International Trade Theory and Policy
by Steven M. Suranovic

Trade 100-7

Public Goods and National Security

One of the oldest and most common arguments supporting protection is the so-called "national security argument," also called the national defense argument. This argument suggests that it is necessary to protect certain industries with a tariff, to assure continued domestic production in the event of a war. Many products have been identified as being sufficiently important to warrant protection for this reason. Perhaps the most common industry identified is agriculture. Simply consider the problems that would arise if a nation did not have an adequate food supply at a time when it was at war with the outside world. Low food stocks may induce severe hardships and even famine. A simple solution to avoid this potential problem is to maintain a sufficiently high tariff in order to keep cheap foreign goods out, and in turn, maintain production of the domestic goods.

Similar problems may arise in many other industries. Consider the potential problems for a country's national security if it could not produce an adequate amount of steel, aluminum, ships, tanks, planes, fuel, etc. etc. etc., in the event of a war. The products that could be added to this list are enormous. Indeed, at one time or another, in most country's histories, almost every product imaginable has been argued is important from a national security perspective, and thus is deserving of protection. One of the most interesting arguments I've heard (related in another textbook) is that made by the embroidery industry who once argued for a protective tariff in the US because embroidered patches on soldiers uniforms are essential in maintaining the morale of the troops. Thus it was clear, to them at least, that the embroidery industry needed to be protected for national security reasons.

National Security and Public Goods

We can make better sense of the national security argument if we classify it in the context of the theory of the second-best. In this case, we must note that the national security argument is actually incorporating a market imperfection into the story to justify the use of a protective tariff. The market imperfection here is a public good. National security is a public good and public goods are excluded from the standard assumptions of perfect competition. Thus, whenever a product has public good characteristics, we can say that a market imperfection is present. Traditionally the literature in economics refers to concerns such as national security as a non-economic objective. The effects that food production may have on the nation's sense of security, for example, was thought to fall outside the realm of traditional economic markets.

In general, public goods have the following two consumption characteristics; they are non-excludable and they are non-rival. Non-excludability means that once the product is produced it is impossible to prevent people from consuming it. Non-rivalry means that many people can consume the produced product without diminishing its usefulness to others. Here's a few examples to explain the point. First consider a non-public good, soda pop. A soda is excludable since the producer can put it into a can and require you to pay for it to enjoy its contents. A can of soda is also a rival good. That's because if I consume the can of soda, there is no way for anyone else to consume the same can. This implies that a can of soda is NOT a public good. On the other hand, consider oxygen in the atmosphere. (This is an odd example because oxygen in the air is not formally produced, but let's ignore that for a moment) Atmospheric oxygen is non-excludable, because once it is there, everyone has free access to its use. It is impossible (or at least very difficult) to prevent some people from enjoying the benefits of the air. Atmospheric oxygen is also non-rival, because when one person takes a breath, it does not diminish the usefulness of the atmosphere for others. Thus, if atmospheric oxygen did need to be formally produced, it would be a classic example of a pure public good.

The typical examples of public goods include national security, clean air, lighthouse services, and commercial-free TV and radio broadcasts. National security is the public good we are most concerned with in international trade. It is a public good because, once provided, it is a) difficult to exclude people within the country from the safety and security generated and b) multiple individuals can enjoy the added safety and security without limiting that received by others.

We know from the theory of the second-best that when market imperfections are present, government policies can be used to improve the national welfare. In most cases trade policy can be used as well. It is well known in economic theory that when a good has public good characteristics, and if private firms are free to supply this good in a free market, then the public good will NOT be adequately supplied. The main problem occurs because of free-rider-ship. If a person believes that others may pay for a good and if its subsequent provision gives a benefit to all people - due to the two public good features - then that person may avoid paying for the good in a private marketplace. If many people don't pay, then the public good will be insufficiently provided relative to the true demands in the country. It is well known that government intervention can solve this problem. By collecting taxes from the public, and thus forcing everyone to pay some share of the cost, the public good can be provided at an adequate level. Thus, national welfare can be increased with government provision of public goods.

A similar logic explains why trade policy can be used to raise a country's welfare in the presence of a public good. It is worth pointing out though, that the goods highlighted above, such as agricultural products and steel production, are not themselves public goods. The public good one wishes to provide in greater abundance is "national security." And it is through the production of certain types of goods locally that more security can be provided. For example, suppose it is decided that adequate national security is possible only if the nation can provide at least 90% of its annual food supplies during wartime. Suppose also, that under free trade and laissez-faire domestic policies, the country produces only 50% of its annual food supply and imports the remaining 50%. Finally suppose the government believes that it would be very difficult to raise domestic production rapidly in the event that imported products were ever cut off, as might occur during a war. In this case a government may decide that its imports are too high and thus pose a threat to the country's national security.

