Trade creates wealth. Regulation destroys it.

The auto industry is a perfect example of how regulation can hinder the market.

We?re wrapping up our discussion of international trade in Econ 100 today with an analysis of tariffs and import restrictions. The defense of protectionism is a classic example of the Broken Window Fallacy in action.

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Suppose the government decides to impose restrictions of some kind on automobiles produced in Japan. To the untrained eye, this looks like a great idea. More Americans are employed making cars, and they earn higher incomes. Detroit booms. It?s easy to see autoworkers? nice cars and nice houses and conclude that protectionism is a great idea.

But there?s more to this than meets the eye. What we don?t see are the hidden costs of protectionism. The first is the waste from using costly production methods. Protectionism changes manufacturers? incentives, and they use capital and labor that could have been better-used elsewhere to produce (say) cars. The economic imagination is useful here. If people weren?t making cars, they could be making medical devices. Or tacos. Or automotive repair services (it stands to reason that if you can build cars, you can probably also fix them). Or any of a number of other things. As Russell Roberts points out in The Choice, there might be some short-run costs for workers who have trouble retooling; however, free trade leads to new opportunities for the next generation.

The second cost comes from the fact that tariffs increase the price of cars. When prices rise, people demand less of something. Consumers are worse off because they have fewer cars, and the cars they are no longer buying are cars that would cost less than consumers are willing to pay in the absence of tariffs. Interventions like tariffs raise the incomes of some workers by impoverishing others.

The third cost comes from the change in incentives when it is discovered that people can raise their incomes by getting favors from the government. At best, favors from the government are a zero-sum transfer from one group of people to another. In reality, however, people use scarce resources to effect these transfers. Consider just one cost: the cost of flying to and from Washington, DC. The plane that is flying auto executives and union representatives from Detroit to DC could be used for something else, like flying people from Detroit to New York for business or from Detroit to Los Angeles for a vacation. The prospect of subsidies, tariffs, and other benefits from the government means that people will take valuable resources that could have been used to create wealth (planes, the time and energy of flight attendants and pilots, bags of roasted peanuts) and instead use them to transfer wealth. On net, we?re all worse off.

*Interested readers might be wish to read The Choice by Russell Roberts. In it, a television manufacturer is visited by the ghost of David Ricardo. Hilarity ensues, and the case for free trade is explained beautifully. The link is to my Amazon Associates Account; any revenue I get from Amazon Associates sales will go to the Fellowship Memphis ?Engage Memphis? fund.

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