Trade: A Defense
There has been an ongoing discussion sub-text throughout the entire crisis and recovery cycle I think we need to surface and make more explicit. That is the role of trade in our economy. There was not much reaction to President Obama’s recent commitment to expand US exports as a way of creating jobs. For some reason exports are seen as a naturally beneficial thing. By extension, I presume, imports are somehow not very good.
As in all things the answer is ‘it all depends’.
Here’s the primary issue: an economy is a vast allocative machine. It shuffles resources around between various activities and attempts to satisfy the needs and wants of its inhabitants as best as possible. If it does this well it allows those resources to be ever more productive. This means that any particular level of resources satisfies an increased level of needs or wants. As I have said before: productivity is the magic potion that allows this to happen.
A relatively free economy, one that has few artificial limits on the allocative machinery, will tend to be more dynamic in the way it seeks solutions to the ‘optimal’ distribution of resources. This is both an intuitive and a theoretically sound statement. But only so long as there are strict rules to put boundaries around the allocative effort: we have just experienced the consequences of a relatively unbounded economy in the financial sector, where the rules were so lax some people were able to gain a disproportionate allocation for themselves at the cost of a lesser allocation for others. They did this because the lack of rules enabled them to bias the allocative process in their favor. In essence they ‘cheated’ and prevented the competitive process from limiting their gains. Such people represent the antithesis of the archetypical denizens of a free market system. They are the rogues Karl Marx identified as the inevitable rotten core of capitalism. It was because Marx was spot on in his analysis that societies wanting to exploit the innovative aspects of capitalism all apply rules to limit its excesses. That way they avoid the trap he identified.
Within this allocative machine there are a number of things we can state with near certainty.
One of which is that if we allocate resources to one thing or activity, we cannot also allocate them to another. This implies that if we favor an activity, by giving it a tax advantage or by setting tariffs and so on, resources will flow into that activity and away from something else. Further: we have introduced a distortion. By bending the allocative process in an activity’s favor we have simultaneously burdened everything else. Those other activities will not take place, or will be reduced, because we have channeled resources elsewhere.
The only tike there is an exception to this distorting result is if there are excess or idle resources not currently being drawn upon. But even then such ‘spare capacity’ is a short term problem. Over the life of a full economic cycle, as resources are more fully drawn down for use, the distortion will eventually appear – things that might have been produced will not be because of the prior use of the necessary resources elsewhere.
This is all elementary.
And it applies to trade.
If we boost exports by giving them a tax advantage or other subsidy, we inevitably reduce the level of activity somewhere else in the economy. The number of jobs allocated to exports goes up, but at the cost of a decline in jobs doing something else. The total number of jobs stays the same. We have not increased employment, we have simply shuffled it about within the economy.
The only time this basic relationship can be altered is if aggregate world trade increases sufficiently to allow the increased export employment to co-exist with such economic growth that the total level of resources available expands and allows the disadvantaged activities to take place anyway. Even then the allocative machinery is still being biased, which means that somewhere within the economy there are needs or wants going unfulfilled because we have erected a barrier to prevent that fulfillment.
This introduction of bias can be done in a negative sense also: to disadvantage imports. This is protectionism.
The recent spat between the US and Europe over the US Air Force tanker contract is a good example of protectionism. The original contract bidding process produced a clear winner: the European Airbus version of a military tanker. It was larger, had greater range, greater carrying capacity, and was more cost effective than the US based Boeing version. Naturally the Air Force went with the European aircraft. This created a furor in Washington and, despite the fact that a significant part of the European plane was built in the US by Northrup, Congress forced the Air Force to re-submit the contract to bidding, this time re-written specifically to benefit Boeing. Rather than waste time on a clearly rigged bid, the European consortium, including Northrup, has declined to bid.
