The Ricardian Insight on Trade

Is it possible for a nation to become impoverished by trade by outsourcing everything?  Some people seem to think so.  For example, see this comment by a “William Ryan” on this Carpe Diem blog post:

Then we can just let China and Mexico make everything for us so the few at the top can hoard all profits and prosper from.

The problem with this sentiment is that it is mathematically impossible.  If we stick with the standard theory of trade (and one which these folks appear to accept), then the actor that produces something at the lowest economic cost will specialize in that production.  However, it is impossible to be the lowest-cost producer in everything.  “Lowest economic cost” is a relative term.  If one has a lower economic cost at one thing, s/he necessarily has a higher economic cost in another thing.  The example we gave yesterday of Bananaland and Fisherland provide a mathematical example of this concept.

This insight was developed by David Ricardo 200 years ago.  It is still relevant today.

On Bananas, Fish, and Trade

Commenting on this blog post, Warren Platts writes:

If imports were stopped by a stroke of a pen, there would still be a trillion dollars of pent up demand per year from American consumers. If the demand for goods couldn’t be satisfied with imports, domestic manufacturers would take up the slack, creating jobs. Things would be more expensive, sure, but the GDP would grow a lot faster, more people would have good jobs.

Warren’s argument, while common, is incorrect.  Imports, which do satisfy demand, generate more demand for other products by virtue of the fact they are of lower economic cost.  As Warren says, if these imports were stopped, “things would be more expensive.”  This inherently means that there are not “trillions of dollars in pent up demand per year,”that American manufacturers can simply “take up the slack.”  Rather, those trillions of dollars are released by the imports and would become constrained by the forbidding of such.

By way of example, let’s say we have two countries: Bananaland and Fisherland. In autarky (that is, no trade), Bananaland can produce 50 fish or 50 bananas.  Fisherland can produce 100 bananas or 200 fish.  If each country divides their time evenly between each activity, Bananaland can produce and consume 25 bananas and 25 fish.  Fisherland can produce and consume 50 bananas and 100 fish.  In this autarky, the price of bananas in terms of fish is 1 in Bananaland and .5 in Fisherland (in other words, Bananaland needs to give up 1 fish to produce 1 banana.  Fisherland need only give up half a banana to produce 1 fish). The two countries open trade with one other and, given that both countries want to consume the same number of bananas after trade as before (an assumption made for simplicity; doesn’t change the story if we relax this), then the citizens of Bananaland agree to send 25 bananas for 37 fish (a price of .68).  To satisfy this, Bananaland stops producing fish and produces only bananas (they produce 50 bananas).  Fisherland cuts back on banana production to 25 but ramps up fish production to 150.  The day comes and the two trade.  Now, Bananaland consumes 25 bananas and 37 fish.  Fisherland consumes 50 bananas and 113 fish.  Their total economic well-being (crudely called “GDP”) is Bananaland: 62 (25+37) and Fisherland: 163 (50+113).

Bananaland, convinced their getting a bad deal following the lack of fishing in their country (remember, what was once a thriving industry) and the low prices they now pay, elect a protectionist on the grounds that he (and he alone) will “Make Bananaland Great Again!”  He promptly forbids all imports of fish from Fisherland.  They go back to their autarky ways.  Since Bananalanders now pay higher prices for their fish and more resources are devoted there than elsewhere, they can only consume 25 fish and 25 bananas.  Their GDP falls to 50!*  There was “pent up demand,” but the higher costs the various citizens now have to pay to even just consume the same amount they did before eats up that “pent up demand.”  The domestic manufacturing simply cannot supply it.

Adam Smith first explored this concept way back in 1776, and David Ricardo formalized it with the theory of Comparative Advantage.  Trade occurs for the simple reason that it provides people with better outcomes than other alternatives.  Other alternatives simply cannot provide the desired outcomes.

Update: I realized, as reading though this, I made a small math error.  It has been corrected.

*It’s worth nothing a similar decline happens to Fisherland, a nation where they can produce much higher levels than Bananaland.  Their GDP falls to 150.  Even their manufacturing cannot satisfy the “pent up demand.”

On Protectionism and Competitiveness

A common argument heard for protectionism is that it increases/enhances competitiveness of the domestic firms, that it “levels the playing field” (this argument used to be made primarily when talking about “infant” industries in a country, but more recently is used to justify actions taken against China and other “trade manipulators”).  The problem with this argument is that it is simply impossible.

