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How Trade Works

by Philip I. Levy and Claude Barfield

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Few who read this book will go on to become subsistence farmers, grow their own food, sew their own clothes, and whittle branches for entertainment. Not that there’s anything wrong with all that.

Instead, readers will likely specialize and trade. You may grow cash crops as farmers; produce machine tools in factories; or provide health care to your fellow citizens. We rarely think about how dependent each of these vocations is on trade. As valuable as machine tools may be, you cannot eat them, nor wear them, nor live in them. The only way a factory worker is able to meet her basic needs is to trade the machine tools she produces for other goods and services.

In a rudimentary economy, our worker would barter her tools directly for eggs or cloth. In a modern economy, she would receive money for her work, which is easier to store and significantly less fragile than eggs. But it is the same basic idea either way.

It is not hard to see the gains from specialization. If a child breaks his wrist in a fall, we would not be satisfied to have it treated by the class teacher, nor the school nurse, nor even a family doctor. We would want the child seen by an orthopedist, someone who specializes in understanding the intricacies of how bones function and mend. If there are to be such specialists, someone else will need to grow their food and build their houses. The idea that individuals will specialize and be more productive is central to how modern economies function and advance.

The economist Angus Maddison provides some striking numbers about just how far specialization and trade have brought us. If we compare the United States in 1820 to the United States in 2001, early Americans were more self-sufficient, worked harder, and earned less. In 1820, they worked an average of 968 hours per person per year, versus 770 in 2001. But for each working hour, the early Americans produced $1.49 worth of goods and services in 1820, compared to $28.59 in 2001 (a comparison that accounts for inflation).

Of course, some of this growth came from great discoveries, such as how to harness electricity, how to use engines for locomotion, and how to produce disease-resistant and well-fertilized crops. Yet even such discoveries came from the specialization of scientists and inventors.

What, you may ask, does any of this have to do with international trade, with current account deficits, with trade agreements and commercial disputes? The principle is the same. Countries can specialize in producing those goods and services they can make at their lowest cost and trade with other countries for mutual gain.

Although the underlying principle of specialization and market exchange may be the same, there are some important differences when we trade across international borders rather than trading across towns.

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