A natural response in this instance is to put high tariffs in place to prevent imports from crowding out domestic production. Surely, a tariff exists that will reduce imports to 10% and subsequently cause domestic production to rise to 90%. We know from tariff analysis, that in a small country case, a tariff will cause a net welfare loss for the nation in a perfectly competitive market. These same gains and losses and net welfare effects can be expected to prevail here. However, because of the presence of the public good characteristics of national security, there is more to the story. Although the tariff alone causes a net welfare loss for the economy, the effect is offset with a positive benefit to the nation in the form of greater security. If the added security adds more to national welfare than the economic losses caused by the tariff, then overall national welfare will rise. Thus, protectionism can be beneficial for the country.

The national security argument for protection is perfectly valid and sound. It is perfectly logical under these conditions that protectionism can improve the nation's welfare. However, because of the theory of the second-best, many economists remain opposed to the use of protectionism even in these circumstances. The reason is that protectionism turns out to be a second-best policy option.

Recall that the first-best policy response to a market imperfection is a policy that is targeted as directly as possible towards the imperfection itself. Thus if the imperfection arises because of some production characteristic, a production subsidy or tax should be used. If the problem is in the labor market, a tax or subsidy in that market would be best, and if the market imperfection is associated with international trade, then a trade policy should be used.

In this case, one might argue that the problem is trade related, since one can say that national security is diminished because there are too many imports of, say, agricultural goods. Thus, an import tariff should be used. However, this logic is wrong. The actual problem is maintaining an adequate food supply in time of war. The problem is really a production problem because if imports were to be cut off in an emergency, the level of production would be too low. The most cost effective way, in this situation, to maintain production at adequate levels will be a production subsidy. The production subsidy will raise domestic production of the good and can be set high enough to assure that an adequate quantity is produced each year. The subsidy will cost the government money and it will generate a net production efficiency loss. Nevertheless, the efficiency loss from a tariff, one that generates the same level of output as a production subsidy, will cause an even greater loss. This is because an import tariff generates both a production efficiency loss and a consumption efficiency loss. Thus, to achieve the same level of production of agricultural goods, a production subsidy will cost less, overall, than an import tariff. We say, then, that an import tariff is a second-best policy. The first-best policy option is a production subsidy.

Another Case when a Trade Policy is First-Best

There is one case in which trade policy, used to protect or enhance national security, is the first-best policy option. Consider a country that produces goods that could be used by other countries to attack or harm the first country. An example would be nuclear materials. Some countries use nuclear power plants to produce electricity. Some of the products used in this production process, or the knowledge gained by operating a nuclear facility, could be used as an input in the production of more dangerous nuclear weapons. To prevent such materials from reaching countries, especially those which may potentially threaten a country, export bans are often put into place. The argument to justify an export ban is that preventing certain countries from obtaining materials that may be used for offensive military purposes is necessary to maintain an adequate national security.

In the US export bans are in place to prevent the proliferation of a variety of products. Many other products require a license from the government to export the product to certain countries. This allows the government to monitor what is being exported to whom and gives them the prerogative to deny a license if it is deemed to be a national security threat. In the US licenses are required for goods in short supply domestically, goods related to nuclear proliferation, missile technology, chemical and biological weapons, and other goods that might affect regional stability, crime, or terrorist activities. In addition the US maintains a Special Designated Nationals list which contains a list of organizations to whom sales of products is restricted and a Denied Persons List which contains names of individuals with whom business is prohibited. Finally, the US maintains exports bans to several countries including Cuba, Iran, Syria and Sudan. (This info is as of Feb 2007: See the US Dept of Commerce's Trade Information Page here for more information).

In this case, the export control policy is the first-best policy to enhance national security. This is because the fundamental problem is certain domestic goods getting into the hands of certain foreign nations, groups or individuals. The problem is a trade problem best corrected with a trade policy. Indeed, there is no effective way to control these sales, and thus to enhance the national security, using a purely domestic policy.

Summary

What follows is a short list of some of the important results from this section.

  • The preservation of national security is a common justification for the use of protection.
  • The preservation of national security is a type of non-economic objective
  • Protection can help maintain an adequate domestic supply of materials critical in the event of war, including food, steel, military equipment and petroleum.
  • Export bans can be used to prevent the proliferation of materials that may eventually prove to be threatening to a nation's security.
  • Import tariffs can raise national welfare when increased production of the protected product enhances national security.
  • Protection can be beneficial because of the presence of a market imperfection. National security is a public good which is the imperfection
  • A production subsidy can achieve the same level of production at a lower cost.
  • A production subsidy is the first-best policy when increased production of a good enhances national security.
  • An import tariff is a second-best policy option.
  • An export ban can raise a nation's welfare when the export of a product reduces national security.
  • The export ban, a trade policy, is the first-best policy option when export of a product reduces national security.

International Trade Theory and Policy - Chapter 100-7: Last Updated on 2/16/07

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