The "free trade reduces prices" fallacy, yet again

This time the culprit is Tyler Cowen. In his column for the New York Times today, Cowen argues that freer trade in food commodities such as rice would boost global supplies and help reduce prices.  He is probably right about the first, but not about the second. The effect of freer trade on domestic food prices depends on whether a country is a food importer or exporter.  Freer trade would reduce prices of food (relative to other prices) only in countries that are food importers.  Food exporters would experience a rise in the relative price of food, and there is simply no way of escaping that reality. 

Trade works by relieving the relative scarcity of goods.  The key here is the term "relative."  Food importing countries are food scarce countries, and as they open up to trade, the relative price of food falls.  But if you are Thailand or Argentina, where other goods are scarce relative to food, freer trade means higher relative prices of food, not lower.  And all the induced efficiency benefits and short- vs. long-run effects that Cowen talks about have no bearing on this conclusion: in the end some countries have to be net importers, and others net exporters.

Comments

[Bersant]

Tyler's piece is wrong on so many levels. I think NYT needs to be better at satisfying its free trade tendencies.

Coming back to Dani's comment on prices, I think there is a common mistake a lot of people, and, surprisingly, many economists, do when discussing free trade. The lower price argument has a strong and unrealistic implicit assumption to it. The fact that freer trade will immediately expand production (capacities are in place, right?), increase competition and set in economies of scale, which will lower costs and subsequently prices. Over a certain period of time this could be true for some goods but generalizing this to all goods is misleading to say the least.

[Raghav]

It doesn't seem like he actually says that lifting trade restrictions will always and everywhere lower prices. (The lede comes closest, but read literally, it doesn't either.)

In fact, he writes, "Export restrictions send a message to farmers that their crops are least profitable precisely when they are most needed." And implicit in that sentence is that the relative price of rice will go up in rice-exporting countries under freer trade.

[Anh Tran]

Although I don't agree with Cowen when he says rice hoarding is a normal free market behavior, I think that that there is nothing wrong with his conclusion that freer trade reduces the global price for rice.

Dani is correct in saying that freer trade would increase the relative price for rice in rice exporting countries. However, what Cowen is saying, I assume for reading the piece, is that the average global price for rice, not just the price for rice in rice exporting countries, would reduce.

It would be problematic if one uses Dani's high-relative-price-argument as an excuse to restrict exports. Actually, the increase in relative price of exporting goods is a manifestation of the theory of comparative advangtage at work. It would be misguided to protest free trade based on the outcome of one section of the whole picture. Here, the whole picture include the buyers and sellers of all goods and services available in the market, regardless of its country of origin.

When we fully take market distortions in terms of environmental and social costs into account, free trade is good thing the world over. Think about those poor Vietnamese farmers selling their rice and fish throughout the world without the unreasonalbe restrictions from their own government and the governments of other countries. That would be is significant economic and political empowrement for them.

[Ken Houghton]

Give you a hint: if 93-95% of the suply isn't being traded internationally, that's probably because the indigenous demand is greater than the international demand. (If one could sell my rice on the open market and make enough to buy a preferred food, one would. Since one doesn't, they cannot.)

So when Cowen blithely proclaims that "the trade in rice doesn’t flow to the places of highest demand," he's ignoring his own data that the highest demand is internally--for exactly the reason stated above (that is, importing other foods is less utile than using the rice domestically; the highest demand is among the highest producers).

[Diana]

By the same logic, relative prices of food would also increase if the food exporting countries started importing more other goods (say pharmaceuticals), which would lower the prices of those other goods relative to food prices. Importing more stuff would generally be a sign that those countries are better off though, correct? So what's your point?
Overall freer trade will make food cheaper everywhere in absolute terms. Even if food is relatively more expensive people will be better off in absolute terms. Tyler is correct.

[anon]

I read the piece, Cowen never commits the fallacy.

[Sebastian]

Diana - simple example to show that freer trade will not decrease absolute prices for food:
Assume a World Market price for beef of 100$ per unit.
Assume that beef is abundant in, say, Argentina, so that, given no int. trade at all, it's domestic price would be lower. Now, with free int trade (assuming no transportation costs and Arg. being a ¨small" country with no effects on WM prices), the domestic price for beef in Argentina would equal the WM price of 100$.
Now have the Argentine gov´t impose export taxes of 100% on beef, so that they only get 50$ for a unit of beef selling on the WM at 100$. That means, of course, that equilibrium domestic prices would also be at 50$.

