Suppose that last night, while you were sleeping, government agents came during the dark of night to blockade your house. In the morning, when you went to take out the garbage, you were greeted by the following sight: barbed wire sealed off all points of exit from your property, tanks poked their turrets from between tree limbs, Army sharpshooters patrolled the perimeter to make sure that nobody attempted to escape. What would your reaction be? ("Hey, honey, there's a lot of people outside our house. Did you forget to pay the phone bill this month?") Suppose you found out that the reason for all this activity is that the government was simply enforcing a new law: "Henceforth, each household is forbidden to engage in trade with any other household." Power and telephone lines were cut. Water lines into the home were blocked. Effective immediately, each family was responsible for providing all its own food, clothing, entertainment, and other needs. Take some time to answer the following question: What would be the effect of this new law on society's happiness?

Seems like a no brainer, right? Suppose instead, government passed a new law which mandated the following: "Henceforth, each town is forbidden to engage in trade with any other town." Now the barbed wire, tanks, and Army sharpshooters are pulled back to the city limits. This law isn't quite as severe as the previous law, because there are at least some opportunities for trade within the town. But it's still pretty bad. The good news is the local paper gets delivered to your home, since the newspaper company is located in town. The bad news is that the paper is done in crayon, because the company that produces the ink is located in a different city. The good news is that you're able to watch programming from the local cable TV company. The bad news is that instead of watching Baywatch, the only station in town is showing repeats of the production of "Goldilochs and the Three Bears" by Mrs. Smith's 5th grade class. You get the idea.

A law which discouraged trade outside a town's borders would surely lower society's happiness. Similarly, a law which discouraged trade outside a state's borders would also surely lower society's happiness. Does it not follow, then, that protectionist policies which discourage trade outside a country's borders can only have the same effect?

Or think of it this way. Suppose Adam and Johnny agree to a voluntary exchange of goods. Since the exchange is voluntary, Adam and Johnny must both believe that the trade has made them better off. The same thing holds true for trade between Annalisa and Josephine. And Andrew and Joanne. And Adonirah and Jack. Now let's join Adam, Annalisa, Andrew, and Adonirah together and call them a country, like "America." And let's join Johnny, Josephine, Joanne, and Jack together and call them a country, like "Japan." If these voluntary exchanges make each person better off individually, how can the same set of voluntary exchanges make the countries of "America" or "Japan" worse off? How can something be unquestionably good at the individual level, but bad when we sum up the exchanges?

International trade--that is, trade between countries--is remarkably simple to understand because, in principle, it is no different than trade within countries. That was the point that Adam Smith was making when he wrote the words that begin this chapter--over two hundred years ago. Not surprisingly then, the same, simple framework that we have used to analyze resource transfers within countries can also be applied to resource transfers between countries.

Suppose an American car dealership imports Honda Civics from Japan. The dealer pays $12,000 to Honda of Japan to import the car. It turns around and sells the Civic for $16,000. Ignoring the other costs of the dealer, we can represent this transaction in our beloved Profit Table as follows.

Assuming the market price of Honda Civics is right around $16,000, the dealer's revenues represent a dollar measure of the happiness that some American consumer will receive because one more Civic was available. In exchange for this car, Americans have traded $12,000 of green pieces of paper. What will Honda of Japan do with this money? One possibility is that they will trade their dollars for yen at the foreign exchange desk at the Bank of Tokyo. But the Bank of Tokyo isn't all that interested in holding on to American dollars (the local McDonald's only takes yen), so it looks for someone who is willing to swap yen for dollars. Maybe a Japanese business office in Osaka is interested in buying American personal computers. It goes to the Bank of Tokyo and exchanges its yen for the $12,000. The business office can now buy 3 personal computers at $4,000 a piece. After a short trip abroad, those twelve thousand dollars return to the U.S. to pay for 3 personal computers that get shipped to Osaka.

