Category Archives: Economics

Peter Navarro’s Economic Ignorance on Trade

Trump economic adviser and Death by China author Peter Navarro’s recent column in The Wall Street Journal, “China’s Faux Comparative Advantage,” is a doozy. This is not a compliment; it is dangerous that someone so uninformed about basic economics has the president’s ear. Navarro’s mercantilism is the economic equivalent of Ptolemaic astronomy, and should be treated as such—a historical curiosity and an obstacle to human progress. Navarro’s thinking on trade suffers from three big-picture errors. This post will look at those, then see how they apply to his column. The result is not pretty.

The first big picture flaw is that mercantilism. It is an old economic doctrine, rooted in nationalism and what is euphemistically called anti-foreign bias. Mercantilist policies usually take the forms of trade barriers against foreign businesses, special favors for domestic businesses, and sometimes currency manipulation. They aim to maximize exports while minimizing imports from abroad. The result is that people have more money in their pockets from selling all those exports.

The tradeoff is that there is less stuff people can buy with that extra money, since imports are restricted and more goods and services are going overseas. Mercantilist policies not only reduce consumer choice and standard of living, but having more currency without more wealth to match it causes inflation and distorts the price system.

Adam Smith, as far back as 1776, wrote of “those vulgar prejudices which have been introduced by the mercantile system,” (pp. 597-98 of the Modern Library edition of “The Wealth of Nations”) and the “mean and malignant expedients of the mercantile system,” (p. 660), while noting that “in the mercantile system, the interest of the consumer is almost constantly sacrificed to that of the producer” (p. 715). Note that the word “consumer” does not appear in Navarro’s column.

Second, Navarro badly misunderstands the theory of comparative advantage. This has been a standard piece of the economist’s toolkit ever since David Ricardo published “Principles of Political Economy and Taxation,” 201 years ago. Yes, Navarro is that far behind the curve. Fortunately, Ricardo spells it all out in a mere nine pages (pp. 133-41 of the Liberty Fund edition, available for free here), using an easy-to-understand example of England and Portugal trading cloth and wine. And if that’s too much, George Mason University’s Don Boudreaux explains comparative advantage even more concisely here. The lesson is simple: do what you’re good at, and don’t do what you’re bad at. That way everyone can make more wealth using the same amount of resources.

Third, Navarro thinks in aggregates, not individuals, joining the Keynesian and Harvard-MIT traditions in error. Countries don’t trade with each other, people do. “China” and “America” do not trade with each other; people who live in China and people who live in America do.

Remember this every time Navarro’s boss tweets something like “We are on the losing side of almost all trade deals. Our friends and enemies have taken advantage of the U.S. for many years. Our Steel and Aluminum industries are dead.” As Ludwig von Mises points out on p. 44 of “Human Action,“ “It is always single individuals who say We”. Also, domestic steel production is above its 40-year running average, according to the St. Louis Fed. Ditto aluminum.

Individuals would not trade with each other unless both parties expect to be better off. Otherwise they’d never make a deal in the first place. And in a world of more than two countries, those aggregate figures between any two countries almost never perfectly balance out in a given year. Americans don’t just trade with Chinese, they also trade with Canadians, Germans, Brazilians, Kenyans, and more. And those trades make a lot of sense for the people involved in the deals, even as they confuse and enrage aggregate-thinkers such as Navarro.

Now to go through Navarro’s column point by point.

“In large part because of China’s dominance in manufacturing, the U.S. last year ran a bilateral trade deficit in goods of $375 billion, or more than $1 billion a day.”Two things to pick apart here. One, China’s manufacturing output is roughly $5 trillion per year. The U.S., despite having roughly a quarter of China’s population, generated more than $6 trillion of manufacturing output last year, just shy of 2014’s all-time record. Moreover, China has to devote nearly half its GDP just to manufacturing to reach that figure, while the U.S. economy is so diversified that its manufacturing sector is less than a quarter of its GDP, even as it exceeds China’s by a trillion dollars in absolute terms.

So even with the Chinese government’s own mercantilist policies helping to increase exports, they do not dominate U.S. manufacturers. Also, much of what goes on in Chinese factories is simple assembly of components designed and manufactured elsewhere—my tablet, for example, says on the back, “Designed by Apple in California, Assembled in China”. Are such products really Chinese-made if the design and components all come from elsewhere? That is a difficult question to answer.

The second flaw in Navarro’s single sentence—an impressive achievement—is the trade deficit fallacy. For example, I run a massive trade deficit with my local grocery store. I purchase thousands of dollars of groceries from them every year, but I don’t remember them ever buying a single thing from me. And yet, we’re both better off. I get groceries, and my grocer gets money to stay in business and make a profit. If this wasn’t a win-win relationship, we would not consent to trade with each other. My trade deficit with them has no bearing on human well-being; it is an accounting artifact. Writ large, the same reasoning applies to U.S.-China trade. If it didn’t, there would be no trading.

