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.

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.

Throwing Out the Baby With the Bath Water

At Cafe Hayek, Don Boudreaux highlights a new paper by Jonathan Rothwell challenging the findings of David Autor et al that trade with China is harming American workers.  The abstract of the paper sounds interesting, but I want to focus on one point in particular (Emphasis mine):

At the community level, Autor, Dorn and Hanson (2013) find that local areas have experienced slower job and wage growth and higher unemployment because of import competition with China. Upon analyzing their data, I conclude that their results are biased by the weaker macroeconomic performance of 2000-2007 relative to the 1990s. When I analyze inter-local area economic changes — rather analyzing changes within and across areas — I fail to reject the null hypotheses that import competition has no effect on wage or employment growth, except within the manufacturing sector during the most recent period, or that it has no effect on many other outcomes, including labor force participation, intergenerational mobility, and mortality.

There’s an interesting lesson to be learned here, beyond just what Rothwell finds:

Findings can depend on how one slices the data. To wit, Autor et al find significant negative effects when the data is within or across areas and Rothwell finds significant positive effects when the data is inter-local area. We see the same in minimum wage (time series vs panel data, etc).

Any statistician can tell you that regression models can change depending on how you cut and categorize the data: different “n” can give different outcomes, different controls and dummies can give different signs, etc. We try for robustness, but it is still at the end of the day a model.

Of course, none of this is to disparage the work of Autor et al or Rothwell, or even econometrics in general (an important field, if used correctly). But we need to fully understand its limitations and our own assumptions, and be very careful before tossing out theory.

Gordon Tullock, in his 1967 paper in the Western Economic Journal, demonstrates exactly this.  Tullock begins with a conversation regarding welfare costs from monopolies and tariffs, citing recent research that finds these welfare losses are pretty minimal.  In fact, they’re so small that Tullock finds:

Judging from conversations with graduate students, a number of younger economists are in fact drawing the conclusion that tariffs and monopolies are not of much importance.  This view is now beginning to appear in the literature.

Does this mean our theory about trade and tariffs are wrong?  Does this mean tariffs can be helpful, or at least not substantially harmful?  Does this mean microeconomists spend too much time focusing on tariffs at the expense of other topics?  Or is it a measurement issue and the theory is fine?  Tullock explores this issue and finds it is a measurement issue, not a theoretical issue.  In other words, our tools not theory were incomplete.  Tullock explains in the article the need to factor in lobbying costs which do not show up in the standard welfare analysis but are nonetheless substantial (read the article for yourself to see his argument.  It’s short, 9 pages, and not technical at all).

Had Tullock not looked beyond the initial challenge to trade theory, had he (and other economists) just thrown off the theory based upon the small welfare losses, the world would be a far worse place.  As it is, his (and Jim Buchanan’s) explorations eventually lead to the field of Public Choice and provided us with a cleaner understanding on the theory of trade, tariffs, monopolies, politics, and the costs associated therefrom.

The story of Gordon Tullock in the 1960’s is why anyone should be weary of claims that theory of any kind is “mistaken” or “proven wrong” by this or that study.  We see this all the time with minimum wage.  The good economist (or scientist) will ask the question, as Tullock (and Mundell) did back in the 60’s: Is the theory invalid, or our tools?  It may be the theory is (such as with the case of geo-centrism) or our measurement tools are lacking.  In fact, we see this with regards to minimum wage: measurable job losses may be minimal, but there are many other margins firms adjust along, not all of whom are measured.  It would be mistaken to toss out the theory.

Economics is still a young science.  I suspect, as has already happened, some of our theories will be tossed out as we gain more insight and knowledge.  But we musn’t be too hasty in doing so (especially when there is political pressure to do so), lest we sacrifice knowledge for convenience and insight for what my professor Thomas Startmann calls “naive analysis.”

Can a Trade War Create Free Markets?

Craig Walenta’s comment on this blog post at Cafe Hayek got me thinking.  Craig says:

“Well they’re [tariffs] also a way to maybe compel a foreign country to cease its protectionist activities they’re engaging in.”

