Bardhyl Salihu and Predrag Rajsic

Many theorists before and after David Ricardo have analyzed the issue of cross-border exchange of goods and services. Most of them, with more or less success, have argued that any restrictions on trade are harmful for both parties. However, as Peter Boettke pointed out,[1] in today’s world of stylized market models, the proponents of economic interventionism have more space to come up with additional ad-hoc reasons why there may be “real-world” benefits from government interventions that are not included in these models. One of the often invoked “benefits” of domestic protectionism are the so-called national interests. Even though these interests are rarely explicitly defined or explained, many people tend to take these arguments at face value and support such policies.[2]

One recent radical example of economic interventionism is the case of Serbia and Kosovo. After Kosovo declared its independence from Serbia in 2008, Serbian government decided to retaliate by banning the import of all goods produced in Kosovo. Now, two years later and disappointed with the grim economic situation, many in Kosovo are claiming that the Government of Kosovo should also ban the import of goods produced in Serbia. The key question, however, is who wins and who loses as a result of these policies and is this overall a wise decision

As Kenneth Arrow demonstrated,[3] trying to answer this question in a utilitarian framework would be a futile exercise. This is simply because the world of ordinal utility—the world we live in—“social utility” is a concept that lacks economic meaning. In plain English, it is impossible to implement an interventionist policy that would make every member of a society better-off. There are always some gainers and some losers. But, since individual utility is not a physical quantity, there is no such thing as total social utility that could be maximized.

In light of this fact, we need some other approach in assessing interventionist policies. The Austrian school approach offers a powerful method from which we can derive the logical consequences of a given action and present them to the audience, which is then free to form their own value judgment. This is what we intend to do here, first, by assessing the meaning of so-called “national interests” and, next, by clarifying the workings of trade restrictions and their adverse effect on productivity, capital formation, and ultimately, satisfaction of consumer wants and needs.

National Interest as a Vague Concept

Politicians often justify their intervention in the economy with alleged “social benefits” or “national interest.” These collective terms are rarely defined, making it hard to determine whether they have been fulfilled once set as criteria. However, these problems are dealt away once we assess economic policy using methodological individualism, approach at the centre of the Austrian school.

This approach maintains that the only way to study economics—the science of human action—is to start with an acting individual human being and then derive group dynamics by determining the nature of the interactions of individuals comprising this group. The reason for this is clear-cut: only individuals act. They are rational beings that set their own goals and the means to achieve them. The society—which is an abstract concept that can only be defined through the interactions of individuals that comprise it—is not a conscious being that thinks or experiences emotions as a unitary entity.

Any State-dictated economic policy that aims to make the “society” or a “nation” better off is self-contradictory. A political intervention in the market process is backed by the force of the State apparatus. If a policy would indeed make everyone better off, it does not require force to be implemented. This is why it is impossible for the government to intervene in such a manner that all the individual “national” interests are served; any intervention must necessarily lead to some gaining at the expense of others. Consequently, any ban or restriction of imports to serve the “national” interests must come at the detriment of the importers. The profit that the importers would earn from free trade is taken away at the delight of those emotion-driven voters that support this isolationist policy.

Even if we ignore the problems of “national” interest, we still face the question of whether forced trade restrictions would lead to an improvement in the political relationships between the Serbian and the Kosovo governments. If we are to learn anything from the great thinkers that lived before us, Ludwig von Mises for example, it is that lasting peace can only be brought about through voluntary human cooperation. Mises observes that “[w]ars, foreign and domestic (revolutions, civil wars), are more likely to be avoided the closer the division of labor binds men.”[4]

Unfavorable economic conditions are always strong inciters of social unrest and nationalist hatred. The relative poverty that exists among Albanians and Serbs often tends to exacerbate the political problems more than in other similar conflicts around the world where the parties in conflict are relatively richer (e.g. in Spain, Ireland, Cyprus, etc.). In this sense, the concept of national interest is self-defeating if it promotes a destructive economic policy. It is tragic, however, that those politicians or voters who think they are following the “national” interest by promoting interventionism, are actually undermining the productive basis of the whole country by supporting unsound policies. The next section explains how and why.

The Economics of Exchange

In order to determine the beneficiaries and those that lose from trade restrictions, it’s important to review the elementary concepts of economics. The economics of exchange teaches us that two or more individuals trade because they have discovered their comparative advantages and therefore think will benefit from it. From this, we can logically deduce that any restriction by a third party (such as the State) will hamper this trade and make the trading parties worse off because it closes down alternatives that traders would voluntarily choose to improve their wellbeing.

