"Au Contraire, Mr. President: Trade Deficit Is Not a Big Deal"

Daniel R. Pearson discusses his article "Au Contraire, Mr. President: Trade Deficit Is Not a Big Deal" on Freedomworks' The Paul Molloy Show.

Cooking the trade-account books

One of the madder recent ideas to come out of the Trump administration in the U.S. is  a plan to change the way the U.S. calculates trade deficits. The administration suggests not counting re-exports in the U.S. trade balance. That is, the administration wish to exclude from U.S. exports any goods first imported into the country, e.g. cars, and then transferred to a third country, e.g. Canada or Mexico, unchanged. This would make the country's trade gap appear larger than it now. Data on trade balances and surpluses are at the center of a political battle in the U.S. over whether existing trade agreements the U.S. has with other countries should be retained, renegotiated or tossed out altogether. Should the change be implemented, it would have a large effect on the data involving countries that have free trade deals with the U.S. In some cases this new methodology would even change a trade surplus into a trade deficit.

Professor Mark J. Perry makes four points with regard to the the administration's idea,

1. This proposal is apparently based 100% on politics and 0% on any economic theory or on standard, well-established double-entry national income accounting practices.
2. The proposal’s main (and possibly only) motivation is to manipulate and artificially exaggerate America’s trade balance for goods, mostly (exclusively?) for political purposes – to re-negotiate trade deals or provide reasons to impose import tariffs.
3. The proposal is a departure from well-established double-entry national income accounting procedures that consider imports and exports without regard to the economic concept of “value-added.” That is, the proposal would switch from double-entry accounting for the cross-border movement of goods to a new “single-entry accounting” methodology that would count all goods entering the U.S. as imports, but would fail to count some U.S. exports if they are defined as “re-exports.” This would represent a significant departure from the way imports and exports have been calculated by the Department of Commerce for nearly 100 years.
4. Most of what gets exported from the U.S. contains some amount of imported content, so why only change the way “re-exports” are calculated? For example, many Ford and GM cars contain more than 50% non-U.S. content. If those automakers export cars assembled domestically, the value of those exports count 100% as U.S. exports, even though some “domestic” cars could contain 60% or more foreign content. And yet, if Ford or GM imports a car from Mexico and re-exports those vehicle to Canada, those exports would not count at all for U.S. export? Further, it’s possible that GM and Ford cars assembled in Mexico could contain parts and content imported from the U.S., which further makes the new manipulated recalculation questionable.

Perry continues by making the point this idea is being proposed purely for political reasons,

This proposal for recalculating trade balances is a manipulative single-entry accounting scam that is being proposed for political reasons only. A single-entry accounting approach to calculating trade balances serves only one political purpose/outcome – to artificially inflate the trade deficit for goods — and is not supported by any economic or national income accounting theory or standard practice.

All this is just one more reason to worry about the Trump administration's views on international trade.

An interesting bit of history on the expression "There’s no such thing as a free lunch"

From an interview (pdf) with Milton Friedman.

QUESTION: Can you tell us—I don’t happen to know—under what circumstances you first said the famous words “There’s no such thing as a free lunch”?

FRIEDMAN: Peggy Noonan, who has written some very good words that you have all heard such as “Read my lips”—it’s too bad she wasn’t able to enforce the words she wrote—asked me if I could remember when I first used the words “There’s no such thing as a free lunch.” The answer is no, I don’t remember. However, I am not really the originator of that statement. A colleague of mine at the Hoover Institution traced it back to some time in the nineteenth century in the parlance of saloons: If you bought a beer, they would give you a free lunch. That’s where the phrase originally came from. It was made popular by Robert Heinlein, a science fiction writer who wrote a wonderful novel called The Moon Is a Harsh Mistress. The novel’s setting is a settlement on the moon that revolts using the motto TANSTAAFL (There ain’t no such thing as a free lunch). I may say that the revolution was a success because of a wonderful near-human computer.

But Adam Smith didn't say that

In a recent posting on the death of Kenneth Arrow Tim Harford writes,

Two achievements [of Arrow's work] are particularly celebrated: his impossibility theorem about the paradoxes of social choice, and his welfare theorems, which formalised the most famous intuition in economics — Adam Smith’s idea that a market produces social good from individual selfishness.