Craig makes a common (at least among some free market supporters) argument for tariffs on the grounds of promoting free markets, but I’m not quite sure it’s a likely outcome.  The reason is incentives.

Governments tend to like tariffs for multiple reasons, and among those are: 1) they’re vote-getters, 2) they generate tax revenues.  If we assume governments, like all organizations and people, are self-interested and rational, then the case for tariffs becomes obvious: it’s a relatively cheap (in terms of political effort) method of promoting one’s political power.  It is not in the interest of the government to reduce tariffs.  Reduction in tariffs would either mean an increase in other, perhaps less politically safe, taxes or cutback in spending (assuming this to be revenue neutral) and the politician himself would need to look elsewhere for votes.  When a foreign nation enacts protectionist measures against a country, it is unlikely they would respond to removing their tariffs because they face the same incentives as the host nation.  Further, the host nation has no incentive to reduce tariffs even if it “wins” the trade war.

In short, I strongly suspect an “arms race” will develop among the competing nations, one which will only lead to higher tariffs and lower standards of living.  Just as war cannot promote peace, a protectionist trade war cannot promote free markets.

An Economist’s Dream

It’s not often one gets so many economic fallacies contained in one area, but this article in Bloomberg is one of those rare instances where we do.  Rather than quote relevant areas, I’ll just let you read through it; it’s short but contains many mistakes.

There are several econ 101 problems the author makes this article:

1) the first two charts are meaningless. Looking at total unemployment and total wages and not minimum wage unemployment and wages, obscures the truth. For example, if a minimum wage worker was laid off but two new CEOs were hired, then the unemployment rate would fall and real wages would rise. The cost of the minimum wage would be hidden by the hiring of the CEOs.

2) The final graph is the clincher: the minimum wage, at $11 is well below what the workers were already making! According to the graph, they’ve earned well above that for at least a decade! Since the minimum wage was set below the market rate, then it wasn’t “binding”, which means it wouldn’t have had an effect because workers were already earning more!

3) Assuming away my first two points, there is still nothing conclusive. Laying workers off is just one of the margins employers can adjust to a minimum wage hike, and it’s one done more in the long term than the short term (see work by David Neumark). In the short run, which this change represents, employers are more likely to adjust by cutting hours, benefits, or supplementing with capital equipment (to the extent they can). There are many margins they can adjust along. To look only at unemployment (and especially so in such a flawed manner such as this) is mistaken.

4) My final point is one must remember to look for the “unseen” job losses. These are hard to measure but still very real. Let’s say, for example, a business owner was going to expand her store, and to do so needed 4 extra workers. The hike goes into effect. It is now cheaper for her to hire 3 workers and have one machine to augment them (prior to the hike, the relative cost of the machine was too high). The official employment statistics would count this as 3 jobs added, but not count the one job lost. That job was very real, but now it’s gone.

 

Trump’s Tariffs Can’t Make America Great Again

For all his talk about “Make[ing] America Great Again,” Trump’s two man proposals, limiting trade (via punitive tariffs on “unfair” or “cheating” nations) and limiting immigration (via walls and watch lists) stand in direct opposition to that goal.  This blog post will focus on the first item (trade) and a follow-up post will focus on immigration.

Continue reading

Prices are Always Present

There is a price for everything, and nothing can change that price.  Government legislation cannot lower it.  Personal wishes cannot change it.  The price of a good is based off of its relative scarcity compared to other resources, and thus rations.  Just as no act of Congress can repeal the law of gravity, no act of Congress can change a price.

Sure, Congress could change a monetary price, but the price of a good is more than just its monetary price; that is merely a rationing tool.  When the monetary price of a good is unnaturally forced down (say, via legislation), then other non-monetary aspects of the price will rise.

