Increased Opportunities Do Not Indicate a Shortfall

Trade deficits are often pointed to as a sign that there is a “savings shortfall” or “savings imbalance” within a nation (see, for example, this article).  This description, as Scott Sumner reminds us, is an implication of the GDP accounting model.  In this lens, there is no objection to classifying as trade deficit as a savings imbalance.  But does it make economic sense to view it in such way?

Let’s go back to a main question of economics: why do people trade?  Specialization of labor allows people to focus on the things they are comparatively better at and trade with others to get the rest of their needs.  In other words, people trade because their time is best spent doing what they are best at.

As David Ricardo showed us, when people specialize, they increase production; that is to say, new consumption opportunities emerge when people specialize and trade.  At no point is this development considered a “production imbalance.”  So, why then is the identical situation considered a savings imbalance when viewed at a macroeconomic level?  Other than the mathematical wrangling of the GDP accounting formula, I have no good explanation.  As people specalize and trade, new opportunities, both for consumption and investment emerge, which indicates a new balance developing.  The economy has gotten larger; there is no imbalance.

Trade-Offs and Public Policy

This semester, I have been studying Law & Economics with Robin Hanson at GMU.  In class, we have been discussing the legal system, how it is structured, and other ways to structure it.  Questions we’ve pondered include: why can one appeal on matters of law and not matters of evidence?  Why are rules of evidence what they are?  Should all contracts be enforced or what limits should be placed on them?  Why are property taxes structured they way they are?  Why common law in the US as opposed to civil law?  Etc.

Simultaneously, I am evaluating a book for my course this summer: Trade-Offs by Harold Winter.  Trade-Offs is a public policy-focused look at economic reasoning.  In the book, he points out one of the dangers of public policy analysis (Page 5, original emphasis):

Even if there is agreement on the broad objective of maximizing social welfare, policy objectives may differ due to differences in the definition of social welfare.  A good example of this can be found in the economic analysis of crime.  To deter crime, we must use resources for the apprehension, conviction, and punishment od criminals.  But should the benefits that accrue to individuals who commit crime (also members of society) be added to social welfare?  If yes, this may suggest that fewer resources can be used to deter crime, because crime itself has offsetting benefits.  If not, crime is more costly to society, and more resources may be needed for deterrence.  Notice, however, that it is a fact that a criminal reaps a benefit from commiting a crime (or why commit the crime?), yet it is an opinion as to whether that benefit should be counted as social welfare.  Policy objectives and definitions of social welfare are subjectively determined.

What is also subjectively determined, as explained by Carl Dahlman in his 1979 Journal of Law & Economics article The Problem of Externality, is the effectiveness of the policy change proposed.  When a policy proposal is made, the proposer implicitly assumes that whatever institution he is invoking (government, market, etc) can necessarily solve the problem he’s subjectively identified better than the status quo (otherwise, why would he make such a proposal?).

All this subjectivity means that discussing “optimal” policy gets really tricky.  Optimal tariffs, Pigouvian taxes, optimal forms of law, legislation, etc are going to depend greatly on how we measure social welfare.  When discussing tariffs, should the welfare of foreign producers and consumers be counted?  If so, why?  If not, why not?  When discussing Pigouvian taxes, should the welfare of clean-up companies be taken into account (eg, the laundromat who loses business because fewer people are washing soot-caked clothes) and is government necessarily the best solution?  What makes sense given a certain accounting of social welfare doesn’t with a different accounting.

Answers to these questions can go a long way in helping us consider supposed market failures: whether something optimal or suboptimal will depend a lot on how these trade-offs and welfare are measured (to Winter’s point above, if the welfare of criminals is taken into account, there may be too much police activity.  If the welfare of criminals is not, there may be too little).  In this sense, optimality is in the eye of the beholder.

I’d argue that the subjective nature of social welfare policy suggests a strong presumption of liberty for people to choose their own way.  Indeed, there is no initial reason to believe any given action taken by an individual is somehow sub-optimal given the subjective nature of social welfare.  Even something like pollution is subject to these conditions.  This realization also should force economists (and their consumers) to ask the question “what are we assuming?” and “how are my biases affecting this analysis?”

Economists rarely argue about data.  It’s somewhat rare that someone made a math mistake or jumbled data (ideally, that gets caught long before publication).  Outcomes are not in question, but the subjectivity of trade-offs are.

