Free Trade as Insurance

Nature has blessed humans around the world with different endowments.  Some live near water, and thus have lots of fish.  Some are good with numbers and figures.  Some live near forests and timbers.  Et cetera et cetera. Trade helps evenly distribute those gifts that Providence has bestowed upon us.  The person with lots of fish can trade it for timber.  The person with lots of clothes can trade it for jewelry.  The goods are distributed across the people, not according to the “luck of the draw” of their endowments, but by their desire to better themselves.

The same is true of nations (after all, nations don’t trade.  People do).

But trade also acts as an insurance policy.  If the US (the world’s largest supplier of many foodstuffs) were suddenly hit by a drought, and half the crop died, there wouldn’t be mass starvation in the country.  The US could import what was needed from elsewhere.  The price would be higher, to be sure, since there is no a smaller supply (globally) that needs to be distributed, but there would still be the supply.  If, however, the US were “independent,” as the protectionists wish, then such a agricultural disaster would be magnitudes worse.

Having supply lines across the world doesn’t, as the protectionists like to claim, make the US more vulnerable.  It makes us less vulnerable!

Sacrificing the Ends for the Means

Throughout his writing career, Frederic Bastiat repeatedly emphasized that consumption is the end goal of economic activity, that the consumer should be the focus of economic analysis.  While each man is both producer and consumer, man produces so he can consume.  In other words, production is the means and consumption is the ends.  This makes sense if we look at our own lives: we go to work so we can afford our homes, food, cars, clothes, etc.  We don’t consume our clothes, cars, food, homes, so that we can work more!

Although not considered much of a theorist, Bastiat was a bit ahead of his time with this emphasis.*  It would be another 50 years before the commonly-recognized supply and demand curve we use today was developed by Alfred Marshall.  Using the Marshallian Curve, we can explore Bastiat’s** insights with regard to international trade.

Let’s ask the question: what happens when we impose a tariff on international trade?

First, let’s start with our standard supply and demand curve:

20170406_093528

The green-shaded areas are “consumer surplus,” or what the consumer gains from the international trade.  The orange is domestic producer surplus (what domestic producers gain).  Domestic producers supply some of the quantity demanded (Qs) and the rest is made up in imports (Qd-Qs).  The total societal surplus is the green and the orange areas added together.

What happens when we impose a tariff?  This:

20170406_094005

Green is, as above, consumer surplus.  Orange is producer surplus.  Added in here is the blue area (tax revenue) and red (deadweight loss).  What’s going on here?  Much of what we have is a transfer of wealth: producers gain (from the consumer), government gains (from the consumer).  But where does the deadweight loss come from?  The consumer!  Not only is there a total reduction in welfare in the society (not merely a redistribution), but it all comes from one segment, the segment that is the ends of all production.  The entire welfare loss is borne by the consumer!  

The implications of this analysis are stunning, at least from an economic perspective: you reduce the ends to get more means; Protectionism results in more effort for less welfare!  The supposed blessings of scarcity that protectionism promises never materialize.

*Nor should Bastiat be considered a theorist.  He wasn’t.  He was a great distributor of economic ideas, but didn’t form any himself.

**And Say’s, Smith’s, and Ricardo’s

Ruminations on Equal Pay Day

Today is Equal Pay Day, which means two things are certain: 1) some groups will be arguing that the pay gap is very real and must be addressed and 2) some groups will be arguing the pay gap is a myth and should be dismissed.  Both groups are simultaneously right and wrong.  It is true that, adjusting for various economic factors, much of the pay gap goes away (Group 2 is correct).  However, it is also true that there is some gap that remains which could be due to discrimination (Group 1 is correct).

But economics is limited in this story.  We can provide economic explanations, but there are other factors that other fields could provide insight into as well.  For example, why is it that there is an unadjusted 80-cent gap to begin with?  Are women encouraged to avoid the higher-paying fields?  Sociology could help answer that.  Are women just worse negotiators then men?  Psychology could help answer that.  Are the biological differences that could account?  Biology could help answer that.  Is there legislation that encourages discriminatory hiring practices?  Legal studies can help answer that.  These various disciplines could provide valuable insights.

A mistake I think many economists make (myself included) is sometimes thinking the economic way of thinking is the only way of thinking.  It is powerful, to be sure, but it is not alone.  We can help provide some answers (like on the pay gap) but not all the answers (nor should we.  Division of labor).

My two cents on the pay gap: Is discrimination an explanation for the difference between men’s and women’s pay?  It’s probable; the size of the effect is difficult to know.  Unlikely responsible for a large portion.  Is government the solution?  Possibly.  If the issue is poor incentives from legislation, then government would have to repeal such legislation.  If there are other causes, governmental interference would likely cause more harm than good.

I think the pay gap deserves more thought than many economists are willing to give it, and it especially deserves thought from the sociologists and legal scholars (my gut feeling is that is where we will find much of the gap explained).

Warts and All

Yesterday was Opening Day for the Washington Nationals at Nationals Park in Washington, DC.  Some 40,000 people made their way to the Waterfront to see the Nationals take on the Miami Marlins.  At the corner of N and First Streets, SE, the traffic and pedestrian crossing was a nightmare.  People were flooding out from the Metro headed to the Park.  The crossing guards could barely keep order, and both cars and pedestrians were getting frustrated (this effort was compounded by the fact the traffic lights were still on, often contradicting the guards’ orders).  It was, in short, a charlie-foxtrot.  One might even say it was a government failure.

Although the government’s solution to the pedestrian issue was less-than-ideal, it would be incorrect to immediately jump to the conclusion that a laissez-faire approach would automatically be better; that a “free-market” approach would be better than the government approach.  The free-market approach would come with its own set of problems (perhaps, for example, since pedestrians have the right-of-way, tens of thousands of people would have crossed the streets and no car would have been able to move for hours).  It’s indeed possible that the free-market approach would have generated a worse outcome than the government approach.

Harold Demsetz (among others) warns us against the Nirvana Fallacy; that is, assuming a different (often preferred) method would not contain the same flaws (or flaws at all) from the current method.  We see this very often in politics (eg socialism), but free-market supporters can run aground of the fallacy, too.  Markets, just like governments, are populated with humans with the same foibles.  The incentives are different, to be sure, but markets can fail, too.  One mistake I think far too many market supporters is to assume that markets are not only perfectly efficient (the “efficient market hypothesis”), but also they instantly adjust.  That is not the case.  By arguing, as many do (especially many anarcho-capitalists) that the market solution is always the superior solution is incorrect for the exact same reasons that socialists arguing the government solution is always superior to the market solution.

Markets are extremely powerful.  Generally speaking, they provide excellent results.  But markets are just one of our institutions, and they function best when search and transaction costs are minimized.  For certain problems, there may be other institutions out there that would perform better.