“Contrary to the textbook model, whereby currency adjustments help rebalance trade, the U.S. trade deficit with China has been persistent—more than $4 trillion cumulatively since 2002—and growing.” Navarro can use the word textbook as much as he wants—and he uses it four times in the span of 700 words—but it doesn’t mean what he says is true.

If anything, the Chinese government’s currency adjustments have had the opposite effect. An artificially cheap yuan means that not only do Chinese companies send more of their products overseas where Chinese consumers can’t use them, but imports become artificially expensive, even without additional tariffs. The result of these real-world currency adjustments is less consumer choice and higher prices for Chinese consumers. America’s government should not compound the Chinese government’s mistakes with its own. I don’t know what textbooks Navarro has been reading, but none that I’ve come across say anything remotely like what he alleges.

“To protect its market, China erects high tariff barriers—e.g., its auto tariff is 10 times that of the U.S. China has high nontariff barriers, too, including intrusive licensing requirements and foreign-ownership restrictions that keep the playing field tilted in favor of Chinese companies.” Navarro rightly wants the Chinese government to lower its trade barriers and open its markets. Current policies obviously hurt the Chinese people, though they seem of little or no concern to Navarro; he neglects to mention them in his article. China’s mercantilism also puts U.S. producers at an artificial disadvantage in one of the world’s biggest markets, which does concern him.

“China’s faux comparative advantage is the result of its state-directed investments, nonmarket economy, and disregard for the rule of law.” These three things are precisely the opposite of advantages for Chinese consumers and producers. State-directed investments prioritize politics over people, and usually have a lower rate of return to boot. China’s recent growth only began post-Mao, when its near-total state slowly began to tolerate some form of a market economy.

And until a reliable rule of law does arrive in China, legal uncertainty will limit what its wealth creating sector can achieve. The Chinese people still suffer from what economists Daron Acemoglu and James Robinson call “extractive institutions.” Until the Chinese government becomes less predatory, Western living standards will elude hundreds of millions of deserving people.  Time will tell which direction the Chinese government chooses, but all three of Navarro’s assertions here are wrong.

“Because high-technology acquisitions often generate spillover benefits for the Chinese military, its SWFs [Sovereign Wealth Funds, basically government-run investment portfolios] are often willing to pay distortive prices, far above what the free market would dictate.” The Chinese government is no saint when it comes to foreign policy, or how it runs its state-owned enterprises. But this is no reason for Navarro to get a case of the vapors—or to offer support for starting a trade war.

Regarding actual war, since Navarro seems to think is part of the Chinese government’s economic aims, not only does the U.S. have a larger, better-equipped military than China, it outspends the next eight largest militaries combined. Navarro’s national security arguments might appeal to some conservatives—and defense contractors. But mercantilism’s economic harms mean fewer resources are available for defense than would otherwise be the case. And as a foreign policy gesture roughly equivalent to a middle finger, mercantilism raises the risk of a war happening in the first place.

Many businesses love mercantilist policies. Trade barriers hobble foreign competitors, while subsidies, sweetheart financial deals, and other domestic favors let executives sit back in their chairs instead of rolling up their sleeves and making the best possible products for consumers at the lowest possible price. This is why nearly all economists agree that mercantilism hurts people.

“It is in the name of fair, reciprocal and ultimately free and prosperous trade that President Trump is standing up to China’s intellectual-property theft and other unfair trade practices.” Not by repeating the Chinese government’s mistakes, he’s not. Navarro and Trump’s belligerent, zero-sum approach to trade hurts both the U.S. and China. Rather than copying China’s failed policies, the U.S. government should lift its trade restrictions and encourage other governments to do the same. Sadly, this does not seem to be the current path, and Navarro is partly to blame.

He should take the same advice that Brett Favre once gave to a referee: take two weeks off, then quit.

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What’s Driving the New Economy: Reviewing ‘Tomorrow 3.0’

Modernity is the most beautiful process in the world. As Deirdre McCloskey explains in great detail, since 1800 or so life expectancy has doubled, infant mortality is down more than 90 percent, incomes are up at least 16-fold, transportation is anywhere from ten-fold to a hundred-fold faster, we can instantly communicate with loved ones even if they’re thousands of miles away, and virtually the entirety of human knowledge and culture are available to nearly everyone for free or close to it, thanks to the Internet.

We truly do live in amazing times. And according to Michael Munger, who directs Duke University’s multidisciplinary PPE program (it stands for Philosophy, Politics, and Economics), we are on the cusp of a revolution that could accelerate the ongoing betterment of humankind. He makes his case in the new book Tomorrow 3.0: Transaction Costs and the Sharing Economy.

