Today’s Quote of the Day…

…comes from page 29 of “Modern Principles of Economics” (4th Edition) by my GMU professors Alex Tabarrok and Tyler Cowen:

The most important tools in economics are supply, demand, and the idea of equilibrium.  Even if you understand little else, you may rightfully claim yourself economically literate if you understand these tools.  Fail to understand these tools and you will understand little else.

Amen to that.

A Robust Theory of Trade

Economists are often accused of ignoring moral consequences of trade, or in particular, being focused too much on material well-being (for example, see here).  There is a lot of truth to this claim; much of our models to focus narrowly on measurable items like material wealth.  I agree with this criticism very much and lots of my research focuses on ways of re-inserting moral man into economic models.

But it is incorrect to argue that free trade is either immoral or amoral.  The earliest free trade philosophers (Adam Smith, David Hume, Frederic Bastiat) all approached trade from a moral point of view.  Hume gives us a justice argument for free trade, Smith demonstrates the strong presumption of liberty in a modern society, and Bastiat shows how protectionism can quickly become a perversion of law and justice.  Economists have long spent time considering the moral aspects of trade.

But one thing that really rubs people the wrong way regarding trade is the concept of competition.  Firms and individuals compete with one another for scarce resources and that competition can sometimes lead to outcomes that make some observers uncomfortable (workers getting laid off in favor of machinery, for example.  Or low-cost labor overseas).  Because of the unpleasant nature of this competition, free trade often gets labeled immoral.  But let’s look at the nature of competition and how it is used in economics.

Economics appears to begin with the assumption of a somewhat Hobbseian jungle world: all actors are self-interested and looking to maximize their own gains.  From this, we derive the concepts of competition and the “invisible hand” which leads to improvement for everyone while appealing to their self-interest.  To quote Adam Smith: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.”

But surely altruism exists!  Surely people are not so wrapped up in self-love they dismiss all of humanity!  How can this dismal view of humanity, that we are merely self-interested, dominate economics?  The answer is two-fold: 1) Everyone is, to some extent, self-interested (what Russ Roberts likes to call “the Iron Law of Me”).  We tend to focus on events close to us and our loved ones far more than events separate from us.  2) This method of conceptualizing humanity makes our models robust.  Lots have been written on #1, so I’d like to focus on #2.

The idea of self-interested humans makes economic models robust.  In a sense, by assuming humans at their “worst,” it allows for humans to act at their “best.”  For example, simple economics indicates that, after a disaster, prices should rise in order to incentivize people to bring more supplies into the area.  The pursuit of profit will bring in people looking to make a buck.  This is the self-interested story.  But what happens if the community and nation band together and donations fly to the area?  The effect is the same: an increased supply to where it is needed most.  By weakening the assumption, the result remains: the model is robust.

So, why the assumption of self-love in the first place?  Well, let’s reverse the scenario.  A disaster strikes.  People are altruistic and chip in and send supplies to the disaster area.  People will band together when things get tough.  This is our model.  But let’s weaken the assumption of altruism.  Disaster strikes.  People are only self-interested.  What happens?  Nobody sends supplies.  Since the results of the model change, it is not robust.

The concept of self-love does nothing to reduce the usefulness of our models.  Whether true or false is irrelevant as the results of the model do not change.  So long as the presumption of liberty is upheld, in other words, no central planning is attempted, then the assumption of human behavior and its results are largely irrelevant and economic models are robust to the changes.

Gains from Trade

Both parties will gain from a trade if the value to the buyer exceeds the price the seller is asking, and the price the seller receives exceeds the value he has for the good/service.

Returning to our beautifully hand-drawn graph (yup, we at a Force For Good are on the cutting edge of 19th Century technology), we can graphically show these gains from trade thus:

IMG_20171022_101324

For every consumer price willing to be paid (as shown by the demand curve) that exceeds the price sellers are willing to receive (the supply curve) a trade is expected to occur, and the gains from these trades will be the difference between the price the consumer pays and the difference the producer receives.  The sum of all these gains is the green triangle above, what we in economics call total surplus.*  We see here what we have logically derived: trade is beneficial.

Up until now, we have been talking solely about interpersonal trade, one person trading with another.  To derive a market demand curve, that is all people trading in this market, we simply sum all the individual demand curves together (∑D) and all the supply curves together (∑S).  The logic is as follows: if one person is willing to buy one apple at $5, and a second person is willing to also buy just one apple at $5, then the market demand for apples at $5 is 2 apples.  Same with suppliers.  This summating function allows us to expand our specific conclusions derived from the past few posts to a more general claim: it doesn’t matter if the trade is inter-personal, inter-town, inter-county, or inter-state (note that externalities do not change this analysis.  See the Coase Theorem).  The conclusions are also true with the inter-national level, a topic which we will expand upon in the next blog post.

* Note that we could separate this out between consumer surplus and producer surplus, but for our purposes here, such a distinction does not matter.  It does not change the analysis one wit.

