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.

The Difference Between Econ 101 and Econ 801

An advantage of teaching undergraduate students as I simultaneously work on my graduate work is I get to go through both undergrad textbooks and graduate books at the same time.  Currently, I’ve been working my way through Cowen and Tabarrok’s Principles of Economics for my undergraduate class and George Stigler’s Theory of Price and Donald Watson’s Price Theory and Its Uses for my research.

We often hear, primarily by people who dislike the implications of Econ 101 models, that Econ 101 is too simplistic, too unrealistic for the real world.  They’ll point to other economic models that better conform to their desired views (eg, the monopsony model for minimum wage).  “We can’t rely on Econ 101!  It’s just too simple!”

But what’s interesting to me is that going through these upper-level texts (Stigler is a high-Masters, low-PhD text), one sees they are not fundamentally different from the undergrad texts.  This holds in other texts, too, such as David Kreps’ Microeconomic Foundations.  There may be more math to formalize the models, but the intuition remains the same; the implications remain the same.

Basic supply and demand analysis gets us a very long way.  It is not complete, of course.  No theory ever is.  But supply and demand is fundamental.  Seeking to overthrow the foundations will not necessarily lead to a more coherent theory.

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.

 

What Naval Warfare Shows About the Market Process

You stare out over the watery landscape through your binoculars.  Endless grey skies that go on for thousands of miles.  Carefully scanning, you look for any sight of the enemy battleship in the area.  You know she’s there…but where?

“Contact!  Starboard!” comes the shout.  You whip around and sure enough, there is, on the horizon, a ship.  You pull out your binoculars and see the distinctive black cross on a red background flag of the Kriegsmarine.  “Target acquired!” you shout, confirming what the officer saw.  “Bring us around.  Gunner, I want a firing solution now!”

“Aye aye!”

Your ship, a massive American battleship, comes around and you gain on your prey.

“Solution plotted!” yells the gunner.  “Elevation, 20 degrees!  Keep this bearing!”  You nod.  You see from the bridge the main batteries change position and elevation, their silence now an omen of the death they carry.

“Guns ready!’ comes the shout.  “Fire,” you command.

The massive ship bucks as all six 15-inch cannons fire.  The blast is loud enough to deafen everyone temporarily.  The ship rocks as though hit by a large wave.  Hot death is quickly headed toward the enemy ship.  You look through your binoculars:

Splash!  Splashsplashsplashsplash!  All six rounds miss.

“Damn!  We overshot!  New solution!”  Again, the gunners recalculate.  “19.8 degrees, sir!”  The guns are realigned and the command is given again.  Splash!  Splashsplashsplashsplash bang!  One round hits, but it is a glancing blow.

“I have you now,” whispers the gunner as he does his calculations again.  “19.9 degrees, sir!”  “Fire everything we’ve got!”

Again, the ship roars with the fury of a god.  You watch through your binoculars.  Even from several miles away, you can hear the boom as the rounds hit their target.  A massive plume of smoke and fire erupts from the enemy ship.  “Direct hit, sir!  They’re sinking.  It looks like we got their magazine!”  A cheer goes up from the crew.  The prey you have been hunting for weeks was now dead in the water.

How was victory achieved?  Tenacity, no doubt.  But also trial-and-error.  The gunner and crew had to operate on their best information at the time.  As new information came in (missed shots), they adjusted their plans.  Eventually, they were able to have a direct hit by making changes.  In other words, their failures allowed them to ultimately succeed.

The same is true for a market process.  Markets fail.  People notice those failures.  They subsequently make adjustments.  Those adjustments help correct for the market failures and bring people closer and closer to their goals.  Market perfection may never be achieved, but it is tended toward.

People fail.  People learn what not to do.  People correct.  That is the market process.  Failure is just as important as success.

Who Are the Economic Experts?

Economists are considered the economic experts.  After all, we’re the ones with the PhDs, the fancy mathematics, the complex theories that purport to explain everything.

But the reality is quite different.  We are not the economic experts.  Indeed, a good education in economics inoculates one from thinking himself an expert and forces him to think himself more of an observer.

The real economic experts are everyone.

People understand how to act in their own best interests. Nothing about the market needs experts to guide it. People are not fools who require technocrats to tell them what they can and cannot buy.  The outcome of the market, the observed phenomena that are the market process, is nothing more than the results of people interacting with one another; human action but not human demand.  People are acting on information that they have and the signals they see.  They are the experts, not the economist or technocrat.

Protectionists disagree, however. They believe they know better than everyone else. They believe they know better than the Joes of the world. They believe they know better than people what is in their own best interest. So they seek to impose their will upon everyone else, the opinions, hopes, and dreams of the others be damned. “They are not educated,” the protectionist thinks. “They are not versed in the theorems and mathematical proofs that show that Joe is harming himself. If only he had a benevolent hand to guide him; to push him in the right direction (or tug on the leash, if necessary).”

Free marketers believe non-economists do indeed know more economics than the economists. That’s precisely why they argue for free markets; so people can exploit their knowledge and expertise to the best of their ability. The protectionists and socialists (but I repeat myself) disagree. They believe themselves to be far smarter than the Joes of the world and that the Joes are simply too stupid to act in their own behalf.

Markets are observed empirical phenomena, not a technocratic outcome.  The market process is not a theory per se but an actual outcome.  The theory is used to explain why that outcome occurs, but it is an outcome nonetheless.