Common BOP Beliefs

Three common misconceptions regarding international trade and the balance of payments are:

1. A trade deficit is always bad.

A merchandise trade deficit means that a country’s merchandise imports exceed its merchandise exports. There are two possible explanations for a trade deficit:

Situation 1. Country A is economically weak and has low productivity, and therefore, its exports are weak. Country A is forced to import, because its own productivity is low. It has a trade deficit by necessity, not by choice.

Situation 2. Country B is economically strong and has a great amount of purchasing power. Country B voluntarily chooses to import, because its purchasing power is high and its economy is strong. This country’s trade deficit is actually a symptom of its strong economic health. This kind of trade deficit gives no reason for concern, and does not require changes in economic trade policy.

2. We should protect our domestic industries to improve our balance of payments.

If we protect our industries by imposing tariffs and quotas on foreign products, other countries will protect theirs. This will lower our exports. The result is a loss in specialization and a decrease in our standard of living.

According to the Austrian School economist, Henry Hazlitt, imports are additions to our country’s wealth. If we are able to increase our goods and services from abroad, it increases our quantity of goods and wealth. Real goods are obtained in exchange for paper money. We have the purchasing power to do it, and can feel fortunate to enjoy goods that we either cannot produce, or cannot produce as efficiently.

Proponents of tariffs and quotas criticize countries that sell their goods to us at below-market prices. According to Hazlitt, the argument that these countries sell their goods cheap (dump) in order to obtain a monopoly position in that industry usually is of no concern in the long run. In the long run, the potentially high monopoly price will attract competition and will negate the effects of the monopoly forming. Low foreign prices should be welcomed, because they lower the general price level in our country and free up purchasing power for consumers to purchase other goods, including domestic ones.

Protectionism leads to less specialization and less competition, and this leads to less efficiency and lower overall world-wide production.

3. We should discourage foreign investments into our country.

People believe that it is undesirable for foreign companies to purchase domestic real estate, businesses, stocks, bonds, etc. However, it is often a sign of a strong and stable economy, and it can be considered a compliment that foreign investors want to risk their savings in our economy. Furthermore, the additional capital provides funds for the expanded business operations, and results in greater employment. The argument that it would give foreign investors too much control over our economy is debatable, because most business owners are driven by economic motives and a desire to expand their wealth and not to upset any political or cultural balances. In this age of terrorism, countries do want to watch out for foreign investments motivated by political malintentions. If such investments do take place, it is the government’s responsibility to immediately freeze and confiscate the foreign assets.

Economic Inter-dependency Strengthens Political Ties

Economic inter-dependency strengthens, not weakens, political ties. International trade may be the single most important deterrent of political and military conflict. Countries that have strong economic ties are unlikely to engage in conflict, because their economies have too much to lose if they go to war. Economists, therefore, encourage strong international economic ties and a free exchange of products and resources.

What About Sweatshops?

There has been much debate about factories in Third World countries that employ low wage workers for production of goods meant for exports to industrialized countries. Critics point out that working conditions in these factories are poor and sometimes dangerous, and wages are insufficient to support minimal living conditions. Opponents of sweatshops support boycotting corporations that run these factories or that purchase their goods from these factories.

It is true that conditions at many so-called sweatshops are poor and employees are more prone to serious accidents. However, is boycotting these factories the answer? Many factories are owned and managed by local entrepreneurs who compete with other local companies as well as factories in other Third World countries. If these owners were to significantly improve the working conditions it would raise their costs considerably and they would need to raise their prices. This will price them out of the market if local and foreign competitors don’t improve their conditions. Therefore, it becomes a choice of going bankrupt or surviving and providing jobs at minimally (or less than minimally) acceptable working conditions. If the sweatshop goes bankrupt, unemployment will grow even higher than it already is. Laid-off sweatshop workers will then be forced to find other employment at local wages that are generally even less than at the sweatshop factory.

Critics of sweatshops will say that we need to force multinational companies (like Nike) to only purchase goods from factories with higher wages and good working conditions. A counter-argument to this, however, is that if wages and working conditions improved significantly, then prices of the goods would increase, and multinationals may find it more beneficial to produce in their own (U.S., Europe, wealthier Asian countries, etc.) country. This would then also lead to the closing down of the Third World country factory.

Supporter of sweatshops point out that low wages and poor working conditions are part of a natural process of economic development. When a country with high unemployment and low wages begins the process of industrialization, it will struggle with poor conditions at first. The United States did approximately one century ago, Japan experienced this approximately 50 years ago, and many other currently well-off countries struggled at first. Sweatshops provide jobs to many people, contribute to economic growth and over time help raise wages and improve working conditions. Supporters of sweatshops believe that boycotting sweatshops will halt this economic development and hurt workers in Third World countries.