Don Boudreaux on free trade, protectionism, and the China shock

From David Beckworth’s podcast series, Macro Musings comes this audio of an interview with Don Boudreaux on Free Trade, Protectionism, and the China Shock.

Don Boudreaux is a professor of economics at George Mason University as well as the co-director of the Program on the American Economy and Globalization at the Mercatus Center. He joins the show today to talk about the future of trade and globalization. David and Don also discuss the history of protectionism in the US, President Trump’s trade policies, and why the China Shock thesis may signal bad economics.

Mental experiment on the effects of minimum wages

This thought experiment is from Don Boudreaux at Cafe Hayek.

Imagine that you’re given the option of buying ten-dollar bills for $5 a piece. How many will you buy? The answer is obvious: as many as the sellers of these discount-priced ten-dollar bills will sell to you. Of course, in reality $10 bills are never available for sale at $5 a piece. Or are they?! In a very real way, reality does indeed sometimes offer such deals. If a worker that can produce $10 per hour worth of output is currently paid by his or her employer only $5 per hour, a competing employer can profit by hiring, at some wage higher than $5 per hour, that worker away from his or her current employer. Indeed, employers will compete for this worker until this worker’s hourly wage is bid up to $10. (If you doubt this outcome, the burden is on you to explain why this worker’s wage will stop rising at some amount less than $10 per hour. It’s a surprisingly difficult burden to meet.)

Now imagine that you’re offered the prospect of buying five-dollar bills for $10 a piece. How many $5 bills will you buy? The answer again is obvious: none. Even if you’re a billionaire, you have no incentive to spend $10 to buy a $5 bill. The fact that you can “afford” to do so is irrelevant. If someone is asked to predict how many $5 bills, say, billionaire Nick Hanauer will buy if each of these bills is priced at $10, that someone would surely say “none.” And that someone would surely be correct.

The minimum wage is economically identical to a scenario in which government prohibits the sale of Federal Reserve notes at any price below $10 each. No bill worth less than $10 would be purchased. No one will knowingly buy something worth only $5 for a price higher than $5.

The above example involving Federal Reserve notes is easy to grasp. Yet change the item for sale from “five-dollar bill” to “low-skilled worker who can produce on average no more than $5 worth of output per hour,” and many people – including even some economists – somehow mysteriously find reason to believe that people will pay for $5 bills some price greater than $5.

Losing one’s wits over the trade deficit

At the Cafe Hayek blog Don Boudreaux has been writing wise words to the Wall Street Journal about trade deficits. Boudreaux writes in response to a letter written by Clyde Prestowitz in defense of Peter Navarro’s views on the trade deficit,

First, Prestowitz insists that trade deficits are debts that must be “repaid.” Not so. For example, most of the nearly $7 billion that BMW invested over the past quarter century in its Greer, SC, operations is part of America’s trade deficit, yet none of this investment is debt. It’s equity. Americans are not obliged to repay one cent of these funds.

It’s true that BMW’s owners, as Prestowitz correctly says about investors generally, “expect a return on their investment.” But no equity investors, foreign or domestic, receive returns unless they use their equity productively – that is, unless their equity is used to produce value that would otherwise not exist. Therefore, any returns received by successful foreign equity investors are created by these investors’ own vision, efforts, and risk-taking. Contrary to Prestowitz’s implication, these returns are not resources taken from Americans, for these returns would not exist absent the particular productive uses to which the foreign investments are put.

This misunderstanding is repeated when Prestowitz writes that “At least some of that return is repatriated to the home countries of the investors…. That repatriation constitutes a net outflow of wealth.” Again, the wealth to which Prestowitz refers is created by the foreign investors. It may “flow” out of the U.S., but it exists in the first place only because of the entrepreneurial vision and risk-taking of the foreign investors who earn it.

The second example of Prestowitz’s error arises from his failure to understand what happens when foreigners “repatriate” wealth earned in America. Returns on investments in America are earned in dollars. When BMW repatriates its U.S. returns to Germany, it converts those dollars into euros – and the sellers of euros who accept BMW’s dollars will either spend or invest those dollars in the U.S. Prestowitz’s is mistaken to suggest that repatriation of foreign returns causes a leakage of demand from the U.S. economy.

Both points made by Boudreaux are important, but the second is one I have made several time on this blog (eg here) since it is an idea many people seem to get wrong. Dollars do not leave a country. For example, the only place New Zealand dollars are useful is in New Zealand so if someone takes profits "out of New Zealand" the only way they can do so is by selling those dollars. The only place the buyer of those dollars can use them is New Zealand.

If economic ignorance were a natural resource, our world would be paradise

You have to love a heading like that! It comes not from me but from the ever insightful Don Boudreaux at the Cafe Hayek blog. Boudreaux is commenting on the idea that the government subsidisation of low-skilled workers’ "housing, food, medical care, and transportation" enables employers of such workers to pay them less than some "true value" of their work.

There is an obvious question as to what this "true value' is.

Boudreaux writes,

The central economic point is this: the welfare programs to which Mr. Phelps alludes (with the possible exception of transportation subsidies) reduce the supply of labor and, thus, push wages up. Far from employers being subsidized by such welfare programs, employers of workers who receive these government benefits are obliged, as a result, to pay wages that are made artificially high.

