A contradiction in my (previous) views

I used to (i.e., last week) believe the following two claims:

1) Taking the government policies of country A as constant, more trading opportunities with country B will make country A better off.

2) International competition will force countries to improve their economic policies, otherwise they will be “left behind.”

I know many classical liberals who believe both propositions, as did I. But it is not so easy to square the circle. If 2) is true, that must mean that if country A faces greater international competition, and does not improve its economic policies, it must be worse off (admittedly the phrase “left behind” is vague, but what else could it mean?). Which means that 1) cannot be true as stated.

You might argue for a different version of 2): “2a) International competition will force countries to improve their economic policies, competition benefits the citizens no matter what, but it will starve the government of revenue, presumably because of resource mobility.”

But 2a), while possible, is a funny claim. If the citizens are better off, you might think that gdp is higher, and thus you might think that tax revenue is higher as well. Rising standards of living tend to produce rising tax revenue. You could spin a scenario where capital flight, combined with goods reimportation, raises living standards while lowering tax revenue, but it will be hard to find this empirically.

Alternatively, you might argue for a better version of 1): “1a) More trading opportunities are good for country A, in part because they force country A to improve its economic policies.” This will work, but it is a weaker argument for free trade for country A than we are used to.

So what gives? I suggest two adjustments. First, free trade can sometimes make country A worse off, even if it benefits countries A and B in the aggregate. Second, international competition may motivate countries to make reforms by threatening a loss of relative international status, but it won’t make the citizens in country A worse off in most plausible cases. My views are thus revised.


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