Free Trade: The Unsung Hero

From page 46 of Matt Ridley’s great book, The Rational Optimist:

The cumulative accretion of knowledge by specialists that allows us each to consume more and more different things by each producing fewer and fewer is, I submit, the central story of humanity. Innovation changes the world but only because it aids the elaboration of the division of labor and encourages the division of time. Forget wars, religions, famines and poems for the moment. This is history’s greatest theme: the metastasis of exchange, specialization and the invention it has called forth, the ‘creation’ of time. The rational optimist invites you to stand back and look at your species differently, to see the grand enterprise of humanity that has progressed – with frequent setbacks – for 100,000 years. And then, when you have seen that, consider whether that enterprise is finished or if, as the optimist claims, it still has centuries and millennia to run. If, in fact, it might be about to accelerate to an unprecedented rate.

A brand new perspective has occurred to me during the first 50 pages of this book: Trade is the unsung hero for humanity.

It’s something that everybody around the world does every single day, and it is the reason why human beings have reached a standard of living that includes more leisure and comfort than anybody else in any other era could only have dreamed about!

So it seems suspicious that Ridley would even have to write an entire book about this. Trade’s phenomenal transformative power already seems so obviously true, so self evident that a 359 page discussion on the topic just seems like the workings of a sadist.

But books like Ridley’s or even simple YouTube videos like Milton Friedman rehearsing Leonard Read’s masterpiece, I,Pencil, are necessary! This kind of stuff quite literally changed the way I perceived the world upon coming out of my 12 year stint in the government-run education indoctrination camp. And, on this blog, I suspect I am not alone.

On the other hand, “Fashionable opinion” on free trade is a far cry from the stuff of Ridley’s book; it seems to be either hostility or ignorance. But ignorance in a more eerie sense than mere apathy; more like the people who show up on our TV and computer screens have all implicitly agreed to some sort of conspiracy to simply pretend like none of this kind of stuff exists…

I’m going to continue reading Ridley’s book. But every page frustrates me for the sincere belief that this ought to be common knowledge. Ridley isn’t inventing his own profound theories here; he’s simply saluting and bringing attention to a phenomenon which is as powerful and invisible as electricity: Free trade.

Let’s Talk Taxes

Seemingly every 2-4 years, the Federal Government starts talking tax reform.  The same talking points are repeated over and over: high tax, low tax, red tax, blue tax.  But from an economic standpoint, taxes are much more subtle.

The standard economic story of taxes is fairly simple: as the price of something goes up (in this case, the price increase is due to taxes), you get less of it.  Higher taxes on labor (income tax, payroll tax, etc) discourage labor.  Higher taxes on cigarettes discourage smoking.  Therefore, many economists argue, taxation should be as low as possible.  Therefore, tax cuts can stimulate economic growth.

However, taxation does go to support government and institutions like stable property rights (under which I am classifying law enforcement and national defense), courts, and the like.  Other economics argue these institutions encourage economic growth, so taxation should be relatively high to fund and develop these institutions.  So tax hikes can stimulate economic growth.

Both arguments are reasonable and not mutually exclusive.  There is likely some optimal level of taxation necessary to promote desirable institutional development without being a net drag on the economy.et’s say that the economy is beyond that optimal point of taxation, that the current level of taxation is too high and is a net drag on the economy.  Does it immediately follow that taxes should be cut to stimulate growth?

Let’s say that the economy is beyond that optimal point of taxation, that the current level of taxation is too high and is a net drag on the economy.  Does it immediately follow that taxes should be cut to stimulate growth?  I argue no.  If taxes are cut without regard to spending, that is taxes are cut and deficits emerge, then it won’t do much to stimulate growth.  This is because people are rational and forward-looking.  If taxes drop and deficits rise, then people will realize that, at some point, those deficits will need to be covered, either by higher taxes in the near future, or by government borrowing, which means higher taxes down the road.  People will begin to prepare for these higher taxes by saving more in the meantime knowing they’ll have a higher tax bill coming.  In short, there would be little (if any) effect on the economy from the tax cut; it’ll be no different than if there had been no cut at all.

However, if the tax cut were permanent, that is coupled with a cut in spending so that there is no deficit, then the cut would likely have a more positive effect.  Knowing (to the extent they can) that taxes won’t rise means they see their higher amount of kept income not as a temporary thing, but as a permanent change.  The tax cut would have a more stimulative effect on the economy.

When discussing taxation, it’s important to remember that deficits matter, too.  A tax cut that only generates deficits won’t have the same effect as a tax cut that does not generate deficits.