What is Free Trade?

The following is a letter to the Wall Street Journal:

Edmund Miller argues that Dr Boudreaux misses the point of President Trump’s trade policy, that he is merely just using tariffs to get “free and fair” trade and zero tariffs.  Ignoring the fact President Trump has explicitly denied this is his goal at all (see, for example, his comments here and here), Mr Miller rather misses the point of free trade.

Free trade is nothing more than this: the observed outcomes that occur when people are free to make their own decisions.  Nothing more, nothing less.  By using his authority as the head of the executive branch of the US government to punish certain people for behaving in certain ways, President Trump is explicitly against free trade.  It may be “fair trade” (however we wish to define that), but it cannot be called free trade in the correct sense of the word.

Jon Murphy

Fairfax, VA

PS: see also Don’s response here

Obsolescence: Economic and Technical

The language of economists is often fraught with confusion for a simple reason: we use common words and use them in a precise manner that is different from what many people think.  We inherited a language and our words don’t quite fit into others mouths easily.

One such word is “obsolescence.”  People tend to think of “obsolescence” in a technical sense, that is as something that is old and thus no longer needed.  The horse and buggy was made obsolete by the automobile.

Economists think of the term in a different manner, that is to describe a method of acting that is no longer economically practical given the change in costs/benefits.  This may include adopting a new technology, but it may not.  By way of example, consider the following: why do some people still take the train when we can fly everywhere?  In a technical sense, the airplane has made the passenger train obsolete.  But people still ride the train because the costs of riding are lower than the benefits of riding versus the same calculus of flying.  For some people, the act of flying is obsolete.

Ian Fletcher makes this very mistake in responding to Pierre Lemieux’s new monograph What’s Wrong with Protectionism?  Fletcher writes:

You [Lemieux] attack a protectionist straw man. For example, contrary to what you [Lemieux] say on page 48, reasonable opponents of unilateral free trade do not advocate protecting “obsolete manufacturing.”

Fletcher is confusing technical and economic obsolescence.  Protectionists do indeed advocate protecting obsolete manufacturing; they are obsolete in that they are no longer serving people’s needs since people are now choosing imported products.  If this were not the case, then protectionism would not be needed.  These firms might be at the top of the tech world, but that does not mean they are successfully serving a need.  To protect them is indeed to protect an obsolete industry.

Tariffs Harm Suppliers, Too

Michael Hicks of Ball State points us to an important bit of news regarding the current Administration’s strategy of using tariffs as a billy club:

The landed cost of U.S. beans in China is currently similar to Brazilian soybeans even with the 25-percent tariff, but Chinese crushers are reluctant to take U.S. supply as they fear authorities may not approve cargoes and that tariffs could climb further.

Hicks adds:

Game Theory 101 (prerequisite is Trade 101): Reduce volatility over the long run by trading with more stable and predictable partners. Signaling through ‘crazy’ behavior, with uncertain payoffs is higher risk.

And while the Chinese may be the ones primarily reducing their imports, this can affect other US trading partners as well.  Once solid allies like Canada, Mexico, South Korea, and the EU suddenly find themselves targets of tariff aggression.  If the behavior of your trading partner’s government is erratic, you face increased costs in dealing with them.  Higher costs, ceteris paribus, mean less quantity demanded.  All firms, then, likely face costs of the tariff, not just the immediate industry facing the tariff.

An erratic tariff regime can be seen as akin to political instability.  Economic actors (buyers and sellers) like certainty.  Countries with greater political uncertainty, where things are more governed by arbitrary legislation rather than principled actions, tend to see weaker economic performance and less economic dynamism as these actors have to take into account these increased costs.

Trump’s supporters may hail his behavior as “4-d chess” and “superior negotiating,” but it comes at a real cost.

As Compared to What?

On this Carpe Diem post by Mark Perry, commentator Citizen Buddy writes:

It is my firm belief that Mutual Free Trade is exponentially superior to Unilateral Free Trade.

While Citizen Buddy’s comment may be true, it is wholly irrelevant to the matter at hand.  Rarely is the choice between mutual free trade (he is using it here to state both countries’ governments do not obstruct their citizens’ trading patterns) and unilateral free trade.  The relevant trade-off is between unilateral free trade and scarcityism.  When faced with that trade-off, unilateral free trade will win every time.

Considering the relevant trade-offs prevents us from making a Nirvana Fallacy and keeps us disciplined in our thinking.  Preferences may be one thing, but budget constraints always exist.  We may prefer complete free trade, but in absence of that, unilateral free trade will do.

Whose Tariffs are Reducing Exports?

Business Insider reports that since Donald Trump started a trade war with China, the US trade deficit has increased.  In August, this has been primarily due to falling exports.  BI goes on to say:

The primary reason for the increase in the deficit [in August] was a collapse in exports, especially soybeans, which fell off by $1 billion, a 28% drop from the month prior. China, the largest buyer of US soybeans, imposed tariffs on the American crop and it appears the restrictions are taking a toll.

Placing the blame on Chinese tariffs for falling soybean exports is not entirely correct.

