15 May 2018

One Cheer and One Criticism for Don Boudreaux on Trade Deficits

Trade 10 Comments

(Notice kids that I’m doing this on my personal blog; I’m not picking a public fight with Don. Also, if Don has anything to say in response, I will edit this post and paste his reaction into the body, below.)

I think it’s fair to say that nobody has been hammering home the case for free trade since Trump got elected, more than Don Boudreaux. In the present post, I will first praise a subtlety that he has been making, showing the flaw in standard protectionist views. But then I will also criticize another of his posts, where Don repeats the same approach that Robert Barro used and which might (I claim) mislead people.

THE CHEER

In this post, Don writes:

After reading my letter in the Wall Street Journal on why U.S. trade deficits do not necessarily imply greater American indebtedness, Steven Crow describes the examples that I use to make my point as all involving “transferring U.S. assets to foreign creditors” (Letters, May 14).

Mr. Crow is mistaken.

Consider my example of BMW building a factory in South Carolina. This factory was created by BMW. Because it did not exist before BMW created it, this factory cannot possibly have been a U.S. asset that was ‘transferred’ to foreigners, be they creditors or otherwise. BMW’s factory in Greer, SC, exists only because BMW conceived of it, financed it, built it, and operated it profitably for the past quarter-century. It is neither an asset that ever belonged to an American nor one whose creation resulted in any further American indebtedness.

 

This is great stuff, and it underscores one of Don’s frequent points, namely: A trade deficit is not necessarily a form of debt increase, at all.

To really see it, forget about currencies and just think of barter. You’ve got two countries, USA and Germany, that (let’s suppose) initially have nothing to do with each other in terms of trade. Now in this year, the Germans decide to send over a cargo ship loaded up with bricks, cement, glass, lumber, and a bunch of alcohol and steak. The Germans then negotiate with some Americans for the following deal:

==> The American owner of a piece of land gets to keep a little bit of the alcohol and steak, in order to rent the use of his land for one year.

==> The American workers get to keep the rest of the alcohol and steak, in order to use the raw materials to construct a car factory.

The way the trade accounts are maintained, the US runs a trade deficit this year with Germany, because of the bricks, cement, glass, and lumber that Americans imported from Germany, without any corresponding exports. (In contrast, the American exports of labor and land rental exactly matched the American imports of alcohol and steak from Germany.)

Because we assumed an initial condition of no trade relations, this year’s trade deficit is also equal to this year’s current account deficit, which means there is a capital account surplus. And…YEP! The Germans invested and acquired a nice new factory in America, while the Americans made no investments in acquiring German-based assets.

Now in this scenario, Don wants to know: In what meaningful sense did the Americans become “more indebted” this year? It’s true that now the U.S. is “on the hook” for sending the net cars of this factory (after subtracting the cars that must be given in barter to the American land owner, as well as any workers employed in the factory) back to Germany, or to be sold to Americans for other goods that can then be shipped to Germany, but this flow of net factory output back to Germany (in the future) isn’t a subtraction from what Americans otherwise would have been able to consume. No, total output within the boundaries of the U.S. is now higher, because of the German investment.

 

THE CRITICISM

In this post, Don writes a letter to Donald Trump:

Earlier today you said “We’re importing a lot of cars. We want a lot of those cars to be built in the U.S. Build them here, and also ship them overseas. Doing a reverse act.”

Soooo….. You want to arrange for us to spend more of our own time, labor, and resources producing valuable outputs to be shipped overseas, and for us to receive fewer valuable outputs in return. I’m stumped. Can you spell out just how this arrangement will “make America great again”?

Are we made “great” when our government simultaneously obliges us to produce more goods and services for foreigners, and for those same foreigners to send to us in exchange fewer goods and services? In what way, Mr. President, do we Americans “win” at trade – in what manner are we Americans “put first” – when you force us to work harder than we otherwise would to produce goods and services for foreigners’ consumption, and for foreigners to work less hard than they otherwise would to produce goods and services for our consumption?

As I said in my reaction to Robert Barro, I think this type of argument might mislead most readers. (And again, let me say that I’ve used similar reasoning in the past.)