Just as minimum wage cannot create new jobs, it just outlaws current jobs, so it is with protectionism.  Protectionist tariffs do not create more efficiencies and competition, they just outlaw/restrict certain efficiencies and competition.  This doesn’t make the protected firms more competitive.  In fact, it reduces the competitiveness of the protected industries!

Allow me to explain via metaphor:

In the 2016-2017 NFL season, the Cleveland Browns were the worst professional football team (as measured by the win-loss record).  “This is hardly fair,” say the Browns ownership.  “The other teams are so much better than we; we only got a single win!  This is costing us revenues from ticket sales, jersey sales, etc.  Other teams can woo big-name free agents better than we can and we need to mortgage our future by trading draft picks to get anyone good via a trade.  How can we expect to compete?”  NFL commissioner Roger Goodell agrees: “In order to increase league competitiveness, I hereby issue the following decree,” he says.  “Whenever a team is playing someone worse then them, they must bench their top players at each position.  This will allow teams like Cleveland to be more competitive!”

I do not think anyone would argue that Mr. Goodell is right in his proclamation, that hobbling better teams makes the League more competitive.  It reduces the competitiveness of the League.  It reduces the quality of the product of the League.  The Cleveland Browns are helped by this rule change, make no mistake, but only at the expense of the rest of the League and the consumers of its product (football fans).

Like much of protectionism, the argument for tariffs on the grounds of enhancing competitiveness relies on a half-truth, an economic sophism (to borrow Bastiat’s term).  It relies on the seen effect of the benefit to the protected firm(s), but does not see the unseen costs to everyone else.

On Foreign Ownership

At this Cafe Hayek blog post, commentators Ed Rector and Tony Hart echo similar concerns.  First, Ed:

In other words, foreigners owned 17.46% of US assets in 2000 and foreigners owned 26.41% of US assets in 2009.

What is overlooked in the series of posts on the trade deficit vs returning capital flows is that those foreign-owned US assets earn a return that is presumably paid to those foreign owners.

and now Tony:

So, Griswold tells us about US assets owned by foreigners. What about foreign assets owned by US citizens and businesses? And then compare the incomes going out and coming in.

Both echo concerns that a greater share of US assets (that is, assets that are located in the US), are now owned by foreigners.  For some reason, this is a bad thing (although neither elaborate why).  But there is little reason to be concerned in these numbers.

First, the capital stock of the US (and indeed the world) is not fixed.  The fact that a greater share of US assets are owned by foreigners does not necessarily mean that fewer assets are now owned by Americans.  Indeed, as Griswold’s data (in the linked blog post) show, American-owned assets have been rising, too!  Americans are getting more productive and foreigners want a piece of that pie, too.

Second, the fact that assets are foreign-owned is not, as is often insinuated (to be fair, not by these two comments) a national security threat.  If anything, it reduces security issues.  As economic ties build between areas, then the risk of conflict falls.  Foreigners earn returns on their investments, which makes the cost of going to war higher.  Sure, there may be some assets you don’t want owned by a potentially hostile foreign nation (power plants, weapon factories, etc), but that’s not what’s being bought.  Trust me, the Swedes aren’t going to weaponize their Ikea stores.

Third, in a direct response to Tony’s comment above, the fact that foreigners are investing more into the US than we are investing elsewhere is a good thing.  It’s not a sign of US weakness; it’s a sign of US strength.  It indicates the US holds better opportunities for investments than other options in the rest of the world.  Just logically, it doesn’t make sense that foreign-owned assets make the US weak: no one boards a sinking ship just to plunder its treasure.

Fourth, in direct response to Ed above, the fact that foreigners earn returns on their investments is, again, a good thing.  It means those assets are productive: their producing goods/services valued by Americans, they’re employing Americans (generating payroll and the like); in short, they’re being useful.  Again, this is a testament to the strength of the US economy, not a weakness.  The fact that the returns go to someone on the other side of an imaginary line is meaningless.

The tl;dr version of this post: I fear assets owned by a Chinese person no more than I do assets owned by a North Carolinian.

Ruminations on Monopoly and Antitrust

Monopolies are often derided by economists and non-economists alike, and often for good reason: monopolist firms are less efficient than their perfectly-competitive counterparts (to use more technical language, they charge a price higher than their marginal costs), which means consumers pay more for fewer goods.  Partly based off this theory (but also because of political pressures from reformers) the US in 1890 passed the Sherman Antitrust Act, which has become the main tool for the government to break up monopolies into more firms.  This act is hailed even by some free-market advocates for its efforts to create competitiveness.  Are monopolies undesirable and do they run counter to free market principles?  I argue “no” to both questions below the fold.