(Btw. - the quite good NYT article on Argentina
http://www.nytimes.com/2008/04/27/world/americas/27argentina.html has increased my concerns about their import taxes, which do indeed seem excessive and stifling technological modernization in Agriculture)

[Free trade fundamentalist]

Obviously you haven't even read the piece. But of course that is not necessary you know already that free traders are fundamentalists, so you can safely assume that fall for all possible fallacies.

[Diana]

Sebastian,

I think you are missing my point. Even if Argentina is a small country and its production does not affect WM prices, increased production and sale at higher WM prices means higher income for Argentinians, which means they can buy more stuff. So it is not clear that higher WM prices of beef will harm them! At the same time free trade will allow them to import goods that are scarce in Argentina at lower prices (as Dani pointed out), which I am assuming is a good thing for Argentinians.
So, higher beef prices in Argentina may mean less beef consumed in Argentina, but it also means higher incomes for Argentinians, which I think they would probably enjoy.

[K. Williams]

Dani, come on. If you remove export restrictions and price ceilings at home, there's a greater incentive for farmers to grow crops. So there would be more supply available globally, which -- assuming constant global demand -- would eventually reduce prices.

Regardless, Cowen's point in this piece isn't about lower prices per se -- it's about ensuring that food gets to those places that want and need it, and that the global supply of food continues to increase. To deny that free trade in food would help in this regard seems obtuse at best.

[happyjuggler0]

I find it amusing that Dani cites Argentina as an example of where it makes sense to ban or tax exports of food (i.e. not use free trade). Perhaps he should read the Argentina article linked to by Tyler.

The feedback effects of an export ban are such that less food will likely be grown in Argentina. This is true in all countries with export bans or high export tariffs.

I wouldn't be at all surprised to see global flower prices fall due to supply substitution in countries that engage in protectionist export tariffs on food.

[Gene O'Grady]

At least in California discussion of price incentives and global demand doesn't have an awful lot to do with how much rice is grown for whom -- it has it a lot more to do with choices about the use of the scarce resource of water, and that really isn't best dealt with by individual homines economici.

[Sebastian]

should read "export taxes" after the btw. above.

Diana,
OK, but then you're making a point about the overall welfare effect of free trade - which Dani has shown in his empirical work to be much weaker than theory would suggest.

Regardless of that, though, the argument here is about food prices - partly because they have distinct distributive qualities - the people hurt most by high food prices are the poor, who will benefit least from more imports.
(To avoid misunderstandings: I think everyone here would agree that the poor in food importing countries are hurt by export taxes in food exporters).

As for Cowen's article - I agree with other people that his main argument is about increasing production rather than lowering prices (on the contrary - his demand argument seems to _rest_ on higher (export) prices.
I have no idea if he's right on that - he doesn't cite any empirical indication, let alone analysis that he is, though the argument is intuitive. Generally, though, Cowens is one of the true "free market fundamentalists" who makes a life of explaining why free markets are always great, so yes, I'm doubting some of what he write because of who he is.

[Domino]

Dani, you're at risk of becoming an ideological reactionary. You've ignored a good, progressive and legitimate point here to raise a side issue and score a cheap shot. This is the sort of debating approach I'd expect from Socialist Alliance or the GOP. You're better than this.

[MW]

"As for Cowen's article - I agree with other people that his main argument is about increasing production rather than lowering prices (on the contrary - his demand argument seems to _rest_ on higher (export) prices."

Don't misunderstand Cowen. His argument was not FOR higher export prices, but that higher export prices already exist. The world market price for grain and rice did not materialize out of thin air. They came from real shortages and real starvation experienced by other countries.

Dani's argument assumes that the only pertinent variable is the short-term consumption of goods within net exporting countries. Dani neglects to mention that exported goods go to satisfy a real need within other countries. On a world-wide scale, then, free trade produces a neutral effect.

Later on, free trade incentivizes more production and does reduce the world-wide price of goods while increasing world-wide production. For an empirical example, consider oil exports from Canada. Oil companies have invested billions of dollars in expensive shale oil exploration in the Canadian tundra and oil from these mines have supplied much of the oil to the American midwest. If Canadian oil exports stopped tomorrow, so would these investements. The American (and world-wide) price of oil would go up even more and the world as a whole would take a hit to its standard of living.

[Fabio]

I do not agree that Tyler Cowen is wrong; your claim that, despite rising supply, prices would not eventually fall seems curious in view of the relative inelasticity of food demand.

