Is Government Part of the Economy?

The question posed in the title of this post is key to understanding the relationship of governmental policies to individuals and the economy.

Traditionally, governments are considered as agents outside the system (in technical terms, exogenous).  For example, the following comes from Jack Hirshleifer’s 1970 textbook Investment, Interest, and Capital (page 11):

Following the standard tradition of economic analysis…government will be treated as an agency outside the social-exchange relationship, purportedly acting in the interests of society as a whole rather than the interests of the particular social grouping who happen to constitute the government.

A lot of welfare economics, from Pigou to modern, tend to treat government the way Hirshleifer describes. It’s an impartial spectator that can, with proper knowledge, set things right. Government can just come in and, with some perfectly crafted policies, fix any “market failure.”

But one of the things Public Choice teaches us (and this goes back to Bastiat) is that government is not separate from the system, but indeed part of it (in technical terms, government is endogenous). It is populated by the same people as those who make economic decisions. Governments are populated by people, and those people have hopes, dreams, desires, senses of right and wrong, just like the rest of us. They’re self-interested (which is not the same as selfish or self-centered), just like the rest of us. They respond to incentives, just like the rest of us.  Once we incorporate this simple fact, then the expectation of government “serving the public interest” becomes problematic.  Even if we assume away the knowledge problem, to expect government to be “molded from finer clay”, so to speak, and to be able to adjust the system from afar without any impact on the government itself is the height of foolishness.

So yes, in theory, with extremely strong assumptions, one can construct a tariff or tariff system “free” from cronyism. But if we weaken those assumptions, if we take government as endogenous (internal) rather than exogenous (external), then simple welfare economics like Pigou goes right out the window.

Let the Market Process Work!

In response to this Carpe Diem blog post on steel tariffs, aiken_bob writes:

I think everyone needs to take a chill pill. I believe what Trump is doing on so many fronts is just testing the old rules to find out what really works today.
In the era of big government, both here and in the EU, there have been countless lobbyist working for the NGOs or corporate masters that have written the rules that benefit them. I have to believe that the vast majority are now outdated or just wrong.
It is pretty obvious that you can’t get congress to change every little law so enter Trump to shake things up. I really believe there is a method to his maddness.

You’ll get no argument from me that there are many, many, many rules and regulations written by lobbyists to benefit themselves.  However, if that is a problem (as both aiken_bob and I consider it to be), then Trump’s actions are just more of the same: more rule writing and more regulations written by lobbyists to benefit themselves at the expense of others.  Steel tariffs are just another line item in this ledger from Hell.

If the problem is the rules were written by lobbyists then the solution is simple: tear them up.  Unilateral free trade.  You will see very quickly what works and what doesn’t when subjected to the forces of competition.  Those that work will remain.  Those that do not will be chased out.  People will be allowed to choose what they will, act how they want, without lobbyists influencing/mandating their decisions.  As Mark Perry likes to say: competition breeds competence.  In short, let the market process work!

Today’s Quote of the Day…

…is from Page 6 of the Foundation for Economic Education’s 1996 edition of Bastiat’s classic 1850 magnum opus Economic Harmonies:

The moving parts [of economies] are men, that is, beings capable of learning, reflecting, reasoning, of making errors and of correcting them, and consequently of making the mechanism itself better or worse. They are capable of pain and pleasure, and in that respect they are not only the wheels, but the springs of the machine. They are also the motive forces, for the source of the power is in them. They are more than that, for they are the ultimate object and raison d’être of the mechanism, since in the last analysis the problems of its operation must be solved in terms of their individual pain or pleasure.

Economics has long forgotten this simple insight: economies are human.  They are made up of human actors who have their own motives.  The bundle of plans, what my GMU professor Richard Wagner likes to call “an ecology of plans”, that emerges from these trillions of interactions is what we call an “economy” or “society.”

Models are helpful for thinking about a situation, but we musn’t forget that our models are populated with people and not “representative agents.”

Trade Wars are Fought Within, Not Among, Nations

President Trump likes to talk of trade wars: with China, with Canada and Mexico, with Europe.  It doesn’t matter.  Trade wars are easy to win.  But, Mr. Trump and his enabler advisor Peter Navarro mistake who the enemy is in a trade war; it is not the foreign nation or their producers; they are, at best, collateral damage.  Rather, the enemy, the one who bears the brunt of a trade war, are the domestic consumers.

The Economist reports on a number of industry associations that oppose Trump’s tariffs on steel and aluminum.  Many of these industries are ones that were clamoring against foreign production and demanding tariffs of their own just a few months ago (eg Boeing, Ford).  If the steel and aluminum tariffs stick around, then these same companies will be put at a disadvantage.

But does the action stop there?  Absolutely not.  These same companies, seeing the bounties bestowed upon Nucor and Alcoa will, in turn, demand their own tariffs and their own subsidies (as they already have, in the case of Boeing).  Other producers will seek protection as well, further raising tariffs or subsidies.  There is no logical or natural stopping point for the trade war; indeed, all this becomes even worse if foreign nations raise their own trade barriers.  Internally, more and more calls for protection* arise and the government fights a trade war with its own people.  Every protectionist action will have a negative consequence on some other domestic actor who will have the incentive to seek his/her own protection.  What’s more, even producers not directly involved may seek some of the rents the government hands out.