But to show just how deeply confused this Mr. Phelps is, let’s pretend that he’s correct to insist that welfare programs artificially reduce wages. Mr. Phelps then asserts that “Failure to pay a living wage gives consumers artificially low prices and increases corporate profits.” Because nearly all employers of low-skilled workers operate in intensely competitive industries such as retail and food service, workers’ artificially low wages would indeed result in artificially low prices for consumer goods, but not in increased corporate profits. The ability to hire workers at artificially low wages would attract new entrants into these markets, as well as cause existing firms to expand their outputs, until the rate of profit earned by employers of these workers is no higher than it would be if wages were higher. That Mr. Phelps is oblivious to this reality is sufficient reason to dismiss his economic analysis.

While I agree with Boudreaux's point, I do wonder just how large the effect is. Of all the things the government does to stuff-up the labour market is this a big player?

Navarro on the trade deficit (updated)

As bizarre as this sounds Peter Navarro, Trump's main trade adviser - Navarro is director of the White House National Trade Council, has written in an article in the Wall Street Journal that

The economic argument that trade deficits matter begins with the observation that growth in real GDP depends on only four factors: consumption, government spending, business investment and net exports (the difference between exports and imports). Reducing a trade deficit through tough, smart negotiations is a way to increase net exports—and boost the rate of economic growth.

Now as a matter of national income accounting this is just plan wrong, as any Econ101 student will be able to tell you. Let us ignore the economics of it for now.

The national income identity that Navarro is using is GDP=C+I+G+NX, where C is consumption, I is investment, G is government spending and NX is net exports which equals exports (X) minus imports (M) so we can write GDP=C+I+G+X-M. Now looking at that equation its looks like reducing M will increase GDP, but this is not so. Why?

To see why think about C. When we consume we consume both New Zealand made goods and foreign made goods, so C includes some imports. The same is true for I and G, both these include a component of imports. But as we are interested Gross Domestic Product we only want to include the New Zealand component of C, I and G, so we minus off imports at the end to remove the foreign components of C, I and G, leaving us with only the New Zealand component. That is, if we don't subtract M in the national income identity, we would overstate our GDP by the value of our imports.

Now think about what happens if we reduce imports and thus increase net exports. We reduce M, which makes it look as though GDP will go up but we also reduce the foreign component of C, I and G by exactly the same amount and thus nothing happens to GDP.

What if net exports could be increased by increasing exports via "smart negotiations"? (Whatever that means.) This would reduce the trade balance and thus the size of any current account deficit. But as the balance of payments must be zero a decrease in a current account deficit also means a decrease in the capital account surplus. There has to be a capital account surplus to get the balance of payments to be zero given a current account deficit. But this reduction the capital account means there is less investment and consumption taking place in the economy. A capital inflow lowers the interest rate and thus simulates domestic investment and consumption A smaller current account means a smaller capital account which implies higher interest rates meaning less investment. So if we could somehow increase X we would decrease I and C.

So again it's not clear GDP goes up.

When you start thinking about economics of reducing imports or increasing exports things get even worse but the national income accounting view of Navarro's statement alone should have you wondering about the standard of thinking on trade in the Trump administration.

Update: Don Boudreaux comments on the Navarro piece here, Tim Worstall comments here, Daniel Ikenson comments here, Phil Levy comments here, Richard A. Epstein comments here and Linette Lopez comments here.

What to say to those who lose their jobs because of imports

Here at the Cafe Hayek blog Don Boudreaux takes up one of the most difficult issues to do with advocating free trade, what does an advocate of free trade say to to those who lose jobs to imports?

Nothing that you say to someone who loses his or her job to changing market conditions is likely to satisfy that person. The personal almost always trumps the abstract. The seen hides the unseen. The proximate overwhelms the distant. The present is real while the future is still to be created. This reality, however, does not diminish the importance of defending free trade honestly, unconditionally, and without apology.

Such a defense begins with the insistence that jobs are not lost to imports or to foreigners; instead jobs are lost to fellow citizens – in two ways. First, it is the spending decisions of fellow citizens that determine when particular jobs are created and when they are destroyed. Second, the job lost by Smith is replaced with a new (and likely very different) job filled, if not by Smith, then by Smith’s fellow citizen Jones. So when someone complains about losing his or her job “to imports,” it is right to note that protecting that job necessarily requires that fellow citizens’ freedoms be curtailed and fellow citizens’ economic well-being be reduced. Protection necessarily shrinks the spending power of countless fellow citizens. Protectionism also destroys the actual jobs of many other fellow citizens (for example, jobs in domestic machine-tool factories that disappear because steel tariffs take a bite out of domestic machine-tool production) and destroys the job prospects of still other fellow citizens (for example, retail-store-management jobs that never materialize because tariffs on consumer goods reduce consumers’ demand for such goods).

Again, no such arguments will satisfy someone who believes that his job disappeared because of international trade. But that person’s refusal to accept that these arguments are part of a sound case for free trade does not, as emotionally understandable as this refusal is, render these arguments invalid. If we mute or trim our defense of free trade out of understandable sympathy with the unemployed worker who we see, we are complicit in supporting a system – protectionism – that not only destroys the jobs of workers who we don’t see (but who are, and whose sufferings are, every bit as real as the worker who we do see), but also will deny to our children and grandchildren a future that is as prosperous and as peaceful as possible.

It is necessary to keep in mind when defending free trade that it will destroy some jobs (a fact that is often clearly seen), and this has very real negative effects on people, but it is also necessary to realise that it will also create jobs (a fact that is often unseen) which has very real positive effects on other people. As Paul Krugman has written,

It should be possible to emphasize [...] that the level of employment is a macroeconomic issue, depending in the short run on aggregate demand and depending in the long run on the natural rate of unemployment, with microeconomic policies like tariffs having little net effect. Trade policy should be debated in terms of its impact on efficiency, not in terms of phony numbers about jobs created or lost.