So the bout of protectionism has produced a perverse effect. The US Air Force has been forced into accepting an inferior product in order that Boeing wins the deal. The upshot, presumably is that one national interest – the maintenance of military related production by Boeing, trumped another – the security capability of the US Air Force. We cannot argue that the economy benefitted much if at all: presumably Boeing can expand its overall production and thus employ more people, but unemployment in Boeing’s production locations is already low, and it will probably have to entice workers to move to its locations in order to recruit the necessary workforce. Where might they come from? Well maybe from the areas where Northrup will obviously not be hiring now that it lost the bid. Net? The economy as a whole gains little. But it definitively loses something: the taxpayers end up subsidizing Boeing who makes a less attractive product. So we get a less cost effective plane and diminish our national security all in the name of protectionism.
A less well known example of the damage done by protectionism is the intervention in the steel industry by George Bush prior to the 2004 election. There was a clear political motive: protect US steel workers in Pennsylvania. This goal was wrapped in the usual verbiage about ‘unfair’ foreign competition. So tariffs were introduced on certain types of steel – coincidentally just the types produced in Pennsylvania, and so steel prices rose to levels that made the US producers competitive with those abroad – in this case mainly in India. The result was a big jump in prices for industries that use that type of steel. They, in turn tried to raise their prices to recoup this cost, and found themselves being undercut by competitors who still had access to the cheaper foreign steel.
The net effect?
We saved jobs in Pennsylvania. But lost many more than that as our other manufacturers lost market share. We ended up with fewer manufacturing jobs than we started with. I give Bush credit: he abandoned the tariffs when this all played out, but so far most of those lost jobs have not come back because they were outsourced to factories abroad where the access to cheap steel was not subject to US tariffs.
In other words we suffered a permanent loss of jobs from an ill advised intervention.
A second major thread through most discussions of trade is that some countries have ‘done well’ by supporting export industries and thus run ‘healthy’ trade surpluses. These countries are often looked upon as somehow ‘thrifty’ or diligent when compared with others who run trade deficits.
Once again the reality is more ambiguous than this surface analysis suggests.
A more perceptive analysis tells us that a country with a perennial surplus is actually running a massively unbalanced economy.
There are two major points to make here.
First: the perpetual surplus means that the exporting nation is devoting more resources to satisfying foreign needs and wants than it is to its domestic needs and wants. If it turns out that its domestic economy is fully satisfied, then the situation is worse: the exporter has allocated resources to something utterly dependent on factors abroad over which it has no control. This means that its standard of living is at the whim of others and is not under its own control.
Germany and Japan are good examples of this dependence on foreign demand.
But even this is shallow. Germany is proud of its export industries and bristles that it should boost its own demand. In the context of the current spat it has with Greece, German voters seem to think that everyone should be as self restrained as they are. They presumably overlook the simple fact that were that the case then German factories currently devoted to exports would sit idle – they would not be needed. Thrift is a two edged sword. For those idle German factories to remain open the Germans would have to buy more stuff themselves and give up some of their vaunted thriftiness. Put another way: the current German standard of living depends on other countries being willing to consume products made in Germany. Once that willingness ends, the Germans have to consume their own stuff or face the fact that they will have idle resources sitting around going to waste. That means even higher unemployment than they now have.
The Japanese are in exactly the same situation. They too are proud of their controlled consumption and their heavy emphasis on trade. Their standard of living, which has stagnated for a long time now, depends upon foreign consumption. The Japanese themselves consume far too little to justify all the factories and jobs that they have.
Both Japan and Germany under consume given the level of resources they have to allocate. They prefer to export and not consume. This choice implies that their respective populations are not purchasing as much as their economies can produce. They depend on foreigners to an extraordinary degree for their lifestyles.
China is a different case, although just as distorted. In their case the government manipulates its currency in order to stimulate exports. By doing this is attempts to establish production and thus grow jobs in those industries. But as I pointed out earlier, this implies that it is under-allocating elsewhere. Chinese domestic demand is much less than it could be, so there must, by implication, be very many Chinese people unable to grow their standard of living to the level they desire because there are insufficient goods and services to satisfy their need or wants. Those goods and services are being shipped abroad.
