The Myth of Unfettered Trade

By its opponents, free trade (I’d include free markets, but I’d be repeating myself) is often called “unfettered trade.”  Such a term represents a fundamental misunderstanding of trade.  Trade is always fettered.  Competition, both from firms and from consumers, fetters trade because trade must be mutually beneficial.

Since trade must be mutually beneficial (since, if both parties don’t benefit, the trade would not occur), then even monopolies face fettered trade.  Even though monopolies are, in technical terms, price-makers (that is, the firm can choose what price it operates at), this does not mean they can charge any price and get the same results.  Firms face downward-sloping demand curves from their customers.  This means that, as price rises, quantity demanded falls (and vice versa: as price falls, quantity demanded rises).  If a monopolist charges a price too high, it may not maximize its profits (think of it like this: which earns more: selling 1,000 units for $1 each or 10 units for $70 each?).  Further, if a monopolist harms their consumers, their consumers can ultimately choose not to consume the product and seek substitutes or other alternatives.  These forces constrain the firm’s actions; in other words, these actions fetter the trade.*

The phrase “unfettered trade” is used for justification for government intervention in trade, but the argument is a red herring; a false representation of market forces.

*By the way, the opposite analysis holds, too: if a buyer offers too low a price, the seller may not choose to sell and so on.

Predatory Pricing and International Trade

A classic piece of industrial organization literature is John McGee’s 1958 article in the Journal of Law and Economics Predatory Price Cutting: The Standard Oil (NJ) Case.

In the article, McGee looks at price-cutting allegations leveled against Standard Oil in the early 1900’s. He examines the evidence of the case but also lays out a rather brilliant critique of price cutting as an effort to secure/gain monopoly power in a market. In short, he logically shows that price cutting is, by far, the least effective means of accomplishing this. It tends to be far more devastating to the price-cutting firm and, if the market is competitive, such price cutting could go on for years and years. It is far cheaper to simply buy up competition.

Dr McGee’s analysis should give us pause when considering “dumping” allegations in regard to international trade.  Dumping is a form of predatory pricing: manufacturers exporting goods to foreign markets and selling well below cost in order to grab market share.  As Dr McGee logically lays out in his article, predatory pricing tends to be extremely costly to the predator.  This could be why governments need to subsidize the firms in order to perpetuate the scheme.  However, as GMU economist Don Boudreaux points out in this blog post, subsidies harm the economy as a whole, while enriching the few who receive them.  Assuming China is subsidizing exports for the purpose of monopolizing highly-competitive markets, China is opting for short-term gains for firms by socializing the losses from the predatory pricing behavior on the off-chance they can monopolize a market.  Dr McGee’s analysis in the article indicates this is an extra-risky strategy (mergers and partnerships with US firms would be a far more effective way of accomplishing this goal).

Upgrades

I apologize with all the different looks the blog has had over the past few days.  After a year and a half of the old stuff, I figured it was time for a new look.  I am happy with the way things look now, so I shan’t be changing things.  At least for a while.  Thanks for your patience.

Why Can’t Success Just Be Success?

The above video is a Foot Locker ad featuring Tom Brady.  The ad takes a humorous swipe at Deflategate, but there is a larger issue I want to discuss, specifically this quote:

“Just because something’s great year after year doesn’t mean something’s going on.”

In the context of this ad, Brady is talking about Deflategate and the other scandals that have faced the Patriots over the past 10 years.  However, in a larger context, this statement is equally relevant.  People often point to inequality and success as proof “something’s going on.”  Peter Thiel pointed to the US’ trade deficit as proof “something has gone wrong.”  Income inequality is pointed to as proof capitalism is broken.  “Windfall profits” are proclaimed evidence of unfair business practices.  In baseball, accusations of steroids follow a player’s successful as sure as night follows a sunset.

To be fair, these inequalities may be a sign of something amiss.  But they alone do not mean something is amiss.  With respect to Frued, oftentimes success is just success.  A baseball player becomes successful because of hard work and luck, just as a businessman becomes successful through hard work and luck.  Their successes (higher home runs/higher profits) are not because of nefarious dealings but the natural end result of their efforts.  The fact they outperform their colleagues/competitors is a sign what they are doing is working, and should be encouraged, not deterred.  Legislation designed to go after successful people simply because of their successes (re-distributive taxation, windfall profit tax, tariffs, and the like) can and will have the effect of driving down competition, or forcing it away from maximizing gains into more risky and less socially beneficial areas of competition (for example, see Armin Alchain and Reuben Kessel’s 1962 paper Competition, Monopoly, and the Pursuit of Pecuniary Gain.

