Rationale for Trade

The consequences of trade do not by themselves establish the rationale for trade. To do this we have to understand that trade is in essence a form of production.

When a region trades, it provides inputs, incurs input costs and environmental expenditures, obtains outputs, and consumes these to achieve effectual value.

All the essential elements of local production are present, except that the outputs consumed differ from the outputs produced.

The decision to trade is thus fundamentally a decision to assign a locally available set of inputs to the remote production of an output. ENL therefore considers trade to be an allocation issue, and applies the logic of allocation to this subject.

A consequence of this approach is that trade, unlike local production, takes into account the effectual value arising from consumption. The discussion below therefore refers to effectual value rather than potential value, and to gains rather than potential gains.

Rational allocation means directing inputs to a specific output in order to maximize aggregate health.

In order to do this, the society must know, or be able to estimate, the health benefits from the various output possibilities. These benefits, known in ENL as gains, are equal to the effectual value derived from consumption minus the input cost incurred in production.

To maximize aggregate health, each set of inputs should be allocated to the output that will result in the highest attainable gains.

When seen from the perspective of allocation, the expanded range of outputs resulting from trade gives a society more options in choosing the output with the highest gains.

For example, it may turn out that imported pineapples achieve gains that exceed those of apples and strawberries. If so, inputs should be redirected to this import.

The other main benefit of trade — the decrease in input costs — will increase the gains of the affected outputs, thus modifying the allocation choice as well.

For example, the input cost of strawberries might drop from 90 to 60 health units because of trade. If this change means that strawberries now result in the highest gains among the possible outputs, a society's inputs should be redirected to their production.

Note that, in this basic trade logic, the expansion of the output range is not a qualitative issue. That is, when health-based consumption is being considered, a society does not benefit simply because a greater variety of outputs has been made available.

The benefits of trade being discussed here are purely quantitative and based on health — the imported pineapples should be chosen if they result in higher gains than the locally-produced outputs, not because they taste different from apples and strawberries or because they add an exotic touch to the dinner table.

Let us now review ENL's trade rationale by using a fairly realistic example of the first effect of trade — the addition of a new final output that expands the range of allocation choices.

The Canadian province of British Columbia (BC), is heavily forested and thus a good place to grow trees for lumber. Costa Rica is a lush tropical country and is therefore a great spot for growing pineapples. Treating BC as the local region, what gains might we achieve by exporting our lumber to Costa Rica and importing their pineapples in exchange?

Assume that we have reached the target quantities for all final outputs that require lumber in their production. This means we cannot gain health by using any additional wood ourselves.

The environmental budget for wood extraction has not yet been exhausted in BC, so we have ecological space to extract more wood. With this in mind, we get in touch with the Costa Ricans to talk trade, and discover that they are willing to exchange 500 kilograms of their pineapples for 1,000 board-feet of our lumber.

If this is the best deal we can get from them, should we proceed? Let's run through the allocation logic and see.

Pineapples are final outputs and therefore have potential value. When they arrive in BC's stores they will reach consumers, who will convert this potential value into effectual value.

BC incurs negligible input cost in this process, so our health gains from importing the pineapples will be the effectual value associated with their local consumption.

Now consider the lumber we must ship to Costa Rica in return. Extracting logs from our forests and transforming them into lumber in our mills will incur both natural cost and labor cost. We will also have to ship the lumber to Costa Rica. Because transportation is part of production, this will incur further costs that we will also have to bear.

The total of all these costs is the input cost of the exported lumber.

Clearly, what we gain from this trade is the difference between the effectual value from consuming the pineapples and the input cost from producing the lumber. This difference is called the net gains from trade.

If the net gains are negative, the trade obviously makes no sense.

Assuming they are positive, however, should we start shipping lumber to Costa Rica and look forward to the pineapples that will be coming back? Not quite yet — we have only dealt with the benefit from trade, not with its rationale.

Our aim is not just to increase our society's health, which we now know this trade will accomplish, but to maximize it. We therefore have to go through one more step to justify the trade relationship.

The resources we would expend for this trade are the inputs required for lumber production — labor, machines, buildings, oil, and so forth. So the question is: will our trade with the Costa Ricans maximize the health we could potentially achieve from these inputs, considering all alternative production (including other trade) possibilities?

The situation that confronts us is summarized in the following figure.

The rationale for trade
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The gains from imported pineapples (90 — 50 = 40) are greater than the gains from local apples (90 — 70 = 20) and strawberries (100 — 90 = 10). The inputs should therefore be allocated to lumber in order to permit the importation of pineapples. The question marks indicate that we have no knowledge of Costa Rica’s effectual value relating to the lumber or input cost relating to the pineapples. EV and IC are used for effectual value and input cost, respectively.

At the bottom of the diagram is a set of inputs, which we are seeking to allocate. At the top are three output options: locally-grown apples, locally-grown strawberries, and imported pineapples.

For each output our economy incurs the indicated input cost and achieves the indicated effectual value. The basis for the allocation decision is straightforward: when we put these inputs to work we should maximize the gains that will result. These gains are as follows:

Local apples: 90 — 70 = 20
Local strawberries: 100 — 90 = 10
Imported pineapples: 90 — 50 = 40

The imported pineapples are the clear winners here, so we should proceed with this trade.

Of course, this means that the inputs should be allocated to the production of the lumber we intend to export. In this situation, the addition of the import has given us the opportunity to increase aggregate health relative to exclusively local production.

It should be noted that, in making the gains comparison during allocation, it was entirely irrelevant that the pineapples will be imported instead of being produced at home.

What factors made the trade for pineapples the allocation winner? BC has lots of trees, and (let's assume) our mills are relatively friendly to both workers and the environment. Under these conditions, we can produce lumber at low input cost.

This low cost, combined with the high effectual value from Costa Rica’s wonderful pineapples, allows the gains from this trade to exceed the gains from the locally-produced apples and strawberries.

Let's examine the trade with Costa Rica a little more closely.

We have full knowledge about the input cost of the exported lumber because we incur this cost ourselves. Similarly, we have full knowledge of the effectual value of the imported pineapples because our population experiences this benefit directly.

However, we probably know nothing about the effectual value of the final outputs for which the lumber is destined. Similarly, we are likely to be ignorant about the input cost of the pineapples produced in Costa Rica. There is in fact no need for us to know about these two factors. This is why the arrows relating to Costa Rica's interactions are labeled with question marks.

Also unknown to us, but not shown in the diagram, are the environmental expenditures incurred by the Costa Ricans in producing the pineapples, and thus whether or not they are violating any of their environmental budgets in this production.

Finally, we know nothing about the depletion of nonrenewable resources that might be involved in Costa Rica's production.

All these unknowns are the result of our choosing regional rather than global geographical scope. In adopting regional scope we are consciously isolating our economy from the rest of the world and ignoring the global implications of our actions.

If we decide that such ignorance is irresponsible, we have no choice but to adopt global scope. Trade will then disappear, and we will assume full responsibility for determining all values, costs, and environmental impacts before making allocation decisions in our global ENL economy.

To summarize: The rationale for considering trade is that this modifies the local economy's allocation options, first by expanding the range of outputs that can be obtained with its inputs, and second by effectively reducing the input cost of locally-produced outputs.

The rationale for trade itself is that an import offers the highest available gains among the allocation options for a specific set of inputs.

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