Who Competes with Who?

President Trump (and other protectionists) like to frame international trade as a context: the domestic nation is competing with foreign nations and that imports must necessarily harm and exports necessarily help.  Aside from the numerous logical and mathematical issues with this interpretation, it is economically incorrect from the perspective of competition.

International trade represents the exchange of goods and services across political borders by individuals.  More simply put, it involves buyers on one side of an arbitrary line and sellers on another.  The fact this is buyers and sellers matter for a simple reason: buyers and sellers do not compete with one another.  They cooperate.

Buyers compete against other buyers.  Sellers compete against other sellers.  Buyers and sellers do not compete with one another.  The seller must offer a price acceptable to the buyer.  The buyer must offer a price acceptable to the seller.  The two will cooperate to make the exchange happen (or else they go their separate ways and other buyers and sellers step in).  What this indicates for international trade is this: when foreign producers are harmed, either through tariffs or quotas, they are not the only ones harmed: their domestic customers are harmed as well.  When Trump mentions “punishing” foreign companies for having the gall to offer Americans the best possible deal, what he is actually talking about is punishing Americans by reducing their options and preventing their cooperation with other people.

If we are to use the (highly misleading) language of nations trading with one another, this means that international trade is not a competition but rather cooperation.  It is impossible for one nation to be losing at trade because there is no competition!  Buyers and sellers cooperate.  When two nations trade, they cooperate.

Trade is Not Zero-Sum

On this post on Cafe Hayek, Per Kurowski writes in the comments:

Trade deficits per se do not worry me as much as a wrongly structured trade deficit. If current trade conditions permit other countries better chances to develop 1st class robots and the smartest artificial intelligence than mine, then I do fret for the future of my grandchildren. Let us not forget the “Arsenal of Democracy”

Mr. Kurowski makes a common mistake regarding trade: trade is not zero-sum.  If other countries are developing 1st class robots and smarter artificial intelligence, it does not necessarily follow that the domestic nation is made worse off by such innovations.  Indeed, the domestic nation stands to gain from such innovations.  A wealthier nation has more to offer the world.  More to trade means more trade.  More trade fosters more growth for both parties.  Even if a nation loses an absolute advantage in robotics or AI or something (as Mr. Kurowski postulates), it still becomes wealthier because of the Law of Comparative Advantage.

Mr. Kurowski also seems to insinuate that such gains by trading partners would pose a threat to national security.  I’ve written on the “protectionism for national defense” argument before, but it bears repeating that trade fosters peace, not violence.  There are two main ways to get what one wants: through cooperation or coercion; through trade or violence.  When trade is encouraged, peaceful cooperation takes hold.  Goods and services can cross borders, making all better off.  Since this trade is mutually beneficial, both nations face higher costs of breaking off those ties.  Even if the two nations get wealthier and can afford more expensive military equipment, the costs of war will rise quicker and the benefits of war fall.  With rising costs and falling benefits, the likelihood of conflict drops (we have seen this pattern take hold over the past few decades as trade liberalized).

If Mr. Kurowski is concerned about the future of his grandchildren, then he should welcome deeper trade ties among nations and not be concerned about trade deficits.  This would mean a wealthier and more peaceful world.  A move to protectionism would mean a poorer and more violent world.

The Rules of Free Trade are Simple

What follows is a letter I’ve written to the Wall Street Journal:

Greg Ip’s 31 May 2018 piece, “Lessons in How to do Protectionism Well,” is interesting to say the least.  However, there is a major way in which Mr. Ip errs.  he writes: “He has thus far been relatively easy on China, which even free traders agree is a serial violator of the rules of free trade…”

It is unclear what rules of free trade Mr. Ip seems to think China has violated.  The rules of free trade are simple: people are voluntarily able to exchange their property rights.  China, at least outside of the country, has not compelled anyone to buy from them.  All trade done with China, that is individuals buying from other individuals who just happen to be Chinese, is voluntary.  China has not violated the rules of free trade at all.  If China were forcing American consumers to buy Chinese products, then yes they’d be violating the rules and should subsequently be punished.  But offering Americans goods at low prices is not a violation as the exchange that occurs is still voluntary.

