An Open Letter to Peter Navarro

13 March 2018

Mr. Peter Navarro
White House National Trade Council
1600 Pennsylvania Ave., NW
Washington, DC  20500

Mr. Navarro:

Last week, you said to Bloomberg: “My function, really, as an economist is to try to provide the underlying analytics that confirm [President Trump’s] intuition. And his intuition is always right in these matters.”

Ignoring the fact your statement is circular in its logic, I must object to your slander of all economists everywhere.  We do not exist to confirm the intuition of the president or anyone we work for.  We do not exist to provide intellectual cover (i.e., “provide the underlying analytics”) for political decisions.  We exist to study the economy.  We exist to study human action and the market process.

Economists are not political shills.  We are scientists and scholars.  Your comments demean us all.


Jon Murphy
Ph.D. Student, Economics
George Mason University
Fairfax, VA

The Parable of the Two Shipmasters

A prudent ship captain his crew set sail for a multi-month journey.  In port, he makes sure he has enough supplies for his crew for the entire journey and then some (just to be safe).  While underway at sea, he checks the galley and finds that about half of his food stores are spoiled because there was some unforeseen blight in the crops he bought.  The captain gathers his crew together and says: “Mates, we have a problem.  Half of our food is gone.  Unfortunately, this means I must put you all on half rations for the remainder of our voyage.”  The crew, understandably, begins to grumble.  They enjoyed their rations and now there will be half?

“But sir!” cries one young sailor, “We were used to our old rations!  The life on the ship was fun.  We had beer and bread and meat.  It gave us strength and kept morale high.  Why must we be tortured so?”

“Because,” replied the captain, “otherwise we may not have enough food to survive our journey.  We are weeks from the closest port and these stores must last.  I promise it is better to have a dearth now than a famine later.”

The crew grumbles, but they comply.  Two months later, the ship arrives at its destination with the full complement of crew who are tired but alive.

At the same time as the above story, a second imprudent ship captain also buys the same amount of food for his journey of the same length.  While out at sea, he also suffers the blight and loses half his stores.  He gathers the crew around and says: “Mates, half our food stores are gone.  It looks like I may have to cut rations.”

“But sir!” another young sailor objects.  “Half rations are no good!  We won’t be merry!  Our lives will be tougher.  This is no good!”

“Agreed,” said the captain.  “The happiness of my crew must come first.  We should not have to suffer inconveniences.  Rations will not be cut!”  The crew cheers.

Two months later, a ghost ship drifts into the port full of emancipated men who have not eaten in over a month.  The few that survived resorted to eating whatever they could find, including each other when necessary.

The above parable is adapted from Adam Smith’s Wealth of Nations, in particular, Book IV Chapter V.  In times of scarcity, prices must rise in order to encourage conservation of resources (in this case, the price acts as the ship captain rationing food).  Prices rise through the acts of speculators buying goods in periods of relative plenty and selling in times of relative scarcity (thus the maxim “buy low sell high”).  It is obvious that the higher prices cause discomfort.  People eat less or less desirable things.  But the alternative to this discomfort is famine.  If prices are not allowed to adjust for whatever reason (the ship captain who keeps rations the same), then the resource is consumed too quickly and famine can quickly set in.  The discomfort is delayed to the future, but it is repaid with heavy interest.

Are Tariffs Taxes on Consumption or Production?

Generally speaking, in economics consumption takes are less disruptive than production taxes.  Since people produce to consume, if a tax falls on production then it reduces production which in turn reduces consumption.  Conversely, if a tax falls on consumption, it can have less of a negative effect.  Tariffs are sometimes defined as a consumption tax, and thus would appear to be preferable to a tax on production like a corporate tax rate or capital gains tax.

Whether or not a tariff is preferable to corporate taxes or capital gains tax would be an empirical question, and one I am not interested in answering at this time.  Rather, I want to push back on the definition of a tariff as a consumption and not production tax.

Much of the US’ imports are of raw/intermediate/capital goods (I forget the exact statistic off the top of my head, but I believe it’s around 55-60%).  Since these are used in the production process, a tariff is necessarily a tax on production.

