
Here is the outline of a secret analysis with the above title that I obtained from a White House source. The report starts by quoting Alexander Hamilton:
“Commerce, like other things, has its fixed principles, according to which it must be regulated. … To preserve the balance of trade in favor of a nation ought to be a leading aim of [the government’s] policy.”
Then, the report goes into analytical mode. It asks us to imagine a world made of two countries, a free-trading country (call it H, for Home country), and another one (F, for Foreign country) where the government subsidizes all exports. Assume that the subsidies are large enough to prevent any competition from unsubsidized businesses. The free-trading country will sustain a large trade deficit and crash. Hence, Hamilton was right, and the report’s conclusion blames the Broadway musical for not emphasizing that.
OK, the story about the secret White House report is fake news. But it is not far from the ideas that seem to circulate there. (And the Hamilton quote is real.) Let’s look under the hood.
One consequence of the model laid out above is that the residents of H buy imports cheap and sell exports dear. The country H (its consumers) has very good terms of trade: it gets a lot for what it (its producers) sell. H exporters specialize in goods not subsidized by the F government. This looks like trade nirvana for H consumers, but it can only last as long as F taxpayers are willing and able to continue subsidizing F exports and thus H consumers.
To better understand, let’s imagine a still more extreme case. Intent on developing a trade surplus, the government of F further forbids its residents to import anything from H. In this case, however, the residents of H would have no F¥ (the currency of F, pronounced “F-yuan”) to import, so the producers of F could not export anything, and the purpose of the subsidies would be defeated. This illustrates the general fact that a country cannot export if it does not import. There must be, at least over time, some balance between exports and imports.
As Jean-Baptiste Say wrote in his 1803 Treatise on Political Economy, “nothing can be bought from strangers, except with native products.” Protectionism is self-defeating. For those interested in the “real world,” it is interesting to note that Say, just like David Ricardo, was a practical and successful businessman before turning to economic analysis.
Note that the problem is not solved if exporters of F accept h$ (the currency of H) as payment for their exports. Either they do nothing with their h$, and it amounts to exporting their goods free, an even better bargain for H; or F exporters sell their h$ to fellow citizens who use them to import goods from H, defeating their government’s protectionism. If you think it’s arduous to be a mercantilism ruler, you’re right. (Mercantilism includes both protectionism and export pushing.)
Aha! the mercantilism will reply, F businessmen (or the F government) can simply use the h$ gained from exports to invest in H, which will provide H residents with the currency necessary to import from F. True, but it remains that at some point, the residents of F will run out of money to subsidize H residents’ imports. F residents won’t be able forever able to export at low prices and import at high prices. F will start exporting less to H and will consequently import less from, or invest less in, H. Protectionism and mercantilism against a free-trading country are self-defeating.
Compounding these problems is another one. F is a socialist or fascist country (or on its way there): how else can its government subsidize exports and forbid imports to such an extent? History and theory suggest that its producers will not long be able to compete with the more efficient free-enterprise producers of H. Except if the government of F forbids exports and can in some way prevent all smuggling, some trade will continue because a country will always have some comparative advantage. But trade flows will be low—as they were between the Soviet bloc and the freer world.
This trade slowdown is, of course, unfortunate, because residents of H and F would benefit from more exchange and more division of labor (and economies of scale). But short of war (provided it is not too destructive), the residents of H and their government can do little about it. Transforming H into a socialist or fascist country too would only make its residents worse off, compounding the problem.
The more mercantilist a country is against a free-trading country, the more costly and the least sustainable its mercantilism will be.
The only serious, non-sentimental way around this conclusion seems to be that F’s mercantilism will lead to the destruction of whole economic sectors in H, which will be costly to rebuild after F’s demise. But this scenario underestimates the resilience, flexibility, and “bounceability” (capacity to bounce back) of businesses used to creative destruction in a free market economy. The scenario also overestimates the competitiveness of producers in a dirigiste economy. Add to this that the situation of H is much easier if other more or less free-trading countries exist in the world (steel and shoes are not only made in China).
READER COMMENTS
john hare
Feb 3 2019 at 8:08am
I have learned much from reading econlog. I consider it a valuable part of my continuing self education. However, many people that need your message are not going to read extensively, much less something that conflicts with their priors. For those, I suggest that people that do have some understanding make an effort to find illuminating soundbites that are short and pointed enough to make a point.
“I wonder how long the Chinese taxpayers can afford to subsidize me.” This one could open the door to a conversation about the actual effects of foreign subsidies. By emphasizing “subsidizing me” instead of subsidizing “you or us”, it puts others in the position of trying to convince me that I am being harmed instead of helped. So, “the ball’s in your court, play it if you’ve got game”.
Pierre Lemieux
Feb 3 2019 at 11:23am
That’s a very good point, John, even if the trade-off is difficult.
john hare
Feb 3 2019 at 6:13pm
I agree that it is very difficult to condense points to sound bites that are still true to the point. I got in the habit of trying to do it with employees so I could get the point across within their attention span. When I try detailed explanations, they tend to tune out. I’ve seen the same thing in political and economic discussions. There’s a reason for politicians using sound bites.
Of course when you find the few that will pay attention, in depth details matter.
