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.

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.

Trade Wars are Fought Within, Not Among, Nations

President Trump likes to talk of trade wars: with China, with Canada and Mexico, with Europe.  It doesn’t matter.  Trade wars are easy to win.  But, Mr. Trump and his enabler advisor Peter Navarro mistake who the enemy is in a trade war; it is not the foreign nation or their producers; they are, at best, collateral damage.  Rather, the enemy, the one who bears the brunt of a trade war, are the domestic consumers.

The Economist reports on a number of industry associations that oppose Trump’s tariffs on steel and aluminum.  Many of these industries are ones that were clamoring against foreign production and demanding tariffs of their own just a few months ago (eg Boeing, Ford).  If the steel and aluminum tariffs stick around, then these same companies will be put at a disadvantage.

But does the action stop there?  Absolutely not.  These same companies, seeing the bounties bestowed upon Nucor and Alcoa will, in turn, demand their own tariffs and their own subsidies (as they already have, in the case of Boeing).  Other producers will seek protection as well, further raising tariffs or subsidies.  There is no logical or natural stopping point for the trade war; indeed, all this becomes even worse if foreign nations raise their own trade barriers.  Internally, more and more calls for protection* arise and the government fights a trade war with its own people.  Every protectionist action will have a negative consequence on some other domestic actor who will have the incentive to seek his/her own protection.  What’s more, even producers not directly involved may seek some of the rents the government hands out.

Trade wars are devastating, but they are inaccurately described as being between two nations.  In reality, however, trade wars are civil wars.

*A point I should make explicit: tariffs are not the only form of protection firms might lobby for.  They may aim for tax breaks, subsidies, grants, etc.  This internal trade war can be fought even if tariffs never rise.

The Ad Hoc Nature of Protectionism

I want to clarify the purpose of my earlier post.  The questions are an attempt to get protectionists to formulate a theory of protectionism.  As it stands, protectionism is extremely ad hoc.  Justifications for various protectionist tariffs range all over the place and are often contradictory with one another.  This is true whether you read a free-market approach to questioning protectionism (eg Bastiat’s Economic Sophisms) or protectionist books themselves (eg James Steuart’s Principles of Political Oeconomy).  There’s no unified theory of protectionism, just ad hoc explanations given.

Indeed, we often see protectionism presented as an exception rather than a rule.  “Oh sure, free trade is great and all,” the protectionist will often say, “but when someone is unfair then protectionism is needed.”  Or some justification is given for protecting infant industries (which, by the way, is contradictory to the unfair argument).  Or some exception is given for national defense (which is contradictory to the unfair and infant industry argument).  The list goes on.  The protectionists set up protectionism as a series of exceptions rather than rules.  It is insufficiently general to be called a theory in any sense.

The few attempts to generalize protectionism revolves around a tragedy of the commons style argument.  My earlier questions are designed to address that assumption.  To argue that protectionism is sufficiently general as to be the rule, and free trade the exception, to US policy, protectionists need to justify their generalizations.  The first step is through answering the questions I posed.  I’ve not seen any satisfying attempts to answer those questions.

Some Questions for Protectionists

Protectionism is, by definition, state-action.  The argumentation is that trade with foreign nations make us worse off (with few exceptions) and we need to protect our industries in order to grow.  Protecting our industries, from unfair competition, from competition in general, whatever the reason, will make people better off than in free trade.  This claim, however, leads us to some questions:

  1. Why is foreign trade a collective-action problem?  In other words, if people were actually made better off via protectionism, what is preventing them from acting in a manner to better themselves naturally?  Why is government needed?
    1. If there is a Prisoner’s Dilemma type situation or some other coordination problem, that doesn’t necessarily prevent a non-government solution from arising.  As Elinor Ostrom discusses in “Governing the Commons,” the Prisoner’s Dilemma is not an inescapable trap.  People can get out of it through various interactions with each other.  To justify government action, there’d need to be some barrier preventing people from getting to the socially optimal outcome point.  What are the barriers that prevent this from occurring?
  2. Why is there a coordination issue at the international trade level but not the intranational trade level?  Protectionists never demand restrictions on intranational trade, preferring to let people act.  What is unique about intranational trade that allows for coordination that international trade does not?  In other words, why are people’s actions at the intranational level sufficient to generate overall prosperity but those exact same actions are insufficient, indeed detrimental, to overall prosperity at the international level?

What’s the End-Goal?

Commenting on this blog post at Cafe Hayek, Donald Jansen writes:

Yes, yes, protectionism is evil. Still. The government needs revenue. Why are tariffs inferior to other taxation schemes? During the many decades of US history in which the tariff was the primary means of financing the US government, the federal government’s share of GDP consistently averaged 3%. Who would not gladly prefer those circumstances over what we have today?

Below is an extended response to him I left:

To the extent a government is desirable, it will need to be financed. To that end, you want a tax, whatever it be, that’ll maximize revenue while minimizing costs. In other words, you’d want the lowest tax rate possible to finance the government.

But note that an optimal tax is a fundamentally different beast than the tariff discussed here. Don is discussing protectionist tariffs, tariffs not meant to fund government but meant to control behavior. The “butwhatabouts” want tariffs to “protect” industry, not to finance government. They want it to achieve some goal different from finance. To that end, the tariff is more likely to be harmful than helpful (barring an extreme set of assumptions).

Understanding the end-goal of an action is important when it comes to discussing the action.  If the goal of a tariff is to fund government, then it will be radically different than a tariff meant to discourage imports.  The former will try to keep imports as high as possible.  The latter wants to keep them as low as possible.  While both beasts have similar names, they have quite disparate goals.  it makes no sense to object to the argument against a protective tariff by pointing out the theoretical benefits of an optimal tariff; it’s comparing apples and oranges.


A Tariff is a Tax on Domestic Manufacturers

At Cafe Hayek, Don Boudreaux makes an important point: if the comparative advantage of one industry is protected by tariffs, that necessarily means another industry’s comparative advantage is reduced.  While this makes logical and mathematical sense from the point of view of the theory, is it reflective of reality?  Yes:

Virtually all steel used in U.S. tire manufacturing must be imported, as domestic steel suppliers cannot meet volume and quality needs for this critical tire safety component. Thus any trade constraint could potentially have a cascading, negative impact on U.S. commerce nationwide, as the transportation industry depends on a reliable supply of tires to ship goods. Additionally, the U.S. military depends on the tire manufacturing industry to supply tires used to protect our national security.

The US tire manufacturing industry, as quoted above, as a consumer of steel would see their comparative advantage reduced, and thus their competitiveness reduced, due to import tariffs on steel.  Their costs rise, their competitiveness is thusly reduced.  All so US steel manufacturers can have potentially higher profits.

I think it’s worth noting that the tire industry is also an industry that feels threatened by imports and demanded tariffs, too.  So the steel industry tariffs would make this supposedly threatened industry even more threatened.

In short, you cannot Make America Great Again by taxing it into oblivion.