After my article appeared in which I criticized Ian Fletcher’s argument for more manufacturing in the United States, Fletcher responded by e-mail and we carried on a back-and-forth debate. It was pretty civil on both sides, something that, unfortunately, is not that common any more. He gave me permission to quote from our e-mail correspondence. You will get more out of it if you read my original critique of Fletcher first. Here are some excerpts that are, of course, chronological.
Fletcher
First, you seem to contend that FDI [foreign direct investment] is an exception to the basic rule in economics that, in Milton Friedman’s words, “there is no free lunch.” That is, you ignore the fact that when foreigners make an investment in the U.S., they own the investment. That the investment took place may be a good thing, but this doesn’t change that fact that when foreigners, rather than Americans, own an investment, this increases the net worth of foreigners and reduces the net worth of Americans by the same amount.
The key here is to take the right baseline. If your baseline for foreign-financed investment is no investment at all, then yes, we should view foreign investment as an unalloyed gain. But the alternative to foreign-financed investment isn’t no investment, it’s American-financed investment. Once one looks at the problem this way, it’s obvious that America is better off with American-financed investment, as then Americans will own the assets and receive the returns they generate.
Second, you seem to contend that the use of the dollar as an international reserve currency obviates our need to pay for a trade deficit by borrowing and selling off assets. Again, this is a baseline problem. The U.S. dollar would still be an international reserve currency even if the U.S. were not running a huge deficit. Running that deficit does not increase the size of our international dollar seignorage. Therefore every additional dollar of deficit we run still compels us to either a) assume another dollar of debt or b) sell off another dollar of assets.
Henderson
You seem to be making the point, in numerous ways, that if we forego consumption and instead save, we will be better off in the future. But that doesn’t mean we’re better off making that choice. Take whatever amount you’re spending this year on consumption, Ian, and instead spend $1,000 less. A year from now you’ll be better off by $1,000 plus interest. So why not do it? And if you do, then slice off the next $1,000 from consumption, and so on. The point is that we make tradeoffs between current and future consumption and you’re saying that we’re making the wrong tradeoff. How do you know?
Fletcher
I am well aware of the concept of intertemporal substitution of consumption.
Granted, if one is indifferent to the idea of staging a consumption binge in the short term at the expense of future prosperity, then my argument doesn’t hold water.
But this is an abstract and silly position, as the political consensus of all major political parties, both in the U.S. and every other nation of which I am aware, explicitly opposes deliberately choosing economic decline.
Nobody defends this outcome as a sincere preference; it is only defended by people who paint themselves into the theoretical corner you are now in.
When I see anyone run on a declinist platform and get elected, I will consider that choice an appropriate guide to public policy.
Henderson
It seems that you think I’m advocating economic decline. I’m not. And I’m not sure how you got that idea.
Fletcher
You aren’t advocating economic decline, but you’re saying it’s fine if people choose to maximize short-term consumption at their long-term cost–which means saying it’s fine if people chose economic decline.
Henderson
Correct. This time you said it accurately.
Fletcher
Indifference to economic decline, in the face of forces pushing this country in that direction, means choosing to let it happen.
Henderson
It seems to me that you’re saying, then, that you would not let it happen. So then the question becomes, “Which choices of people that are causing it to happen would you not allow?”
Fletcher
As noted, I propose to manipulate matters at the systemic level through tariffs, not intervene in specific individual choices.
READER COMMENTS
Tom West
Jul 17 2011 at 3:47pm
Interesting. I think you both got you wanted.
He admitted that people’s freedom to choose was not his highest priority and you admitted that people choosing freely does not necessarily produce the the highest level of long-term economic prosperity.
I’m always happy when people admit that there preferred policies may have a cost. It makes debating opposing policies possible.
Eric Hosemann
Jul 17 2011 at 4:08pm
“As noted, I propose to manipulate matters at the systemic level through tariffs, not intervene in specific individual choices.”
I’d like to see Mr Fletcher clarify this distinction.
AK
Jul 17 2011 at 4:17pm
Why is Mr. Fletcher continuing to choose “economic decline” in his own finances by not further reducing his consumption?
ajb
Jul 17 2011 at 4:44pm
Whether right or not, Fletcher is claiming there is a political externality to the investment decision. One that cannot be changed by any single buyer. Hence, even if all buyers agreed with Fletcher, individual investors would rationally choose to exploit short run gain because of a free rider problem. Hence — assuming an externality — the argument for something like tariffs. Of course, such an externality argument could mean subsidies or quotas or what have you instead of tariffs, but in principle he has a point which Henderson has not responded to.
Tom West
Jul 17 2011 at 5:53pm
ajb, I think he’d have to make the case that the cost of the externality is substantially greater than the total of the individual benefits in order to justify the loss of freedom (at least on this blog).
