little Country (original Fey Accompli post seems to be broken for now):
Folks, I can buy a pair of panties at Wal-Mart for 88 cents. Please stop and reflect on how much of a miracle that is. I stood there under all those fluorescent lights having an “I, Pencil” moment and I almost wept when i saw that. Not because I can’t afford $5 for panties, but because I could get everything I needed for a stranded night for about $20. A little more and I could get a fresh outfit for the next day.

Beyond my own personal gain, the miracle is that those pale green panties with a little lace trim started out as a twinkle in some Cambodian manufacturer’s eye, and dozens of people were involved in getting them from there to my possession, the last person being the checkout saleswoman at Wal-Mart.

All those people took part in making sure that what I needed was there right when I needed it and for an unbelievable price. And everyone’s lives are better because they get to be a part of that process. A more humane system could never be invented, let alone implemented, by one person, or a committee, and by god, not by a government.

Now, if gains from trade were celebrated like this there would not be any need for convincing. Unfortunately, there is very little celebration in the price of cables:

And I'm not talking Monster Cable fancy-pants stuff either. The cheapest generic 6-foot HDMI cables that I could in Best Buy and Target in-store inventory were going for $29.99--a 300 percent premium over the $9.95 I spent at (which wasn't even that great an online price, but the shipping was free).

This experience got me to playing economist. Why, in a free market, are cables so flipping expensive? After all, these same stores carry all manner of items that are priced very competitively relative to online.

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