Signed,

Jon Murphy

George Mason University

A Note on China

On an earlier post, frequent commenter Greg G writes in two separate comments (condensed here for readability):

I think the best argument for tariffs is the astonishing economic success of China in lifting so many people out of poverty in such a short time. It’s not easy to explain how they did that if tariffs are really so inimical to the interests of their own people. Those of us in favor of free trade (and I count myself among that group) need to admit we can’t explain that. As always, we could argue that they would have done even better in some counterfactual where everyone listened to us but that is a very weak argument for a couple reasons. One is that it is always available to everyone. The other is that none of us would have predicted in advance that such an economic miracle was possible even if we had been guaranteed we could dictate policy.

Free market theory predicts that all these state interventions should be bad for Chinese consumers yet no other country’s consumers in history have enjoyed a comparable jump in their standard of living in such numbers in such a short time. Yes, I know they started from a place of extreme poverty and even more Draconian state interventions where it was easy to make big percentage gains. Even so, there are countless other countries that started in extreme poverty and stayed there both with and without a lot of state intervention in the economy. I am not pushing any economic theory that I prefer to free trade but I do still think that the Chinese example stands as a challenge to some of the economic theories that we prefer. It’s at least a little bit awkward that the regime that engineered the biggest economic leap forward in history still calls itself Communist.

Let me begin with a quick point.  Free market theory does not predict that all state interventions are bad.  There are many theoretical cases where interventions such as tariffs can be beneficial.  However, such theories require strong assumptions and a level of knowledge we deem impossible to possess, so we are skeptical of the applicability of such arguments.

More specifically on China:

Greg is right to wonder about China’s massive increase in wealth over the past 30 years.  It is astonishing.  Does it represent trouble for the free market thesis?  I don’t think so.  It adds a lot of credence, indeed.  China has been rapidly reducing tariffs over the past 30 years.  Non-Tariff barriers are falling, too.  In short, China opened their markets to the international market.  I think this has contributed to their economic growth.  It could be better, sure, but they’re steps in the right direction.

However, I fear if China does not institute market reforms, they could find themselves stagnating.  Japan had a similar growth strategy as China in the 70’s and 80’s.  They saw rapid growth but subsequently stagnated from 1990 to present as their protected firms became moribund and unable to handle competition or anticipate market changes.  Unless they allow true market reforms beyond what they already have, China will likely also face such stagnation, albeit at a higher level than Japan.

The Law of Demand in Action (or Why Monopoly Power is Fleeting)

Writing at Human Progress, Martin Tupy has an excellent article on the real effects of predatory pricing and monopoly.  Here is the upshot (although one should read the whole article.  It is excellent):

In a 2014 Council on Foreign Relations report, Eugene Gholz, an associate professor of public affairs at the University of Texas at Austin, revisited the crisis and found that the Chinese embargo [of rare earths to Japan] proved to be a bit of a dud.  Some Chinese exporters got around the embargo by using legal loopholes, such as selling rare earths after combining them with other alloys. Others smuggled the elements out of China outright. Some companies found ways to make their products using smaller amounts of the elements while others “remembered that they did not need the high performance of specialized rare earth[s] … they were merely using them because, at least until the 2010 episode, they were relatively inexpensive and convenient.” Third, companies around the world started raising money for new mining projects, ramped up the existing plant capacities and accelerated plans to recycle rare earths.

In other words, when faced with a sudden shortage, people compensated through other means.  It’s almost as if demand curves slope downward.

Monopolies are still subject to the whims of consumers.  They cannot raise their prices with impunity.  As prices remain high, people will innovate around them.  This indicates that the fear of predatory pricing, that a firm (or country) will seize market power and use it to jack up prices or manipulate people, are greatly overblown.

 

The Role of Money in Trade and Economics

Is money a means or ends?  Confusion over the answer to this question dominates much of the popular conversation regarding economic policy and methods.  Those who see money as an end tend to focus on the production side of economics; wealth is generated by producing and selling things.  The more you sell, the higher your profit, the more wealthy you are (this is the main argument behind mercantilism).  When money is treated as a means, then the focus tends to shift more towards the consumption and trade side of economics: wealth is created when people trade things of lesser value for things of higher value (this is the main argument behind free trade).  Precisely exploring the role of money in trade and economics will go a long way to understanding the means of wealth in society.