A Robust Theory of Trade

Economists are often accused of ignoring moral consequences of trade, or in particular, being focused too much on material well-being (for example, see here).  There is a lot of truth to this claim; much of our models to focus narrowly on measurable items like material wealth.  I agree with this criticism very much and lots of my research focuses on ways of re-inserting moral man into economic models.

But it is incorrect to argue that free trade is either immoral or amoral.  The earliest free trade philosophers (Adam Smith, David Hume, Frederic Bastiat) all approached trade from a moral point of view.  Hume gives us a justice argument for free trade, Smith demonstrates the strong presumption of liberty in a modern society, and Bastiat shows how protectionism can quickly become a perversion of law and justice.  Economists have long spent time considering the moral aspects of trade.

But one thing that really rubs people the wrong way regarding trade is the concept of competition.  Firms and individuals compete with one another for scarce resources and that competition can sometimes lead to outcomes that make some observers uncomfortable (workers getting laid off in favor of machinery, for example.  Or low-cost labor overseas).  Because of the unpleasant nature of this competition, free trade often gets labeled immoral.  But let’s look at the nature of competition and how it is used in economics.

Economics appears to begin with the assumption of a somewhat Hobbseian jungle world: all actors are self-interested and looking to maximize their own gains.  From this, we derive the concepts of competition and the “invisible hand” which leads to improvement for everyone while appealing to their self-interest.  To quote Adam Smith: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.”

But surely altruism exists!  Surely people are not so wrapped up in self-love they dismiss all of humanity!  How can this dismal view of humanity, that we are merely self-interested, dominate economics?  The answer is two-fold: 1) Everyone is, to some extent, self-interested (what Russ Roberts likes to call “the Iron Law of Me”).  We tend to focus on events close to us and our loved ones far more than events separate from us.  2) This method of conceptualizing humanity makes our models robust.  Lots have been written on #1, so I’d like to focus on #2.

The idea of self-interested humans makes economic models robust.  In a sense, by assuming humans at their “worst,” it allows for humans to act at their “best.”  For example, simple economics indicates that, after a disaster, prices should rise in order to incentivize people to bring more supplies into the area.  The pursuit of profit will bring in people looking to make a buck.  This is the self-interested story.  But what happens if the community and nation band together and donations fly to the area?  The effect is the same: an increased supply to where it is needed most.  By weakening the assumption, the result remains: the model is robust.

So, why the assumption of self-love in the first place?  Well, let’s reverse the scenario.  A disaster strikes.  People are altruistic and chip in and send supplies to the disaster area.  People will band together when things get tough.  This is our model.  But let’s weaken the assumption of altruism.  Disaster strikes.  People are only self-interested.  What happens?  Nobody sends supplies.  Since the results of the model change, it is not robust.

The concept of self-love does nothing to reduce the usefulness of our models.  Whether true or false is irrelevant as the results of the model do not change.  So long as the presumption of liberty is upheld, in other words, no central planning is attempted, then the assumption of human behavior and its results are largely irrelevant and economic models are robust to the changes.

Today’s Quote of the Day…

…is from Chapter 3 of Frederic Bastiat’s final work Economic Harmonies (page 499 of the Mises Institute Edition):

Can we concieve a time when man can no longer form even reasonable desires? Let us not forget that a desire that might be unreasonable in a former state of civilization–at a time when all the human faculties were absorbed in providing for low material wants–ceases to be so when improvement opens to these faculties a more extended field. A desire to travel at the rate of thirty miles per hour would have been unreasonable two centuries ago–it is not so at the present day [or 70mph in Bastiat’s time! -JMM]. To pretend that the wants and desires of man are fixed and stationary quantities, is to mistake the nature of the human soul, to deny facts, and to render civilization inexplicable.

JMM: What we take for granted were once unobtainable wants because we had to focus on growing food. As that food was automated (thus destroying a lot of farmer jobs) and became cheaper and taken for granted, more desires, once unobtainable, became obtainable. Desires like kitchen appliances, faster transportation, recorded music, etc. Then, as more of those desires became taken for granted and cheap (displacing lots of manufacturing jobs), we moved to other desires, like better health, better medicine, more diversions (theatre, movies, sports, TVs, etc).

Shift happens, but it happens because desires are being met, which in turn allows new desires to come about. Human desires are indefinite.

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 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.