Today’s Quote of the Day…

…is Frederic Bastiat’s 1850 magnum opus Economic Harmonies found on page 493 of the Mises Institute’s The Bastiat Collection:

Upon the subject of human wants, I have to make an important observation – and one that, in Political Economy, may be regarded as fundamental – it is, that wants are not a fixed immutable quantity.  They are not in their nature stationary, but progressive.

…

Scarcely has a man found shelter than he desires to be lodged, scarcely is he clothed than he wishes to be decorated, scarcely is he satisfied in his bodily cravings than study, science, art, open to his desires an unlimited field.

JMM: Exactly.  Man is always striving to improve his condition.  There is always something new to want, to satisfy some new need that was pushed aside when other things were more pressing.  As one want gets satisfied, two more take its place.

As such, international trade can never fully result in one nation becoming beholden to another.  Those who worry about China destroying US production, who think China can simply dominate us all and subsequently run a monopoly on us, forget this key point.  If China satisfies the need for toys, then the need for computers and airplanes can replace it.  And so on and so on.  As needs/wants get satisfied, more arise, which allows for more specialization and trade.

Trade and Production

Over at Cafe Hayek, Don Boudreaux posts a helpful thought experiment as a way of thinking about trade:

A reliable mental experiment when discussing jobs and trade or innovation is to imagine that you’re Robinson Crusoe stranded alone on a desert island.  You have to work very hard to supply yourself with the bare necessities of survival.  Would you regard yourself as being blessed or cursed if, upon awakening one morning, you discover that some friendly natives from a nearby island have deposited on your island – as a gift to you – a year’s worth of food along with a promise to annually provision you with food in this way?  Of course you would regard yourself as blessed.  It’s clear that these generous foreigners have enriched you even though they have “destroyed” the jobs that you would otherwise have performed to supply yourself with food.  You are clearly and unconditionally made richer by this job destruction.

What holds true for Crusoe who occupies an island alone holds true for, say, the 325 million of us Americans who occupy the landmass that cartographers call “the United States.”

Protectionists tend to object to this thought experiment by complaining such “presents” would destroy the nation’s productive capabilities; the nation would become dependent on these gifts and be unable to produce anything for themselves should the need arise.

However, this objection falls flat because it forgets what, exactly, these “productive capabilities” are.  They are, above all, human.  Factors of production, labor, capital, land, etc are all inert until human action is taken.  A tractor is only as good as the person behind the wheel.

Productive capabilities are never truly destroyed. Resourses shift around, and so do productive capabilities. The factors of production that once went to making food, to stick with the Crusoe example above, now go to making a raft or shelter. If the resource supply is disrupted (the friendly natives stop sending shipments), those productive capabilities are then shifted back into the production of the suddenly-scarce good.  Ultimately, it is Crusoe who is the productive capability, not his farm or fig tree.  In other words, the only way the productive capabilities of an economy could be destroyed is if the people are destroyed.

A Tariff is a Tax on Domestic Manufacturers

At Cafe Hayek, Don Boudreaux makes an important point: if the comparative advantage of one industry is protected by tariffs, that necessarily means another industry’s comparative advantage is reduced.  While this makes logical and mathematical sense from the point of view of the theory, is it reflective of reality?  Yes:

Virtually all steel used in U.S. tire manufacturing must be imported, as domestic steel suppliers cannot meet volume and quality needs for this critical tire safety component. Thus any trade constraint could potentially have a cascading, negative impact on U.S. commerce nationwide, as the transportation industry depends on a reliable supply of tires to ship goods. Additionally, the U.S. military depends on the tire manufacturing industry to supply tires used to protect our national security.

The US tire manufacturing industry, as quoted above, as a consumer of steel would see their comparative advantage reduced, and thus their competitiveness reduced, due to import tariffs on steel.  Their costs rise, their competitiveness is thusly reduced.  All so US steel manufacturers can have potentially higher profits.

I think it’s worth noting that the tire industry is also an industry that feels threatened by imports and demanded tariffs, too.  So the steel industry tariffs would make this supposedly threatened industry even more threatened.

In short, you cannot Make America Great Again by taxing it into oblivion.

Protectionism is Fueling Trade Deficits

The Jones Act, ostentatiously a protectionist piece of legislation, is unintentionally causing the trade deficit to increase.  The US is forced to look overseas for heating since shipping it internally is so expensive because of the Act.

The lesson to take away from this story is that controlling/regulating an economy is no straightforward act.  Passing protectionist legislation is no guarantee to reduce trade deficits, as we can see here.  Actions have unforeseen consequences, and can often result in the opposite of desired outcomes.  Economic activity is complex, and it is not merely a technological problem.

