In addition, free trade disciplines domestic producers and keeps them competitive. It diminishes the possibility of cronyism between government and private sector since foreign producers are outside the control of the government and hard to cartelize. All this is necessary for the independence of the private sector which, in turn, limits the arbitrary powers of government, protects property rights and indeed defends democracy itself.
Raising taxes on the rich will have large domestic consequences
So what does this imply for how a country’s policies should be circumscribed? Economist Dani Rodrik of Harvard University suggests economic policies fall into four broad buckets when seen from the perspective of cross-border flows. Some policies may help or hurt the country but for the most part do not translate into effects elsewhere. For instance, raising taxes on the rich will largely have domestic consequences, with only the rare billionaire deciding to up stakes and become a citizen of Monaco. The need to preserve sovereignty would generally shield such policies from international influence.
Then there are policies, such as raising tariffs on imports, which typically have adverse effects on the rest of the world but also have serious adverse effects on the country imposing the tariffs. The jobs protected by steel tariffs typically are outweighed by the jobs lost in other sectors such as autos. As noted, there should be little room for such “beggar thyself” policies.
Carbon emissions are changing the climate
In another bucket are policies that affect the well-being of all countries by altering commonly held resources, collective resources or the environment. Overfishing on the high seas affects catches everywhere, while carbon emissions are changing the climate. The reluctance to vaccinate all children domestically allows the scourge of polio to re-emerge, threatening children around the world.
The outside world has an important role to play in influencing domestic policies that affect the global commons. But, any effort to reach such agreements will be affected by the asymmetries of power, expertise and information between countries, as well as the lack of democratic engagement within countries. Perhaps when agreements are complicated with uncertain costs of compliance, they should start with “best efforts” pledges, with country-specific binding targets nailed down over time.
The most difficult bucket of policies to address includes those that have positive domestic effects but adverse international effects—those that became known as “beggar thy neighbor” policies during the Great Depression. When a country intervenes directly in exchange markets or through unconventional monetary policies to keep its exchange rate undervalued, or when it subsidizes an exporting sector heavily, it tends to make the country’s exports hypercompetitive and drive down profits in competing countries. The country’s growth comes at the expense of everyone else. Indeed, if others retaliate, as they did during the Great Depression, everyone is worse off.
Most central banks have domestic mandates
While no country has a duty to undertake policies that help others more than itself, it does have a responsibility to avoid policies that do significant harm. For instance, most central banks have domestic mandates: Typically, they are required to keep inflation at around two percent. In normal times, central banks achieve this target through conventional monetary policies—raising or lowering interest rates—which have few sustained adverse external effects.
In bad times, however, when their economies are mired in deflationary conditions, central banks may undertake actions which have the primary effect of depreciating the country’s exchange rate and drawing demand from other countries.