Objectivism & Economics, Part 18

Limits of free-trade. Ayn Rand and her followers are well known advocates of free trade. In her Playboy interview, Rand explained:

The essence of capitalism’s foreign policy is free trade—i.e., the abolition of trade barriers, of protective tariffs, of special privileges—the opening of the world’s trade routes to free international exchange and competition among the private citizens of all countries dealing directly with one another..

Although Rand’s primarily rationalization of free trade rests on moral arguments, nonetheless, Objectivists also contend that free trade is, in terms of economic efficiency and productivity, superior to protectionism. Yet this view is not as irrefragable as laissez-faire and other free trade zealots tend to believe.

The Italian social thinker Vilfredo Pareto, who, early in his career, had been a fervent advocate of free trade, adopted a more impartial view later in life. Although Pareto continued to maintain that protectionism destroys wealth, he came to understand that it had other effects which, under special circumstances, might make up for the wealth lost through the imposition of trade barriers. As Pareto explains in his mammoth The Mind and Society:

We find that protectionism transfers a certain amount of wealth from a part, A, of the population to a part B, through the destruction of a certain amount of wealth, q, the amount representing the costs of the operation. If, as a result of this new distribution of wealth, the production of wealth does not increase by a quantity greater than q, the operation is economically detrimental to a population as a whole; if it increases by a quantity greater than q, the operation is economically beneficial. The latter case is not to be barred a priori; for the element A contains the indolent, the lazy, and people, in general, who make little use of economic combinations; whereas the element B comprises people who are economically wide-awake and are always ready for energetic enterprise—people who know how to make effective use of economic combinations. [§2208]

Pareto’s theory explains why protectionism helped, rather than hindered, wealth creation in 19th century America. American protectionism transferred wealth from agricultural interests to industrial interests—that is, from those who would’ve used the wealth primarily to buy consumer goods to capitalists who invested the money in industrial production. Hence the great success of American capitalism during the latter half of the nineteenth century despite the high tariffs. Entrepreneurial capitalism works best when capital is transferred into the hands of those best fitted to use it. When protectionism manages to accomplish this end, it can be economically beneficial. When protectionism achieves the opposite effect and transfers capital from those best fit to use it to those least fit to use it, the results are economically pernicious.

The typical Objectivist position is that protectionism always diminishes economic efficiency. As Objectivist write Dave Holcberg puts it: [Protectionism] destroys more jobs than it creates because the overall productivity of businesses is diminished by the higher costs imposed on them.” This view, however, flies in the face not merely of the experience of 19th century American capitalism, but of Pareto’s theory, which states that, under special circumstances, protectionism may create more wealth than it destroys.