Free(r) trade ensures that goods are produced where it is most efficient to do so. Thus, it is highly likely that global supply will rise over time (which you acknowledge) and prices eventually fall (food demand is relatively inelastic, thus when you augment supply prices will necessarily fall).

Sure, resource endowments of different countries vary, and thus in countries with food abundance, the absolute price of food may rise. However, that’s the case for any good/service free trade scenario – relative scarcity is different in every country and so are the price effects of opening up to trade. However, it seems fair to say that *globally* (and not necessarily in every country in the world) food prices would be lower under the free trade scenario. Indeed, that’s what the author probably wanted to say.

[Eric H]

Anon nails it; the argument Dani is claiming that Tyler is making isn't made. At least by Tyler.

[gulzar]

Dani,
You are spot on. I have listed out a few reasons why greater trade in rice cannot achieve the objective of lower prices here
http://gulzar05.blogspot.com/2008/04/rice-trade-and-lower-prices.html

[Arslan]

For once, Dani’s argument confounds me. Strictly speaking, a move from less to greater free trade in a two region setting will raise the price of the good in the exporting country and lower it in the importing country. However, in our existing global situation, a move towards freer trade would presumably include lowering export subsidies. But this would, on impact, raise the international price for net importers and reduce the domestic price for net exporters! Indeed, that’s been one of the concerns that some of the net importers of food among developing countries have raised during recent trade negotiations.

[pat toche]

not so much a fallacy as ethnocentrism

ethocentrism:
The tendency to look at other cultures through the eyes of one's own culture

i.e. a U.S. perspective

[Tord Steiro]

Another question is whether increased demand for food will actually boost long time production very much. Most food producers are small agricultural households in developing countries, and while our industrialized agribusiness has a relatively low potential for any sustainable increase in production, it is these farm household that have the most promising potential.

The problem is, however, that they do not necessarily respond very well to increased demand or price incentives. Using the words of Edward Taylor and Irma Adelman: "As a consumer, the household now faces a higher staple price; however, it also experiences an increase in its income due to higher profits from farm production, leading to a positive income effect competing with the negative Slutsky effects outlined above." (http://www.agecon.ucdavis.edu/people/faculty/facultydocs/Taylor/REHO17-02.pdf)

While Elisabeth Sadoulet et al (http://www.jstor.org/stable/pdfplus/2234892.pdf)
tries to figure out why peasant households sometimes appears unresponsive to price signals and government programs.

Understanding these issues appears to be crucial in order to find a smooth way out of today's unrest over increasing food prices. And there is little evidence to support the idea that freer food trade is the silver bullet in the game, although it may prove to be part of a solution.

[BlogReader]

[ Bersant : Tyler's piece is wrong on so many levels. ]

Care to mention at least one in your post?

[ Bersant: Over a certain period of time this could be true for some goods but generalizing this to all goods is misleading to say the least. ]

Let's talk about the good in question: rice. What more is needed to get poorer countries into the position of exporting more rice? Mainly politics as there's already an infrastructure that's underutilized to deliver goods. So I suppose you're right in that there's not going to be a quick fix as the politicians want to keep their cushy jobs.

[John V]

Cowen responds to Rodrik's critique.

http://www.marginalrevolution.com/marginalrevolution/2008/04/fried-rice.html

[Barkley Rosser]

Dani,

I have to say that this is one of the weakest postings I have ever seen you make. Sure, export restrictions by food exporting countries will keep their prices down. But you agree that freer trade in food will increase supplies, which should reduce the overall global price. Furthermore, it is the importing countries that are hurting in terms of food shortages and threats of starvation, not the food exporting countries. We should exacerbate famine so as to keep food prices down in Argentina?

This is not to say that everything Tyler Cowen argued is correct. Thus, he scuffles over the fact that agricultural land in many countries is very unequally distributed, with that distribution being based on a past that is not viewed as fully legitimate. So, merely enforcing existing property rights may not improve production, but may increase corruption. We have seen redistributive land reform work in many countries, Taiwan an example.

Also, many parts of the production system are provided by government, such as roads and the larger parts of irrigation systems. So, just enforcing property rights or having freer trade does not necessarily improve the provision of these.

[Eco]

Dani,

Instead of picking on Tyler, I think it is time to point the finger on the Argentineans for adopting policies whose outcome is to starve the people from poor food importing countries.

Or do the arguments about a global community only hold when the point is to criticize rich countries?