Let’s Begin at the Beginning

Most conversations about trade begin in the middle.  The conversation revolves around international trade, about people in one nation trading with people in another.  The conversation revolves around GDP and regulations and tariffs and tribunals and all these things tangentially related to trade, but never about trade itself.  The problem with starting the conversation in the middle like this is we miss the all-important fundamentals that are developed in the beginning part of the conversation.  For economists, this gloss isn’t a problem; we’ve been trained and trained on trade.  But for presidents, politicians, pundits, and prophets, this gloss is problematic.  They do not understand the basis upon which trade is built, the logic of the argument because they miss it (I suspect this is a good amount of the reason opinions diverge so strongly between economists and the man-on-the-street on the nature of international trade).  Therefore, I offer this blog post as a humble contribution to the conversation.

Let’s begin at the beginning: Why do people act?  They act because they must feel, given the information they have at the time, that their action serves some desired end/purpose.  In other words, that action is purposeful.  Given purposeful action, why do people trade?  What causes Smith and Jones to exchange their goods with one another?  The answer is obvious (by which I mean its literal interpretation (derived from observation) as opposed to its more colloquial use of “trivial”): Both Smith and Jones benefit from this trade.  If either party did not benefit, then no trade would happen.  It is from this first principle that we must build the conversation around trade, but it is this first principle that much of the political conversation ignores.

In the coming days,  I will be posting a series of blog posts exploring trade from the first principle that trade is mutually beneficial.  Stay Tuned!

Institutional Diversity and Trade

A popular argument against free trade is that the logic of trade requires identical (or at least similar) rules/institutions between the trading parties.  Dani Rodrick recently made this argument, and you can see Don Boudreaux’s response here.  There is absolutely nothing in the logic or argument for free trade that necessitates similar institutions between the partners.  Only one thing is required: both parties benefit.

However, for both parties to benefit from trade, they must inherently be different from each other.  If the two were identical, then no trade would ever occur.  Diversity in tastes, in endowments, in incomes, even in rules, are desirable and, to differing degrees, necessary.  The idea that trading partners must be similar to one another, including in their belief structures, undermines the logic of trade.

Moving from the individual level to the national level, institutional diversity helps show actual costs and benefits of various institutions.  For example, if the whole world were as protectionist as Red China in the 1950’s, no one would know what a horrible scheme that is as the whole world would have looked like massive starvation.  Fortunately, the Chinese realized their mistake and have become rapidly more open-trade, thus leading to their huge economic gains lately, but it was the fact that institutional diversity existed that such folly was understood.  If a given national government decides not to allow peaceful trading between their citizens and another group of citizens, then their citizens are harmed and the true costs of their institutions, as well as their true benefits, are not known.

Diversity is a necessary ingredient of trade.

Today’s Quote of the Day…

…is found in a letter from Frederic Bastiat to Richard Cobden (leader of the Anti-Corn Law League) dated 8 April 1845.  The letter can be found on page 58 of the Liberty Fund’s collection of Bastiat’s correspondence, The Man and the Statesman (emphasis added):

Sir,

Since you have permitted me to write to you, I will reply to your kind letter dates 12th December last.  I have been discussing the printing of the translation [of Cobden’s speeches and pamphlets] I told you about with M. Guillaumin, a bookseller in Paris.

The book is entitled “Cobden and the League, or the Campiagn in England in Favor of Free Trade.”  I have taken the liberty of using your name for the following reasons: I could not entitle this work “The Anti-Corn Law League.”  Apart from the fact that this would have a barborous sound for French ears, it would have brought to mind a limited conception of the project. It would have presented the question as purely English, whereas it is a humanitarian one, the most notably so of all those which have brought campaigning to our century.