Chris Kerns
Jul 17 2011 at 6:28pm
Emphasis mine. Disclosure: I haven’t read the full arguments on both sides. However, I take issue with the all-to-common fallacy in the quote above. Mr. Fletcher seems to believe the economy is a zero-sum game, which is not the case.
Two points:
1) If a foreign national has no attractive investment opportunities in his home country, then making an investment in the U.S. brings capital to the U.S. that otherwise wouldn’t be here and allows for investments that otherwise wouldn’t happen. No losers required.
2) If there are comparable investment opportunities in the home country and the investment is made in the U.S. anyway, then the only real loser is the investor’s home country. The U.S. still benefits.
One caveat is that there is a lot of capital out there looking for good investments, which are quite few. This competition for investment opportunities drives yields on those investments down. So, U.S. investors may lose out via competition for good investments, but sympathies typically don’t fall on the side of capital, anyway.
Brandon Berg
Jul 17 2011 at 6:43pm
I’m not sure I follow. Fletcher is saying that Americans aren’t saving enough, and that the solution to this is…tariffs?
How is imposing tariffs a reasonable way to go about increasing savings, as opposed to, say, rducing the $1.5 trillion of dissaving the government is doing every year, increasing or eliminating the caps on 401(k) and other tax-advantaged savings plans, or reducing taxes on dividends and capital gains?
Brandon Berg
Jul 17 2011 at 6:54pm
Really, isn’t this like saying that since not enough Americans are getting PhDs in science, we should restrict the immigration of foreign-born researchers?
I guess I shouldn’t expect too much from the author of a book called Free Trade Doesn’t Work (looking forward to his upcoming book, The Heliocentric Hoax), but this strikes me as so silly that I feel like I must be missing something.
Brandon Berg
Jul 17 2011 at 7:17pm
On second thought, I probably shouldn’t have made fun of the title of his book. I apologize for that.
kebko
Jul 17 2011 at 7:33pm
If it is possible to not save enough (according to Ian Fletcher), then it must also be possible to save too much (according to Ian Fletcher). If foreigners save too much, wouldn’t it be reasonable to run a current accounts deficit?
Also, it appears to me that foreigners are investing in low return securities like treasuries while Americans are investing with high returns. It looks to me like much of the current accounts deficit is just what foreign investors require in order to make up for their poor returns. The ownership of assets is not nearly as imbalanced as the trade deficit would lead us to believe.
Curtis
Jul 17 2011 at 7:35pm
I never understood this sort of logic. Systematic tariffs do intervene in individual choices: Slapping everybody in the face means I get slapped in the face individually.
8
Jul 17 2011 at 8:43pm
Eric,
I believe he’s talking about a flat tariff, just like some economists favor a flat income tax with no exemptions.
Is the U.S. not in economic decline? This is why, even if I thought Fletcher was totally wrong, I’d put money on his ideas achieving political currency. The U.S. consumers aren’t choosing decline. Foreign governments are choosing to game the system and “win” the economic competition. Consumers (including USG) are naturally responding to the incentive of cheap credit and cheap imports.
I think his most interesting arguments are against Ricardo. I didn’t realize that Ricardo assumed there’d be no international mobility of capital. That seems like a big hole in comparative advantage, given the current financial system.
Brandon Berg
Jul 17 2011 at 9:46pm
8:
Foreign governments are choosing to game the system and “win” the economic competition.
Does Fletcher actually have a model under which changing the assumptions regarding mobility of capital and labor reverses Ricardo’s conclusions? Casting doubt on the comparative advantage theorem is all well and good, but it does not in and of itself constitute an argument for mercantilism.
Gregor Schubert
Jul 17 2011 at 9:56pm
Here Fletcher is implicitly violating the “no free lunch” axiom he claims to defend. After all, the investments that foreigners are buying in the US are supposedly not being handed to them for free. Rather, their price probably represents a rough estimate of the present value of all future returns. Thus, saying that Americans would be better off owning the assets rather than being paid a fair price for them (in the form of desirable imports) means that the owning of the asset by Americans somehow creates additional value above and beyond the present value of cash flows that foreigners would receive and pay for – a free lunch!
Similarly, as long as the price for the asset was fair, the “net worth”- the present value of all consumption flows – of neither Americans nor foreigners should not change a bit as a result of the transaction, UNLESS the returns of the investment change with ownership. What am I missing here?
Noah Yetter
Jul 17 2011 at 10:29pm
That’s the long and the short of it right there. This man does not believe that “systemic manipulation” interferes with “individual choices”. I am at a loss for words.
muirgeo
Jul 17 2011 at 11:00pm
Hands down victory for Ian Fletcher.
