Free Trade 25: Excess Supply or Demand and Trade

Trade between and among people and enterprises happen because it benefits them, both sellers and buyers, producers and consumers, wholesalers and retailers. Free trade encourages people to become efficient, to produce more as they know that their output will find their way to other people who want and demand their products, wherever they are in the planet.

I will dwell on some economic theory on how excess supply by producers, and excess demand by consumers -- you and me and our families and friends -- adjust with each other, even with zero government intervention.

Some people say "Economics is common sense" and "Economics is the study how to ruin the economy." The first quote is more frequent and the quick answer is "Common sense is not too common." The second quote is more satirical and my quick answer is "the State and most politicians ruin the economy."

I say that "common sense is not too common" because what most people would consider as "common sense" is actually using coercion or more government intervention. The price of gasoline rises, so government should regulate oil prices or nationalize all foreign oil companies in the country. The price of medicines are expensive, so impose drug price control or put up a government pharmaceutical company. The price of tilapia, bangus and galunggong are rising, so government should conduct daily checks and impose price control in public markets. In short, when the problem is supply gap (demand is larger than supply), the solution is politics, not economics.

Economics has a short and direct definition: It is the study of proper allocation of scarce resources (money, time, cars, land, cellphones, etc.) given unlimited wants by people.

Here are two graphs that one would normally encounter when taking basic economics course. The "universal" supply-demand analysis. Above graph shows supply gap, or excess demand. Many people want the price of tilapia medium size at only P1 (say PhP70 per kilo). The demand is at Q1 (say, 1 million kilos) but at that price, the supply is only at Q2 (say only 0.4 million kilos). So you have a supply gap of 0.6 million kilos as tilapia farmers and sellers will not sell at only PhP70 per kilo because they will lose money. 

To solve the problem, allow the price -- do NOT impose price control -- to rise to Po (say PhP85 per kilo) and that's where supply meets demand at Qo (say at 0.8 million kilos). Those who are willing to pay the price will get the tilapia. Those who are not willing to pay the price, they will find other food to buy, like more vegetables, or tilapia small size, and so on.

The second graph is the opposite: there is supply glut or excess supply. The weather suddenly just turns too good for tilapia farming, the price of tilapia feeds just fell, the weeds and other natural food for tilapia in the pond just mushroomed. Result is huge supply of tilapia, and they are of the medium to large or extra-large sizes, no small sizes. But consumer demand for tilapia remains the same. Tilapia farmers and sellers will be forced to sell at a lower price -- no need for government to subsidize the tilapia farmers. What used to be P100 per kilo for large size and P85 per kilo for medium size, will have to be sold at P85 and P70 per kilo, respectively. Then more people will buy the tilapia, they will buy less bangus or chicken or pork.

Above graph is when supply declines, say there was a super-typhoon which damaged many agricultural crops. The supply curve of sitao (stringbeans) shifts from S to S', say from 200,000 kilos to only 150,000 kilos. If consumer demand will remain the same, then the price will go up from Po to P1 (say from P20 to P25 per kilo). If government will impose a sitao price control, then there will be a supply gap of (Qo - Q1), say 20,000 kilos. So many people will be looking for sitao at only P20 per kilo but are not available in the public market as the earlier buyers have already snapped all the remaining sitao.

Graph below shows when supply is only one unit. Say a painting by a very famous painter who has died a long time ago. The owner of the painting can choose any price along the demand curve by many people who have different appreciation of the work and have different budget. The owner will naturally sell to whoever can give the highest price. There is no need for government to intervene and force the owner to sell at a capped, lower price so that some not-so-rich buyers can also afford to join the price bidding.

In most if not all instances, government intervention in price-setting (control high price, or subsidize to cause lower price) is totally unnecessary. Price control will discourage existing and future producers and sellers of the product or service that is being price-controlled. Price subsidy will encourage more producers and sellers until taxpayers will revolt at the unnecessary transfer of money from their pockets to the pockets of government cronies.

Extending towards international trade, government intervention in making imported goods expensive via import tax and related charges is not good. It only protects local producers and cronies and raise more money for the bureaucracy but disadvantages the consumers, you and me and our families and friends. The same way, making exported goods cheaper to consumers abroad via export subsidies and other forms of domestic support to exporting companies (done by some developed countries in Europe, North America and Asia) is not good. It is disadvantageous to the taxpayers of those countries, while it may be advantageous to the consumers abroad, like us in the developing world. Such "advantage" of course is temporary as it distorts the production and marketing costs of foreign and local producers, distorts the spending behavior of taxpayers and consumers.