But Adam Smith didn't say that. As the historian of economic thought Mark Blaug notes,

"[ ... ] Smith's faith in the benefits of 'the invisible hand' has absolutely nothing whatever to do with allocative efficiency in circumstances where competition is perfect a la Walras and Pareto; the effort in modern textbooks to enlist Adam Smith in support of what is now known as the 'fundamental theorems of welfare economics' is a historical travesty of major proportions. For one thing, Smith's conception of competition was, as we have seen, a process conception, not an end-state conception. For another society, a decentralised competitive price system was held to be desirable because of its dynamic effects in widening the scope of the market and extending the advantages of the division of labour - in short, because it was a powerful engine for promoting the accumulation of capital and the growth of income" (emphasis added)

In short, it's not clear to me, at least, that Smith would have been much impressed by the work of McKenzie, Debreu and Arrow et al with regard to the approach and results of general equilibrium theory. In fact, in today's terms, I often think of Smith being more Austrian-like than neoclassical-like.

Ref.

• Blaug, Mark 1996. Economic Theory in Retrospect. 5th edn. (pp. 60-1). Cambridge: Cambridge University Press.

Boudreaux on the minimum wage and free trade

Jacob Hornberger and Richard Ebeling discuss the economics of the minimum wage and free trade with Donald J. Boudreaux on the "Libertarian Angle" (from the Future of Freedom Foundation).

Bottleneckers: gaming the government for power and private profit

From the Cato Institute comes this Cato Daily Podcast in which Caleb O. Brown talks to Dick M. Carpenter II about so-called "bottleneckers" and how they restrict competition and harm the public. Brown and Carpenter of the Institute for Justice discuss Carpenter's new book, Bottleneckers.

Governments and the "war on drugs"

An interesting talk on why governments are loosing the "war on drugs". Affecting demand is more important than changing supply.

When fighting the war on drugs, governments typically devote enormous resources trying to reduce the supply. But is this effective? Journalist and author Tom Wainwright, of the Economist and author of Narconomics, talks with EconTalk host Russ Roberts about the ways that the drug cartels respond to government attempts to reduce the availability of drugs. Like any business trying to maintain profitability, cartels look for ways to cut costs and maintain or grow revenue. Wainwright uses extensive on-the-ground interviews and reporting to understand the behavior of the cartels and argues that reducing demand would be a much more effective strategy for reducing drug use.

A direct link to the audio is available here.

Some thoughts on the role of firms and government interference in the market

This is from the third instalment in (oddly named - seems more pro-state than anything) ProMarket's new interview series on the economic theory of the firm. In this instalment, they ask Chicago Booth’s Steven Kaplan how the existing theory should be modified. Kaplan is the Neubauer Family Professor of Entrepreneurship and Finance at the University of Chicago Booth School of Business.

Q: The neoclassical theory of the firm does not consider political engagement by corporations. How big an omission do you think this is?

I am a bit confused. Hasn’t the idea of regulatory capture and, implicitly, political engagement, been a subject of economic study since George Stigler’s “Theory of Economic Regulation” in 1971? In other words, it would be a big omission if, in fact, it were omitted. In reality, economists have paid attention to political engagement for a long time.

Q: To what extent is political engagement by corporations responsible for the current populist discontent?

Very little. The biggest source of populist discontent is the dislocation caused by technological change and globalization. That dislocation has made the global economy much better off overall. The global poverty rate has declined substantially. Billions of people now earn a living rather than starving. It is a huge success. As Nobel Prize winner Angus Deaton wrote, “Life is better now than at almost any time in history. More people are richer and fewer people live in dire poverty. Lives are longer and parents no longer routinely watch a quarter of their children die.” At the same time, this success has challenged the less skilled in developed countries—particularly the U.S. and Western Europe.

The second biggest source of discontent comes from the policies implemented in those countries that make it more expensive to hire less skilled workers. Raising the minimum wage, licensing rules, and other employment mandates increase the costs of hiring less skilled workers. At the same time, technology and globalization reduce the costs of substitutes. The net effect is fewer jobs. France is the best example. Germany is one of the few countries that moved in the opposite direction and has had less of an employment problem. Immigration policies also have fueled discontent.