By way of example, assume we have Good X. Free from interference, the total price (monetary + non-monetary) of Good X is $30.  At this point, the market is supplied.  However, some legislative body decides that $30 for Good X is too high, so they pass legislation to lower it to $15. Since rationing via monetary price can no longer occur, and nothing has changed to decrease the scarcity of the good, other forms of rationing, such as queuing must occur.  People’s willingness to accept these other forms of rationing will depend on their value of such a good.   In other words, if a person earned $15/hr and they valued the good at $30, they’d not be willing to spend more than an hour in line ($15 monetary price + $15 opportunity cost of standing in line = $30 total cost).  Any more than that, and they’d be worse off than prior to the price injunction.  The total price of Good X has not changed, just the monetary price.

Trade, Tariffs, and Value

One of the glorious things about trade is it increases the value of resources.  Let’s say I earn $10.  With that $10, I can consume 3 apples.  The value of my labor is 3 apples.  Now, let’s say that trade opportunities arise.  Via trade, I can now consume 6 apples with my $10 worth of labor.  The value of my labor has doubled!

Now, let’s say local apple growers, angry that more apples are entering the market, successfully lobby for a tariff on apples.  The effect of the tariff means I can now only consume 4 apples.  The value of my labor has fallen!*  Tariffs (and taxes in general) from the prospective of the consumer are value destroyers.  Tariffs, in this manner, are akin to a disease destroying apple crops (or, perhaps more accurate, bandits constantly raiding apple crops).

Let’s look at the mirror image here – the same situation, but from the producer’s point of view:

In autarky, the value of apples are $3.33 per apple.  Following the opening of trade, that value falls to $1.67.  With the implementation of the tariff, the value rises to $2.50.  From the prospective of the producer, tariffs are value creators.

In an upcoming blog post, I will be writing about some rules of thumb I think (with the help of Armen Alchian) are helpful in determining whose value perspective should prevail.  However, I wanted to emphasize the value-changing nature of tariffs in this blog post, so I will end it here.

*To the untrained eye, one might argue “You were consuming 3 apples.  Even with the tariff, you’re consuming 4.  You still are made better off!  So why not enact the tariff?”  While it is true that one is better off in this tariff-trade scenario than in autarky (no trade), we must look beyond the seen effects for the unseen effects.  One would be considerably better off (to the tune of 2 more apples) without the tariff.  The negative effects of the tariff, while unseen, are very real.

Remember Thy Broken Windows

Taking credit for about 1,000 jobs “staying” in Indiana from a Carrier plant’s decision not to move to Mexico, President-elect Trump proclaimed “Companies are not going to leave the US anymore without consequences.  Leaving the country is going to be very very difficult.”  This statement should strike fear into the hearts of liberty-loving, crony-capitalist hating people everywhere. Unfortunately, many of praised it as a step in the right direction, that the $7m in tax breaks is a “good deal.”  However, this is anything but a good deal.  It sets dangerous expectations that will cost Americans jobs, investments, and wealth.

Let’s start with the explicit threat in Trump’s words.  Firms, that operate or expand into the US, will lose their freedom to make business-effective moves.  This will increase the relative cost of doing business in the US (since the cost of relocation outside the country is now higher), making operating outside the country, not expanding operations at all, or automating, more attractive options. Firms will be far more cautious about their operations, thus reducing the total number of potential jobs and investment in the US.  This is the “unseen” effects of Trump’s threats.  The 1,000 jobs “saved” could come at the cost of many more unseen jobs “lost.”

Another side effect (which flies in the face of one of Trump’s campaign promises to “drain the swamp”) is this move will increase lobbying.  As Justin Wolfers tweeted: “Every savvy CEO will now threaten to ship jobs to Mexico, and demand a payment to stay. Great economic policy.”  There is now an increased incentive for firms to lobby government for funds should they want to leave or relocate.  Given lobbying is certainly an arms race, firms will pour more money into lobbying and less into R&D or their employees.  To be sure, this is already a norm in the US, but Trump is merely perpetuating and expanding it, as opposed to ending it.

So, we have reduced investment into the US and increased interest in lobbying, both of which are economically inefficient activities.  Seems like quite a steep price to pay to give a temporary stay of execution for 1,000 jobs.