So back to square one: government intervention in price setting, whether domestic or foreign trade, is wrong. Government should not do it, and the public should oppose any government move towards that direction.

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See also:
Free Trade 1: Estonia's Free Market, Globalization, May 09, 2006
Free Trade 2: Unilateral Trade Liberalization, May 17, 2006
Free Trade 3: Protectionism Perpetuate Poverty, September 05, 2006
Free Trade 4: FTA in APEC, July 09, 2007
Free Trade 5: Business, Rock Music and Cycling Globalization, July 17, 2007
Free Trade 6: Counterfeit Drugs Worldwide, December 21, 2007
Free Trade 7: Class War, Eco-protectionism and Climate, April 02, 2008
Free Trade 8: Global RIce Price, May 13, 2008
Free trade 9: Parallel Importation of Medicines, May 22, 2008
Free Trade 10: More on Unilateral Trade Liberalization, July 15, 2008
Free Trade 11: Global Petition, Keynes, March 19, 2009
Free Trade 12: Trade and World Peace, April 28, 2009
Free Trade 13: Benefits of Dumpiing, June 16, 2009
Free Trade 14: Import Substitution, AFTA, China, January 08, 2010
Free Trade 15: Customs Bureaucracy, November 09, 2010
Free Trade 16: Price Equalization vs. Export Subsidies, May 03, 2011
Free Trade 17: Consumer Surplus and Human Rights, May 27, 2011
Free Trade 18: Regional Trade and East Asian Model, July 31, 2011
Free Trade 19: Top Exporters by 2050, December 31, 2011
Free Trade 20: Prohibiting 2nd-hand Imported Vehicles, January 10, 2012
Free Trade 21: Abolish or Shrink the Bureau of Customs, February 03, 2012
Free Trade 22: Freedom to Trade, February 10, 2012
Free Trade 23: FNF on Free Trade Agreements, February 10, 2012
Free Trade 24: Trade and Improving Health Outcome, February 15, 2012

Free Trade 19: Top Exporters by 2050

Citigroup released an interesting -- but not exactly surprising -- projections of the world's export heavyweights four decades from now. Out of the top 10, seven are Asian economies. The three non-Asians are the US, Germany and UK. Below is the list, lifted from Citigroup.

These 10 Countries Will Command World Trade In 2050

http://www.businessinsider.com/countries-leading-world-trade-2050-2011-12#10-uk-1

#1 China

Trade in 2050: $52.2 trillion

Percent of world trade: 18.2%.

China, which at $3.6 trillion currently accounts for 9.5% of world trade, will overtake the U.S. in 2015. In 2030, at $21.3 trillion, it will account for 17.4% of world trade.

#2 India

Trade in 2050: $25.7 trillion

Percent of world trade: 9%

India which doesn't make the top 10 countries by trade in 2010, is set to account for 2.8% of world trade in 2015, and 5.6% in 2030.

#3 USA

Trade in 2050: $19.1 trillion

Percent of world trade: 6.6%

The U.S. which is the current global leader in trade, accounting for a massive 10.7% of world trade, is set to account for only 8.2% of world trade in 2030. The U.S. is expected to lose ground to India and China.

#4 Germany

Trade in 2050: $9.9 trillion

Percent of world trade: 3.5%

At $2.86 trillion Germany accounted for 7.6% of world trade in 2010. While trade is projected to rise to $5.8 trillion in 2030, it will account for just 4.7% of world trade.

#5 Korea

Trade in 2050: $9.7 trillion

Percent of world trade: 3.4%

At $1.05 trillion Korea accounted for 2.8% of world trade in 2010. By 2030, this figure is set to rise to $4.7 trillion and account for 3.8% of world trade.

#6 Indonesia

Trade in 2050: $8.8 trillion

Percent of world trade: 3.1%

Indonesia makes the list for the first time in 2050, driven by trade with China, Japan and the European Union.

#7 Hong Kong

Trade in 2050: $8.5 trillion

Percent of world trade: 2.3%

Hong Kong, which didn't make the top 10 list in 2010, is expected to jump to the seventh spot in 2030 with $3.8 trillion in trade.

#8 Japan

Trade in 2050: $7.6 trillion

Percent of world trade: 2.7%

Japan which at $1.78 trillion accounted for 4.8% of world trade in 2010, is expected to slip in the rankings. By 2030, it will account for only 3.5% of world trade.

#9 Singapore

Trade in 2050: $6.8 trillion

Percent of world trade: 2.4%

Singapore will account for 2.7% of world trade in 2030 and its trade will total $3.2 trillion in 2030

#10 UK

Trade in 2050: $6.02 trillion

Percent of world trade: 2.1%

UK's trade is set to rise from $1.77 trillion in 2015, to $3.2 trillion in 2030 and account fo 2.6% of world trade.

