Trade Barriers, Transportation Costs, and Economic Policy

The Case for Open Trade and Its Critics

The world's trading nations have become increasingly interdependent as advances in communication and transportation have reduced or removed barriers to trade, thereby increasing demand for international commerce. Major trading nations have spent the past several decades actively seeking to remove trade barriers between themselves to further encourage trade.

The major arguments for an open trading system are that it will result in more economically efficient trade, thereby raising overall economic activity and, by extension, the wealth of nations. Arguments against open trade can be broad or narrow. Some critics contend that open trading delivers unequal outcomes because those with high amounts of power make the rules, and those rules invariably reflect their own interests above the interests of others. More niche arguments include infant industry arguments and the need for restrictions on trade based on national security concerns. Understanding both perspectives is essential to evaluating trade policy.

Evolution of Trade Theory: From Mercantilism to Modern Economics

Modern trade theory is concerned with questions of economic efficiency and optimizing outcomes. Modern trade theory has moved beyond basic assumptions to study a more realistic world where differences exist between nations, and it incorporates these differences into explanatory models.

Historically, Smith's views on trade were aligned with the concept of free trade. Mercantilists, by contrast, sought to protect their own interests and viewed government as charged with the task of doing so, even by military means. Smith saw this approach as inefficient compared with open trade, which he argued would generate greater prosperity through specialization and exchange. This intellectual shift from mercantilism to free trade theory set the foundation for contemporary trade debates.

Transportation Costs and Comparative Advantage

Transportation costs significantly affect comparative advantage between nations. Higher transportation costs can offset lower factor costs, making goods from distant low-wage countries uncompetitive. Transportation costs are one source among many of comparative advantage. For example, it is cheaper for the US to buy cars from Canada, which has high wages, than from South Africa, which has low wages, for a number of reasons—but transportation costs are among them.

When transportation costs are low, nations have more competitive markets for factor inputs. The US, for example, can buy steel from Asia at lower cost than to produce steel itself, largely because of lower transportation costs. When transportation costs were higher, it was economically inefficient to do so. As global transportation infrastructure improves and logistics costs decline, competitive advantages shift. A more competitive global marketplace for goods will reduce factor input costs via competition, forcing producers to innovate and improve efficiency.

Trade Policy Instruments and Mechanisms

Governments employ several instruments to manage trade flows and protect domestic industries. A tariff imposed on oil imports could theoretically increase US development of oil resources, if cost were the major reason those resources are presently undeveloped. However, such policies work only if they address the actual constraint on production.

Other mechanisms include bonded warehouses and foreign trade zones. A bonded warehouse is a facility where goods are stored under government inspection. A foreign trade zone is a designated city or area where foreign goods are not subject to duties. These mechanisms can reduce import duties because such duties are waived in many cases. Such programs exist specifically to reduce duties in order to stimulate trade, representing a more targeted approach than broad tariffs.