A tax on imports (ie, a tariff) is the same as a tax on exports.  Simply put, by reducing the number of imports into a country, it reduces the amount of currency foreigners can use to buy exports.  By imposing tariffs on Chinese goods, Trump indirectly imposed a tax on US exports to China, reducing the exports himself!

None of this is to say the Chinese tariffs on soybeans didn’t make an already bad situation worse.  But we cannot lay the blame for the decline in exports at the feet of the Chinese.

What is Unique About International Trade?

What is unique about international trade?  This is the question that I pose to my two trade classes (Econ 390: International Economics and Econ 385: International Economic Policy) every day this Fall.  This question is crucial toward understanding the content in the courses.

In Econ 390, the more technical of the two courses, we’re using Paul Krugman, Maurice Obstfeld, and Marc Melitz’s textbook International Economics (among others).  The opening chapters deal with the main models of trade theory: Ricardian, Specific-Factors, Hecksher-Ohlin, and the combined Standard Trade Model.

As with any good model, we start with the simple case of two people.  How does the model develop here?  What are the driving forces of change and outcomes?  What are the impacts of the assumptions?  We then expand the model into the world of international trade.

When we expand the model outward, we notice something interesting: nothing unique happens when the model is expanded to include international trade.  The factors adjusting income distribution stay the same.  The influences governing specialization stay the same.  The key for any of these models is that a change in relative prices changes the distribution of income and economic activity.  This result is no different than microeconomic outcomes.  Any change in relative prices, regardless of whether this occurs because of domestic or international conditions, will cause changes in the economy.  This is a point Krugman et al repeatedly stress in their textbook and a point I repeatedly stress as well.

Let’s take, for example, the Specific-Factors model, which argues that in any form of production, there are some factors of production specific to that production and some factors that are mobile and thus can switch from one form of production to the other.  If there is some relative price change, the model predicts the domestic owners of the specific factor of the now relatively-expensive good will benefit (increased income), the domestic owners of the specific factor of the now relatively-inexpensive good will not benefit (less income) and the domestic owners of the mobile factor will have an ambiguous impact.  Note that it doesn’t matter if this change in relative prices is caused by domestic issues (say, a tax on one good that changes its relative price) or by international trade (a change in world price).  The effect is the same.

So, what then is unique about international trade?  Is it that differing legal regimes between countries have a major impact and thus people should be upset about that?  This doesn’t hold, especially in the United States, as each of the 50 states has different legal rules and regulations.  California, for example, has very stringent rules about labeling and selling; New Hampshire, not so much.  New Hampshire thus has an advantage over California, but people in California aren’t protesting New Hampshire products.  So, the uniqueness of international trade cannot rest on differing legal regimes.

Dani Rodrik suggests its a perception of unfairness due to different “domestic norms” and “social understandings” that is unique.  While the perception may be unique, the actual reality of any unfairness due to these differences is not unique.  Again, domestic norms and social understandings are legion among the various regions of the United States.  Some states have stronger social safety nets than others.  Firms will move to take advantage of less costly regulations.  So, this difference in social understandings is not unique to international trade, either.

There are many other excuses people can give for the uniqueness of international trade and why tariffs are justified internationally but not nationally; I’ve just listed two.  But the same analysis should be performed for each of these excuses.  You’ll find they do not hold up.

In short, there is nothing economically or socially unique about international trade that renders it subject to special rules and regulations.

The Importance of Considering Transaction Costs

Over at Carpe Diem, Mark Perry points us to an article detailing a potential move by Wal-Mart:

Target and Walmart will now face a tough choice: They can absorb the higher costs from tariffs by taking a hit to their profit margins, or they can pass some of the price increases on to their customers.

“Either consumers will pay more, suppliers will receive less, retail margins will be lower, or consumers will buy fewer products or forego purchases altogether,” Walmart warned in its letter.

The Trump administration is using tariffs to push companies to manufacture more goods in the United States. But the National Retail Federation says the administration’s thinking is flawed and carefully planned supply chain plans can’t be redrawn overnight. Retailers order their products six months to a year in advance, and they are left scrambling to find new options for 2019. “The [administration] continues to overestimate the ability of US companies to shift supply chains out of China,” the trade group said in its own letter to Lighthizer. “Global supply chains are extremely complex. It can take years to find the right partners who can meet the proper criteria and produce products at the scale and cost that is needed.”

Implicit in this conversation is the costs to retailers (and manufacturers and anyone else who uses imported goods) to search and find new suppliers.  These costs are very real and necessarily contribute to fewer economic gains in the country.

Trump’s tariff schemes, to use tariffs to force companies to relocate supply chains or operations to the US relies on something of a Nirvana fallacy: that these relocations/readjustments can be done costlessly.  As a former business executive, he should know better.  Firms cannot just adjust their operations costlessly.  Contracts are in place.  New ones would need to be written.  New relationships need to be formed.  Adjustments need to be made to product specifications.  Etc etc.  These are not costless processes.

Even if we were to assume, contrary to ex-ante evidence, that Wal-Mart suppliers relocating back to the US is 1) possible and 2) would be beneficial for the economy as a whole, when you figure in all the costs associated with such a move (that is, all the transaction costs), it is highly improbable that, on net, the move would be positive.