Second: A trade surplus has a flip side. By definition a country with a trade surplus has a capital ‘deficit’. It imports more capital than it exports. China uses this imported capital to buy foreign bonds and other assets, hence all the fuss over the Chinese ‘grip’ on the US Treasury.
Once again this a two edged sword.
What would happen if the Chinese sold its US bonds?
The price of those bonds would drop, so the Chinese would lose a lot of money, and the US Dollar would also decline in value making US exports much more competitive and making Chinese goods much more expensive. Neither of these would harm the US much at all. So the Chinese ‘grip’ is an illusion. The only problem they can cause would be the disruption in the market for US bonds were they to sell all at once. Such disruption could stop the US from selling enough bonds to finance its budget deficit in the near term – although longer term I don’t see that as a problem. Either way the Chinese would have to end up stimulating their domestic economy in order to shift their resources now allocated to sending stuff to America and instead send stuff inwardly.
These examples all seem to suggest that countries should not run trade imbalances, but that they should seek to allow the allocative machinery to fulfill demand in whatever way optimizes the amount of needs or wants it can cover.
And this is why trade itself is generally beneficial for those who engage in it.
Trade is often maligned because it can appear ‘unfair’ or ‘strategically damaging’. Countries, it is argued, should be able to put limits on trade to prevent these anti-social consequences.
I agree up to a point.
But.
Trade is a benefit. It allows us to allocate our resources more effectively. It is the extension of the allocative process to encompass multiple economies rather than simply focusing on one.
The result of trade is that each country involved can allocate its efforts towards those things that make most sense in its own circumstances. Saudi Arabia sits on top of a pot load of oil. Which has very little use or purpose unless it trades it to others who want it. There is no way the Saudis could use all the oil themselves – it has not value domestically, in fact it would be near worthless. It has value only in the context of the needs and wants of others who are prepared to pay for it. Likewise the abundance of cheap workers in China are of little value to themselves at the moment: they do not make enough money yet to justify buying all the stuff they can make. That pool of labor is much more valuable in the context of the American economy where the Americans want to allocate resources to things like movie making, internet start-ups, and professional sports than to factories paying low wages.
All trade should be viewed in such contexts. It is a manifestation of the way in which the allocative machinery is allowed to work. The more we interfere the more we distort the outcome.
As I pointed out at the beginning the introduction of a bias has a two edged effect: we privilege one thing or activity, and inhibit another. We deliberately move resources from one set of needs or wants and employ them on another set. The cost is reduced choice: we place a limit on the way in which resources can be used; and reduced potential: we employ resources on satisfying needs and wants that could be satisfied more effectively – more cheaply – elsewhere. Both these actions diminish the amount of needs and wants we can satisfy with any given level of resources. For example limiting imports of finished goods by taxing them, increase their prices. That leaves us all with less to spend on other things. For society as a whole this has odd outcomes: we can build fewer schools because we are using our money to prop up inefficient manufacturing.
The beauty of economic theory is that it makes this all clear. It also forces us to be explicit when we choose to interfere in the allocative machinery in order to limit or privilege activities.
Attacking trade should be done with the inevitable consequence made clear: we all lose something else. That something else is usually wealth we could have employed on something else we like: hospitals, schools, roads, health care and so on. Diminished wealth is not simply the diminution of consumerism. It is the diminution of the entire economy. Simply put: with restrictions on trade we end up satisfying fewer of our total needs or wants than we could have done. It is no accident that in periods of world history when trade has flourished, so have incomes. Conversely in periods when trade is restricted income growth has suffered.
So trade is not the problem: rigging the allocative machinery for private gain is another story. Corrupt or undemocratic politics trump the benefits of trade every time. Which is why interfering in the machinery to even out access and opportunity is a very different kind of interference and should never be conflated with protectionism. As long as we learn from Marx about the weaknesses of our system we can avoid the results he foresaw.
But that’s for another time.
