Economic Fallacies
The text below originally appeared in 'Economic fallacies Exposed' by Geoffrey Wood. Copyright has been released to the Oxford School of Learning by the Institute of Economic Affairs, to whom we are grateful.
You can download 'Fifty Economic Fallacies Exposed' in a PDF file here [Right Click -> 'Save Target As'].
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VISITING THE UNITED STATES, one is struck by a particular aspect of the discussions of free international trade. The USA is moving towards a North American Free Trade Agreement (NAFTA) which aims, in principle, to remove all government- created trade barriers to the movement of goods between the countries of that area - Canada, the USA, and Mexico. But a major hindrance has emerged - environmental standards in Mexico.
It is not clear whether those who raise this difficulty are concerned about the environment, or concerned just to maintain protectionism. For now, let us give them the benefit of the doubt. Let us assume that they really believe that efficient international trade requires the same environmental standards of every country which engages in it. That fallacy is the one exposed in this column.
Why do countries engage in international trade? One obvious reason residents of one country buy goods from residents of another is that they cannot be produced at home. By far the greatest part of international trade is trade which takes place because some goods can be produced better or more cheaply (or both) in one country rather than in another.
What produces these price differences? (I focus on price differences henceforth as they are what is at issue.) Climate is one factor. Another, very important, is relative abundance of resources, making some cheaper in one country than in another. Note that it is relative abundance in two senses - in one country as compared to another, and abundance produced by ample supply relative to demand. For prices to be low, there needs to be an abundant supply of a good relative to the demand for it. There being a lot of the good, or a little, in the physical sense does not give any information about price.
Now to NAFTA and environmental standards, where the above discussion will help clarify matters and expose the fallacy. Mexico can produce some goods more cheaply than the USA for a variety of reasons. Among these reasons, and particularly important for some heavy industries, is that manufacturers in Mexico do not have to meet the same low pollution standards. Their 'smoke-stack industries' still have smoke stacks!
Why is this, and what would be the consequences of insisting that it be stopped before Mexico was allowed to export to the USA without any restrictions?
There are many reasons. Tastes vary. Smoke may be seen not as damaging to health, but as a symbol of thriving and prosperous industry. But one factor is almost certainly income. Lack of food and of clean water kills more rapidly than does a smoky atmosphere. People will buy food and clean water before worrying about clean air.
Suppose they were compelled to worry, and to do something about it. What would happen? Immediately, costs of production in Mexico would rise. Goods would be more expensive than before, and would either not be exported to the US or exported only in modest quantities, even if trade were free of impediments.
Well-being would be affected both in the US and in Mexico. US residents would not get some goods so cheaply and so would be worse off. Because they could not get these goods so cheaply, they could not afford to buy some other goods. The producers of such goods would be worse off, perhaps out of work. Meanwhile, some Mexicans would see the demand for their products disappear, and so they in turn could be unable to buy other goods, either from Mexico or elsewhere. In summary, both producers and consumers, in the USA and Mexico, would be made worse off if the Mexicans were not allowed to make use of some of their relatively abundant resources - cheap air, water and land. The policy makes no more sense than it would to say that, before the US is allowed to sell grain to Europe, it has to destroy the prairies.
What of the Mexican environment? Free trade between the US and Mexico will increase demand for all relatively cheap Mexican resources. Wages in Mexico will rise. And so will the value people put on clean air!
It is possible that environmental pollution will not diminish in Mexico. That would follow if Mexican tastes really were very different from those in other countries that have developed and become rich. In that unlikely event, it would not be grounds for preventing free trade - or at any rate no better grounds than it would be to prevent free trade with a country because its citizens wore brown shoes to the office.
Insisting that free trade requires similar environmental standards between countries before trade starts is equivalent to saying that all relative advantages should be extinguished by law before trade starts. Acting in accordance with that fallacy would be a recipe for poverty in all the prospective trading partners.
Geoffrey Wood, September 1993
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