BC
Feb 3 2019 at 4:05pm
Agree with the general argument that F’s mercantilist export subsidies do not actually benefit F’s residents at the expense of H’s. However, doesn’t the claim that the export subsidies are “trade nirvana for H consumers” confuse nominal tax and subsidy incidence with economic incidence? A subsidy on F’s exports is also a subsidy on F’s imports (H’s exports). H pays for F’s exports through its own exports, and a tax or subsidy on the seller is also a tax or subsidy on the buyer. So, isn’t the net effect of the subsidy to subsidize the traded goods of H and F at the expense of the non-traded goods? The result is more trade than optimal just as the result of an import or export tax would be less trade than optimal. Both are bad for H and F’s consumers and producers overall, although H’s and F’s exporters (and consumers of those goods) may benefit from the export subsidies at the expense of H’s and F’s producers and consumers of non-traded goods.
BC
Feb 3 2019 at 4:12pm
Maybe, a succinct way of stating the above is that there is no such thing as a tax or subsidy on only imports or exports (just as there is no way to only tax the buyer but not the seller, or vice-versa, in a transaction). Instead, we can only tax or subsidize trade, which results in less or more trade, respectively, than optimal.
Pierre Lemieux
Feb 3 2019 at 9:13pm
That’s a good point, BC, thanks. I am not sure it should be seen in terms of tax incidence, though. And we should consider the implicit subsidy on foreign investment too.
Maniel
Feb 3 2019 at 6:10pm
My wife had a deficit with the neighborhood supermarket. To restore the balance of trade, I had to impose a tariff on the food she was importing into our house. She continues to complain about it, but I have reassured her that the pain is only temporary. Still, she does have questions that are hard to avoid, such as, why she should have to pay me when she’s the one doing the shopping and do I really think that the supermarket will ever start buying from us.
Benjamin Cole
Feb 3 2019 at 7:52pm
The arguments for “free-trade” in theory are well-known.
What Pierre does not anticipate is a very large dirigiste mercantilist authoritarian economies which protect markets by selective subsidies.
Thus, the state-controlled price could actually be higher than the market price, but competitors fear to enter the market— state subsidies of exports would only be increased.
In fact, recently when Foxconn explored building a plant in Wisconsin, provincial governments in China increased subsidies to flat-panel display manufacturers. Foxconn has famously back down, much to the chortles of those who oppose state subsidies of private enterprise.
Also, presently, this supply of imports to the United States appears to be inelastic. That is, when the US imposed tariffs on certain goods, China increased subsidies to those same goods. Thus, income was shifted to the US from China, with no cost to US consumers.
Warren Buffett has raised the interesting idea of allowing private or state enterprises to bid on the right to import goods and services to the United States .
If global competition is ferocious enough and subsidized enough I think this would be of tremendous benefit to US taxpayers and consumers
In conclusion, I wish that Pierre would show as much concern for the rights of pushcart, motorcycle sidecar, and truck vendors to ply their craft in US in urban centers as he shows for multinational corporations and China-subsidized exporters.
Pierre Lemieux
Feb 3 2019 at 9:03pm
Thanks for your comments, Benjamin. I would have thought that my post answered many of your arguments… But let’s move on. What would you think of the government (a.k.a. Leviathan) also auctioning the right to travel to foreign countries (which translates into imports), the right to marry foreign persons, or the right to free speech? If the latter looked too obviously tyrannical, what could be the objects of government auctions could be the right to buy paper, to rent halls, or to buy internet connections.
Benjamin Cole
Feb 7 2019 at 5:21am
Pierre:
Yes, in fact local governments may already control the right to operate a public hall, through licensing and zoning, and thus could control my “right” to rent a hall, or the hours of operation, or whether I can play music, or have dancing, show movies, serve alcohol. No one seems to mind these intrusions—as I have said, I wish Pierre L. would pay more attention to routine local government suffocation of enterprise.
Some people have suggested auctioning US citizenship rights, or even voting rights. These are popular ideas in libertarian circles. So why mot import rights?
Given that there really is no such thing as “free” “fair” or “foul” international trade—-the whole field is a muck-scrim of government and multinational manipulations—-the idea of auctioning off import rights has merit. If thugs run Chicago (it is always Chicago, btw) then thuggery is the route to prosperity.
A stiff-backed preacher can sermonize on Sundays—but making money Monday through Friday is a different operation.
Matthias Goergens
Feb 4 2019 at 7:18am
Why auction off those exporting rights by the government? The individual consumers can run those auctions to decide who they want to buy from.
And in fact they already do.
Pierre Lemieux
Feb 4 2019 at 1:52pm
Matthias: I fear I don’t understand your argument.
Felix
Feb 5 2019 at 8:55pm
I believe he means that consumers run an auction every time they go to a store and decide what to buy. If a product has increased its price, fewer people will buy it, and contrariwise for price decreases.
I have saved this link; I argue with too many people who complain that any managed trade is not free trade, so just lay back and enjoy it. I doubt I can get many to read it, but posting the link will hopefully reach a few who don’t know how little they know.
Pierre Lemieux
Feb 6 2019 at 11:55am
Felix: I also thought that this is what Matthias meant. If so, he misses a big part of the picture. Indeed, any purchase amounts to participating in an auction. The big difference when government intervenes is that it limits supply. On the free market, bidding up prices calls for higher quantity supplied whenever it is in any supplier’s interest to do it. A government auction that limits supply is a monopoly.
Comments are closed.