Today’s Quote of the Day…

…is found in a letter from Frederic Bastiat to Richard Cobden (leader of the Anti-Corn Law League) dated 8 April 1845.  The letter can be found on page 58 of the Liberty Fund’s collection of Bastiat’s correspondence, The Man and the Statesman (emphasis added):

Sir,

Since you have permitted me to write to you, I will reply to your kind letter dates 12th December last.  I have been discussing the printing of the translation [of Cobden’s speeches and pamphlets] I told you about with M. Guillaumin, a bookseller in Paris.

The book is entitled “Cobden and the League, or the Campiagn in England in Favor of Free Trade.”  I have taken the liberty of using your name for the following reasons: I could not entitle this work “The Anti-Corn Law League.”  Apart from the fact that this would have a barborous sound for French ears, it would have brought to mind a limited conception of the project. It would have presented the question as purely English, whereas it is a humanitarian one, the most notably so of all those which have brought campaigning to our century.

By presenting the issue of free trade as a humanitarian issue rather than a sectarian or nationalist issue, he demonstrates the universality of the principles of free trade.  Many opponents of free trade like to argue that free trade is conditional.  They may argue that free trade requires “transnational rule-making institutions.”  Or that trade only is good if one nation (ie the nation of the speaker) benefits.  Or that free trade needs to be “fair” (whatever that means).  But Bastiat makes no such prerequisites.  Bastiat and Cobden both argue that free trade is not an English concern, not a French concern, not an American concern, but a human concern.

The Anti-Corn Law League that Cobden was part of was founded in opposition to the Corn Laws, a series of mercantilist legislation that raised the price of food within Great Britain by restricting imports.  Given this legislation occurred at the same time as the Irish Potato Famine, the Corn Law, by artificially increasing scarcity of food, likely caused many deaths in Ireland from the famine.  The Corn Laws contributed to a humanitarian crisis.  We are seeing similar situations going on in Puerto Rico, where scarcity is increased because of the Jones Act, and Houston and Florida where scarcity is increased because of anti-price-gouging legislation.  Free trade is a humanitarian concern, not a sectarian concern.

In Stark Contrast

In booming economic times, the detrimental effects of policies like minimum wage, immigration restrictions, protectionism scarcityism, or socialism, can be hard to see.  The good growth outweighs the bad from the policies, obscuring their effects.  However, once times get tough, then the negative aspects of these policies stand in stark contrast.  By way of metaphor, imagine going downhill in a car.  Lightly applying the brakes won’t do much (depending on how steep the hill is, you may actually gain speed!).  However, if you are going uphill, even a light tap will have a large effect on the car.

Unfortunately, the obscurity generated by the good times can cause less careful thinkers to determine that there are no negative effects of the policies they want.  We see this quite often with protectionism.

We are now seeing the negative effects of protectionism and immigration restrictions here in the US following three major hurricanes that have hit in the past month: Harvey in Houston, Irma in Florida, and Maria in Puerto Rico.  In normal times, the detrimental effects of artificially high prices and artificially scarce resources tend not to be noticed.  Like the farmer who grows 100 acres of corn, and 1 acre is destroyed by parasites, it’s not too noticeable.  But if a disaster hits, and how only 10 acres can grow with 1 acre being destroyed, it’s very problematic.  When times are tough, and resources scarce, the market needs to work.  These artificial restrictions only make the scarcity worse.

Looking at disasters like Irma, Harvey, Maria, etc give us an excellent chance to test the claims of the scarcityists, that protectionism, minimum wage, and immigration restrictions grow the economy, not shrink it.  Given the tough time Texas, Florida, and Puerto Rico have is recovering basic supplies, it’s hard to believe the claims of the scarcityists.  Abundance is wealth, not scarcity.

Unintended Consequences of Protectionism: The Jones Act and Highway Congestion

In 1920, the US government passed the Jones Act, an act requiring all sea shipping between US ports be done on ships that were built, crewed, flagged, and owned by Americans.  The act is a clearly protectionist measure designed to protect domestic shipping from foreign competition (although there is also a national defense argument for it).  The idea is that a cheaper foreign shipping company could not undercut US shippers on domestic trade routes.  If I were to ship something via ocean from Miami to Boston, I’d have to do it on US built, crewed, flagged, and owned ships.

The Jones Act, to the extent it is binding, raises the cost of ocean shipping in the US (if this were not the case, say it were already cheaper to ship on US ships than foreign ones, then the Jones Act would not be binding).  When the relative price of something rises, it encourages the use of substitutes.  The main substitutes for domestic shipping are trucking and railroad (and air to a lesser extent).  With the rise of ocean shipping costs from the Jones Act, transporters would turn to trucking and rail.  Furthermore, since trucks take up a lot of room on the highways and freeways, it is likely the marginal increase in trucking from the Jones Act increases congestion on the highways.  In short, the unintentional result of the Jones Act is to increase traffic congestion (and, potentially, traffic accidents as well).

Some interesting thoughts for further research:

  1. Do trucking and rail companies lobby in support of the Jones Act (bootlegger and Baptist)?
  2. Has the Jones Act had a measurable impact on the level of traffic (this is an empirical question that would be extremely hard to answer because of the age of the Act)?