The Economic Perspective on Trade

Economists believe trade can make everyone better off. Trade is the exchange of goods and services for other products, money, or other compensation. Everyone involved in an exchange transaction can benefit from it. One of the ways a person or country can become wealthy is to trade a lot.

Different opinions about trade create some of the strongest economic controversies. For centuries, however, economists have argued that trade is a primary source of wealth and prosperity and is beneficial to all trading partners.

One of the greatest benefits of trade is that it allows specialization. Specialization is concentration on the production of particular goods and services. If a person or country engages in trade, then it no longer needs to produce everything it needs or wants. Instead, it can focus its energies on activities it does especially well and trade for the other things it needs or wants.

Three of the basic needs in life are food, clothing and shelter. If people are especially skilled at making clothes, for example, they can then make more clothes than they need and trade the extra clothes for other things, such as food and shelter. Similarly, people who are skilled at growing food can trade food for clothes and shelter. People who are skilled at building houses can trade them for food and clothes. When people specialize and trade, it is possible for everyone to benefit.

Consider the following simple example of the benefits of specialization and trade. Suppose two people, Robinson Crusoe and Friday, are stranded on an island. They can survive with the rags they wear and by scavenging for food, but both would prefer to have a new set of clothes each month and to eat cultivated food every day. While working for a month, suppose Crusoe can make two sets of clothes (shirts and trousers) if he spends all his available time making clothes. Alternatively, if Crusoe spends his time cultivating food, the best he could do is grow enough food to feed one person for two weeks. If Crusoe splits his month’s labor between the two activities, he could make one set of clothes and grow enough food to feed one person for one week.

Suppose Friday has a different set of talents. While working for a month, suppose Friday can make only one half of a set of clothes (just the trousers, perhaps) if he spends all of his available time making clothes. Alternatively, if Friday spends all his time cultivating food, then he could grow enough to feed two people for a month. If Friday splits his month’s labor between the two activities, then he could make one quarter of a set of clothes (half a shirt, perhaps) and enough food to feed one person for the entire month.


Output if his labor for the entire month is devoted to making clothes Output if he equally splits his labor for the month between making clothes and growing food Output if his labor for the entire month is devoted to growing food
Robinson Crusoe 2 sets of clothes
(no food is grown) 1 set of clothes and food for one person for one week food for one person for two weeks
(no clothes are made)
Friday 1/2 of a set of clothes
(no food is grown) ¼ of a set of clothes and food for one person for a month food for two people for a month
(no clothes are made)
Table 1. Specialization and Trade Allow an Economy to Produce and Consume More Output Than in the Absence of Trade.


If Crusoe and Friday do not trade, then they must produce their own food and clothing. Depending on how he allocates his labor, Crusoe could make two sets of clothes and no cultivated food, one set of clothes and enough food for one week, no new clothes and enough food for two weeks, or another similar combination . Depending on how he allocates his labor, Friday could make one half set of clothes and no cultivated food, one quarter set of clothes and enough food to feed one person for one month, no new clothes and enough food to feed two people for the entire month, or another similar combination. In the absence of trade, neither person is able to have a new set of clothes each month and enough cultivated food for the entire month.

If Crusoe and Friday specialize and trade, however, then each person can have a new set of clothes each month and enough cultivated food to satisfy their needs. This occurs if Crusoe completely specializes in making clothes and Friday completely specializes in growing food. Every month Crusoe would make two sets of clothes and Friday would grow enough food to feed two people for the entire month. If Crusoe trades one set of clothes for a month’s supply of food, both men have a new set of clothes each month and enough cultivated food to satisfy them every day. Because of their different skills in making clothes and growing food, it is impossible for them to obtain this level of satisfaction in the absence of specialization and trade.

A similar argument can be made for trade between countries. What complicates it from a social policy standpoint, however, is that the process of specialization requires a country to shift resources into activities that a country does relatively well (such as manufacturing computers or other high technology equipment) and shift resources away from activities that another country may do relatively better (such as manufacturing steel, textiles, or furniture). The country as a whole benefits from the availability of cheaper foreign products. Some individuals lose their jobs, careers, and way of life in the process, however. The government attempts to lessen the hardships imposed on these individuals by providing them with financial assistance, education, training, and help in finding new jobs. Trade adjustment assistance is a federal program that provides financial assistance to those injured by import competition.

Trade is another area where people ignore tradeoffs. Workers and politicians often decry the loss of American jobs to manufacturers in foreign countries. Keeping those jobs in the United States typically results in higher prices for the products or higher taxes to provide government subsidies to those industries, however. If foreigners produce a product more cheaply than Americans, the way to convince consumers to buy the American product is to raise the price of the foreign products through import taxes, or to lower the price of the American product through tax-funded subsidies. Politicians typically only discuss part of the issue when they say they will protect American jobs. They usually fail to mention the costs to consumers and taxpayers.

The benefits of specialization and trade are explained more fully in module 11 (The Evolution of Trade Theory).

Trade Adjustment Assistance is explained more fully here.

Footnote: As Crusoe devotes more time to one activity, he must sacrifice what he could have produced in the other activity with that time.