What some people might think Don means in the above–and this isn’t a strawman, because the WSJ editor (?) who subtitled Barro’s piece explicitly fell into this trap–is something like this: “Right now we import a bunch of goods, and we export a bunch of goods, but the imports exceed the exports to the tune of 1 million cars. If Trump got his way, we would keep the other imports the same, but we’d cut back on imports by (say) 500,000 cars per year, and we’d keep our other exports the same, except we’d increase our car exports by 500,000 cars per year. Then we’d have balanced trade, going forward. But this is stupid,” so continues the person who might be misled by Don’s post, “because it effectively means every year, Americans have 500,000 fewer foreign cars to enjoy, and to add insult to injury, we have to bust our butts producing an additional 500,000 cars in order to send them abroad as gifts to foreigners. What kind of crappy deal is that?! Give me trade deficits any day!

OK so in case that’s what some of Don’s readers are walking away with…it’s wrong. Now to be fair, it is just as sophisticated (or not) as Trump’s mercantilism. But what I’m saying is that this type of view–which ends up thinking Americans are somehow lucky ducks with our trade deficit–is not right.

If we were dealing with spot barter transactions, then it would be correct to say that a decrease in the amount of goods given up–without a decrease in the amount gained–represents a boost in the “terms of trade.” So for example, if Americans initially are sending 1 billion bushels of wheat to Japan in exchange for 250,000 cars, and then the Americans manage to renegotiate the deal so that they only send 900 million bushels of wheat, then yes, this makes the Americans richer. Specifically, they are getting the 250,000 Japanese cars in exchange for 10% less wheat.

But when the U.S. runs a trade deficit, it’s not getting “more imports in exchange for fewer exports” in this sense. Rather, we are still paying “full market price” for all the imports, measured in dollars. The gap between imports and exports is made up by Americans selling net assets to the foreigners.

To return to our bushel/car example: Suppose instead of sending 1 billion bushels of wheat to Japan in exchange for 250,000 cars, that now the Americans send over 900 million bushels of wheat and sell IOUs promising the Japanese holders 115 million bushels to be delivered in 3 years in order to get those same 250,000 cars this year. Now it is not at all obvious that the renegotiated deal is better. In any event, it would be crazy to describe this renegotiation as the Americans getting the same quantity of Japanese cars in exchange for 10% less work.

10 Responses to “One Cheer and One Criticism for Don Boudreaux on Trade Deficits”

  1. guest says:

    “Rather, we are still paying “full market price” for all the imports, measured in dollars.”

    Or measured in opportunities satisfied (or expected to be satisfied), for that matter.

    To be sure, though, if the “full market price” at one moment means 1 million imported cars and 0 exported cars, and at another moment means half the imported cars, and 500 thousand exported cars, all other things equal, consumers are better off with the former arrangement – even though in neither case is anyone “getting away” with anything.

  2. Tel says:

    Suppose one country settles all its imports by shipping gold bars.

    If you see the gold as merely a commodity (i.e. a product) then there is no trade deficit, it’s a simple barter.

    If you want to regard gold as a payment (i.e. money) then there is a trade deficit.

    Either way there’s no debt, and no interest payments to worry about. Either way there’s still going to be an issue down the track when the gold runs out (as the Spanish discovered in the 16th Century, eventually you do have to learn how to work and produce).

    https://en.wikipedia.org/wiki/Price_revolution

    • guest says:

      Ron Paul said the same thing about having to eventually produce something:

      Classic Ron Paul – 1988 Campaign Interview (part 2)
      [www]https://www.youtube.com/watch?v=Tpp5XOJPGlM

      Interviewer: “If elected President, how would you handle the trade debt?

      Ron Paul: “Well, we wouldn’t worry a whole lot about it. We’d have sound money. And when you have sound money and free trade, you don’t worry about trade deficits.

      Do you know what the trade deficit is between New York and Texas? Nobody knows, and nobody cares. If we don’t have enough money in Texas, we have to quit buying. That’s what would happen in the world if you had a sound monetary system – a gold standard where people couldn’t create money out of thin air.

      “The only time these trade deficits mean something is when you’re on an inflated, paper money system like we are, today; and then they mean something.

      So, if you have a gold standard, sound money, and free markets, you don’t even keep the records. If you spend too much money and you come up short, you gotta go back to work and earn some money …”

      To say that there’s a problem when gold runs out is another way of saying that prices, in terms of gold, rises “too high”.

