Transferring Wealth is Not the Same as Creating Wealth

The Commerce Department has proposed tariffs of up to 20% on Canadian sofwood lumber imports.    These tariffs are phrased by the Administration and supporters as “leveling the playing field” and wealth creating measures.  Ramiyer, commenting on this blog post by Mark Perry, has a typical protectionist scarcityist argument:

Plus [the tariff] saves thousands of jobs who can afford to purchase and go out and eat. These people are real workers. Not some people who just throw their opinions or Wall Street Looters or big cheaters as in case of some CEOs.

It is true that some jobs are ‘saved’.  But that is only half the story: many jobs are lost, too.  Tariffs do not create wealth.  They transfer it.  Tariffs transfer wealth from consumers to producers and the government (for a graphical representation, see my blog post here).  Unlike free trade, no new wealth is created (in fact, tariffs cause wealth to disappear!). The wealth is merely transferred from the consumers and their spending habits to the producers and their spending habits. Therefore, a nation cannot, though tariffs and artificial scarcity, create wealth; it cannot tax itself into prosperity.  It can merely redistribute wealth.

What’s interesting about this is, until very recently, the same people arguing for tariffs now understood this.  They decry welfare and high corporate taxes for the exact same reason I outlined above for opposing tariffs.  I find the hypocrisy nauseating.

Sacrificing the Ends for the Means

Throughout his writing career, Frederic Bastiat repeatedly emphasized that consumption is the end goal of economic activity, that the consumer should be the focus of economic analysis.  While each man is both producer and consumer, man produces so he can consume.  In other words, production is the means and consumption is the ends.  This makes sense if we look at our own lives: we go to work so we can afford our homes, food, cars, clothes, etc.  We don’t consume our clothes, cars, food, homes, so that we can work more!

Although not considered much of a theorist, Bastiat was a bit ahead of his time with this emphasis.*  It would be another 50 years before the commonly-recognized supply and demand curve we use today was developed by Alfred Marshall.  Using the Marshallian Curve, we can explore Bastiat’s** insights with regard to international trade.

Let’s ask the question: what happens when we impose a tariff on international trade?

First, let’s start with our standard supply and demand curve:

20170406_093528

The green-shaded areas are “consumer surplus,” or what the consumer gains from the international trade.  The orange is domestic producer surplus (what domestic producers gain).  Domestic producers supply some of the quantity demanded (Qs) and the rest is made up in imports (Qd-Qs).  The total societal surplus is the green and the orange areas added together.

What happens when we impose a tariff?  This:

20170406_094005

Green is, as above, consumer surplus.  Orange is producer surplus.  Added in here is the blue area (tax revenue) and red (deadweight loss).  What’s going on here?  Much of what we have is a transfer of wealth: producers gain (from the consumer), government gains (from the consumer).  But where does the deadweight loss come from?  The consumer!  Not only is there a total reduction in welfare in the society (not merely a redistribution), but it all comes from one segment, the segment that is the ends of all production.  The entire welfare loss is borne by the consumer!  

The implications of this analysis are stunning, at least from an economic perspective: you reduce the ends to get more means; Protectionism results in more effort for less welfare!  The supposed blessings of scarcity that protectionism promises never materialize.

*Nor should Bastiat be considered a theorist.  He wasn’t.  He was a great distributor of economic ideas, but didn’t form any himself.

**And Say’s, Smith’s, and Ricardo’s

Warts and All

Yesterday was Opening Day for the Washington Nationals at Nationals Park in Washington, DC.  Some 40,000 people made their way to the Waterfront to see the Nationals take on the Miami Marlins.  At the corner of N and First Streets, SE, the traffic and pedestrian crossing was a nightmare.  People were flooding out from the Metro headed to the Park.  The crossing guards could barely keep order, and both cars and pedestrians were getting frustrated (this effort was compounded by the fact the traffic lights were still on, often contradicting the guards’ orders).  It was, in short, a charlie-foxtrot.  One might even say it was a government failure.