The trade economist Douglas Irwin has this to say on the matter of trade and jobs,

The claim that trade should be limited because imports destroy jobs has been around at least since the sixteenth century. And imports do indeed destroy jobs in certain industries: [...]

But just because imports destroy some jobs does not mean that trade reduces overall employment or harms the economy. [...]

So in terms of jobs the free trade/protection debate is about which jobs there are in an economy rather than the total number of jobs. Changes in trade policy moves jobs a round the economy, free trade moves jobs away from sectors of the economy that produce things we are (relatively) bad at doing towards things we are (relatively) good at doing. Each of free trade and protection will be good for some people and bad for others. Perhaps the real question is, how do we best help those who in the short-run are harmed by changes in trade policy?

A challenge to mercantilists

A challenge from Don Boudreaux at the Cafe Hayek blog. Boudreaux issues the following challenge to any protectionist/mercantilist/economic-nationalist who might wish to take it on:

Identify one plausible economic problem caused by free trade that is unique to trade and commerce that spans political borders. Just one. That is, identify a problem with free trade that arises when people are free to buy and sell internationally but that does not arise when people are free to buy and sell intranationally.

In other words, what economic problems can we avoid by restricting international trade that we don't have to deal with in internal trade?  I've got to admit I've yet to think of anything even remotely plausible as an answer to this challenge.

The Elemental Case for Free Trade

From the Cafe Hayek blog comes this great piece from Don Boudreaux on The Elemental Case for Free Trade. Everybody, especially politicians, should read and think about this.

The following are remarks delivered by Professor Boudreaux on October 14th, 2016, in Atlanta, GA, at Hillsdale College’s 10th annual Free Market Forum.

I.

The positive economic case for free trade is straightforward. Here I distill it into ten – well, as you’ll see, really eleven – elemental points.

First, nothing about political borders justifies treating trades that cross those borders differently than trades that don’t. Whatever benefits result from you trading with someone in Kentucky are no less available when you trade with someone in Korea. Whatever economic problems – real or imaginary – are caused by you trading with someone in Korea are no less likely when you trade with someone in Kentucky.

Second, all economic activity is ultimately justified by how much it enables us to expand our consumption, not by how much it enables us to expand our production. Consumption is the end; production is the means. Of course, production is an essential means; we cannot expand consumption without expanding production. But production is not the ultimate purpose of economic activity. If you disbelieve me, ask yourself how much you’d pay for a sawdust-nail-‘n’-cardboard pie that took its well-meaning baker several days to produce. If you answer “nothing,” then you get this point.

Third, specialization expands output. And the greater the amount of specialization, the greater the output. A medical profession made up only of family-practice physicians will save fewer lives and reduce less pain than a medical profession made up of specialists such as neurosurgeons, podiatrists, cardiologists, ophthalmologists, and – my favorite (because many years ago one of these specialists saved my young son’s life) – pediatric gastroenterologists.

Fourth, specialization requires trade. A pediatric gastroenterologist based in New York City today enjoys a high standard of living, but only because many people willingly pay him to specialize in that highly specialized line of work and willingly accept his money in exchange for what they produce. This physician is rich only because he trades with others. If farmers, carpenters, tailors, airline pilots, and economics professors were unwilling to trade with him, he’d have no time to practice pediatric gastroenterology. He’d instead have to grow his own food, build his own home, and make his own clothing. He, and the rest of us, would be much poorer.

Fifth, specialization increases with the size of the market. The greater the number of consumers and producers, the larger is the scope for each producer to focus on a narrow specialization. This fact is why large cities have niche restaurants, such as vegan Lebanese, and highly specialized physicians, such as pediatric gastroenterologists, while small towns don’t feature restaurants and trades so highly specialized.

Points four and five working together spark self-reinforcing improvement: more trade promotes more specialization which, in turn, promotes more trade. Economies grow and standards of living improve.

Sixth, an important consequence of expanding the area of trade – of increasing the size of the market – is what economists call “increasing returns.” Doubling the number of people who trade freely with Americans causes the GDP of this larger economy to more than double. Per-capita GDP rises for all of these people who trade freely with each other. Compare medical care in an economy that features among its health-care professionals only 100 family-practice physicians to medical care in an economy with, say, 20 family-practice physicians and 180 specialists, such as pediatric gastroenterologists.

Seventh, there’s no limit to the degree to which labor can specialize and to which, as a result, total output can expand and expand at an increasing rate – that is, exhibit increasing returns. Put differently, the degree to which labor can specialize and cause total output to expand isn’t limited to, or defined by, the size of any particular country. Nor does the size of any particular country define a point beyond which the growth of specialization and output slows or becomes less reliable.

That is, even in a country as geographically large and as heavily populated as the United States, nothing in economic theory or history suggests that expanding the boundaries of our trading patterns externally – that is, beyond our borders – results in less expansion of our consumption and production than when we expand the boundaries of our trading patterns internally. We in Georgia or Virginia stand to gain just as much by expanding our trade with Mexicans as we stand to gain by expanding our trade with New Mexicans. There’s no reason not to have a global economy without economic boundaries.