      Logically, though, higher gold prices (or a supposed “lack” of bullion), themselves, cannot lead to a systemic problem – you can still barter or labor for goods at a higher gold price (either in physical gold or in terms of gold).

      There’s a book on Mises.org called Forty Centuries of Wage and Price Controls: How Not to Fight Inflation which shows, over and over again, that when prices are burdensomely high and government gets out of the way, economic laws solve the problem.

      Only coercion can result in sustained shortages or surpluses.

      • Andrew says:

        Those were the days. End the Fed!

  3. Andrew says:

    It’s weird. I feel like all of the free market economists are talking past the issue. Many Americans feel that we are, as a nation, losing our manufacturing base and productive capacity. The trade deficit is being used as a proxy for that. Americans are saying, “Look, there’s plenty of consumption going on right here in America but instead of buying American made products and giving fellow Americans opportunity to work, we’re buying cheap crap from overseas and subsidizing poverty.”

    In response, free market economists are saying, “Well, a trade deficit doesn’t necessarily mean, blah blah blah,” or “Actually, we’re better off having that cheap crap than jobs because otherwise we would have to work more and we wouldn’t be able to eat so many Cheetos. Who wants that, Mr. President?” This economy used to have a place for the lower and middle classes that didn’t involve waiting tables or bagging groceries. We used to make things that were built to last. Now we make very little and buy cheap junk from other countries.

    I get that there are a lot of reasons for all of this: other countries have caught up, automation is eliminating certain jobs, US regulations overburden the market, etc. But attacking President Trump’s political usage of the trade deficit when talking to his base completely misses the point. His base is looking for something valuable to do with their lives. Telling them that the trade deficit doesn’t always mean what they think it does has near zero impact.

    • guest says:

      If Trump’s base wants to find something meaningful to do with their lives, they can do it without interfering in my trades with better (in my subjective preference), cheap, foreign, and yes, planned-for-obsolescence goods.

      The reason cheaper crap is sometimes way better than goods that are built to last is because innovations can come so fast that it’s actually worth paying less for things that will be “outdated” in a short amount of time.

      Give me the option of cheap crap so I can decide for myself how high of a time preference I have for goods that last verses multiple goods that don’t.

      • Bob Murphy says:

        guest wrote: “If Trump’s base wants to find something meaningful to do with their lives, they can do it without interfering in my trades with better (in my subjective preference), cheap, foreign, and yes, planned-for-obsolescence goods.”

        In fairness, I think Andrew was merely saying, “This type of rhetoric from free-traders isn’t helping defuse the calls for coercion.”

      • Harold says:

        In market terms it is not junk by definition if people are buying it. Using labels like junk is a rhetorical method to sway people’s view of the argument without adding any content.

        We can state it more accurately as follows:
        “We used to make things that were built to last. Now we make very little and buy superior, less expensive goods from other countries.”

        Andrew has a point, the argument about free trade is a proxy for people feeling they have lost their place in the world. Similarly the argument about immigration. To my mind the way to tackle this is to point out why these arguments are appealing to emotion and will not solve the problems that people are concerned about. This is what economists are trying to do.

        However, many studies as well as experience shows that using rational arguments and evidence to sway people’s minds is unfortunately not an effective method.

        • Andrew says:

          Another issue here is the way that economists use the word “we.” They say it as if the costs and benefits of American-style free trade fall proportionally to the people. When economists and others say “we” are better off being able to “buy superior, less expensive goods from other countries,” Trump voters start to wonder who this “we” is that they keep hearing about. From a democratic point of view, an average economy that benefits the many may be preferable to an excellent economy that benefits the few. Given that an excellent economy was never on the table and given how many other regulations are already on the books, what’s the big deal with adding a few tariffs to the mix?

  4. George Thoroughgood says:

    “Earlier today you said “We’re importing a lot of cars. We want a lot of those cars to be built in the U.S. Build them here, and also ship them overseas. Doing a reverse act.”
    Soooo….. You want to arrange for us to spend more of our own time, labor, and resources producing valuable outputs to be shipped overseas, and for us to receive fewer valuable outputs in return.”

    So Boudreaux is so entranced by theory that it has made him incapable of thought.

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