9 February 2020 – I’m about half way through a course on global economics at Keiser University, and one of this week’s assigned readings is a 2012 article by Argentine-American legal scholar Fernando R. Tesón discussing his views on the ethical basis of free trade. I was particularly struck by the wording of his conclusion section:
More often, trade barriers allow governments to transfer resources in favor of rent-seekers and other political parasites. … Developed countries deserve scorn for not opening their markets to products made by the world’s poor by protecting their inefficient industries, while ruling elites in developing nations deserve scorn for allowing bad institutions, including misguided protectionism. (p. 126)
This was unusually blunt in a scholarly article! Tesón, however, did a good job of making his case. Citing David Ricardo’s and Hecksher-Olin’s theories of comparative-advantage, He provided a well-thought-out, if impassioned, argument that trade barriers are misguided at best, and at worst unconscionable. Among the practices he heaped scorn upon are “tariffs, import licenses, export licenses, import quotas, subsidies [emphasis added], government procurement rules, sanitary rules, voluntary export restraints, local content requirements, national security requirements, and embargoes” (Tesón, 2012, p. 126).
Generally, that was a defensible list. All of those practices tend to slew market-based purchase decisions toward goods produced by firms lacking true competitive advantage. The case against subsidies, however, is not so simple. There are various reasons for creating subsidies and ways of applying them. Not all are counterproductive from an economic-development standpoint.
Stephen Redding, in a 1999 article entitled “Dynamic comparative advantage and the welfare effects of trade” pointed out that comparative advantage is actually a dynamic thing. That is, it varies with time, and producers can, through appropriate investments, artificially create comparative advantages that are every bit as real as the comparative-advantage endowments that the earlier theorists described.
The original Ricardian model envisioned countries endowed with innate comparative advantages for producing some good(s) relative to producing the same good(s) in another country (Kang, 2018). Redding pointed out that a country’s productivity for manufacturing some good increases with time (experience) spent producing it. He posited that if the country’s competitors’ comparative advantage for producing that good is not great, it may be possible for the country to, through investing in or subsidizing development of an improved production process, overtake its competitors. In this way, Redding asserted, the relative competitive advantage/disadvantage situation may be reversed.
The counterargument to subsidizing such a project is that the subsidy has an opportunity cost in that the subsidy uses funds exacted from the country’s taxpayers to benefit one or more selected firms. Tesón’s position is that this would be an inappropriate use of taxpayer funds to benefit only a small subset of the country’s citizens. This is ipso facto unfair, hence his stigmatizing such a decision. The reductio ad absurdum rejoinder to this argument is that it leaves government powerless to effect economic development.
In a democracy, government decisions are assumed to have tacit acceptance by the whole population. Thus, an action by the government to support a small group developing a comparative advantage through a subsidy must be assumed to have a positive externality for the whole population.
If the government is an autocracy or oligarchy, there is no legitimate claim to fairness for any of its decisions, anyway, so the unfairness argument is moot.
There are thus conditions under which subsidizing firms or industries to develop enhanced productive capacity for some good make economic sense. Those conditions are as follows:
Competitors’ comparative advantage is small enough that it can be overcome with a reasonable subsidy over a reasonable length of time;
There is reason to expect the country will be able to maintain its improved comparative advantage situation after subsidies have been removed;
Achieving a comparative advantage for production of that good will have ripple effects that will generate comparative advantage throughout the economy.
If and only if all of these conditions obtain is it reasonable to create a temporary subsidy.
An example of an inappropriate subsidy is that by the European Union for Airbus, which began with the company’s launch in 1970 to create an EU-based large civil aircraft (LCA) industry to compete with the U.S.-based Boeing Aircraft Company and continues today (European Commission, 6 October 2004). While this history indicates that item 1 on the list above was fulfilled (Airbus became an effective competitor for Boeing in the 1980s), and item 3 certainly was fulfilled, the fact that the subsidies continue today, half a century later, indicates that item 2 was not fulfilled.
On the other hand, the myriad salutary effects that came out of the Polaris missile program of the mid-20th Century shows that all three conditions were valid for that government-subsidized project (Engwall, 2012).
Engwall, M. (2012). PERT, Polaris, and the Realities of Project Execution. International Journal of Managing Projects in Business,.5(4), 595-616.
European Commission. (6 October 2004). EU – US Agreement on Large Civil Aircraft 1992: key facts and figures. (MEMO/04/232). Retrieved from https://ec.europa.eu/commission/presscorner/detail/en/MEMO_04_232
Kang, M. (2018). Comparative advantage and strategic specialization. Review of International Economics, 26(1), 1–19.
Redding, S. (1999). Dynamic comparative advantage and the welfare effects of trade. Oxford Economic Papers, 51, 15-39.
Tesón, F.,R. (2012). Why free trade is required by justice. Social Philosophy & Policy, 29(1), 126-153.