Why We Trade What We Trade

President Trump is a renegade for a number of reasons, including wishing the haters and losers a Happy Thanksgiving on Twitter. But he has been shockingly consistent throughout his life in his opposition to trade. It’s not that he’s opposed to free trade, he says, but that he wants fair” trade. He wants to bring American jobs back.

Sometimes, it’s best to ignore President Trump’s tweets – especially if you’re a senator that’s been accused of being drunk. But it is worth examining Trump’s policy opinions on a difficult topic like trade. After all, why can’t a rich nation such as the United States simply produce most things in America, benefiting American workers and consumers?

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There is perhaps no topic that generates greater consensus among economists than the beneficence of trade between countries. Trading goods and services is a mutually beneficial path towards economic prosperity. Bertil Ohlin won a Nobel Prize for showing just this.

Bertil Ohlin was a Swedish economist and politician born in 1899. He won the Nobel Prize in economics in 1977 for a theory modeling trade between countries that explains why we trade what we trade. Ohlin’s insights help us understand why we don’t produce certain things, such as t-shirts, all that much in America anymore.

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Ohlin’s theory begins like this. Take two countries, and assume that the citizens of the two countries have the same needs. Now assume that the two major factors of production – machines and people – are not available in the same proportion in each country. For example, the United States could have two machines for every worker, and Mexico could have two workers for every machine.

Ohlin’s theory predicts that these two countries will specialize in producing the goods where they have a relative abundance. That is, the country that has the greater proportion of capital (the United States) will produce capital-intensive goods. The country that has the greater proportion of labor (Mexico) will produce labor-intensive goods. These differences allow for the possibility of trade.

Notice that Ohlin’s theory states that it is the relative difference that matters, not the absolute difference. The United States has nearly three times as many workers and has more machines than Mexico. However, Ohlin’s theory suggests that trading between the two countries is still beneficial.

Why? Because in the United States – with an abundance of machines compared to Mexico – it’s less costly to produce capital-intensive goods, such as airplanes. Alternatively, in Mexico – with an abundance of labor – it is less costly to produce labor-intensive goods, such as t-shirts.

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Recall that in Ohlin’s model the citizens of both countries have the same needs. Therefore, both Americans and Mexicans need an equal amount of airplane rides and new t-shirts.

The relative differences between the two countries allow them both to specialize in production that is less costly. The ability of the countries to trade permits this specialization to happen. Specialization leads to greater production using fewer inputs.

Bertil Ohlin’s model and theory on international trade certainly makes some simplifying assumptions. Nonetheless, Ohlin’s contributions help provide a greater understanding of why countries produce what they do, and how trade makes countries better off.

President Trump, his administration, and many Americans are rightly confused as to how trading with others, especially poor countries, can possibly make Americans better off. Understanding international trade is a complicated endeavor; complicated enough to earn you a Nobel Prize if you can advance our understanding in a clear manner.

However, the economic theory is fairly clear. Using policy, such as tariffs and subsidies, to bring particular jobs back to America does not change the relative differences between countries. These policies simply interrupt the specialization process happening between the trading countries. Policies that interrupt trade require using more resources to get the same amount of stuff. As Bertil Ohlin explained, the path to economic prosperity partly lies in the differences between rich and poor countries. These differences are nothing to be scared of.

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