By presenting the issue of free trade as a humanitarian issue rather than a sectarian or nationalist issue, he demonstrates the universality of the principles of free trade.  Many opponents of free trade like to argue that free trade is conditional.  They may argue that free trade requires “transnational rule-making institutions.”  Or that trade only is good if one nation (ie the nation of the speaker) benefits.  Or that free trade needs to be “fair” (whatever that means).  But Bastiat makes no such prerequisites.  Bastiat and Cobden both argue that free trade is not an English concern, not a French concern, not an American concern, but a human concern.

The Anti-Corn Law League that Cobden was part of was founded in opposition to the Corn Laws, a series of mercantilist legislation that raised the price of food within Great Britain by restricting imports.  Given this legislation occurred at the same time as the Irish Potato Famine, the Corn Law, by artificially increasing scarcity of food, likely caused many deaths in Ireland from the famine.  The Corn Laws contributed to a humanitarian crisis.  We are seeing similar situations going on in Puerto Rico, where scarcity is increased because of the Jones Act, and Houston and Florida where scarcity is increased because of anti-price-gouging legislation.  Free trade is a humanitarian concern, not a sectarian concern.

Richard Thaler Wins Nobel Prize

University of Chicago economist Richard Thaler wins the 2017 Nobel Prize in Economics for his contributions to behavioral economics.

Personally, I am happy with this outcome.  Thaler is a very good economist whose recognition is long overdue (his sometimes co-author and frequent collaborator, Daniel Kahneman, won the Prize back in 2002).

Over at Marginal Revolution, my GMU professor Tyler Cowen has a great write up on Thaler’s work, including some areas I did not know about.

Two books of Thaler I highly recommend are The Winner’s Curse and Nudge (co-authored with Cass Sunstein, another person worth reading).  Both are fascinating, and challenging looks at the standard assumptions of economics and provides surprising insights.

Today’s Quote of the Day…

…is from page 155 of the Liberty Fund’s edition of Adam Smith’s 1759 book The Theory of Moral Sentiments (emphasis added):

In war and negotiation, therefore, the laws of justice are very seldom observed. Truth and fair dealing are almost totally disregarded. Treaties are violated; and the violation, if some advantage is gained by it, sheds scarce any dishonour upon the violator. The ambassador who dupes the minister of a foreign nation, is admired and applauded. The just man who disdains either to take or to give any advantage, but who would think it less dishonourable to give than to take one; the man who, in all private transactions, would be the most beloved and the most esteemed; in those public transactions is regarded as a fool and an idiot, who does not understand his business; and he incurs always the contempt, and sometimes even the detestation of his fellow-citizens. In war, not only what are called the laws of nations, are frequently violated, without bringing (among his own fellow-citizens, whose judgments he only regards) any considerable dishonour upon the violator; but those laws themselves are, the greater part of them, laid down with very little regard to the plainest and most obvious rules of justice. That the innocent, though they may have some connexion or dependency upon the guilty (which, perhaps, they themselves cannot help), should not, upon that account, suffer or be punished for the guilty, is one of the plainest and most obvious rules of justice. In the most unjust war, however, it is commonly the sovereign or the rulers only who are guilty. The subjects are almost always perfectly innocent. Whenever it suits the conveniency of a public enemy, however, the goods of the peaceable citizens are seized both at land and at sea; their lands are laid waste, their houses are burnt, and they themselves, if they presume to make any resistance, are murdered or led into captivity; and all this in the most perfect conformity to what are called the laws of nations.

 

Free Trade: The Unsung Hero

From page 46 of Matt Ridley’s great book, The Rational Optimist:

The cumulative accretion of knowledge by specialists that allows us each to consume more and more different things by each producing fewer and fewer is, I submit, the central story of humanity. Innovation changes the world but only because it aids the elaboration of the division of labor and encourages the division of time. Forget wars, religions, famines and poems for the moment. This is history’s greatest theme: the metastasis of exchange, specialization and the invention it has called forth, the ‘creation’ of time. The rational optimist invites you to stand back and look at your species differently, to see the grand enterprise of humanity that has progressed – with frequent setbacks – for 100,000 years. And then, when you have seen that, consider whether that enterprise is finished or if, as the optimist claims, it still has centuries and millennia to run. If, in fact, it might be about to accelerate to an unprecedented rate.