Eighth, economic competition is good and it works just as effectively across political boundaries as it does within political boundaries. Competition disciplines firms, it spurs entrepreneurial creativity, and it discovers and encourages – much like a process of natural selection – what works best economically. Importantly, the competition that comes from free trade directs workers and other resources into those lines of productive activities at which each is most efficient. There’s simply no reason to neuter with trade restrictions the competition that comes from abroad simply because that competition isn’t home-grown.

Ninth, as Julian Simon taught, human beings in market economies are the ultimate resource. The ultimate resource isn’t land or petroleum or deposits of iron ore or of gold; it’s not factories or software or tractors; it’s not inventories of wheat or of rolled steel or of cash on hand. It’s human creativity and ingenuity. Indeed, it’s only because human creativity made them so that petroleum and iron ore and wheat and you-name-it are resources. Without human creativity these things would be mere raw materials, mere globs of molecules, that are no more valuable or useful to human beings than they are now to antelopes and hamsters.

And yet human creativity is one of the few resources that has consistently gotten more scarce over the course of the past 250 years.

We know that human creativity has gotten more scarce because its market price has risen enormously over the past few centuries in the market-oriented world. For example, the real hourly pay of the average American worker is today, conservatively estimated, about 60 times higher than it was in 1790.[1] This rise in the price of labor signals that it is has become more scarce relative to the demand for human labor.

In contrast, most other resources and productive inputs – including energy, metals, and transportation services – have become, and are still becoming, less scarce, if we judge them (as we should) by the trends in their real prices. They’re becoming less scarce precisely because we have more creative human beings contributing to the market economy.

Free trade maximizes the ability of the people of a country both to contribute their own creativity and effort to the global economy and to tap into the creativity and effort of the billions of other ultimate resources that reside in other countries. We tap into that creativity directly when we offshore productive tasks to foreign workers. We tap into it indirectly when we buy goods produced by foreign workers and entrepreneurs. Why would we wish to artificially reduce our and our fellow citizens’ access to supplies of the ultimate resource?

Tenth, restrictions on trade inevitably are driven by special-interest-group politics. Even if a sound theoretical case can be made for trade restrictions, it’s simply unrealistic to expect the state to be guided by that case. Instead, politicians and bureaucrats will only use that case as cover to create monopoly privileges for politically influential producer groups.

I here, at the last minute, add an eleventh point to the elemental case for free trade. I was reminded of this point just this morning by an e-mail from my great colleague Walter Williams. Walter asked me to remind you that countries don’t trade with each other; people trade with each other. China doesn’t trade with America. Individuals who reside on that part of the earth that we today call “China” choose to trade with other individuals who reside on that part of the earth that we today call “America” and who choose to trade with people in China.

That’s it. That’s the elemental economic case for free trade.

II.

But there’s a second part to the case for free trade. It’s the part that’s been constructed in response to the multitude of misunderstandings that have arisen over the centuries with regard to trade.

This second part to the case for free trade is the longer part. The reason is that the capacity for misunderstanding and mischaracterizing trade is enormous. Many falsehoods require many corrections.

Here I’ve time only to mention a few pieces of this second part of the case for free trade.

First, over the long-run free trade causes no net loss of jobs. Put differently – and harkening back to a point made above – any change in consumer spending causes some workers to lose jobs while creating jobs for other workers. International trade isn’t unique on this front. The jobs lost today to imports are replaced tomorrow by other jobs.

And these other jobs are, overall, better than the lost jobs because they are the ones at which the workers in the country have a comparative advantage. The jobs lost are ones at which the workers have a comparative disadvantage.

If you worry that the loss of particular jobs today cannot be made up for by the creation of new jobs, consider that in 1950 the U.S. workforce contained roughly 60 million people, with roughly 57 million jobs. The unemployment rate in 1950 was 5.3 percent. Today, the size of the U.S. workforce is about 160 million, with about 152,000 jobs. In 66 years, the number of workers and the number of jobs in America have each increased by a bit more than 150 percent. The rate of unemployment today is a not-too-shabby five percent.

Over the long run, the number of jobs is determined not by the freedom of trade but by the size of the labor force, by the flexibility of labor markets, and by workers’ willingness and abilities to remain unemployed as they search for better job offers. What free trade does is to replace worse jobs with better jobs; protectionism protects worse jobs by preventing the creation of better ones.

Another objection to free trade is that it is undesirable if it creates trade deficits. This is an egregious fallacy, because another name for trade deficits is “capital surpluses.” Every cent of a U.S. trade deficit is a cent invested by foreigners in America or in dollar-denominated assets. These investments not only return the dollars to the U.S., they also signal that the U.S. is a relatively attractive place to invest. Further, by enlarging our capital stock, they enrich us.

If commenters started referring not to “our trade deficit” but to “our capital surplus” – an exactly equivalent term – there’d be much less misunderstanding and mischief caused by this accounting artifact.

Finally here, it’s a myth that high-wage Americans can’t compete against low-wage foreigners.

Specialization arises according to comparative advantage, which doesn’t stop operating as the wages of workers in a nation rise relative to wages elsewhere. But this point is esoteric. Another point is that low wages reflect low productivity. Americans’ wages are higher than Chinese wages because American workers on average are more productive than Chinese workers. So next time someone says “We can’t compete against low-wage foreigners,” translate that claim into its equivalent: “We can’t compete against low-productivity foreigners.” The latter claim sounds as silly as it really is.

III.