Trade wars are devastating, but they are inaccurately described as being between two nations.  In reality, however, trade wars are civil wars.

*A point I should make explicit: tariffs are not the only form of protection firms might lobby for.  They may aim for tax breaks, subsidies, grants, etc.  This internal trade war can be fought even if tariffs never rise.

Trade and Production

Over at Cafe Hayek, Don Boudreaux posts a helpful thought experiment as a way of thinking about trade:

A reliable mental experiment when discussing jobs and trade or innovation is to imagine that you’re Robinson Crusoe stranded alone on a desert island.  You have to work very hard to supply yourself with the bare necessities of survival.  Would you regard yourself as being blessed or cursed if, upon awakening one morning, you discover that some friendly natives from a nearby island have deposited on your island – as a gift to you – a year’s worth of food along with a promise to annually provision you with food in this way?  Of course you would regard yourself as blessed.  It’s clear that these generous foreigners have enriched you even though they have “destroyed” the jobs that you would otherwise have performed to supply yourself with food.  You are clearly and unconditionally made richer by this job destruction.

What holds true for Crusoe who occupies an island alone holds true for, say, the 325 million of us Americans who occupy the landmass that cartographers call “the United States.”

Protectionists tend to object to this thought experiment by complaining such “presents” would destroy the nation’s productive capabilities; the nation would become dependent on these gifts and be unable to produce anything for themselves should the need arise.

However, this objection falls flat because it forgets what, exactly, these “productive capabilities” are.  They are, above all, human.  Factors of production, labor, capital, land, etc are all inert until human action is taken.  A tractor is only as good as the person behind the wheel.

Productive capabilities are never truly destroyed. Resourses shift around, and so do productive capabilities. The factors of production that once went to making food, to stick with the Crusoe example above, now go to making a raft or shelter. If the resource supply is disrupted (the friendly natives stop sending shipments), those productive capabilities are then shifted back into the production of the suddenly-scarce good.  Ultimately, it is Crusoe who is the productive capability, not his farm or fig tree.  In other words, the only way the productive capabilities of an economy could be destroyed is if the people are destroyed.

Unfair Trade and General Rules

Unfair trade has dominated the political conversation lately. Allegations that China, South Korea, Mexico, Canada, and many others are being unfair, whether they pay too low or they subsidize some industry, or their tariffs are too high, whatever, abound. These allegations justify the use of tariffs to punish the offending nation(s). Free trade, they say, cannot exist in the face of such injustice and, while it is a fine general case, exceptions must be made for these injustices to be corrected.

But do injustices that occur from a general rule justify exceptions therefrom or to even overturn the rule?

Consider the following general rule: All people in the United States, when accused of a crime, will be tried in an open court before a jury of their peers.  The ruling of that jury, barring legal issues, is final.

With that rule in mind, consider the following:

A man is accused of rape.  The evidence seems straightforward.  After a long trial, the jury retires to deliberate.  After a few days of deliberation, the jury returns a verdict of “not guilty.”  There is an uproar within the local community.  “He was clearly guilty!” they cry.  “The decision should be overturned!  The jury system failed to deliver justice!”

The natural inclination of any spectator of this situation would be to decry the jury rule.  It had clearly failed to deliver its promise.   But would overturning such a rule be in the best interests?  I think prudence and wisdom suggest “no.”  Or, at least, extreme caution.

A general rule, like trial by jury, serves a particular purpose.  By nature of its generality, it will not be perfect in all cases.  But because it is so general, it can work in most cases.  In the case of the jury process, the particular purpose of this rule is to prevent unfair prosecutions and to have evidence judged on its merits; by presenting to a lay audience, it is a test to see if it is plainly obvious that a crime has been committed.  Wisdom and prudence suggest that, since this rule has persisted so long, caution should be exercised before overturning it.  it may lead to undesired consequences (perhaps tyranny, in the case of juries).

To extend this to trade, the general rule is that people may trade with whomever they want so long as it is voluntary.  There are relatively few ways in which the state can object to trade (obviously prohibited items like drugs, prostitution, etc).  But this general rule has led to some undesirable outcomes: people have lost jobs to import competition and automation.  Some of these job losses, it is observed by some, occurred because this competition is “unfair” due to state subsidies, tax preferences, etc.  They, therefore, want to overturn the general rule (or create exceptions to it).  Tariffs, restrictions, or outright bans are often banded around as solutions.

But, again, prudence and wisdom urge caution before overturning such a rule.  Could it lead to a “slippery slope?”  Are the protections granted by the general rule worthwhile?  Would the exceptions to the general rule that are granted lead to other forms of rent-seeking, and unfair actions taken by domestic groups (eg, everyone starts clamoring for protections)?  The benefits of the general rule are obvious; the costs and consequences, not so much.

Even if we grant that the actions taken by some governments to “support” their trade position are indeed unfair, like the jury example above, creating exceptions to the general rule may achieve more mischief than good.

A final point in conclusion: none of this is to claim status or say the status quo is always and everywhere preferable.  General rules can, and should, be examined and overturned when necessary.  Rather, what this post is to do is to urge caution when it comes to overturning general rules; a willy-nilly attitude can destroy any and all respect for law and legislation.

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.

Regards,

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