Everyday Economics: Bioshock Edition

On my recent trek between Virginia and Massachusetts (and back), I listened to an audio version of the book Bioshock: Rapture by John Shirley (If you’re looking for something light to take your mind off of things, this is a good book).  The book details the rise and fall of Rapture, a massive underwater city built by Andrew Ryan (a not so subtle jab at Ayn Rand) to escape the “parasitic” governments of the world and build a society dedicated to freedom and free markets.  While the initial goal of Rapture may have been freedom and free markets, as the novel (and the video game that the novel is based on) details, Rapture becomes a totalitarian police state with an extremely wealthy (and often sadistic) upper class, and extremely poor low class, and no one in between.  Some see Bioshock as a refutation of Randian philosophy, however, I will not address that here as I am no expert in Ayn Rand (for an excellent discussion, see The Value of Art in Bioshock: Ayn Rand, Emotion, and Choice by Jason Rose).  I’ll leave that to people far smarter than I.  Rather, I want to address the economic situation of Rapture and discuss, briefly, how that contributed to the downfall.

A few quick disclaimers before I begin:

1. As far as I know, Bioshock: Rapture is not canonical.  However, it is the only detailed source I can find thus far on the days of Rapture that take place before the video game (which is canon) so I will operate on the assumption that my source material is canonical knowing full well everything I write here could become completely worthless insofar as discussing canonical information (the lessons gleaned from this book are still important, however).
2. Nothing in this essay should be taken as implying the rise or fall of Rapture is purely economic.  There are many other factors involved (social, political, medical, psychological, etc).  I skip or gloss over these not because I think they are unimportant (quite the opposite, really), but because I simply lack the expertise to discuss them with any confidence.
3. I will be avoiding using direct quotes in this version of this essay.  The reason for this is simple: I have the audio book, not the book itself.  I can’t easily do verbatim quotes and attribute them to proper pages for citations.  Therefore, the reader should be aware that I am doing this partly out of memory (although I did scribble some notes) and further the reader should assume that whenever I describe what’s happening in Rapture, that is a reference to the work of Mr. Shirley.  The only original material will be my analysis.  Any inaccuracies, either to details or analysis, belong to me and me alone.

The short version of what follows: Rapture cannot be classified in any meaningful sense as a “free market.” It suffers from several deficiencies that prevent us from labeling Rapture as a free market: lack of property rights, lack of free trade (autarky), lack of labor mobility (autarky in the labor market), rejection of altruism, widespread and institutionalized fraud (this issue is speculative based off of interviews with characters within the book but not substantiated by details), and censorship (indirect at first, but more direct later).  In Andrew Ryan’s Rapture, “free market” and “laissez-faire” were not much more than dishonored buzzwords.  It can best be described, in the words of James Buchanan, as “moral anarchy,” (see Moral Science and Moral Order, especially page 190 and Limits of Liberty, especially Chapter 7).  These factors, coupled with other psychological, social, and other factors, lead to the decline, civil war, and eventual fall of Rapture. 

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:

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:

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

Destroy the City to Save the City

Commenting on this blog post, a “Daniel DiMicco” says:

Your commentary couldn’t be more misleading and dead wrong. Rather than the picture you paint, the Steel Industry is the “canary in the coal mine”. It is the case study for the Massive trade Mercantilism and cheating that China is perpetrating on the USA’s entire Manufacturing sector. Your propaganda doesn’t pass the smell test!

Below is my response:

Daniel Dimicco:

You say that the steel industry is the “case study for the Massive [sic] trade Mercantilism [sic] and cheating that China is perpetrating on the USA’s entire Manufacturing sector.”

Presumably, this means China’s low steel prices are harmful to the American manufacturing sector.

However…what would happen to the US manufacturing sectors that are dependent on steel? Like auto-making, construction materials, and the like? They’d face higher price pressures from any resulting tariffs you demand. Assuming they can’t adjust prices, this would mean they’d need to cut adjust costs elsewhere…perhaps lay off workers, perhaps cut hours, all kinds of things. They’d be negatively impacted by your steel tariffs.

Even if they could adjust their prices, now you’re looking at the effects on the consumers of these steel products. They’d start looking for more cheap substitutes or simply cut back on the amount they purchase. This would weigh on the manufacturing sector as well (as well as the consumers).

In short, your effort to save one canary will kill off several others.

On a related note, I found a picture of protectionists celebrating a tariff hike:

The Ricardian Insight on Trade

Is it possible for a nation to become impoverished by trade by outsourcing everything?  Some people seem to think so.  For example, see this comment by a “William Ryan” on this Carpe Diem blog post:

Then we can just let China and Mexico make everything for us so the few at the top can hoard all profits and prosper from.