Prior to the era of classical economists, however, many believed that there was only a limited amount of wealth in the world and that individuals from a particular country would have to encourage exports (selling goods to others) and discourage imports (buying goods from others) in order to get wealthier. Economist Robert P. Murphy candidly explains this in his brilliant introductory book to economics:

During that period, when countries used gold and silver as the basis of their trading, it seemed intuitive that running trade surpluses made a country richer. After all, by consistently having more exports than imports, a country’s stockpile of gold and silver would increase, because “more” or “fewer” exports and imports were measured in terms of gold or silver values.[5]

In this fallacious view of the world as a zero-sum game, the laws of exchange were considered simply “wrong” because it meant that two or more individuals would not always benefit from trade.

But, the truth is that the value of the existing goods in the world is not a fixed, objectively measurable quantity. Exchange is an act in which each party gives up something he or she values lees for something he or she values more. As a result, both parties benefit by obtaining a good of a higher value to them. Next, money (today fiat paper instead of gold) is simply a medium of exchange. Most people accumulate money not for the sake of collecting it but to be able to exchange it for goods and services to ultimately satisfy their wants and needs. The 19th century, a century of relatively free trade in Europe, showed in practice the benefits of buying and selling goods across borders without the destructive effects of trade restrictions.

Whenever these restrictions have been applied, the effects have always been detrimental to both buyers (importers) and sellers (exporters). The major effect of restrictions is a reduction in supply of goods in the importing country and therefore an increase in money prices. The exporters that could have sold these goods are also left worse off unable to conduct business as they planned. Instead, the astronomically high prices resulting from a trade ban tend to shift the trade business into the hands of a few smugglers who are willing to take the risk of criminal liability and who have obtained the human infrastructure necessary for this activity. Often times, these smugglers share their profit with some key people in the legal system who silently granted them protection.

Real life, local examples that illustrate this theory can be found easily in Yugoslavia in the 1990s. During the war in Krajina, Croatian authorities closed off the border between this region and the rest of the country. Among other products, diesel fuel was smuggled by the UN soldiers from Croatia into Krajina where it cost about $8. In western Bosnia, which was surrounded from all sides by the Serbian territory, trade was prohibited but certain individuals from the Serbian side smuggled bread and sold it for about $10 a loaf.

Considering that Kosovo is much more dependent on products from Serbia than vice-versa, any trade restriction would have similar effects, with prices of basic goods such as bread going through the roof. But, the individuals that are prevented from completing their trade are not the only ones to lose. Other “domestic” individuals or firms would also suffer. A successful business creates a stock of capital goods that would not have been produced had this business been prevented from engaging in exchange with the “foreign” partners. This stock of capital goods provides a productive basis not only for this particular business but also for others with whom it cooperates by using this stock. Smuggling, on the other hand, consumes capital resources through maintaining the necessary organizational infrastructure, which would have been unnecessary in the conditions of legal trade.

Another, not often stressed issue is market fragmentation. To understand the detrimental effects of market fragmentation, imagine a country that at some point gets divided in two parts and each part declares a total restriction of trade with the other. Now imagine this step one more time—each of the two parts declares independence and banns all trade with the other part. Instead of one market, there are now 4 isolated markets. We could take this division further until the head of every household in the country declared independence and restricted all exchange with other households. The result would be an elimination of the price mechanism altogether. Thus, although this is sometimes not immediately obvious, trade restrictions impede the proper functioning of the price mechanism.

The Key Role of the Price Mechanism

Market prices serve a multifaceted purpose. Their primary role is what Friedrich Hayek called the use and distribution of knowledge in society.[6] As a signal that reflects supply and demand, market prices contain valuable information for both producers and consumers about the relative advantages of different courses of action. Second, and probably most importantly in this case, market prices serve the purpose of a common measuring stick among producers. Those individuals that found themselves to be relatively more productive in a particular occupation, relative to any other occupation under the common market price, decide to specialize in this line of production. A common market price in two regions (say A and B) with unrestricted exchange reveals the relative productivities of the producers in the two regions. If only a few individuals decided to specialize in a certain line of production (say, wheat farming) relative to the total market demand, this reveals that most individuals in this region are relatively more productive in some other line of production.

In addition, this shows that some producers of wheat in region A are more productive than any individual in region B that currently does not produce wheat but could decide to produce it under a higher market price. As a consequence, an imposition of an import restriction by the government of region B would reduce the total available supply of wheat in that region. The consumers would, given the reduced quantity, bid higher prices for whatever little wheat is produced in region B. This would push the price up and, in the long run, induce some individuals to switch from their previous line of production into the production of wheat. However, these individuals are less productive compared to the former exporters from region A and need to use more resources to produce the same amount of output. Therefore, an import restriction reduces the total input-productivity in the “protected” industry. Another way to make up for the lost supply is to import wheat from other more politically desirable but more geographically distant regions, which would have a similar price-increasing effect.

