By Vincent J. Truglia
In 1956, Richard Lipsky and Kelvin Lancaster introduced the Theory of the Second Best. What they were aiming for was to explore what would happen if all the required conditions for economic models were not met. They concluded that if even only one of the so-called necessary conditions were not met, then a policy of moving closer to the required theoretical conditions is not necessarily the best approach. The policy implications are profound.
Free trade has been the model espoused by most economists since the days of Adam Smith and David Ricardo. However, today many economists do not like to discuss the theory of the second best because when doing so it becomes clear the argument for unfettered free trade is a hollow one. Once we are in the world of the second best all bets are off as to what the best policy approach is.
We are in the midst of a significant policy debate about the re-introduction of tariffs in the US. It seems most commentators continue to base their analysis of the imposition of tariffs on trade models based on a world of pure competition, perfect information, markets that will always clear themselves, etc. It is obvious we do not live in such a world. Therefore, believing that moving ever closer to free trade is always the best policy falls flat. Deciding the impact of tariffs or other trade restrictions requires a robust exploration.