If the first major revolution in human history was the Agricultural Revolution and the second was the Industrial Revolution, Munger’s new book argues that a third, technology-based revolution is just getting underway. Imagine an economy that has an Uber for nearly everything, and renting and sharing are more common than ownership.

Munger uses the example of a power drill. Most people have a bunch of tools sitting in their garage or basement, sitting idle almost all the time and doing little more than taking up space. The average drill, for example, might have a cumulative lifetime use of a half hour, even if it’s owned for decades. This drill, along with unused cars, housing, and more, is idle capital that people could be making use of. So what’s stopping them?

Transaction costs are. A student of the late Nobel economist Douglass North, Munger observes about his old teacher that “for Doug North, it did not really matter what the question was. The answer always starts with ‘transaction costs.’” Transaction costs are the costs of doing business. In addition to the price of a good, the consumer pays, with time if not money, the cost of finding a good in the first place, waiting in line for it, verifying its quality, shopping around for a good price, and so on. According to Munger (and Doug North and Ronald Coase, no doubt, if they were still with us) transaction costs are key to understanding the third economic revolution now underway.

Going back to the drill example, Munger says, “I don’t need a drill. What I need is a hole in this wall, right here.” If you own the drill, problem solved. Just fetch it from the closet when you need it. But what about the other 99 percent of the time when the drill does nothing but collect dust? Drill-less people who need holes in their walls could be using it, and you could profit from it. Everyone would benefit.

So why don’t these win-win arrangements happen more often? Because the transaction costs are too high. The new economy being born doesn’t depend so much on making stuff as it does on lowering transaction costs so win-win deals can happen more often and more easily.

The drill owner needs to solve three problems—triangulation, transaction, and trust. Triangulation is finding a renter in the first place, and figuring out how to get her the drill. Transaction is making sure money changes hands. And trust is being confident that the other person will make good on their end of the deal. Both owner and renter have to solve all three of these transaction cost problems, or else they will never get together in the place.

Companies like Uber and Airbnb work by lowering transaction costs. If I need a ride, Uber’s app can connect me with a driver in seconds. That solves the triangulation problem, especially compared to waiting for a cab in the rain during rush hour. Uber also solves the problem of the transaction itself. It has both the rider and drivers’ credit card info, making payment so easy neither rider nor driver even need to carry a wallet. And the trust problem is solved by a ratings system that incentivizes both rider and driver to treat each other honestly and well.

In the years to come this type of business model will expand, lowering transaction costs across the economy, opening new opportunities people haven’t even thought of yet, and making life cheaper and more convenient for nearly everyone. It will also greatly reduce waste and idle capital. People won’t need as much stuff, and the stuff there is will be used much more intensively and efficiently.

It is too early to see all the positive and negative consequences this third revolution will have, but change is inevitable. Modernity is a never-ending process; people are always looking for ways to make things better. The transaction cost revolution is the next step, and it is already changing lives. With Munger’s help and a little Econ 101 knowledge, that change will be much easier to navigate.

The Goal of Economics

From p. 5 of Frank Knight’s 1951 book The Economic Organization:

Civilization should look forward to a day when the material product of industrial activity shall become rather its by-product, and its primary significance shall be that of a sphere for creative self-expression and the development of a higher type of individual and of human fellowship. It ought to be the first aim of economic policy to reduce the importance of economic policy in life as a whole.

An Economist’s Love Letter to Books

 
“No university will ever have at one time four economists of the quality of Adam Smith, David Ricardo, Irving Fisher, and Alfred Marshall, to say nothing of a dozen of their best colleagues—but they can all reside in one’s library. Their subtle minds are ever ready to instruct and tease and baffle.”
 
George Stigler (U. Chicago, 1982 Nobel laureate), Memoirs of an Unregulated Economist, p. 219.

The Level of Political Discourse Has Never Been Very High

From pages 140-41 of Nobel laueate George Stigler’s 1988 autobigoraphy, Memoirs of an Unregulated Economist:

I have recently reread it [F.A. Hayek’s 1944 book Road to Serfdom], and I simply cannot understand why it became popular. I mean this as a compliment to Hayek… Hayek has always been both a gentleman and a scholar.

The DNC Platform and Inequality

As the Democratic National Committee convention wraps up in Philadelphia, I took some time to look over theparty platform’s planks on inequality. Iain Murray and I counsel a “People, Not Ratios” philosophy on inequality in our recent study; the Democratic platform mostly takes the opposite approach.

