Element 1.4: Voluntary Trade Promotes Economic Progress

“We rail at trade but the historian of the world will see will see that it was the principle of liberty.”

The foundation of voluntary trade is mutual gain. People agree to an exchange because they expect it to improve their well-being. Voluntary trade is a win-win transaction. Both parties gain more than they give up; if they did not, they would not agree to the exchange. This positive-sum activity permits each of the trading partners to get more of what they value at a relatively low cost. There are three major sources of gains from trade.

First, trade moves goods from those who value them less to those who value them more. Thus, trade can increase the value of goods even when nothing new is produced. For example, when used goods are bought and sold, the exchanges do not increase the quantity of goods available (as new products do). But the trades do create value by moving products toward the buyers who value them more than the sellers. Both gain. Otherwise, the voluntary exchange would not occur.

People’s preferences, knowledge, and goals vary widely. A product that is virtually worthless to one person may be a precious gem to another. A highly technical book on artificial intelligence may be worth nothing to an art collector but valued at hundreds of dollars by an engineer. Similarly, a painting that an engineer cares little for may be cherished by an art collector. Someone with cancer might be willing to pay many thousands of dollars (or more) for a life-saving drug that has a negative value (due to side effects) to a healthy person. Voluntary exchange that moves the AI book to the engineer and the painting to the art collector will increase the net benefit derived from both goods. The trade will increase the wealth of both people and also of their nation. It is not just the amount of goods and services produced in a nation that determines the nation’s wealth, but how those goods and services are allocated to create value.

Second, trade expands production and consumption possibilities. Trading partners will be able to produce a larger output when each specializes in production of items they can produce at a low opportunity cost, and acquires everything else through trade. When people specialize, they can then sell these products to others. Revenues received can be used to purchase items that would be costly to produce themselves. This specialization and voluntary exchange makes it possible for people to produce larger quantities of goods and services than would be otherwise possible. Economists refer to this principle as the law of comparative advantage. This law applies to trade among individuals, businesses, regions, and nations.

The law of comparative advantage is just common sense. If someone can provide you with a product at a lower cost (remember, all costs are opportunity costs) than you can supply it yourself, voluntary trade makes sense. You can then use your time and resources to produce more of the things for which you are a low-cost provider. In other words, produce what you produce best, and trade for the rest. The result is that you and your trading partners will mutually gain from specialization and trade, leading to greater total production, higher incomes, and elevated standards of living. In contrast, trying to produce everything yourself and being self-sufficient requires using your time, talents, and treasures to produce many things for which you are a high-cost provider. This would result in lower production and income while sacrificing the items and benefits others can offer.

For example, even though most doctors might be good at record-keeping and arranging appointments, hiring someone to perform these services is generally in everyone’s best interest. The time doctors use to keep records is time they could spend caring for patients. Because the time with patients is worth a lot, the opportunity cost of doctors keeping records will be high. Thus, doctors will almost always find that hiring specialists to manage their records is advantageous for themselves, their office staff, and, most important, their patients. Moreover, when doctors specialize in the provision of physician services and hire others with comparative advantages in recordkeeping and office management, costs will be lower, services will be better, and combined output in health care will be larger. It is possible to grow wine in Siberia with extensive greenhouses refrigerate ponds enough to raise artic trout in Azerbaijan but why bother when a simple swap would be so easy!

Third, voluntary exchange allows businesses to achieve lower per-unit costs by adopting large-scale production methods. Trade allows businesses to expand their market areas so they can plan for larger outputs and adopt processes that take advantage of economies of scale, as happened after 1989 when juices from Moldova entered the global market. Such processes often lead to substantially lower per-unit costs and enormous increases in output per worker. Without trade, these gains could not be achieved. Market forces are continuously reallocating production toward low-cost producers (and away from high-cost ones). As a result, open markets tend to allocate products and resources in ways that maximize the value, amount, and variety of the goods and services channeled to paying consumers. China is a perfect example of a controlled economy whose citizens, after it joined the global trading system in 1995, were able to take advantage of the signals given by trade and comparative advantage to lift literally billions of people (in both China and other countries in the region) out of poverty.

The importance of trade in our modern world can hardly be exaggerated. In fact, the World Bank credits global trade and lowering trade barriers for helping eradicate extreme poverty.⁽⁶⁾ Trade grants people living in extreme poverty access to products and resources far beyond what is available within their borders. The net benefits of trade move across nations, income groups, races, genders, and people of differing political views and cultural values. Can you imagine the difficulty involved in and costs associated with producing your own housing, clothing, and food, to say nothing of computers, smart devices, dishwashers, automobiles, and vaccines without trade? People who acquire these things have them largely because their economies are organized in ways that motivate individuals to cooperate, specialize, and trade. Countries that impose obstacles to exchange—either domestic or international—reduce the ability of their citizens to achieve gains from trade and to enjoy more prosperous lives.