Money Can’t Buy Me Fear

What follows is yet another economics lesson from The Simpsons.  The show has been on for nearly 30 years and is just packed full of tidbits like this:

Episode 11, Season 3 Burns Verkaufen der Kraftwerk (air date 5 December 1991) involves Mr Burns selling his plant to Germans and going into retirement.  Throughout the episode, Mr Burns’ retirement antics lead to public ridicule (in one scene, Burns is playing boccie with some other old folks.  He is barely able to throw the ball a foot, and the others laugh insultingly).  The culmination is when Burns and Smithers walk into Moe’s, where Homer and the other plant employees are drinking.  Homer had just been fired by the German plant owners and lashes out at Mr Burns.  The whole bar joins in mocking Mr Burns, and he leaves embarrassed.  Outside the bar, Mr Burns has a revelation: “What good is money if you can’t inspire terror in your fellow man?

Mr Burns learns an important lesson, one so often forget in conversations of wealth inequality and “the 1%.”  Money affords one no power.  Mr Burns is the richest man in town by far, and certainly wealthier than Homer, and yet that matters not one bit in their exchange.  Homer is able to cut Burns down to size without any fear of repercussions.  What can Mr Burns do?  Throw money at him?

Mr Burns’ power came from his owning the plant, not from his money.  As plant owner, he has power over his employees (to the extent they decide to work for him) and he has a legally protected (and connected!) monopoly, which affords him some level of power, but that is more due to political connections.  Strip those away, and Burns is powerless (even though he is richer.  He sold the plant for $100,000,000).

Money does not give power, inspire fear, or destroy individuals.

Property Rights and Government

On my post from last week, Why I am Not an Anarchist, several commentators (and friends of the blog) raised many important questions.  I will try to answer some of them, but I do not promise completely satisfying answers.  Unfortunately, a blog does not afford me quite the resources necessary.  For those who are interested, the response is below the fold.  Block quotes are from the different commentators.  Regular text is my response.

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Economics Does Not Exist in a Vacuum

When making the conditional predictions economics allows us to make, economists use the assumption ceteris paribus, aka “all else held equal.”  Non-economists (and even some economists!) interpret this to mean “this result will hold only if we assume the world is a vacuum.”  This leads to many objections such as “minimum wage may cost jobs in theory, but this is the real world and businesses will still hire!” or “I agree with free trade in principle, but China manipulates their currency!”  While these statements may be true, they are irrelevant to the question asked.

Rather than assuming a vacuum, ceteris paribus means “Looking at only the effect of this change.” In other words, we want to know how the change in something (minimum wage, opening trade, etc) will affect another thing.  The fact there are other variables that may swamp the variable effects is wholly irrelevant.

Let me explain by way of example: A small town is considering passing minimum wage legislation.  The town economist predicts it will result in the loss of 20 low-skilled jobs in the town.  The town passes the legislation anyway.  Shortly thereafter, Wal-Mart opens a store in the town and hires 50 low-skilled workers at the new minimum wage.  Does this mean the economist’s prediction was wrong?  Not at all!  Wal-Mart’s decision to open the store in the town was done independent of the minimum wage legislation; it would have occurred regardless.  The fact that Wal-Mart opened the store swamped any negative consequences of the hike doesn’t mean the effects wouldn’t have occurred (I’d be remiss as an economist to not point out there could be many unseen effects going on here not captured by the statistics).

This misunderstanding of economic analysis leads to many ineffective, and often counter-productive, policy arguments.

Right to Work vs Right to Contract

One of the local ballot issues in Tuesday’s election here in Virginia was a constitutional amendment to the state barring “closed-shop”, that is barring agreements between firms and unions to require union membership or dues as a condition of employment.  Such legislation, referred to as “right to work” (RTW) are common in the US. However, the ballot measure was defeated here in Virginia, an outcome which I support and voted for.

On the surface, this could be seen as a violation of my free market (free from coercion) principles.  Aren’t such agreements coercive?  Why should a worker be compelled to join a union?  These questions are legitimate, but ultimately inaccurate to describe closed shops.  In fact, the RTW legislation is coercive.

I will make a simple case.  Firms should be allowed to enter into voluntary agreements as they wish.  They have property rights, just like people.  If a firm wishes to enter into an agreement of its own free will with a union for a closed shop, then it should be able to.  Legislation to prevent such agreements violates the firm’s right to contract.  If a worker voluntarily agrees to take a position in a closed shop knowing full well of the requirements, he has no right to complain or challenge the agreement between the firm and union.  This would be akin to a person buying a home in a HOA knowing the rules require it to be painted green and then complaining he can’t paint it orange.

