With The Donald now busy playing poker with Little Rocket Man, the threat of a trade war has receded. Good. Gives us time to get our thinking straight before the threat returns.
Everyone knows a trade war would be a terrible thing, but most people's reason for thinking so is wrong. This misunderstanding means such a war could happen, even though everyone knows it would be bad.
It seems common sense for a country to want to protect its industry by imposing a tax – known as a tariff or import duty – on imports competing with locally-produced goods. After all, we win and foreigners lose.
The problem arises only if the foreigners retaliate and slap a tariff on our exporters. That's bad for us because it may lead to job losses among those of our workers who earn their living making goods for export.
Is that the way you figure it? Sorry, it may be common sense, but it's wrong. You need to have learnt a bit of economics to see why, because the case against protection is "counterintuitive" – it doesn't seem right, but it is.
The reason people can't see what's wrong with protection is that every baby is born with a disease called mercantilism.
Mercantilism is the belief that exports are good, but imports are bad. Why? Because we – Australia – make money selling exports to foreigners, whereas it costs us money to buy imports, the foreigners' exports.
So mercantilists see Australia as like a company, and our balance of trade as like a company's profit and loss statement. The more you can export and the less you can import – the higher your trade surplus - the richer you become.
What's wrong with that way of thinking? Plenty. For a start, it's the mentality of a miser – someone who loves money for its own sake, not for what it will buy.
Money is just a means to an end, not an end in itself. The economic game is about producing goods and services so we can consume them. Production is the means; consumption is the end. Focus on one at the expense of the other and you've actually done badly in the game.
Similarly, jobs are just a means to an end. Why do people want jobs? So they can earn money and then spend it.
Exports are production, imports are consumption (although much of our imports are of machines we use in the production process). Production without consumption makes sense only to a miser.
Get this: 80 per cent of the way Australia makes its living is by all the workers and businesses and governments producing goods and services and selling them to other Australian workers, businesses and governments, so they can be consumed.
In principle, we could raise the 80 per cent to 100 per cent by only selling to and buying from ourselves. So why do we sell about 20 per cent of the things we produce to foreigners?
Not because it makes us richer, nor because it creates more jobs. It's solely so we can afford to buy some of the goods and services produced by businesses and workers in other countries, when we judge them to be better or cheaper than the stuff made locally.
Exports are good solely because we can use the proceeds to pay for imports – and imports are also good because they raise our material standard of living by giving all of us (workers, would-be workers and dependents) access to goods and services that are better or cheaper than those made in Australia.
If we weren't willing to use the proceeds from our exports to pay for imports from other countries, those countries would refuse to buy our exports.
Refusing to buy our exports would leave those countries worse off (because they'd lose their ability to buy the things we can produce better or cheaper than they can), as well as leaving us worse off because we lost our ability to use our export income to buy their exports.
This, BTW, is why trade wars are mutually self-harming. A group exercise in cutting off your nose to spite your face.
Why wouldn't it be better to be 100 per cent self-sufficient? Because this would limit the benefits to us from "specialisation and exchange". Our domestic economy is organised on the basis that we're all better off if each of us specialises in producing what we're good at, then uses money to exchange what we've produced with what other specialists have produced.
Opening our economy to trade with other countries merely extends this principle, on which we've always run our domestic economy, beyond our borders.
This is why the mercantilists' assumption that trade is a zero-sum game – if you win, I lose – is wrong. Both sides win because both benefit from the "mutual gains from trade".
It follows that the mercantilist notion that foreigners are the only people who lose when we decide to protect some of our industries is wrong. The biggest losers are every other industry and every Australian who loses their access to cheaper or better imported goods and has to pay more for the local version.
That is, tariffs are a tax, not on foreigners, but on Australian producers and consumers. A way of favouring some Australian industries at the expense of all the others. A redistribution of income to favoured industries from those that aren't favoured, and from Australian consumers generally. A form of rent-seeking.
And thus, an attempt to protect some jobs at the expense of all other jobs. Great idea.
Trade wars are destructive not primarily because it's crazy for other countries to retaliate – which it is – but because the country that provokes the retaliation by protecting some favoured industries is damaging itself.
Better to let it stew in its own juice than punish it by harming yourself.
