Common BOP Beliefs

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

Myth #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. This is not a good situation.

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.

Myth #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.

Sometimes countries use protectionism (imposing tariffs, quotas, and other trade restrictions) to punish other countries’ unfair trade practices. For example, the United States has accused China of violating intellectual property right laws. In addition, the United States is unhappy that China restricts international trade by, for example, requiring that U.S. companies form a partnership with a major Chinese company before they can invest in China. By punishing foreign countries (raising tariffs), the hope is that the foreign country will eliminate its unlawful and restrictive foreign trade practices. Thus far, China hasn’t changed its practices yet and it appears that the Trump administration’s protectionist policies have harmed U.S. economic growth.

Countries benefit the most and, in the long run, increase their standards of living if they engage in free and unrestricted international trade. Protectionism, on the other hand, leads to less specialization and less competition, and this leads to less efficiency and lowers overall world-wide production.

Myth #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 need to watch out for foreign investments motivated by harmful intentions. If such investments do take place, it is the government’s responsibility to immediately freeze and confiscate the foreign assets.

Economic Interdependence Strengthens Political Ties

Economic interdependence strengthens, not weakens, political ties. International trade may be the single most important deterrent to political and military conflict. Countries that have strong economic ties are unlikely to engage in serious 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 less developed 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 less developed 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 other 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 to only purchase goods from factories with higher wages and good working conditions. For example, Nike has been criticized for running sweatshops in less developed countries. However, Phil Knight, one of the co-founders of Nike, wrote in his brilliant memoir “Shoe Dog”, that when Nike became aware of the working conditions of some of the factories that manufactured Nike shoes (Nike doesn’t own these factories – it merely places orders), it provided support to improve the conditions over time. It even encouraged some factories to significantly increase the workers’ wages, but it was turned down by government officials who didn’t want shoe workers to make more money than local doctors.

Another argument against raising poor countries’ factory wages too much is that if wages 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 less developed country factory.

Supporters 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 so a little more than 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 permanently hurt workers in less developed countries.