Note also that in the top six, only S. Korea has a relatively small population. The other five are large population economies. Which proves once again that people are assets, not liabilities, and thus government-sponsored population control is bad policy, but I digress.

Small population economies like Hong Kong and Singapore are able to squeeze themselves in the top 10 for two main reasons: (a) they are a free trade economies. HK in particular has a unilateral free trade policy; no trade negotiations, no need for WTO perhaps, exporters from other countries can bring in their goods to HK so long as these are not among the regulated or prohibited products like bombs. And (b) they are financial centers in the region.

Regardless of the types of protectionism that many sectors would want to erect, like "to save the planet", people want free trade, free choice in sourcing the various goods and services they need. That deep desire for free trade, for free choice and free market, will keep world trade humming and rising in the years and centuries to come.

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Last June 06, 2011, I wrote this:

More on Free Trade

A friend commented to my paper, Econ for statists 7: Free trade and consumer surplus last May 27 this year. She wrote,

Aside from (rise in) consumer surplus, there's also loss in producer surplus brought about by price reduction with MFN (WTO) and preferential (free trade agreements) tariff reduction. But net effect, we do gain from free trade. For preferential trade, however, there's some trade diversion effect. For example (hypothetical, but i think this is true), Philippine imports sugar from Thailand rather than from Cuba even though cuban sugar is more competitive. Why? Because we have FTA with Thailand under ASEAN; we enjoy low tariffs from Thailand. That's trade diversion (this can be shown in the consumer surplus, producer surplus graph). Although, in effect, we can still gain from FTAs.

And all these surpluses, losses (consumer and revenue) are just static effects of free trade brought about by price reduction, induced by MFN and preferential tariff reduction. A country will appear to have gained more if we consider the dynamic effects -- economies of scale, technology transfer, FDIs, structural change and reforms, competitiveness incentives, depending of course on the agreements agreed by FTA members. Japan, EU, US, for example, would negotiate technical cooperation chapters. They usually offer plant and technology improvement (particularly for fish products in order to comply with SPS and TBT), technical assistance/capacity building (service sector, reforms in domestic regulations).

In general, we do gain from trade more than just on consumer surplus. The problem with FTAs is that we are now having this Asian noodle bowl, for example. Too many FTAs, overlapping, defeating economies of scale, confusing to traders. There's a study/survey (not sure if already released) that says preferential tariffs are, in fact, not used by traders because they're either confused or they don't know preferential tariffs exist. And some customs staffs also do not know all these preferential tariffs; some can't memorize, making FTAs futile, in particular, for trade in goods. -- Aiken

I thanked Aiken for her additional inputs. Hong Kong often comes to my mind when people talk about FTA, WTO, MFN, etc. HK does not need any of them. HK simply declared a unilateral trade liberalization, zero government to government negotiations, agreements and protocols. Unilateral free trade is unconditional opening of borders to foreign goods at zero tariff. The only imported goods that HK subjects to government regulations are perhaps guns, bombs, poisonous chemicals and substances, virus-infested food products, live animals that may bring in certain viruses, related items. In short, only when goods would affect public health and security, that government regulations come in. Otherwise, it steps back, no unnecessary bureaucracies and taxation. So that HK is able to efficiently utilize its bright minds. Away from trade politics towards actual trading and money-making.

Free trade simply means freedom to trade by the people. If someone needs a new laptop at his specific budget range and desired specifications, he does not care if that laptop will come from HK or Singapore or S. Korea or China or the US or Germany, etc. He does not need government to indirectly tell him that he can import from these countries but not from the other group of countries because of higher tariff and plentier regulations.

Or carinderia (cheap restaurant) owners -- there are tens of thousands of them nationwide -- want cheaper rice, cheaper onions, garlic, chicken, etc. because that is what their poor consumers want. So they do not care much if those raw food products will come from the Philippines or Vietnam, Thailand, Taiwan, China, US, or anywhere else. They just want cheap food for their poorer consumers and still make a good profit at the same time. So the FTAs that many governments negotiate, reject, renegotiate, revise, horse trade, etc. simply defeats the real spirit of what "free trade" really is.

Smuggling is a market signal, or consumer signal, that people do not want unnecessary taxes and regulatory bureaucracies that cause unnecessary rise in prices more than their free trade price. Smuggling is also an indicator that bureaucracies love protectionist policy because it allows them to extort money from traders and consumers.