Although the government’s solution to the pedestrian issue was less-than-ideal, it would be incorrect to immediately jump to the conclusion that a laissez-faire approach would automatically be better; that a “free-market” approach would be better than the government approach.  The free-market approach would come with its own set of problems (perhaps, for example, since pedestrians have the right-of-way, tens of thousands of people would have crossed the streets and no car would have been able to move for hours).  It’s indeed possible that the free-market approach would have generated a worse outcome than the government approach.

Harold Demsetz (among others) warns us against the Nirvana Fallacy; that is, assuming a different (often preferred) method would not contain the same flaws (or flaws at all) from the current method.  We see this very often in politics (eg socialism), but free-market supporters can run aground of the fallacy, too.  Markets, just like governments, are populated with humans with the same foibles.  The incentives are different, to be sure, but markets can fail, too.  One mistake I think far too many market supporters is to assume that markets are not only perfectly efficient (the “efficient market hypothesis”), but also they instantly adjust.  That is not the case.  By arguing, as many do (especially many anarcho-capitalists) that the market solution is always the superior solution is incorrect for the exact same reasons that socialists arguing the government solution is always superior to the market solution.

Markets are extremely powerful.  Generally speaking, they provide excellent results.  But markets are just one of our institutions, and they function best when search and transaction costs are minimized.  For certain problems, there may be other institutions out there that would perform better.

Reality vs Perception

Over at the Liberty Law Blog, Prof. John McGinnis has an excellent piece on legislating.  He writes (emphasis added):

A Nebraska Senator has introduced a bill to require photo identification for voting, not because voting fraud is an actual problem, but because Nebraskans perceive there to be such fraud, whether it exists or not.

If voting is a fundamental right protected by the Constitution, legislation should burden its exercise only to address actual harms, not some people’s impressions of reality.  Thus, the legality of these laws should turn on the question of actual voter fraud and the utility of voter identification in curbing it.

I agree with the good professor, and think this rule should apply not to just legal matters, but economic matters as well.  An argument I’ve heard more and more in recent months in favor of protectionism from people who are nominally free market is that, with our current trade policy, it creates the perception of unfairness; it creates the perception of China “stealing jobs”, of a “hollowing out of the manufacturing base,” of “economic stagnation.”  It doesn’t matter that the data say otherwise, but the perception is there and that’s why Trump won.  Therefore, they conclude, we need some trade barriers to keep the protectionists at bay.

This argument is very similar to the one McGinnis addresses: there is this perception, so therefore we should pass legislation to combat the perception, even if it infringes on people’s rights.  For the same reasons McGinnis rejects the argument in the link, I do so here: legislation that burdens the free exercise of a right should only address an actual harm, not a perceived harm.  Given that free exchange is a fundamental human right, the infringement of such requires the burden of proof to be on those calling for tariffs; they must demonstrate actual unique and substantial harm, not just the perception of it and demonstrate the usefulness of their proposed actions in addressing the harm.*

In short, the perception of harm is not enough to justify the infringement of the right to trade.

*Notice I said “actual unique and substantial harm,” instead of just “harm.”  The reason for this, which will be addressed in a forthcoming blog post, is because any action whatsoever can conceivably harm anyone, but that alone is not grounds for outlawing it.

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.

Benefits to Trade

Over at Cafe Hayek, Don Boudreaux shares some charts I made for him as his RA.  One of the charts is the Fraiser Institute’s Freedom to Trade Internationally Index compared to GDP per capita (a proxy for individual wealth) from the World Bank.  In the charts Don has, there is a linear regression line.  Below, I have the same graph, but with an exponential trend line:

freedom-to-trade

This trend line fits better than the linear one.  This suggests an interesting relationship: the relationship between the freedom to trade and individual wealth is exponentially positive.  In other words, the more free the people of a nation is to trade, the faster and faster their wealth grows!  The implication of this is even marginal tariffs could have a substantial effect on economic activity and wealth.

Other than putting together the graph, I haven’t played around with the data too much, something which I aim to remedy in the near future.  But, at a first look, this suggests a strong positive relationship between trade and economic well-being, and certainly hurts the case that trade, as Trump has put it, is “beating us to a pulp.”