I close not with economics but with ethics. After all is said and done my support for free trade is grounded in ethics, regardless of the economics. I believe deeply that if you work and earn income honestly, that income is yours to use as you choose. You may use it to buy tomatoes from your neighbor or to buy tomatoes from a farmer in Mexico. It’s your money. It belongs neither to the state nor to any domestic producer.

Yet protectionist arguments rest on the premise that your neighbor has some positive claim on your income. If you are prohibited from buying tomatoes from Mexico, or – more commonly today – penalized with a tariff for doing so, the state is insisting that domestic tomato growers have an ethical claim on part of your income. If you do not spend your income as the state, or as domestic tomato growers, deem best, you will be penalized. Tomato-growers’ economic well-being is elevated above yours. I find this presumption, which undergirds nearly all protectionist policies, to be reprehensible and ethically indefensible.

Yes we can run trade deficits forever

Over at the EconLog blog Scott Sumner has blogged on Why America can run trade deficits forever. The logic, of course, applies to any county. Summer writes,

The US has been running large current account deficits for many decades. Commenters often suggest that this means we are becoming a debtor nation, living beyond our means. This is not true.

The US earns more from our foreign investments overseas that foreigners earn on their investments in the US. China earns $65 billion selling goods to the US, and fritters the money away in loans to places like Venezuela. Meanwhile our multinational corporations make shrewd investments overseas, which bring lots of money back to the US economy.

The international accounts balance out perfectly, once you include trade in goods, services, and assets. The overall balance of payments deficit is precisely zero, if measured properly. Some countries, such as China, are relatively good at exporting goods. They run a positive trade balance. The US is relatively good at international investment---we run a persistent trade deficit, financed by our profits on overseas investments. Or we sell the Chinese "goods" such as houses in LA, that don't count as US exports because they are not physically moved overseas.

Our balance of payments accounting doesn't really correspond to what's going on in the real world. If we sold the Chinese mobile homes, and put them on a ship to China, they'd count as exports. It sounds crazy, and it is, but that's how the accounting is done.

This does not mean that we live beyond our means. GDP in the US is much larger than US consumption. Over time, we are becoming wealthier and wealthier. If countries like China ever became more adept at international investment, then the US would have to share a greater proportion of its GDP with the rest of the world.

In the comments to the post Don Boudreaux writes:

Nice job - but why do you suggest that America's trade (or current-account) deficit requires that Americans consistently earn profits on their foreign investments? It seems to me that all that is required for Americans to run capital-account surpluses consistently or even indefinitely is that foreigners continue, year after year, to find America to be a relatively more attractive place to invest than Americans find non-American places. Indeed, if we Americans were so very good at investing abroad that we consistently profit on most such investments, that reality - by steadily increasing our foreign investments relative to foreigners' investments in America - would put downward pressure on our current-account deficit.

Any interesting response to the Summer post comes from Phil in the comments,

A perpetuation of this transfer will lead to major trouble. To understand why, take a wildly fanciful trip with me to two isolated, side-by-side islands of equal size, Squanderville and Thriftville. Land is the only capital asset on these islands, and their communities are primitive, needing only food and producing only food. Working eight hours a day, in fact, each inhabitant can produce enough food to sustain himself or herself. And for a long time that's how things go along. On each island everybody works the prescribed eight hours a day, which means that each society is self-sufficient.

Eventually, though, the industrious citizens of Thriftville decide to do some serious saving and investing, and they start to work 16 hours a day. In this mode they continue to live off the food they produce in eight hours of work but begin exporting an equal amount to their one and only trading outlet, Squanderville.

The citizens of Squanderville are ecstatic about this turn of events, since they can now live their lives free from toil but eat as well as ever. Oh, yes, there's a quid pro quo--but to the Squanders, it seems harmless: All that the Thrifts want in exchange for their food is Squanderbonds (which are denominated, naturally, in Squanderbucks).

Over time Thriftville accumulates an enormous amount of these bonds, which at their core represent claim checks on the future output of Squanderville. A few pundits in Squanderville smell trouble coming. They foresee that for the Squanders both to eat and to pay off--or simply service--the debt they're piling up will eventually require them to work more than eight hours a day. But the residents of Squanderville are in no mood to listen to such doomsaying.

Meanwhile, the citizens of Thriftville begin to get nervous. Just how good, they ask, are the IOUs of a shiftless island? So the Thrifts change strategy: Though they continue to hold some bonds, they sell most of them to Squanderville residents for Squanderbucks and use the proceeds to buy Squanderville land. And eventually the Thrifts own all of Squanderville.

At that point, the Squanders are forced to deal with an ugly equation: They must now not only return to working eight hours a day in order to eat--they have nothing left to trade--but must also work additional hours to service their debt and pay Thriftville rent on the land so imprudently sold. In effect, Squanderville has been colonized by purchase rather than conquest.

In reply to this argument Don Boudreaux writes:

The scenario you describe is possible. But it does not undermine the larger point made by Scott. The reason is that you implicitly assume throughout your tale that all of Squanderville's trade deficit becomes Squanderville's debt and that none, or too little, of that debt is used to finance the production of capital that will increase future output in Squanderville. Given the name of that mythical country, that is not a bad assumption.

But in reality any real country can run a trade (or current-account) deficit without incurring a smidgen of debt - such as, for example, when producers in country F simply hold some of the currency they earn by selling goods to denizens of country D, or when producers in country F use some of these earnings to buy shares of stock in businesses headquartered in country D, or when producers in country F use some of these earnings to build factories or retail outlets in country D.