Iain and I argue that from an ethical standpoint, the mathematical difference between rich and poor is irrelevant. What matters is making sure that all people, especially at the economic bottom, have enough to live comfortably and securely. The DNC platform instead is about ratios, ratios, ratios: “most new income and wealth goes to the top one percent (p. 3),” “the top one-tenth of one percent of Americans now own almost as much wealth as the bottom 90 percent combined (p. 10),” and so on. Some of the policies it proposes to reduce inequality ratios include:

  • Tax hikes on the wealthy. This would have the unintended effect of leaving less capital for small businesses and startups. The wealthy tend not to hoard their wealth like Scrooge McDuck or Smaug the dragon from The Hobbit. They invest most of their wealth, and as it circulates throughout the economy, and small-scale entrepreneurs, innovators, and other value creators benefit—as do their consumers.
  • Tax breaks for favored corporations. Intentional or not, this would be very good for lobbyists, and hardly anyone else.
  • Tax hikes for disfavored corporations. Ditto, as unpopular industries descend on Washington to try to avoid punishment. If the federal government is going to have a corporate tax, it should be as simple and uniform as possible. Of course, the ideal corporate tax rate is zero—companies pass on their costs to consumers, so it’s really you and me who pay corporate taxes, not GE or Microsoft.
  • A $15 hourly minimum wage. Iain and I discuss this in our other recent paper, “The Rising Tide.” Higher minimum wages would help some workers, but with severe tradeoffs. Some workers will find themselves working fewer hours, or even fired. Other workers, especially younger workers, will never be hired in the first place, denying them the chance to gain skills and experience that can lift them up the economic ladder as they get older. This could potentially increase inequality ratios over the long run. Workers would also see fewer on-the-job perks, such as free parking and meals, flexible vacation policies, and so on. The minimum wage is not a free lunch.
  • Expanded collective bargaining. Again, some workers will get a raise, but at others’ expense. Fewer jobs, higher consumer prices, and more are all among the tradeoffs. And again, increased unionization could increase inequality by giving privileges to union members at non-members’ expense.

Progressives and classical liberals share the same goal when it comes to poverty—ending it. Achieving that goal requires people across the political spectrum to focus more on people, and less on ratios. In that respect, the DNC platform has a long way to go. The most effective policies involve eliminating barriers to entrepreneurship. These include reforming occupational licensing requirements that now affect a third of American workers, as President Obama has suggested. We also recommend clearing vast swathes of the 175,000-page Code of Federal Regulations. Other helpful policies include affordable energy, easy access to capital, and a commitment to an honest price system. For more policy ideas, see Iain’s and my recent papers.

Collective Bargaining Increases Inequality

I recently pointed out that minimum wage regulations increase inequality. That’s not what the “Fight-for-15” activists intend, but it is the result they would achieve. Collective bargaining is another unintentional inequality-increaser. The reasons why are pretty similar, as Iain Murray and I point out on pp. 10-14 of our recent paper, “The Rising Tide.” This week there were two opposing developments in Washington related to the issue: the National Labor Relations Board issued a decision that strengthens the hand of unions seeking to organize workers for representation via collective bargaining, but the House Appropriations Committee voted to defundrelated regulations from being implemented by both the Department of Labor and the National Labor Relations Board.

Just as minimum wages benefit some workers, so does collective bargaining. Union members tend to earn higher wages than their non-union peers working similar jobs. And just as with minimum wages, these benefits come with tradeoffs. Fewer jobs for non-members, higher consumer prices, and more are all part of the collective bargain. Some people make more, because other people make less and pay more.

According to a recent report from the Council of Economic Advisors about declining labor force participation, the U.S. is in the 90th percentile among OECD countries when it comes to union-friendly labor policies. But is only in the 62nd percentile for entrepreneurship-friendly policies (p. 30). Those percentiles are a useful priority guide for policymakers.

Another CEI study by Ohio University economist Lowell Gallaway and researcher Jonathan Robe finds that in union-heavy states such as Michigan, per capita income is as much as $11,000 lower than what it could be without powerful unions and their exclusionary policies. That’s nearly $28,000 per year for an average-size household—money that could be spent on better schools, housing, food, clothing, and much else. Instead, that money is never made at all.

There is also evidence that many union members don’t even want to be members. When Wisconsin gave many government employees a choice on whether or not to join a union, many of them decided against unions. In a painful bit of symbolism, the very first AFSCME local, founded in Madison in 1932, saw its membership decline more than 85 percent within just a few years after the law passed.

Many politicians and activists want to reduce economic inequality, and collective bargaining is one of the most popular policies for doing so. But not only does it actually increase inequality—union benefits come at consumers’ and other workers’ direct expense—the proper goal is to make the poor better off. Iain Murray and I aim at that goal in our recent papers, “People, Not Ratios” and “The Rising Tide.” We encourage others to join us.