Firms, unions, and individuals all have the right to enter freely into contracts.  None of them have the right to use government coercion to change the terms of the contract after the fact.

PS: please forgive any typos.  I am typing this on my phone while trapped underground on the Metro

Update: Fixed typos and grammatical errors.

Why I Am Not An Anarchist

Anarchy, that is the absence of rulers (not rules!), is a very attractive institutional arrangement. It would be the ultimate state of freedom for humanity.  I have many friends and there are many intellectuals I respect who are anarchists, and I am highly sympathetic to their cause.  However, I am not an anarchist for the simple reason of property rights.  Property rights, which are the key to exchange and prosperity, cannot exist in anarchy.

A property right is an enforceable claim.  This means the claim must be 1) legitimate and 2) enforceable.  If, for example, I claim I am the rightful heir to the throne of the Roman Empire (in other words, the throne and all its rights are my property), and I can prove it somehow, the claim is not a valid property right.  It is unenforceable since the Roman Empire doesn’t exist any more.

In anarchy, how would rights be legitimized and enforced?  A standard answer is through agreements: I build my home on a plot of land, you build your home on a neighboring plot, and we both agree where our boundaries will lie.  An outside arbitrator can resolve any disputes (provided both parties accept the legitimacy of the arbitrator).

That’s all well and good, but what about competing claims?  Let’s go back to our earlier example.  You and I have our separate agreements.  Unbeknownst to us, another neighbor is concluding an agreement with a person which gives him a title to land which encapsulates elements of our lands.  Naturally, this would lead to some kind of conflict, which will revolve around the answer to the question: whose claim is legitimate?  Is our claim legitimate because we concluded our agreement first?  Is our neighbor’s claim legitimate because her family has hunted on that land for generations?  It’s a tricky question with no right answer.  The situation may be able to be resolved with an agreement (like before) but it provides us no clear answer on what a legitimate claim is.  In fact, since any two claims would need to go to some kind of arbitration, a person could easily game the system: with no clear delineation of what makes a title legitimate, a person could claim rights for all kinds of things and, when challenged, leave with some kind of payment, whether or not he had a reasonable claim in the first place.  I strongly suspect such a system would lead to anarchy without rules.

Without some kind of uniform understanding of property titles (what makes a claim legitimate), property rights aren’t worth anything.  There needs to be some uniform standard, agreed upon by all*, that determines who owns what and documents such claims (to prevent fraud and make it easy for newcomers to see ownership).  Furthermore, to prevent defection or gaming, this standard would need to be enforced.  Whatever body develops and enforces these titles is, in a literal sense of the word, a government; they govern property rights.

At this point, I want to be perfectly clear: I am not arguing property rights originate with a government.  In our above example, we see the rights originate from natural use (hunting) or from contract between two people.  In other words, property rights derive from natural use of the property (the use of its resources), or from contractional use.  Neither of these were created by the state, simply legitimized and enforced according to the will of the participants.

Property rights are a deep and confusing issue spanning multiple disciplines: economics, law, political sciences, history.  The writings in this post will not, indeed should not, be accepted by everybody.  This is merely my explanation on why I am not an anarchist.

*When I say “agreed upon by all,” I am using the phrase in the Rousseau/Buchanan sense: members of a group are presumed to agree to the conditions under which they live so long as they 1) have freedom of movement and 2) dwell within its borders.

Words Matter

In my readings, I stumbled upon this rather interesting article from 2002, The Meaning of Property Rights: Law vs Economics (Land Economics, Vol 78., No. 3).

The authors, a law professor from Indiana University and an economics professor from Butler College, discuss an important, but oft overlooked, issue within interdisciplinary studies:

Economists define [property rights]…sometimes in ways that deviate from the conventional understandings of legal scholars and judges.

This is problematic because:

[Some] economists’ idiosyncratic definitions of property rights, if used to guide policy, could lead to suboptimal economic outcomes.

This is one issue I find with the economics profession in general; we tend to be very loose with our definitions, using terms that may be technically correct but convey unintended meanings.  One such example of this is “trade deficit.”  While it is true that there is a trade deficit, by mathematical definition, when imports exceed exports, the term “deficit” has a negative connotation.  I strongly suspect this is partly what leads to confusion about international trade, why so many people think imports are bad and exports are good.

The good economist, indeed the good scholar of any discipline, must be careful with his words.  Sometimes, it may be a game of semantics, but it is an important one.