When Ikea, for example, builds a store in Newark, New Jersey, the stock of capital in America increases as the U.S. trade 'deficit' thereby rises. It's true that some higher proportion of capital in the U.S. is now owned by people whose passports are issued by a foreign government, but so what? From my perspective as an American I am no poorer because of this Swedish investment in NJ, and I am likely wealthier: I can now get more furniture at lower prices and, perhaps, I might even get a better job working at that Ikea store (or, alternatively, my wage in my current job at Acme Furniture Retailer in Hackensack, NJ, might be bid up due to the resulting additional competition for workers such as myself)

There are other reasons why your tale fails to capture the full range of reasons why country D's consistent trade deficits are not necessarily a problem for the people of country D, but I'll not list them here.

In reality, country D's consistent trade deficits in fact do not imply that country D is mortgaging its future to foreigners. Country D's trade deficit might very well be both a signal that the people and economy of country D are growing stronger and more prosperous over the long run and fuel for that stronger growth, for stronger growth in country D is what more capital investment in country D's private economy causes regardless of the nationalities of the investors. (The trade deficits that the U.S. has run for most of its history are almost certainly generally of this happy sort. Witness, for example, the British investments that helped in the 19th century to finance the building of railways in America.)

Further, the fact that country D's trade deficit, in any particular circumstance, might in fact be the result of such mortgaging as you describe in your tale is a reflection not of trade policy but of the high time preferences (or, if you prefer, the economic myopia) of citizens of country D. High-time-preferences (or myopia) among the citizens of D - whether expressed purely privately or through the agency of government borrowing - might indeed be a problem, but it is neither one that will be solved by trade restrictions nor one that even requires that the citizens of D trade with foreigners at all. Such profligacy as you rightly suggest is damaging over the long run is perfectly possible to play out exclusively within the borders of country D, without D running a trade deficit.

Much of the issue here is just a misunderstanding of an accounting convention, what gets recorded where in the national accounts. The so-called "trade deficit" or current-account deficit may be a symptom of something being wrong somewhere in the economy, but it is not in and of itself a problem.

Boudreaux on robots

At Cafe Hayek Don Boudreaux makes a good point about the effects of robots on employment:

Robots not only do not threaten to increase long-term unemployment, they make our lives easier and more prosperous – and they’ve done so for eons. Witness the wheel, the lever, the bucket, the shovel, the cart, the harness, the plough, the rope, the spear, the knife, the pulley, the pipe, the pump, the oar, the sail, the printing press – and, of course, the steam engine, the locomotive, the bulldozer, the bus, the jet engine, the kitchen blender, the washing machine, the light switch, the flush toilet, the microprocessor. As Deirdre McCloskey writes in her new volume, Bourgeois Equality, “[t]he repeated alarms against robots are silly, since robots are merely mechanical slaves for our benefit.”

I agree with Boudreaux and McCloskey on this. Changes in technology are nothing new and employment has kept on growing. Why should today be any different? New technology changes the types of jobs there are but it doesn't reduce the number of jobs. And it makes us richer. What's not to like?

Virginia School of Political Economy

In these videos Jayme Lemke interviews Professor Donald Boudreaux of George Mason University on the Virginia School of Political Economy. In this discussion, Lemke and Boudreaux discuss the core insights of public choice economics.

Virginia School of Political Economy I: An Introduction to Public Choice


Virginia School of Political Economy II: The Continuing Relevance of Public Choice

Don Boudreaux discusses the effects of minimum wages

In this video Don Boudreaux discusses the effects of the minimum wage with Reason’s Nick Gillespie.

Paul Krugman should know better (updated)

At the Cafe Hayek blog Don Boudreaux writes,

During the course of the discussion one of my superb students, Chris Kuiper, mentioned in passing that Paul Krugman, in a recent New York Times column, mistakenly described safe drinking water as a public good. Here’s that column. Mr. Krugman emphasizes that safe drinking water is a public good according to “Econ 101.”

I don't think so. At least not back when I did Econ 101.

A public good is a good which has two properties, 1) non-excludable, which basically means if one person gets it then everybody get it and 2) non-rivalrous in consumption which amounts to saying the amount I consume don't affect the amount you can consume.

Now I don't think it will take to long for you to convince yourself that safe drinking water does not have these two properties. To take point 1), If water pipes go to my place but not to yours then I get water and you don't. Or if we pay for water and I pay the bill and you don't your water can be cut off. As to point 2) if water was non-rivalrous why are so many people worried about the amount of water used on farms, for example. If farmers could take all they wanted without reducing the water table their would be no problem. But we know they can't.

Safe water does, of course, have positive externalities that come with it, but this doesn't make it a public good. I'm guessing that what Krugman may be getting at is that safe water is a "merit good". The somewhat odd concept of a merit good was introduced by Richard Musgrave (1957, 1959). A merit good is a good or service which is judged that an individual or society should have on the basis of a norm other than respecting consumer preferences, ie the government forces you to have it. Or sometimes a merit good is thought of as a good which would be under-consumed (and under-produced) in the free market economy. There are, it is claimed, two major reasons for this: (1) When consumed, a merit good creates positive externalities. This means that the public benefit is greater than the private benefit but as consumers only take into account private benefits they will under-consume the good or service (and so it is under-produced). (2) Individuals are myopic, they are short-term utility maximisers and so do not take into account the long term benefits of consuming a merit good and so they, again, under-consume the good.

It could be argued that there are positive externalities in the form public health benefits from safe water and thus it is a merit good. But this doesn't make it a public good.

