Trade Matters
Subject Economic Growth
Topic International Trade
Key Words Economic Growth, Savings Rates, Productivity
News Story

Students of economics are quickly taught one of the principal tenets of Adam Smith's, "The Wealth of Nations," the advantages of free trade. If each nation were to specialize in those goods for which it has a comparative advantage and trade with other nations, more goods and services will be available to everyone and the world's standard of living will increase. Free trade promotes competition with its attendant benefits and spreads access to knowledge and skill, unless countries are forbidden to adopt them. Two economists, Stephen L. Parente and Edward C. Prescott argue in "Barriers to Riches," that poor countries remain poor because of policies established in those countries that prohibit the adoption of more productive technologies.

The authors found many examples of states discouraging the entry of firms that use more productive work practices through the subsidization of existing firms. States also impose regulations that provide workers with lifetime employment or require firms to use official labor exchanges to recruit employees. Local firms are also be protected through the use of tariffs.

Professors Parente and Prescott examined alternative explanations for persistent poverty, such as savings rates and educational levels, but found these explanations insufficient. For example, from 1966 to 1993, the savings rates in poor countries were about the same as in rich countries. As far as lack of education being the cause of persistent poverty, the authors note "Japan didn't double its schooling capital when it doubled its income." After examining the standard explanations for differences in economic performance, the authors conclude that while differences in input levels matter, they cannot account for either current discrepancies or past performance. The cause of these differences is a result of local interest groups blocking the use of efficient production techniques. One of the benefits of free trade is that it forces local monopolies to compete, thereby opening those countries to the most productive manufacturing technologies and practices. Multinational companies, the target of recent protests because they are accused of serving the interest of the rich at the expense of the poor, provide the newest technologies to poor countries and, instead of being the cause of poverty, can be the impetus that generates needed economic growth.

(Updated July 1, 2001)

1. Explain the concept of comparative advantage.
2. Consider two countries each producing two goods, wheat and cars. Draw production possibility curves for each country assuming that one country has a comparative advantage in producing cars and the other has a comparative advantage in wheat.
3. Briefly explain how specialization and exchange can lead to increased production of both goods.
4. Why do some labor unions and firms argue against free trade
Source Virginia Postrel, "Economic Scene: The wealth of nations depends on how open they are to international trade," The New York Times, May 17, 2001.

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