A brand new perspective has occurred to me during the first 50 pages of this book: Trade is the unsung hero for humanity.

It’s something that everybody around the world does every single day, and it is the reason why human beings have reached a standard of living that includes more leisure and comfort than anybody else in any other era could only have dreamed about!

So it seems suspicious that Ridley would even have to write an entire book about this. Trade’s phenomenal transformative power already seems so obviously true, so self evident that a 359 page discussion on the topic just seems like the workings of a sadist.

But books like Ridley’s or even simple YouTube videos like Milton Friedman rehearsing Leonard Read’s masterpiece, I,Pencil, are necessary! This kind of stuff quite literally changed the way I perceived the world upon coming out of my 12 year stint in the government-run education indoctrination camp. And, on this blog, I suspect I am not alone.

On the other hand, “Fashionable opinion” on free trade is a far cry from the stuff of Ridley’s book; it seems to be either hostility or ignorance. But ignorance in a more eerie sense than mere apathy; more like the people who show up on our TV and computer screens have all implicitly agreed to some sort of conspiracy to simply pretend like none of this kind of stuff exists…

I’m going to continue reading Ridley’s book. But every page frustrates me for the sincere belief that this ought to be common knowledge. Ridley isn’t inventing his own profound theories here; he’s simply saluting and bringing attention to a phenomenon which is as powerful and invisible as electricity: Free trade.

Let’s Talk Taxes

Seemingly every 2-4 years, the Federal Government starts talking tax reform.  The same talking points are repeated over and over: high tax, low tax, red tax, blue tax.  But from an economic standpoint, taxes are much more subtle.

The standard economic story of taxes is fairly simple: as the price of something goes up (in this case, the price increase is due to taxes), you get less of it.  Higher taxes on labor (income tax, payroll tax, etc) discourage labor.  Higher taxes on cigarettes discourage smoking.  Therefore, many economists argue, taxation should be as low as possible.  Therefore, tax cuts can stimulate economic growth.

However, taxation does go to support government and institutions like stable property rights (under which I am classifying law enforcement and national defense), courts, and the like.  Other economics argue these institutions encourage economic growth, so taxation should be relatively high to fund and develop these institutions.  So tax hikes can stimulate economic growth.

Both arguments are reasonable and not mutually exclusive.  There is likely some optimal level of taxation necessary to promote desirable institutional development without being a net drag on the economy.et’s say that the economy is beyond that optimal point of taxation, that the current level of taxation is too high and is a net drag on the economy.  Does it immediately follow that taxes should be cut to stimulate growth?

Let’s say that the economy is beyond that optimal point of taxation, that the current level of taxation is too high and is a net drag on the economy.  Does it immediately follow that taxes should be cut to stimulate growth?  I argue no.  If taxes are cut without regard to spending, that is taxes are cut and deficits emerge, then it won’t do much to stimulate growth.  This is because people are rational and forward-looking.  If taxes drop and deficits rise, then people will realize that, at some point, those deficits will need to be covered, either by higher taxes in the near future, or by government borrowing, which means higher taxes down the road.  People will begin to prepare for these higher taxes by saving more in the meantime knowing they’ll have a higher tax bill coming.  In short, there would be little (if any) effect on the economy from the tax cut; it’ll be no different than if there had been no cut at all.

However, if the tax cut were permanent, that is coupled with a cut in spending so that there is no deficit, then the cut would likely have a more positive effect.  Knowing (to the extent they can) that taxes won’t rise means they see their higher amount of kept income not as a temporary thing, but as a permanent change.  The tax cut would have a more stimulative effect on the economy.

When discussing taxation, it’s important to remember that deficits matter, too.  A tax cut that only generates deficits won’t have the same effect as a tax cut that does not generate deficits.