From the perspective of the U.S. economy, here is the trade we just made with Japan. In exchange for one Honda Civic, American consumers gave up three personal computers. Was it a good deal? Sure. Since the personal computers were each priced at $4,000, losing three personal computers meant that American consumers missed out on $12,000 of happiness. That's a bummer. But in return they got a Honda Civic that produced $16,000 of happiness. The bottom line is that this trade has resulted in a net increase of $4,000 in (U.S.) society's happiness. (Lest we think we just pulled a fast one on the Japanese, we should remember that since the Japanese made this trade voluntarily, it must mean that they also were made better off).

Let's use this example to consider the much loathed and generally feared practice of foreign "dumping." Dumping is a practice whereby foreign countries sell their goods in American markets at prices lower than what they charge in their home markets. Why might a foreign country do this? There are a lot of reasons, but consider the one that seems to most offend Americans. Suppose the government of Japan subsidizes the export of Hondas. For every Civic that Honda ships to the U.S., the Japanese government gives Honda of Japan a large cash payment.

Now this seems really unfair. How in the world can American car manufacturers compete against the Honda Civic if the Japanese government subsidizes them? Good question. Though not necessarily the right question. We'd rather ask, how does the practice of foreign dumping affect the happiness of U.S. society? This depends on the amount of the foreign subsidy. If a small subsidy is a little offensive, then a large subsidy should be downright nauseating. So let's assume the absolutely worst case scenario. Let's assume that the Japanese government subsidizes the entire cost of the Civic. Rather than having to pay $12,000 for the Civic, the American car dealer picks up the entire car for nothing, thanks to the Japanese government. We're forced to agree, this is unfair competition at its most unfair. Let's see how this transaction gets reflected in the dealer's profit statement.

Nice looking profits! This car dealer certainly has no complaints about foreign dumping. But how has this transaction affected society's overall happiness? On the one hand American consumers get a spanking new Honda Civic. On the other hand, American consumers give up....what? What did American consumers have to give up in return for the Honda? The answer is, absolutely nothing (note that the dealer's costs are zero). Since the dealer didn't have to send $12,000 to Honda of Japan, Honda of Japan never had $12,000 to exchange with the Bank of Tokyo, which in turn didn't have $12,000 to trade with the business office in Osaka. As a result, the business office in Osaka never placed an order for three personal computers, which means that those three personal computers can now be enjoyed by American consumers.

Here is the trick: the less dollars we have to send abroad to get the goods we want, the less dollars foreign countries have to make claims on our goods and services. And the less goods and services foreign countries take from us, the more we have for ourselves. Dumping? What's to complain about? Rather than taking foreign firms to court for violating anti-dumping laws, we should be doing something more productive, like writing thank you notes!

But...but...but...won't this hurt American car manufacturers? Indeed it will. If the Japanese really did ship us their cars for free, this would dramatically lower the price of cars in America. Of course, those lower prices are telling us something. With all these nice new Japanese cars over here, the extra happiness of an additional American car is pretty small. As a result, we'd like American car manufacturers to stop producing so many cars. Instead, we'd like them to devote their resources to producing other, more valuable things. And if they can't think of anything else to do with those resources, then they better release them to those who can.

How about the fairness argument? It surely isn't fair that American car manufacturers have to compete against foreign cars that are heavily subsidized by their governments. Indeed it isn't, and so we have to return to the purpose of the economy. Is the purpose of the economy to guarantee fairness to all producers? Or is it to maximize the happiness of consumers? Whose benefit are we running this economy for anyway? For Lee Iacocca's benefit? Or for you, a consumer?

From the perspective of the producer, it makes no difference if the price of cars is low because Japanese cars are subsidized by their government, or if car prices are low because Americans have a change of heart and all decide they'd rather take the bus. Wouldn't that be unfair too? ("How dare those consumers decide they don't like our cars anymore! You think they would at least have called and told us they were taking the bus before we shipped all these new cars to the showroom.") And speaking of fairness, was it fair to the horse and buggy industry when Henry Ford introduced his non-hay eating, non-manure producing form of transportation? Talk about unfair competition!

The answer to the question of what is fair is a tough one. We sure are glad we don't have to answer it. In contrast, the answer to the question, Who gains from trade? is an easy one. American consumers do. And as long as trade proceeds voluntarily, the greater the trade, the greater the increase in society's happiness. It's just that simple.