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September 17, 2011

The Conservative Case For... Protectionism [Truman North]

The populist pap from people like Ross Perot and more recently Donald Trump about raising tariffs on foreign goods “to protect American jobs” is a real turn-off for me. Why? Because I can do the economics. Stick with me here, and you will be able to, too (but I promise there will be no math involved). From an economics standpoint, there is really no good argument for tariffs—from the consumer’s, or the producer’s standpoint—free trade means everyone can benefit… assuming our trading partners are actually engaging in free trade.


David Ricardo and the Corn Laws
David Ricardo was one of the giants of “political economy”—a term for early macroeconomics. Ricardo, a Jewish stockbroker, read Adam Smith’s The Wealth of Nations while on holiday in 1799 and was immediately taken with the political arguments mathematical economics might present. He wrote his first economics article at age 37 and reached the height of his influence ten years later, after retiring from the financial business and entering Parliament.

Perhaps the best-known debate on the issue of free trade took place in Parliament during those early years of the 19th century. At that time, the landed nobility—the landowners—controlled Parliament. From 1815 to 1848, imports and exports of grain were subject to tariffs, subsidies and regulations collectively called the Corn Laws, which were designed to discourage importation of grains and encourage their exports. In general, they sought to keep the price of food high; ostensibly to provide good wages to the agrarian worker, but in reality to keep financial and political power in the hands of the landed classes and out of the hands of the bourgeoisie and new financial class. The landlords’ income, clearly, was based in large part upon the value of what they produced. The Corn Laws served to maintain agrarian elite power.

With the advent of the Industrial Revolution, a class of wealthy, urban capitalist emerged. The wages they had to pay were determined in part on the cost of living. The cost of living was based in part upon the cost of food. Food prices kept artificially high hurt their bottom line. And tariffs on grain imports kept food prices artificially high. The political battles raged for some thirty years. However over time, the power of the landowners in the House of Lords gradually diminished.

On the side of repeal was David Ricardo. His principle work, On the Principles of Political Economy and Taxation, was published in 1817. In 1819, he entered Parliament. Ricardo’s Theory of Comparative Advantage, which he used to successfully argue against the Corn Laws, states that specialization and trade will benefit both partners (real wages will rise), even if one trading partner is more efficient at producing everything than the other one.

How is this possible? The key lies in understanding the difference between absolute advantage and comparative advantage.

Absolute Advantage versus Comparative Advantage
A country enjoys an absolute advantage over another country if it uses fewer resources to produce a thing than the other country does. Suppose Elbonia and Krapistan both produce mung beans, but Elbonia’s climate and soil are superior to Krapistan’s, and that furthermore Elbonian labor is more industrious than the lazy Krapistani bums. Elbonia will produce more mung beans per acre than Krapistan and use less labor to bring it to market. Therefore Elbonia can sell mung beans and make a better profit margin on the world market than can Krapistan. Elbonia enjoys an absolute advantage over Krapistan in mung bean production.

But a country enjoys a comparative advantage in the production of a good if the good can be produced at a lower cost in terms of other goods. Suppose Elbonia and Krapistan both produce mung beans and parsnips and Elbonia enjoys an absolute advantage in producing both—that is, Elbonia uses fewer resources to produce either mung beans or parsnips than Krapistan. The central planners in both countries must decide how many resources to commit to both mung beans and parsnips. To produce more of one, land and labor must be transferred out of production of the other. Here’s the critical step: We can then measure the “cost” of production in both countries of mung beans in terms of bushels of parsnips, and vice-versa.

Suppose that in Elbonia, mung beans have an opportunity cost of two bushels of parsnips. That is, they have to give up two bushels of parsnips to grow a bushel of mung beans. At the same time, producing a bushel of mung beans in Krapistan requires the sacrifice of only one bushel of parsnips. Even though Elbonia has an absolute advantage in growing either commodity, Krapistan enjoys a comparative advantage in the production of mung beans because Krapistani farmers don’t have to give up as much in terms of parsnips to grow them as Elbonian farmers do. The opportunity cost for Krapistan to produce mung beans is lower, and therefore they will devote greater resources to their production. Therefore Krapistan can benefit by specializing in mung beans and trading them to Elbonia for parsnips. Likewise, since Elbonian consumers now have a greater supply of mung beans on the international market, it is cheaper to buy them, and it makes sense for Elbonian farmers to grow more parsnips, which are now in shorter supply. Everyone benefits from specialization and trade.

This is the key argument in favor of free trade: While specific jobs in specific industries will indeed be “shipped overseas,” those jobs will be replaced by jobs with better real wages but in different industries; industries which will expand to meet demand created in other countries where the work previously done here will be done, drawing labor and capital away from other industries. Americans and American companies will meet needs created overseas when American consumers’ needs are met by overseas trading partners. And as both trading partners become more specialized and therefore profitable, real wages will rise both here and abroad.