The debate boiling down to David suggesting maximizing out your credit card because things are on sale.. but not to worry because you lost your job… because your home equity is an asset that can be leveraged for more cheap things…. and Ian suggesting… That’s probably not to good of an idea.
Tom West
Jul 17 2011 at 11:19pm
That’s a pretty massive mis-characterization of David Henderson’s position. I would imagine that David would defend the right to be *allowed* to maximize your credit card, not suggest that it’s a good idea.
Sentiments like that are as silly as my suggesting that your position is that anything you do not approve of should be prohibited by law. You’d be offended by such a stupid characterization, and you’d be right to be offended.
Perhaps you might try a fairer characterization?
Tracy W
Jul 18 2011 at 9:48am
Fletcher seems to have a zero-sum view of investment – eg he says “But the alternative to foreign-financed investment isn’t no investment, it’s American-financed investment.” And he also says: “That the investment took place may be a good thing, but this doesn’t change that fact that when foreigners, rather than Americans, own an investment, this increases the net worth of foreigners and reduces the net worth of Americans by the same amount. ”
But this is not a general result. Some potential investments of course are mutually exclusive, eg if you build a hospital on a piece of land, there’s no point in trying to increase the same land’s fertility for farming. But other potential investments can build on each other – eg more hospitals can support more specialised medical technology firms. More fertile farms can support more specialised farming support services.
So more foreign investment can lead to more total investment, rather than just being offset by less American investment.
The Engineer
Jul 18 2011 at 10:15am
David, in the next round of debate, could you please take a concrete example?
How does Honda, and Toyota, and Hyundai, and Volkswagen, and BMW, and Mercedes’ investment in US manufacturing facilities make Americans worse off?
We get the vehicles we want (substituting Camry’s and Accords for the Chevy Caprices we used to buy), Americans get jobs at these plants and at nearby suppliers, and, perhaps, one day Honda and Toyota will even become American companies (incorporated in the US, having their primary stock listing on the NYSE, and employing a US based management team).
What is the downside? For all his kvetching, it’s AWFULLY theoretical.
Bill Williams
Jul 18 2011 at 11:22am
This is all so arcane and theoretical. Nineteenth century America was very protectionist, with tariffs averaging 35%. Rather than tariffs causing calamity, American manufacturuing thrived during the period 1800-1930 with high tariffs. In the real world, not the theoretical world, the U.S. protectionism before 1933 worked better for American manufacturing than the free trade has worked since 1933. Free trade for the U.S. has been unilateral economic disarmament because foreign competators believe in mercantilism & game the system.
Bill Williams
Jul 18 2011 at 11:28am
This is all so arcane and theoretical. Nineteenth century America was very protectionist, with tariffs averaging 35%. Rather than tariffs causing calamity, American manufacturuing thrived during the period 1800-1930 with high tariffs. In the real world, not the theoretical world, the U.S. protectionism before 1933 worked better for American manufacturing than the free trade has worked since 1933. Free trade for the U.S. has been unilateral economic disarmament because foreign competators believe in mercantilism & game the system.
Costard
Jul 18 2011 at 2:13pm
David, I think you both miss the point. Foreign investment and high consumption are not symptoms of time preference or comparative advantage or any generalized economic law. They are the result of a very specific trade situation in which a portion of the world has subsidized its exports via currency manipulation. Nations accumulate high dollar reserves that they are unwilling to repatriate into native currencies for fear of devaluing the dollar and harming trade. This money flows into American securities, keeping prices high and returns low; there is little incentive for dollar-earners to save, whereas (imported) goods for consumption are cheap.
Low treasury yields encourages deficit spending and suppression of domestic inflation via foreign central banks means we can maintain expansive monetary policy without seeing much in the way of inflation. Such policy becomes necessary in the face of weak recoveries and slow growth. But the process weakens the dollar, strengthens foreign currencies, and the imbalance can be maintained only with greater intervention. At some point it cannot be maintained, there is a panic, foreign capital is withdrawn, exchange rates rebalance, and we end up in a situation with extreme inflation in consumer goods – virtually all of which are imported now – and deflation in domestic capital goods.
Calling this the outcome of consumer preference is naive. What choice does anyone have? Spend now while things are cheap; or earn 1-3% on money and investments that will lose much of their value in the near or intermediate future.
Equally absurd is the idea that a trade war will save us. It would mean wrecking successful American industries in a bid to save nonexistent ones.
Insofar as the problem is specific nations, any policies we employ to address it should deal with those nations specifically. But given that any action on our part results in higher inflation and a decline in capital markets, the cure in this case is a political nonstarter – and IMO we’re riding this disease to its natural conclusion.
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