Krugman also claims education is a public good.

There should, however, be much less debate about spending on what Econ 101 calls public goods—things that benefit everyone and can’t be provided by the private sector. Yes, we can differ over exactly how big a military we need or how dense and well-maintained the road network should be, but you wouldn’t expect controversy about spending enough to provide key public goods like basic education or safe drinking water. (Emphasis added)

And again no. To take just condition 1) from above, you can clearly exclude people from education. But again there are positive externalities to education, so a merit good.

Krugman, who is after all the co-author of an Econ 101 text, should know all of this. He is getting very sloppy when discussing basic economic ideas.

Refs.:

• Richard A. Musgrave (1957). "A Multiple Theory of Budget Determination," FinanzArchiv, New Series 25(1), pp. 33-43.
• Richard A. Musgrave (1959). The Theory of Public Finance, pp. 13-15.

Update: Tim Worstall also makes this point.

Consumption is the goal

One of the many things Adam Smith taught us is that the ultimate goal of economic activity is consumption and not as many people, most famously perhaps the mercantilists, seem to think, production. Adam Smith pointed out more than 240 years ago that "Consumption is the sole end and purpose of all production". We value production as a means of getting to the goal of consumption.

Trade helps consumers while protection helps producers and thus if production is the ultimate goal then we should support protection. If on the other hand we see consumption as the ultimate economic goal then we should oppose protection. While this point may be well appreciated among economists its not as well understood by non economists. Don Boudreaux has been trying to correct this situation with an opinion piece in the Pittsburgh Tribune-Review. He writes,

Suppose [...] that we accept an opinion held by many advocates of tariffs and other import restrictions — that opinion being that economic policy should be judged not by how well it enables people to consume but, instead, by how well it keeps current producers doing what they do.

“People take pride in their work,” these protectionists observe. “If trade causes them to lose their jobs, they'll lose their dignity. And preventing honest, hardworking people from losing their dignity is reason enough to restrict trade.”

No one doubts that excelling at a job is a source of self-respect and dignity for workers. But what's the root source of this self-respect and dignity? It's not just the worker's knowledge that she is providing well for herself and her family. If providing well for oneself and one's family were sufficient to create self-respect and dignity, then the successful armed robber and arsonist-for-hire would have self-respect and dignity.

Essential to a producer's self-respect and dignity is the belief that he earns his living honestly. The producer takes justified pride in his work not merely because that work pays him well but because that work is socially useful.

Protectionism, however, destroys this source of pride — or, it would destroy this source of pride if protected producers understood the nature of protectionism. Protectionism allows a handful of producers to earn incomes not by serving consumers but, instead, by being served by consumers. Protectionism is a policy, enforced with threats of violence, that prevents consumers from spending their incomes in ways that promote their own best interests; protectionism is a policy of forcing consumers to spend their incomes in ways that promote the interests of current producers.

Protectionism treats production as the ultimate goal of economic activity — a goal that consumption must be made to serve.

Unlike workers and producers who succeed when trade is free, workers and producers who remain in their current jobs only because of trade barriers do not serve their fellow human beings as well as they possibly can. They do not truly earn their incomes. And there is no dignity in that.

Cool book and website

There is a cool new book and website available on the work of F. A. Hayek designed for the general reader.

The book is the The Essential Hayek by Donald J. Boudreaux.

The chapters in the book are:

1. How we make sense of an incredibly complex world
2. Knowledge and prices
3. Individual flourishing and spontaneous order
4. The rule of law, freedom, and prosperity
5. Legislation is distinct from law
6. False economic security and the road to serfdom
7. Economic booms and busts
8. The curse of inflation
9. The challenge of living successfully in modern society
10. Ideas have consequences

The website is The Essential Hayek where you can download a free pdf of the whole book, read the chapters of the book and watch short videos which explain the ideas in the book.

The machines are coming, do we care?

Man has been inventing labour saving technology ever since, well, man has been man. And it has yet to lead to long-term mass unemployment. And yet the Luddite type fear that machines will take over all the jobs in the economy is making something of a come back.

Economist Donald J. Boudreaux has written a letter to the editor of the New York Times to make the point that all known examples of labour-saving technology have lead to greater well being for the masses, not mass suffering. So why do people think this time will be different?

Warning that modern labor-saving technology is making humans expendable, Zeynep Tufekci writes that “[o]ptimists insist that we’ve been here before, during the Industrial Revolution, when machinery replaced manual labor, and all we need is a little more education and better skills. But that is not a sufficient answer. One historical example is no guarantee of future events, and we won’t be able to compete by trying to stay one step ahead in a losing battle” (“The Machines are Coming,” April 19).

Ms. Tufekci is mistaken to insist that the Industrial Revolution is the lone historical example of humans having had to adjust to labor-saving technology. As the economic historian Deirdre McCloskey notes, while the introduction of such technological improvements greatly accelerated since the Industrial Revolution, these have occurred throughout all of human history.

Examples of labor-saving technology that were created before the Industrial Revolution include the wheel, the lever, the pulley, the bucket, the barrel, the knife, the domesticated ox and horse, the fishing net, and moveable type. Examples of such technology created after that revolution are even more numerous; they include the harnessing of electricity, the internal-combustion engine, the assembly line, chemical fertilizers and pesticides, refrigeration, and, of course, today’s many IT marvels. Yet history knows no example of the introduction of labor-saving technology that caused permanent and widespread increases in involuntary human idleness. And at least since the dawn of the Industrial Revolution, all advances in such technology in market economies have been followed by improvements in the living standards of the masses - including (contrary to Ms. Tufekci’s suggestion) those advances introduced during the past few decades.