This import restriction would have a negative effect not only on the residents of region B but also on the residents of region A. Those previously exporting wheat now have to sell it domestically or find new markets. But, if they could sell this wheat domestically at the pre-restriction price, they would have done that instead of exporting. Therefore, if they want to sell their wheat domestically, they need to offer it at a lower price. Consequently, some of the least productive producers in region A might become unprofitable and decide to employ their resources in some other line of production. However, this switch is never smooth or costless, especially knowing that if these people thought they could produce something else profitably at the given prices, they would have done it before the trade restriction.

This example illustrates a restriction in trade of only one commodity. But this reasoning can be extended to a total trade ban, only now the negative effects would be vastly magnified. The trade ban would result in a loss of productivity in both regions in all lines of production by redirecting resources from more to less productive producers by political force. Thus, the market process directs productive resources from less to more productive individuals through voluntary exchanges while the political process directs resources in the opposite direction—from more productive to less productive uses—by political force.

It is maybe not immediately obvious that the operation of a centrally planned economy is to some extent similar in nature to the operation of economies isolated by political force. The Soviet economy in the 20th century, operated under a direct denial of the proper functioning of the market prices. The allocation of resources was determined by “experts” and politicians, not by the wants of the consumers though the price system. Most of us witnessed both serious shortages as well as idle resources that eventually brought the Soviet economy to a collapse. These shortages and misused resources were, at least partly, a consequence of a misallocation of resources resulting from the absence of real market prices.[7]

In Yugoslavia, although socialism wasn’t fully implemented and the price mechanism worked freely to some degree, there were still major problems where the government intervened massively. For example, it was common that grocery stores had to throw out some of their products because administrative process of getting the permit to lower the price to clear excess supply would take months. By the time the permit was issued many products would be past date. Another example is the car industry. There were various restrictions on the import of foreign cars. The government-administered price of domestic low-quality cars was low but the waiting lists were six or more months. The healthcare sector was in a particularly dire shape. By the 1980’s the only way to avoid months long waiting lists for surgery was to bribe the nurses and the doctors.

Despite all these arguments, one might still ask—but what if some people simply want to include their political preferences into their purchasing decisions and boycott the imported product? Isn’t this the same as an import ban?

Boycotts vs. Trade Restrictions

Whenever someone is forced to alter his or her actions, the ethical case is also at stake. From this point of view, restrictions on trade are unethical because they force some citizens to give up goods they would normally buy for the sake of some other people’s political goal. In a free society, all individuals should be allowed to weigh whether it’s more important for them to pursue political ends or to satisfy any other ends they may have. Politicians, again, make the case for their unethical restrictions based on “national” interest. But as was said above, ethical questions involve acting individuals. Since groups (local or national) do not act, one can’t make a valid, collective ethical case for an entire group.

Among those who have advocated for restrictions, there may be some who would still prefer a boycott of goods from Serbia as opposed to blocking the border entirely. It’s important to make this distinction because it is crucial. A boycott is an attempt by someone to persuade others not to buy a product or a service.[8] Usually people boycott for reasons other than the conventional quality attributes and price. These reasons sometimes include political ends or animal rights. The major effect of boycotts is the reduction of demand for imports in a particular market. This naturally induces some able entrepreneurs to offer products to the export market at lower prices. Others still have the option of serving the domestic consumers at higher prices. Thus, this option offers far more flexibility than the outright ban.

Every individual is free to buy or abstain from buying a product or a service, so boycotting is an individual decision that doesn’t interfere with the rights of others and doesn’t force others to do something they don’t want to. Trade restrictions, on the other hand, are decisions made for others and then implemented by a threat of violence (i.e., criminal liability for breaking the import prohibition).

Conclusion

It does not really matter which side imposes trade restrictions first. What does matters is the a priori truth that every time individuals are restricted from making voluntary exchanges, the outcome will be unfavourable for both of them regardless of whether they are trading domestically or between Serbia and Kosovo, Northern Ireland and the Republic of Ireland, Israel and Palestine or any other place on the globe. All trade restrictions are harmful, but outright bans are extremely detrimental. Even if the Serbian government continues to uphold its ban (which is, as was shown, at its own detriment as well) the decision of the Kosovo government to do the same would have even more catastrophic consequences.

The idea of national interests that politicians often stress is unconvincing at best. The political tensions between Serbia and Kosovo will not be solved and neither side will prosper if the economic relations continue to be directed by emotion-driven politics rather than by reason-driven economics. The “national” interests will continue to be the interests of a chosen few merchants, served by corrupt politicians on both sides of the border at the expense of most of the Albanian and Serbian population while undermining the future prospect for peaceful relations.

Notes: