The Rules of Free Trade are Simple

What follows is a letter I’ve written to the Wall Street Journal:

Greg Ip’s 31 May 2018 piece, “Lessons in How to do Protectionism Well,” is interesting to say the least.  However, there is a major way in which Mr. Ip errs.  he writes: “He has thus far been relatively easy on China, which even free traders agree is a serial violator of the rules of free trade…”

It is unclear what rules of free trade Mr. Ip seems to think China has violated.  The rules of free trade are simple: people are voluntarily able to exchange their property rights.  China, at least outside of the country, has not compelled anyone to buy from them.  All trade done with China, that is individuals buying from other individuals who just happen to be Chinese, is voluntary.  China has not violated the rules of free trade at all.  If China were forcing American consumers to buy Chinese products, then yes they’d be violating the rules and should subsequently be punished.  But offering Americans goods at low prices is not a violation as the exchange that occurs is still voluntary.


Jon Murphy

George Mason University

Who Are the Economic Experts?

Economists are considered the economic experts.  After all, we’re the ones with the PhDs, the fancy mathematics, the complex theories that purport to explain everything.

But the reality is quite different.  We are not the economic experts.  Indeed, a good education in economics inoculates one from thinking himself an expert and forces him to think himself more of an observer.

The real economic experts are everyone.

People understand how to act in their own best interests. Nothing about the market needs experts to guide it. People are not fools who require technocrats to tell them what they can and cannot buy.  The outcome of the market, the observed phenomena that are the market process, is nothing more than the results of people interacting with one another; human action but not human demand.  People are acting on information that they have and the signals they see.  They are the experts, not the economist or technocrat.

Protectionists disagree, however. They believe they know better than everyone else. They believe they know better than the Joes of the world. They believe they know better than people what is in their own best interest. So they seek to impose their will upon everyone else, the opinions, hopes, and dreams of the others be damned. “They are not educated,” the protectionist thinks. “They are not versed in the theorems and mathematical proofs that show that Joe is harming himself. If only he had a benevolent hand to guide him; to push him in the right direction (or tug on the leash, if necessary).”

Free marketers believe non-economists do indeed know more economics than the economists. That’s precisely why they argue for free markets; so people can exploit their knowledge and expertise to the best of their ability. The protectionists and socialists (but I repeat myself) disagree. They believe themselves to be far smarter than the Joes of the world and that the Joes are simply too stupid to act in their own behalf.

Markets are observed empirical phenomena, not a technocratic outcome.  The market process is not a theory per se but an actual outcome.  The theory is used to explain why that outcome occurs, but it is an outcome nonetheless.

Today’s Quote of the Day…

…comes from page 29 of “Modern Principles of Economics” (4th Edition) by my GMU professors Alex Tabarrok and Tyler Cowen:

The most important tools in economics are supply, demand, and the idea of equilibrium.  Even if you understand little else, you may rightfully claim yourself economically literate if you understand these tools.  Fail to understand these tools and you will understand little else.

Amen to that.

The Big Rock Candy Mountain

On Monday, I opened my inaugural lecture in my Econ 100 (Economics for the Citizen) class by showing this video:

The Big Rock Candy Mountain is a hobo’s Paradise.  Everything he wants is at his fingertips.  Lakes of whiskey and stew, lots of places to sleep, where they “hung the jerk that invented work.”  Truly a Heaven on Earth.

But the economic problem is that we don’t live on the Big Rock Candy Mountain.  We live in a world of scarce resources, that is a world where choices need to be made.  How does one decide?  How can one maximize his resources?  How do we interact with one another on this issue?  How do we develop rules and institutions that govern these interactions?  These are the questions that economists study.*

Economists spend most of our time repeatedly reminding people that resources are scarce.  Politicians like to pretend otherwise.  Scarcityists like to pretend otherwise.  But they are merely chasing a hobo’s dream.

*Note the subtle difference between these questions, which are positive in nature, and the normative questions of “how should resources be allocated” and “who should decide” that many pseudoeconomists like to think economics is.

Cause, Effect, and Misallocation

In preparation for a price theory book I am writing, I am re-reading George Stigler’s classic 1966 text The Theory of Price.  The following is found on page 19 (3rd edition):

[I]t has become a major task demanded of all economies: they are required (as soverigns use this word) to provide technological advances, capital accumulations, improved labor forces, and larger incomes.  So strong is this demand, that sometimes a method by wich western nations become richer–industrialization–is confused with the growth itself, and inappropiate industries that reduce a nations’s income are adopted to increase it.

Confusing cause with effect is a major problem facing all analysts.  This becomes doubly true when discussing economic growth when policy is involved.

Industrialized nations are wealthy, but it doesn’t necessarily mean such industrialization is the cause of wealth.  Rather, industrialization is itself a symptom of a deeper cause, that is the division of labor.  “Industrialization” is a term without definition, as it can refer to many kinds of industries.  Comparative advantage is what tells us what kind of industrialization is needed to foster growth.

The United States has a comparative advantage in high tech industries; we are an extremely intelligent people with lots of capital (both human and machine) at our disposal.  China, however, has a comparative advantage in low tech industries; they have lots of unskilled labor at their disposal.  It makes sense for the US to industrialize in high tech industries and China to industrialize in low tech industries.

But even within countries, industrialization is varied.  In the US, the vast middle of the country has some of the most fertile farmland in the world.  It makes sense for those states to be agriculturally-based and other places, like Texas, to be resource-based, and others, like Massachusetts, to be tech-based.

A scheme based on the mistaken notion that “industrialization = progress” will lead to misallocation of resources.  Resources, such as labor, capital, time, will be diverted into less productive and more costly areas.  This, in turn, leads to a net decline in wealth compared to where it otherwise would have been.  An example of this is China during the “Great Leap Forward.”  Industrialization, specifically of steel, was all the rage of the Communist Party.  All production was geared toward steel production.  This inherently meant a rapid decline in production of other items–like food.  China’s poverty deepened.

The Great Leap Forward is an extreme example, but other historical cases of misallocation of resources due to the mistaken belief of “industrialization = wealth” include the USSR, modern Venezuela, and North Korea.

When examining the causes of economic growth, one must be very careful in determining cause and effect.  This is where price theory really shines.

Grad School Advice from a Grad Student

What follows below are some of the lessons I’ve learned while in school.  I write them here to share them with you:

Econ 101 is called “fundamental” because it is just that. Everything you’ll learn in your higher level classes are built off of Econ 101. All the theories, all the techniques, all the tricks you’ll learn are spawned from Econ 101. Just as calculus is built off of mathematical operations like addition, subtraction, division, and multiplication.

When I am doing research, I often find it is best to go back to my introductory Econ textbook (either Alchian & Allen or Tabarrok & Cowen) and review the material. Several times, I’ve found either a mistake in my reasoning or a better way of exploring my problem.

It’s easy to drink one’s Kool-Aid and become enraptured with the mathematics and statistics of economic analysis. It’s trivally easy to prove just about anything you want. But do not fall into that trap. Use the mathematics and statistics as a tool to tease out your assumptions. Translate your formulae into English. If you can’t do that, burn the mathematics. (Paraphrased from Alfred Marshall)

One thing about grad school is that it is extremely tough on the ol’ ego. There are constant rejections, frustrations, failures, and nonsense. There are insane levels of stress and pressures and it takes a lot to get even one praiseworthy bit of work done.

What makes it bearable are the people you surround yourself with. Mentors are invaluable. But so are friends, colleagues, and collaborators (who are often one and the same). Without my friends here at GMU, I’d probably go insane. 

 Grad school isn’t an individual effort. It’s a team sport. We pick each other up when we’re down, we boost each other to get over obstacles, and we share in each other’s victories and defeats. I’m part of a fraternity that they couldn’t pay me enough to leave.

Find your friends. Stick by them. Remember that we’re all strapped to this roller coaster named Life together.

A Note on China

On an earlier post, frequent commenter Greg G writes in two separate comments (condensed here for readability):

I think the best argument for tariffs is the astonishing economic success of China in lifting so many people out of poverty in such a short time. It’s not easy to explain how they did that if tariffs are really so inimical to the interests of their own people. Those of us in favor of free trade (and I count myself among that group) need to admit we can’t explain that. As always, we could argue that they would have done even better in some counterfactual where everyone listened to us but that is a very weak argument for a couple reasons. One is that it is always available to everyone. The other is that none of us would have predicted in advance that such an economic miracle was possible even if we had been guaranteed we could dictate policy.

Free market theory predicts that all these state interventions should be bad for Chinese consumers yet no other country’s consumers in history have enjoyed a comparable jump in their standard of living in such numbers in such a short time. Yes, I know they started from a place of extreme poverty and even more Draconian state interventions where it was easy to make big percentage gains. Even so, there are countless other countries that started in extreme poverty and stayed there both with and without a lot of state intervention in the economy. I am not pushing any economic theory that I prefer to free trade but I do still think that the Chinese example stands as a challenge to some of the economic theories that we prefer. It’s at least a little bit awkward that the regime that engineered the biggest economic leap forward in history still calls itself Communist.

Let me begin with a quick point.  Free market theory does not predict that all state interventions are bad.  There are many theoretical cases where interventions such as tariffs can be beneficial.  However, such theories require strong assumptions and a level of knowledge we deem impossible to possess, so we are skeptical of the applicability of such arguments.

More specifically on China:

Greg is right to wonder about China’s massive increase in wealth over the past 30 years.  It is astonishing.  Does it represent trouble for the free market thesis?  I don’t think so.  It adds a lot of credence, indeed.  China has been rapidly reducing tariffs over the past 30 years.  Non-Tariff barriers are falling, too.  In short, China opened their markets to the international market.  I think this has contributed to their economic growth.  It could be better, sure, but they’re steps in the right direction.

However, I fear if China does not institute market reforms, they could find themselves stagnating.  Japan had a similar growth strategy as China in the 70’s and 80’s.  They saw rapid growth but subsequently stagnated from 1990 to present as their protected firms became moribund and unable to handle competition or anticipate market changes.  Unless they allow true market reforms beyond what they already have, China will likely also face such stagnation, albeit at a higher level than Japan.

Murphy in the Library of Economics and Liberty

Here is a link to my latest column at the Library of Economics and Liberty.  A slice:

One last point on the national defense argument. If China, a national security threat and military threat for influence in the region according to President Trump’s economic advisor Peter Navarro were dumping steel in the U.S. market to gain some military advantage, the logical thing for the U.S. government to do would be not to encourage U.S. exports but, rather, to encourage Chinese imports. Since steel is a scarce resource, sending it abroad (i.e., encouraging exports) necessarily reduces the stock of steel in the United States, whereas imports increase it. If China is dumping, then it means that the product is being sent to the United States rather than being used in Chinese markets; for every unit of steel sent to the United States, that is one less unit that could be used for a Chinese war machine and one more for a U.S. war machine. The logical action for the U.S. government would be to purchase a lot of low-cost steel from China and simply stockpile it, thus depriving China of war materials while maximizing U.S. steel stockpiles. In the event of war, the United States would have a large stockpile from which to draw, while China’s would be reduced.

The Law of Demand in Action (or Why Monopoly Power is Fleeting)

Writing at Human Progress, Martin Tupy has an excellent article on the real effects of predatory pricing and monopoly.  Here is the upshot (although one should read the whole article.  It is excellent):

In a 2014 Council on Foreign Relations report, Eugene Gholz, an associate professor of public affairs at the University of Texas at Austin, revisited the crisis and found that the Chinese embargo [of rare earths to Japan] proved to be a bit of a dud.  Some Chinese exporters got around the embargo by using legal loopholes, such as selling rare earths after combining them with other alloys. Others smuggled the elements out of China outright. Some companies found ways to make their products using smaller amounts of the elements while others “remembered that they did not need the high performance of specialized rare earth[s] … they were merely using them because, at least until the 2010 episode, they were relatively inexpensive and convenient.” Third, companies around the world started raising money for new mining projects, ramped up the existing plant capacities and accelerated plans to recycle rare earths.

In other words, when faced with a sudden shortage, people compensated through other means.  It’s almost as if demand curves slope downward.

Monopolies are still subject to the whims of consumers.  They cannot raise their prices with impunity.  As prices remain high, people will innovate around them.  This indicates that the fear of predatory pricing, that a firm (or country) will seize market power and use it to jack up prices or manipulate people, are greatly overblown.