The Giant Sucking Sound
Proponents of free trade have met with a number of arguments in favor of protectionism. The first one I’d like to rebut is this one: We Can’t Buy From Other Countries Unless They Simultaneously Buy From Us. Remember when Ross Perot opposed NAFTA on the grounds that there would be a “giant sucking sound” as all the good jobs in the US moved to Mexico, where labor is cheap? Let’s consider what would happen should this shift occur, as in some sectors, particularly manufacturing durable goods, it already has.

In US citizens wanted to buy everything in Mexico, but Mexicans did not buy anything from us, foreign exchange markets would prevent this from happening. See, Mexican workers are paid in pesos. To buy a good produced in Mexico, the buyer must have pesos. But if no Mexicans wanted to buy anything in the United States, there wouldn’t be anyone willing to part with pesos in exchange for dollars. As a result, the price of the peso—its exchange rate with the dollar—would necessarily go up.

A more expensive peso means Mexican products would be more expensive for Americans to buy. At the same time, the more valuable peso means that American goods become cheaper for Mexicans, since dollars are cheap and plentiful! This means that Mexicans find some goods cheaper in the United States. In fact, exports to Mexico increased from $46B in 1995 to $111B in 2000. The exchange rate adjusts to make up for any wage differential.

The China Syndrome
There is one important exception to this story. A country can buy more goods from another country for an extended period of time if those purchases are balanced by a sale of debt in the form of stocks and bonds. In 2010, the US maintained a $2.73B trade deficit with China. However, China had purchased about $32B in Treasury securities during 2010, more than making up for this trade imbalance, and keeping the value of the Renminbi Yuan artificially low.

Quite aside from the sticky political situation of the Chinese government holding upwards of $1.7T in dollar-denominated debt (as of October of 2010), the plight of the Chinese worker and the resultant push for reform and representation that will inevitably follow can only occur when China allows those workers to realize the gains they are creating by specializing and producing products for which they have a comparative advantage. As long as China holds our debt and continues to buy it, this will keep its currency value artificially low, preventing wages there to normalize. If wages do not normalize in China, there is little hope that capital flows will create commensurate jobs and industry in America. And as long as this “super-structural” unemployment infects our economy in America, it is unlikely that we will be able to manage the sustainable economic growth we need to beat the Obama presidency in particular and our dour and benighted political class in general.

The Opposite Strategy
In order to see how things might turn out if America would fare if she were able to export as much, or more, than she imports, let’s examine the other industrial juggernaut of the West: Germany.

Germany is the world’s biggest exporter, selling over 100B Euros abroad in 2010. During this latest global recession, their unemployment rate has fallen steadily from 8.3% in March ’09 to 7.0% in June of this year. Is this proof by counter-argument? It’s unclear, but there does seem to be a negative correlation between exports and unemployment. Certainly, countries buying up Germany’s durable goods and other exports are not buying up its debt.
Further, Germany’s national debt in 2009 was $1.79T, or about 62% of GDP. The US national debt in 2009 was $8.38T, about 60% of GDP; but in 2011, the national debt will surpass $14.3T, or over 90% of GDP. Germany’s debt-to-GDP is on course to stay about the same at 60-65% (depending on what happens with Eurozone bailouts).

Sherman and Clayton
The Sherman Antitrust Act of 1890 and the Clayton Antitrust Act of 1914 (usually referred to collectively as Sherman-Clayton) prevent such anti-competitive practices as predatory pricing and collusion by American firms. Simply put, attempts by US firms to monopolize an industry are illegal. If a strong company decides to drive the competition out of the market by setting prices below cost, it would be aggressively prosecuted by the Antitrust Division of the DoJ (at least, in theory).

However, can we stand by and allow a foreign competitor do the same in the name for free trade? In essence, by keeping the price of their currency (and therefore the cost of their goods) artificially low, China is dumping its products on our shores below the true cost of production. How should we act when China acts to strategically drive American firms out of business in this way? Free trade may be in everyone’s best interest when we all play by the same rules. But when foreign firms are cheating, like the ones in China (and the American firms located in China), the group that suffers unduly is the American worker—both in terms of wages and benefits, and in terms of the total number of jobs available.

So even though I have already said how I feel about populist blowhards like Trump spewing no-nothing protectionism boilerplate, I have to come around and tell you this: The position they hold is fundamentally correct, even though the non-logic they’re using to get there and their message delivery are at the very least fundamentally flawed.

If we are honest-to-God gonna save our country, our culture, our way of life, then the time for protecting Americans and American industry from predators overseas is now.

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posted by Open Blogger at 05:09 PM

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