Continue reading

On the Blessings of Liberty

Representative Steve King (R-IA) put out a tweet the other day claiming “our” civilization cannot be restored “by other people’s babies.”  To borrow a phrase from one of my favorite philosophers and writers, Johan Norberg, Rep. King is dead wrong.  Our civilization rests upon liberal* values, values such as:

“that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness,” (Declaration of Independence)

Or:

It is not true that the legislator has absolute power over our persons and property, since they pre-exist, and his work is only to secure them from injury (The Law, Frederic Bastiat)

Or:

Men being, as has been said, by nature, all free, equal and independent, no one can be put out of this estate, and subjected to the political power of another, without his own consent.

Being all equal and independent, no one ought to harm another in his life, health, liberty, or possessions. (Second Treatise of Government, John Locke)

These, and many more represent the values of our liberal civilization.  These blessings of liberty, therefore, fall not upon any one group of people, but all groups of people.  Liberty, like her dear sister Justice, is blind and she loves those who love her.  The guardians of Liberty and Justice are not the white man, or even Western Civilization.  Indeed, if they were, they’d be terrible guardians (as early as 1850 Bastiat was warning about the legalization of plunder perverting the law).  Further, Western Civilization no more created Liberty and Justice or liberalism than did they invent fire.

If we look at the above quotes, we see there are no demarcations between who gets natural rights and who does not, who have the right to “life, liberty, and the pursuit of happiness,” and who do not.  Locke said “all men,” not “only Englishmen” or “only men” or “only Christians.”  The US Constitution promises, though the Bill of Rights, protection from government for all people, not just citizens (citizens get certain other political rights, yes, but that is not the topic of discussion here).  Bastiat discusses that the blessings of liberty pre-exist for all people and come not from the legislator.

My message to Rep. King of Iowa is simple: liberty is the birthright of all people, and liberty will bless all people who love and protect her, regardless of their gender, their skin color, their intelligence level, their national origin (or that of their parents), etc.  Those who would deny a person their blessings for reasons of characteristics are no friend to liberty.

Our civilization belongs to all those who love the ideals of Liberty and Justice, who support the rule of law, free markets, and freedom.  Those who seek to destroy those values, including those within the civilization itself, have no claim to the civilization.  Liberty is not inherited by skin color or national heritage.

*Standard disclaimer about meaning “liberal” here in the classical sense

No Distinction Necessary

On this excellent post by Mark Perry at Carpe Diem, commentator Scott asks:

If trade deficits “don’t matter,” why does every country in the world try to erase their own trade deficit by doing everything they can, no matter how allegedly harmful (like currency manipulation), to boost exports and thus decrease their trade deficit? Are all you guys “just right” and everyone is else is “just wrong?”

Scott’s question, if a bit snarky, is important but contains a major fallacy from which nearly all protectionism is derived: namely, he assumes that governments, not people, trade.

There’s an important distinction that’s necessary here: it’s not “every country” that is doing everything in its power to reduce trade deficits. It’s every government. Countries do not trade; individuals do (this is why it’s fallacious to argue that international trade is inherently different).

Once we remember that, the question becomes clearer: why are governments doing everything they can, no matter how allegedly harmful (like currency manipulation), to boost exports and thus decrease their trade deficit?

This question has an answer (one which won Jim Buchanan, among others, his Nobel Prize. One which Adam Smith first proposed way back in 1776): concentrated interests and defused costs. In other words, those who benefit from protectionism are concentrated (the steel industry, the auto industry, etc) whereas those who are harmed are defused (consumers). When you transfer wealth from a large group to a small group, it is easy to see the gains to the small group, but much harder to see the losses to the large group. From a simple Public Choice perspective, this makes the political choice easy: help those who it can be seen and push the costs onto those who cannot be seen.

Of course, the above analysis only holds if we assume that politicians, like other people, are rational, self-interested actors. If we assume that politicians are omnipotent, incorruptible, and pure angels, then yes the argument that protectionism is good because every government is doing it becomes more likely. However, I feel the second assumption is weaker than the first. Thus I’ll use Public Choice Theory.