But what about the other 40%, the consumer goods?  Would a tariff be a tax on production here as well?  I’d argue “yes.”  This is a little counterintutive at first: why would a good imported into the US and sold to consumers without some manufacturing done to it be considered production?  Let’s take a look at the definition of production (emphasis added):

Production occurs when the physical characteristics of resources are improved.  Although we commonly think of production as changing the form of material–from ores to steel, from steel to cars or I-beams–production also includes improving the time of avalibility or location of a good.  moving water from a well into a house is productive, as are carrying coal from a mine to a furnace; tilling the soil, planting seeds, or caring for the crop; harvesting, cleaning, grading, transporting, preserving, and distributing the crop to retail stores; or advertising, wrapping, and delivering a good to the customer’s home.  (Source: Page 136)

Imports enter the US in some port (LA, New York, Boston, etc).  They then must be transported to warehouses and retail stores before they can be consumed.  Since transportation is part of production (it is improving both the time availability and location of a good), then a tariff necessarily is a production tax since the goods are used in some form of production.

Again, whether or not a tariff is preferable to other kinds of taxes is an empirical question.  The point of this post is to discuss a terminological issue.

Predatory Pricing, Tariffs, and the Second Law of Demand

Predatory pricing is a common justification for government intervention in a marker (predatory pricing is when a firm or government tries to gain monopoly power in a market by selling below cost, undercutting competitors and forcing them out, and then raising prices to a monopoly level.  For a great treatment of predatory pricing, see here).

On a recent Cafe Hayek post, Craig Walenta (friend of the blog) objected to a lack of concern vis-a-vis Chinese dumping thusly:

 Of course that which is seen, but that which is unseen are the incidental effects because this absolutely must be incorporated into your business judgment, or you’d just be a complete idiot, and you’re not going to have any sense of what the unseen is unless you actually own a business and talk to other business owners who will tell you that the general rule is that ‘if it can be done in China, EVEN IF IT CAN BE DONE HERE CHEAPER, don’t do it’ — indeed foreign and domestic favoritism clearly impacts businesses that have absolutely no relation to the favored industries in question.
Mr. Walenta’s concern is legitimate.  Why would business owners compete in a market if someone is going to undercut them?  There may be people who do not enter some industry for fear of competition.
But does that mean China can, once they receive monopoly power, can raise and keep prices high with the mere threat of undercutting prices again?  Not likely, because of the Second Law of Demand.
The Second Law of Demand is, to quote Armen Alchian and William Allen (Page 28):
[T]he longer the time allowed to adjust amount demand in response to a price change, the greater is the change in amount demanded, that is, the greater the elasticity…For example, if the price of water were doubled, consumption would immediately decrease some–but would decrease by a great deal more within a few months, after people had more economically made adjustment to their water-using equipment[.]
In other words, people initially make little adjustments to a rise in prices but the longer prices stay high, the bigger their adjustments become.  To stick with the water example, if the price of water spikes quickly, people may water their lawn less or wash their car less, but that’s about it.  If the price of water stays high, people may rip out their lawns and go for rock gardens (eg, Arizona), may shower together to save water, may move to disposable plates rather than washable dishware, etc.
To bring this back to China, if China were to gain a monopoly power and raise prices, even if they were to maintain their monopoly power with the mere threat of lower prices, it is unlikely they would succeed.  At first, they may be able to command monopoly prices, but the high price of steel will eventually force people into different areas: maybe more plastic is used for automobiles than steel.  Maybe wood and brick replace architectural steel.  Maybe some new metal alloy is created to replace steel, or there are shifts to titanium or something like that.  Maybe someone develops a super-lightweight but super-strong material that renders steel obsolete (like Kevlar for buildings).  It’s impossible to know what path things would take.  What we do know is the Law of Demand says that people will adjust, and thus it is highly improbable anyone who gains monopoly power through predatory pricing will be able to maintain monopoly profits.

An Open Letter to President Trump

2 March 2018

Mr. Donald Trump
1600 Pennsylvania Ave., NW
Washington, DC  20500

Mr. Trump:

Late last year, your administration proposed a massive tariff on airplanes manufactured outside of the US.  Your administration said these tariffs were necessary to level the playing field for Boeing.

However, you’ve now proposed a tariff on aluminum, a major component in airplane manufacturing, and our allies are threatening a trade war with us, which would increase the costs of other components necessary for airplane manufacturing.  The tariff and the trade war, which you’ve said is “good” have necessarily put Boeing at a disadvantage compared to foreign airplane manufacturers.