The problem with this sentiment is that it is mathematically impossible.  If we stick with the standard theory of trade (and one which these folks appear to accept), then the actor that produces something at the lowest economic cost will specialize in that production.  However, it is impossible to be the lowest-cost producer in everything.  “Lowest economic cost” is a relative term.  If one has a lower economic cost at one thing, s/he necessarily has a higher economic cost in another thing.  The example we gave yesterday of Bananaland and Fisherland provide a mathematical example of this concept.

This insight was developed by David Ricardo 200 years ago.  It is still relevant today.

On Bananas, Fish, and Trade

Commenting on this blog post, Warren Platts writes:

If imports were stopped by a stroke of a pen, there would still be a trillion dollars of pent up demand per year from American consumers. If the demand for goods couldn’t be satisfied with imports, domestic manufacturers would take up the slack, creating jobs. Things would be more expensive, sure, but the GDP would grow a lot faster, more people would have good jobs.

Warren’s argument, while common, is incorrect.  Imports, which do satisfy demand, generate more demand for other products by virtue of the fact they are of lower economic cost.  As Warren says, if these imports were stopped, “things would be more expensive.”  This inherently means that there are not “trillions of dollars in pent up demand per year,”that American manufacturers can simply “take up the slack.”  Rather, those trillions of dollars are released by the imports and would become constrained by the forbidding of such.

By way of example, let’s say we have two countries: Bananaland and Fisherland. In autarky (that is, no trade), Bananaland can produce 50 fish or 50 bananas.  Fisherland can produce 100 bananas or 200 fish.  If each country divides their time evenly between each activity, Bananaland can produce and consume 25 bananas and 25 fish.  Fisherland can produce and consume 50 bananas and 100 fish.  In this autarky, the price of bananas in terms of fish is 1 in Bananaland and .5 in Fisherland (in other words, Bananaland needs to give up 1 fish to produce 1 banana.  Fisherland need only give up half a banana to produce 1 fish). The two countries open trade with one other and, given that both countries want to consume the same number of bananas after trade as before (an assumption made for simplicity; doesn’t change the story if we relax this), then the citizens of Bananaland agree to send 25 bananas for 37 fish (a price of .68).  To satisfy this, Bananaland stops producing fish and produces only bananas (they produce 50 bananas).  Fisherland cuts back on banana production to 25 but ramps up fish production to 150.  The day comes and the two trade.  Now, Bananaland consumes 25 bananas and 37 fish.  Fisherland consumes 50 bananas and 113 fish.  Their total economic well-being (crudely called “GDP”) is Bananaland: 62 (25+37) and Fisherland: 163 (50+113).

Bananaland, convinced their getting a bad deal following the lack of fishing in their country (remember, what was once a thriving industry) and the low prices they now pay, elect a protectionist on the grounds that he (and he alone) will “Make Bananaland Great Again!”  He promptly forbids all imports of fish from Fisherland.  They go back to their autarky ways.  Since Bananalanders now pay higher prices for their fish and more resources are devoted there than elsewhere, they can only consume 25 fish and 25 bananas.  Their GDP falls to 50!*  There was “pent up demand,” but the higher costs the various citizens now have to pay to even just consume the same amount they did before eats up that “pent up demand.”  The domestic manufacturing simply cannot supply it.

Adam Smith first explored this concept way back in 1776, and David Ricardo formalized it with the theory of Comparative Advantage.  Trade occurs for the simple reason that it provides people with better outcomes than other alternatives.  Other alternatives simply cannot provide the desired outcomes.

Update: I realized, as reading though this, I made a small math error.  It has been corrected.

*It’s worth nothing a similar decline happens to Fisherland, a nation where they can produce much higher levels than Bananaland.  Their GDP falls to 150.  Even their manufacturing cannot satisfy the “pent up demand.”

Even Under Mercantilist Theory, Trump is Wrong

Donald Trump is, to put it nicely, a fact-challenged person.  Makes sense; populists typically are (for example, see my many many posts on Bernie Sanders).  One of his arguments for his tariff schemes is that the US is “losing” at trade.  That argument is based off of a long-since-discredited economic theory known as Mercantilism, where the wealth of a nation is created by exports (Mercantilism was first challenged by Adam Smith in 1776, and later empirically discredited by David Ricardo in the 1800’s and subsequent waves of economists in the 1900’s and 2000’s).

But, even if we assume Trump is right about exports, he is still wrong on the facts.  The United States is, according to the World Factbook, the world’s largest exporter (excluding the EU).  The US exports $2.14 trillion of goods and services each year.  The closest competitor is China, who exports $1.51 trillion goods/services.  US exports are 41.7% higher than our closest competitor.  The US’ export market is the 8th largest economy in the world.  We export more than 196 countries produce.

Even under Mercantilist misunderstandings, the US still stands tall.