That is why I mentioned in my earlier paper the possibility of WTO abolition. HK does not need the WTO or any of those bilateral and regional FTAs. It simply allows free trade to happen. If the Philippines will follow HK's unilateral trade liberalization policy, then there will be no need for our tax money to be used to send trade negotiators, trade lawyers and consultants for global junkets to negotiate "I bring down tariffs here, you reduce trade barriers there..." Worse, the trade negotiators that we send -- and sent by their own respective governments -- can only explain later why real free trade does not happen. It is easy to find someone else to blame while hiding the fact that they themselves carry protectionist sentiments and vested interests when they go to negotiate with other country representatives.

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See also:

Free Trade 14: Import Substitution, AFTA, China, January 08, 2010
Free Trade 15: Customs Bureaucracy, November 09, 2010
Free Trade 16: Price Equalization vs. Export Subsidies, May 03, 2011

Free Trade 17: Consumer Surplus and Human Rights, May 27, 2011

Free Trade 18: Regional Trade and East Asian Model, July 31, 2011

Free Trade 18: Regional Trade and East Asian Model

(This is my article today in the lobbyist.biz, with original title, Philippine Trade and East Asian Economic Model)

Trade, selling what one produces in relative abundance, and buying what one needs but can not produce more efficiently, is among the cornerstones why societies and economies prosper. This philosophy applies both in domestic and international trade.

The National Statistics Office generates the monthly and annual international trade data of the Philippines. The tables though are relatively detailed, like month-on-month and year-on-year changes (value and percentage). I only want to see the cumulative data.

My sister's auditing office has an economics blog, Alas, Oplas & Co. CPAs-RSM. It's cool, short and summarized data, little commentaries. So I used the trade data there in these two tables. The NSO is the primary source of data there.

Of the top 10 or 11 exports market of the Philippines last year, only three are non-Asians: US, Germany and Netherlands. This speaks of the growing regional trade and economic integration in the continent. The main beneficiaries of globalization and global capitalism over the long-term are the neighboring countries themselves, especially if such countries are growing dynamically.

For the top 10 or 11 sources of imports of the Philippines, only the US is non-Asian. Saudi Arabia is also in Asian continent, though the Middle East is much closer to Africa mainland than Asia mainland.

In the first five months of this year, the same top 10 countries in 2010 also ranked in top 10 this year. The difference is that the percentage shares of Germany and Netherlands are shrinking. There is greater regionalism in trade and other economic activities now, than inter-continental trade.

The way the public debt problem of many European and North American economies are dragging and burdening them, slower economic growth, if not economic stagnancy, will be the ultimate result. Governments of welfare states have to retain their high and multiple taxes to sustain those expensive entitlement programs. This process siphons off a big portion of personal, household and corporate income and savings, into state coffers. 

And this brings me to another topic: the East Asian Model (EAM) of economic growth. A friend from Pakistan, Ali Salman, wrote in his article last month, Myth buster: Debunking the clichés in economic policy making". He wrote about certain economic myths like forced collectivism, economic central planning, as “motors” of economic growth in Pakistan and other developing countries. I agreed with many of the things he wrote, except one “myth” which he described as,

"Government should provide everything or at the very least, it should engineer society just like the East Asian Model."

I wrote to him to say that he may have misrepresented the EAM here. The EAM that I know has prospered in recent decades because compared to developed economies of North America and Europe, the EAM is or has:

1. Less welfarist. You don't work, you go hungry. There is little or zero state subsidy for unemployment insurance or food stamps.

2. Less rigid labor laws. Entrepreneurs can hire and fire people easily, the same way that employees can quickly move from one employer to another, or set up own micro or small enterprises.

3. Less environmental dictatorship. Environmentalism and its policies are there, sure, but not as strict as those in Europe and N.America. Thus, many East Asian economies have grown fast via cheap power sources - coal and nuke, especially.

The more that countries and governments attempt to disregard personal responsibility and assert or impose more government responsibility in running the people’s ordinary lives, the bigger will be the long-term restriction on individual and economic freedom, and the larger will be public indebtedness.

As the debt crisis in the US show, BIG governments, socialist or democratic, must learn to step back and scale down their huge bureaucracies and expensive welfare programs. A nanny state that attempts to baby-sit people even if they are already adults, will not help in cultivating more personal responsibility in how people should manage their own lives.

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See also,

Free Trade 12: Trade and World Peace, April 28, 2009
Free Trade 13: Benefits of Dumpiing, June 16, 2009
Free Trade 14: Import Substitution, AFTA, China, January 08, 2010

Free Trade 15: Customs Bureaucracy, November 09, 2010

Free Trade 16: Price Equalization vs. Export Subsidies, May 03, 2011

Free Trade 17: Consumer Surplus and Human Rights, May 27, 2011