Don Boudreaux makes the case that economic freedom and freedom generally are inseparable

Here’s a video of the six-minute talk that was given by Don Boudreaux last month at the Oslo Freedom Forum - a talk that preceded a longer panel discussion – on the inseparability of economic and non-economic freedoms.

Boudreaux on fair trade

Don Boudreaux has written a letter, as only Don Boudreaux can, to the Washington Post:

Harold Meyerson dislikes foreign trade, in part because it destroys some American jobs (“Go slower on free trade,” June 4). And so Mr. Meyerson favorably quotes one of Congress’s staunchest protectionists, Sen. Sherrod Brown (D-OH): “A trade deal, says Brown, ‘should both protect workers and small businesses and better prepare them for globalization.’”

Let’s make a deal. Government will agree to protect only those American workers and small-business owners who in return agree to stop buying foreign-made products.

For example, American steel workers will get protection from steel imports only if they, in exchange, agree to stop buying the likes of Toyota cars, Samsung televisions, Ryobi hand tools, Ikea furniture, Shell gasoline, Amstel beer, vacations to Cancun, and musical recordings by foreign artists such as the Beatles, Elton John, and k.d. Lang. They must also promise to stop buying the likes of bananas, cinnamon, and vanilla and, indeed, even American-made food items if these are shipped to their favorite restaurants and supermarkets in foreign-made trucks – or in trucks equipped with tires made by Michelin, Bridgestone, or some other job-destroying foreign company. These workers would be permitted to drink only Hawaiian coffee; they must quit drinking the Colombian, Guatemalan, and Ethiopian coffees that they’ve become accustomed to drink. Oh, and absolutely no diamond jewelry, as those gems come from Africa. (Sorry, ladies.)

Small-business owners likewise will get such protection, but only in return for their agreement not only to stop consuming foreign-made products, but also to never sell their outputs to non-Americans. These businesses must, in addition, promise to use in their operations only American-made inputs – such as aluminum, wood, chemicals, and insurance services – even when foreign-made substitutes are available at lower prices or in higher qualities.

Deal?

One wonders just what this "deal" would do to the living standards of Americans and if those backing protectionism even realise the effect it would have. Its the seen and unseen. Protectionists see that some group or industry would benefit from protection but don't see the costs of that protection throughout the rest of the economy. Just how would the cost of living rise and the quality of goods and services fall. Doing things that you don't have a comparative advantage in only reduces the average income of the country. America could produce all the goods it wants to consume, it just would mean producing things that those overseas are better at doing and not doing things the US is good at. And foregoing the gains from trade.

Incentives matter: overhead-bin file

Resource allocation by non-price mechanisms usually doesn't work at all well. It gives people the wrong incentives for use of the resource. Don Boudreaux makes this point in a letter to USA Today:

Gary Nudd pleads with airline passengers to “play by the rules” when storing carry-on luggage (Letters, June 1). Makes sense. But a little-known fact that helps to explain today’s chaotic scramble for overhead-bin space was reported recently by Politico: “Two years ago, [U.S. Sen. Charles] Schumer got five big airlines to pledge that they wouldn’t charge passengers to stow carry-on bags in overhead bins.”

Overhead-bin space is scarce and, hence, valuable. So some airlines sensibly experimented with charging for its use. Government intervention, though, stopped this scarce commodity from being allocated by prices. As any Econ 101 student will tell you, the result is a costly free-for-all in which bin space is allocated far more arbitrary – on a first-come, first-served basis – than would be the case if allocation were guided instead by prices.

Sen. Schumer likely imagines that by ridding reality of one of scarcity’s symptoms – prices – he miraculously rids reality of scarcity itself. Today’s mad and frustrating clambering for space in overhead bins, however, proves that Sen. Schumer is deluded.

Population and economic growth

Don Boudreaux has been writing to the New York Times about population growth and the economy:

Reporting on Nigeria’s growing population, Elisabeth Rosenthal uncritically advances the popular narrative that large populations hamper economic development (“Nigeria Tested by Rapid Rise in Population,” April 15). She supports her point with demographer Peter Ogunjuyigbe’s declaration that “If you don’t take care of population, schools can’t cope, hospitals can’t cope, there’s not enough housing – there’s nothing you can do to have economic development.”

Not so.

Fifty countries today have population densities higher than that of Nigeria. Forty-two (or 84 percent) of these have per-capita incomes higher than that of Nigeria – and in many cases multiple times higher. South Korea, for example, has three times as many people per square mile as does Nigeria, yet South Korea’s per-capita income is more than ten times higher than Nigeria’s.

Nor does rapid growth of population necessarily prevent rapid growth of the economy. Over the past 150 years, California has had an average annual population growth rate of about 3.1 percent. (In some periods it’s been much higher, such as in the 1920s when California’s population grew at an average annual rate of 5.2 percent.) Only in the past 40 years has California’s annual population growth rate fallen below Nigeria’s current annual population growth rate of about 2.27 percent. Yet, obviously, this hefty population growth can hardly be said to have been a drag on California’s economy.

The point is an important one for a country with such a small population as New Zealand. A larger population isn't something to be feared in terms of our economic growth. Agglomeration effects that come with large cities is just one example of how a larger population can if fact help growth.