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Wednesday, April 21, 2004

Help save the Welfare State: support free trade!

Throughout the world, politicians that wish to reform their welfare states or regulated economies use globalization as an all-purpose bogeyman. "We have to loosen our labor regulations," Jean Charest might say "because our economy needs it to remain competitive in a globalized world." The predictable result is that both these reforms and free trade are demonized by left-leaning groups.

But this view makes little sense from an economic point of view. Indeed, in discussing free trade between Canada and the United States, economist Eric Rasmusen says:

The conventional wisdom is based on the fallacy of confusing comparative and absolute advantage, I think. The naive view is that if Canada has lower productivity in all its industries than the US, then if trade opens up, Canada will produce nothing, and will instead import everything from the US. The fallacy in this is that if Canada produces nothing, it will have nothing to export to the US, and the American sellers will not send anything to Canada. What actually would happen is that Canada would import from the US the goods it has the biggest productivity disadvantage in, and export to the US the goods for which it has the smallest productivity disadvantage. Free trade will benefit some Canadian producers, despite the fact that their productivity is lower than that of their American counterparts.

It would also be true that even if Canada has onerous regulations that hurt its productivity, Canada would benefit from opening up trade with the US. It would actually become easier for Canada to maintain its welfare state, because the country would become richer.

The economist Tyler Cowen further adds:

Trade is a substitute for factor migration. The more a welfare state country trades, the less likely it is to lose factors of production. And the richer the country it becomes, the more likely it can afford higher levels of taxation. It is because of free trade, in part, that today's world can invest so much in welfare states.

This explains why neither the 1988 FTA between the US and Canada nor NAFTA have brought the demise of the Canadian welfare state, as was often feared at the time (and surely secretly hoped by some who supported free trade.)

Posted by Laurent Moss on April 21, 2004 in International Affairs | Permalink

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Tracked on 2004-04-21 3:05:06 PM

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