I wonder how you reconcile your administration’s actions in October and the actions now given they work at contradictory ends?


Jon Murphy
George Mason University
Fairfax, VA

Can Protectionism/Scarcityism Encourage Industry?

Short answer: not likely

Long answer: Protectionists Scarcityists like to argue that protectionism is needed (or can otherwise) to encourage industry.  Foreign competitors use “unfair” practices to undermine the domestic industry and protectionism scarcityism is there to protect the industry from these shenanigans.  This, in turn, will foster more domestic investment and encourage industry.  But how likely is this to be?  Let’s take a look at the logic.

From a protected industry perspective, it is possible that scarcityist policies encourage some investment in that protected industry.  Domestic production increases (although this is merely a substitute for some of the imports and overall output decreases).  This increased production may encourage more investment, but it is hardly guaranteed to.  These protected industries are protected from competition, so there isn’t much incentive to invest and improve; they are output restrictors.

Enlarging our view to the economy as a whole, scarcityism is far more likely to reduce investment and industry.  As I pointed out above, scarcityism works because it reduces output, forcing prices to rise.  This necessarily means consumers have to spend more to achieve the same standard of living.  In turn, this means fewer savings and since savings are funds used for investment, this means less investment.*  Additionally, since imports are reduced, foreigners now have fewer dollars with which to buy exports or invest in the US economy.  Reduced savings, and thus reduced investment, comes from this area as well.

There are secondary effects of scarcityism as well.  Not only does it reduce overall output in an industry, it encourages the use of wasteful use of current resources.  The protected firms are using less efficient methods of production, which is eating up resources that could otherwise have been released for more valuable purposes.  This, in turn, means fewer resources for industry to use and grow.

In order for scarcityism to foster growth, it’d require an awful lot of luck and some highly specific conditions which are improbable in the real world.

*Note that this same logic holds even if consumers switch to a cheaper substitute for the now-more-expensive goods.

Today’s Quote of the Day…

…is from page 229 Karl Menger’s 1883 book Investigations into the Method of the Social Sciences, specifically Appendix VIII “The ‘Organic’ Origin of Law and the Exact Understanding Thereof” (original emphasis):

However, law can also come into being, and even under the most original conditions, in another way essentially different from the above: by authority. The man in power or intellectually superior can set certain limits to the discretion of the weak men subject to him or of those mentally inferior. The victor can set certain limits for the vanquished. He can impose on them certain rules for their action to which they have to submit, without considering their free conviction: from fear. These rules, however similar they appear on the surface to those of national law, are both by origin and by the guarantees of their realization essentially different from the law which grows out of the convictions of the population and the realization of which was also originally an affair of the nation. Indeed, they can be in direct contrast to national law; they are really statute, not law. But the strong man has an interest in calling them ”’law,” in cloaking them with the sanctity of law, in connecting them with religious  traditions, in elevating them so that they become the objects of religious and ethical education. This is the case until the habit of obedience and the sense of subjection developed by them recognize in them something analogous to law and until this habit and sense scarcely distinguish any longer those rules limiting the discretion of the individual which are produced by the convictions of the nation from those which power prescribes for the weak.

JMM: What Menger means here by “national law” is not some national convention or agreement (in fact, he explicitly rejects the “social contract origin” theory of law), but rather what is more akin to custom and tradition: something that evolved over time to serve a purpose (protect individual interests) and is widely accepted and respected by members of the society.

What Menger does in this paragraph is draw a distinction between “national law” (the subject of the essay thus far) with statutory law.  The primary difference is how these two are established: national law (which is properly called law) is established through human interaction.  Statutory law is established through authority (ie imposed).  The two have superficial similarities only.

This is not to say that statutory law is inherently less desirable that law.  What it is to say is that statutory law can become unhinged from morality, in which case we are faced with the Bastiat Dilemma: “When law and morality are in contradiction to each other, the citizen finds himself in the cruel alternative of either losing his moral sense, or of losing his respect for the law—two evils of equal magnitude, between which it would be difficult to choose.”  To treat statutory law as some “will of the people” or the object of some “divine intelligence” (to use Menger’s term elsewhere in the essay) is to fundamentally misunderstand law.