Political engagement by corporations would be far down the list of important forces.

The basic issue being discussed is that the standard (economic) theory of the firm is silent on the role firms can play in shaping the rules of the game under which they operate. It is argued that in reality, many firms lobby politicians and try to capture regulators in order to modify the rules of the game in their favour.

What I do find strange is 1) Its not clear what exactly they mean by the "standard economic theory of the firm". At times they seem to talk about the neoclassical theory of the firm as if it is in fact a theory of the firm but has Coase pointed out many years ago it's not. If they are not talking about the neoclassical model then what are they talking about? As I have written,

While the post-1970 theory of the firm literature has began the task of developing a genuine understanding of the firm, and closely related issues, it has yet to coalesce around one model or even one group of models. Even within the contemporary mainstream there are a number of competing models, to say nothing of those we could add into the mix if we were to consider the heterodox literature.

2) I’m not sure what they are talking about is a problem with the theory of the firm, they seem to be talking more about a theory of government or regulation or pressure groups or some such thing. Yes firms can influence government policies but so can churches, trade unions, environmental groups etc as well. So I’m not sure their issue is one to do with the theory of the firm as such. 3) As Kaplan points out economists have been thinking about these issues for a long time, even if not as part of the theory of the firm. But as I say in 2) its not clear to me that it is part of the theory of the firm. It's a wider issue than to do with just firms.

A brief prehistory of the theory of the firm

A first draft of a new working paper on the (pre)history of the theory of the firm/theory of production.

The mainstream theory of the firm didn't exist until around 1970. Before then what we had was the `prehistory' of the theory of the firm. For more than two thousand years tools were available that could have given rise to a theory of the firm or, at least, a theory of micro level production, but none appeared. During this time the best that occurred were discussions of macro level or aggregate production. Given the long empirical history of and the importance to the economy of firms one may assume that economists have long been developing a detailed and sophisticated theoretical understanding of the firm but it turns out this is not the case. Up until the 1970s the development of the theory of the firm was a story of neglect and disinterest.

A brief prehistory of the theory of the firm by Paul Walker on Scribd

Seasonality and the invention of agriculture

Why was agriculture invented in one of the big questions in economic history. In a new working paper, The Ant and the Grasshopper: Seasonality and the Invention of Agriculture, Andrea Matranga argues that there is a link between seasonality and agriculture.

During the Neolithic Revolution, seven populations independently invented agriculture. In this paper, I argue that this innovation was a response to a large increase in climatic seasonality. Hunter-gatherers in the most affected regions became sedentary in order to store food and smooth their consumption. I present a model capturing the key incentives for adopting agriculture, and I test the resulting predictions against a global panel dataset of climate conditions and Neolithic adoption dates. I find that invention and adoption were both systematically more likely in places with higher seasonality. The findings of this paper imply that seasonality patterns 10,000 years ago were amongst the major determinants of the present day global distribution of crop productivities, ethnic groups, cultural traditions, and political institutions.

Tyler Cowen on Trumponomics

I still think Trumponomics won’t work. It is too divisive; it will be applied politically, targeting favorites and enemies, rather than in accord with the dictates of efficiency; it may destroy rather than create jobs on net; and most of all it badly damages the U.S.’s global reach by cooperating less on issues of trade and migration. I think of the program as a whole as cashing in on the capital asset of America’s foreign reputation and redistributing some of those rents to Trump-supporting regions. That is a form of shortsightedness, and a sign of the decay of our republic.

That's from Cowen's column, The Left Underestimates Trump's Economic Plan, at Bloomberg. While Trumponomics may very well damage the US economy we also have to keep in mind what damage it will do to the world economy. Trumps moves on trade could spark a trade war which could damage the world trading system. The last thing we need is a repeat of the Smoot-Hawley episode. No one wins a trade war.

"Silent Revolution" by The Benevolent Dictators

"Silent Revolution" by The Benevolent Dictators. The first song from the upcoming album about Adam Smith. Inspired by Book 3, Chapters 2-4 of "An Inquiry into the Natures and Causes of the Wealth of Nations" by Adam Smith.