Money does not predate economic activity.  Money arose out of economic necessity.  In a simple two-person word, it’s easy to see how a barter economy based on comparative advantage can develop.  One person can make fishing hooks while the other fishes, for example.  They specialize in their comparative areas of expertise and barter physical goods for physical goods.  Both are made better off without the need for money.

But, as the world expands, the barter economy becomes more complex and can start to break down.  That is because barter requires double coincidence of wants.  In other words, to successfully barter, you need something that the other person wants.  I am an academic.  In a barter economy, all I can offer are my economic writings.  If I go to the grocery store and the grocer just happens to want an economic tome for the same amount of groceries I just happen to want, then a trade can be arraigned.  But, if he doesn’t, then no trade can occur.  What can solve this problem?  Well, what if there were some medium of exchange, something that both he and I wanted that could be exchanged in lieu of the physical goods/services but could itself be exchanged for physical goods/services?  A numeraire, if you will?  That numeraire is what we call “money.”

Money solves the double coincidence of wants problem.  I can sell my economic ramblings to some university or bookstore patron in exchange for money and turn around and exchange that money for groceries.  The bookstore patron needn’t necessarily have anything physical I desire other than his money; he needn’t provide me any good or service (he’s already done that for someone else).  He need only give me some pieces of paper.  Likewise, I needn’t perform any services for the grocer (I’ve already done that by providing the book to the patron).  I need only supply her with the desired amount of money.

Money also acts well in reducing transaction costs by being divisible.  Going back to our barter example, neither fish nor fishhooks are particularly dividable.  Selling someone one-and-a-half fishhooks is to really sell them one fishhook and a broken fishhook.  A barter deal may not come about because the amount needed to be exchanged in intact units would be too high.  But money solves this problem.  If, for example, my book sells for $10 and the number of groceries I want to purchase cost $5, then I can essentially sell half-a-book to pay for my grocery bill because money can be divisible.  So, the introduction of money as a numeraire into trade increases the number of transactions, thus the depth of the market and the potential wealth gains, into an economic system.

But, as this discussion shows, money is merely a means of increasing the number of transactions.  The goal is not to acquire money, but rather to acquire money in order to be exchanged for something else (don’t believe me?  How many people are clamoring for forms of money, like the Murphy-Bill, to pay bills?  I got a whole bunch of them for anyone who wants them).  In any given transaction, one may exchange their good/service for money, but that is because the money they acquire is desired to be used in other, more valuable, means (if the value they got from the money was less than the value they got from the labor, they’d not exchange).  Money, in and of itself, provides no other uses (indeed, one of the reasons something is chosen as money is because it has no other use.  For example, would anyone want pictures of dead people and numbers on paper if they couldn’t be exchanged for something else?).  You cannot eat money.  It can only satisfy wants and demands by being exchanged.

Let’s apply this reasoning to international trade.  Money is a means to an ends (consumption).  Thus, people trade with other people on the other side of political borders in order to consume.  Just as I traded my money with the grocer to consume food, I traded a few bills with a French producer to consume gin.  I “exported” my labor to the grocery store so I could “import” food.  I “exported” my labor to the French distiller so I could “import” gin.  Thus, we can see that “exports” are what are given up in a trade (the cost) and “imports” are what are gained (the benefit).  Unfortunately, much popular conversation surrounding trade has this exactly backward.  A “successful” trade is one where a person (or group of people called a “nation”) export more than they import.  In other words, they give up more than they get.  This would be akin to saying the person who is a “successful” grocery shopper is the one who spends the most at the grocery store and gets the least in return.  The “smart” shopper spurns all bargains, sales, discounts, and specials.  Indeed, the “winning” shopper would be the one who demands he pay higher prices.  The “best” shopper “laughs” at all the other shoppers who are buying food in bulk, buying what’s on sale, buying specials.  He laughs at the foolish shopper who, by taking advantage of low prices, buys a month’s worth of food for a week’s salary while he buys a week’s worth of food for a month’s salary.

If we treat money as something that merely represents a divisible number of physical goods and services, we can see that all trade is still ultimately bartering.  Just as the goal of barter exchange is to get as much as possible while giving up as little as possible (that is, to “import” as much as possible while “exporting” as little as possible), the goal of trade is to get as much as possible (import) while giving up as little as possible (export).  the inclusion of money into the equation does not change the underlying logic.

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.