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Freeman Essay #22: “Cursed by Economic Knowledge and Ignorance”

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In the May 1998 issue of the Freeman I lamented the deep economic ignorance that marks most media discussions of economic matters – and especially of the economics of international trade [2].  My essay is below the fold.

Economic understanding is a curse. Americans are fed a steady diet of idiotic commentary and specious “analyses” most of which flow smoothly down the gullets of unsuspecting nightly-news, viewers, newspaper readers, and National Public Radio devotees. But for those of us vexed with some comprehension of supply and demand, comparative advantage, the role of prices, the nature of money, and other economic insights, most of what is uttered or written by the news media on economic topics is so ignorant that it hurts to hear it.

This pain is inescapable. Save for those glorious days in the Fall of 1989 when the headlines reported the draining of one communist cesspool after another, I have never as an adult read a newspaper or watched television news without wanting to throw a wrench at some writer or reporter. (Of course, in practice I throw only words.)

News-media discussions of international trade unleash the most wrench-throwing urges.

First and foremost, of course, critics wrongly allege that imports reduce domestic employment. It’s true that cars imported into the United States might reduce the number of jobs in the American auto industry. But employment in other U.S. industries rises because foreign auto producers use the dollars they earn to purchase American goods, services, or assets. Contrary to the suggestion underlying too many newscasts, foreigners don’t sell their cars in the United States because they are abnormally fond of thumb-sized, green-tinted portraits of dead American statesmen. Foreigners, no less than Americans, want to spend the dollars they earn.

If Congress were to prevent Americans from buying foreign cars, employment prospects for U.S. auto workers would improve. But those foreigners who would have received dollars in exchange for automobiles they sell in America no longer receive these dollars. Consequently, foreigners purchase fewer American products and services. Workers in other U.S. industries suffer, as do American consumers.

Protectionism never increases domestic employment; it merely shifts it around.

I proudly report that over the years I’ve taught international trade to hundreds of students and have knowingly failed in only one case to persuade a student of this fundamental lesson. (For the record, this lone student was a member of the Italian Communist Party.)

My students’ first reaction to the realization that protectionism never increases domestic employment is this: “While it would be a mistake to protect domestic workers from foreign competition, the government should provide job re-training and unemployment benefits to help workers who lose their jobs to imports.”

Such cruelty appalls me. Forget that government handouts weaken the incentive for unemployed workers to find new employment. More relevant is the fact that such retraining programs and handouts must be paid for out of taxes. Every dollar taxed away to help so-called “displaced workers” is a dollar taken from the private economy where it would otherwise be spent on goods, services, or investments. Raising taxes to help workers displaced by imports displaces other workers. It’s cruel – or at least grossly arbitrary – for government to assist Mr. Jones by plaguing Mr. Smith.

Another frequent misunderstanding has to do with trade deficits. Whenever the U.S. trade deficit increases, Dan Rather and his brethren intone seriously that such increases are ominous. Such reporting suggests that Dan, Tom [Brokaw], and Peter [Jennings] are each as ignorant of economics as King Tut was of quantum physics.

Here’s a quick lesson in international economic accounting. Every nation’s foreign trade is always balanced. That’s the way the accounting system is designed. If one part of a nation’s trade account is in deficit by $1.96 billion, other parts must be in surplus by $1.96 billion.

When newscasters and other professional chatterers report on America’s “trade deficit,” they are necessarily telling us about only one part of the balance sheet. Sometimes they have in mind the merchandise-trade account, a meaningless report of the dollar value of physical goods that cross our borders in commerce during (say) the month. Worrying about a merchandise-trade deficit makes as much .sense as worrying about a unicorn invasion.

If foreigners buy American lumber or laser printers, these purchases deflate America’s merchandise-trade deficit. But if foreigners switch from buying American goods to buying vacations at DisneyWorld or Merrill Lynch financial services, these purchases inflate our merchandise-trade deficit. There’s no fundamental economic difference between purchases of tangible goods and purchases of services. And yet, one kind of purchase leads to merchandise-trade deficits, while the other kind doesn’t.

A more useful concept is the current account. Unlike the merchandise-trade account emphasized by the news media, the current account includes trade in services in addition to trade in goods. The current account also reckons investment income earned abroad as well as international transfers. It’s quite possible for a country simultaneously to run a merchandise-trade deficit and a current-account surplus – although you’ll never learn this fact from a television reporter.

Even a current-account deficit, however, is no cause for concern. One helpful way to relieve our fears of a current-account deficit is to know that there’s something called a capital account that precisely balances the current account. So if the current account shows a $2.9 million deficit, the capital account shows a $2.9 million surplus.

Suppose that in 1998 we import $2.9 million more goods and services than we export. Disregarding investment income and transfers, America will then run a $2.9 million deficit in its current account for 1998. But foreigners didn’t provide us with $2.9 million of goods and services for nothing. Foreigners must now be holding $2.9 million more in U.S. cash or dollar-denominated assets.

This deficit both signals and promotes economic health. Foreigners investing their dollars in America, rather than cashing their dollars out immediately for goods or services, indicate that the U.S. economy enjoys solid long-run prospects. (The story is more complicated when the current-account deficit is caused by heavy government borrowing at home. But even here the problem is government debt financing, not the current-account deficit.) Moreover, these investments put downward pressure on interest rates, easing U.S. firms’ access to capital. The result is greater productivity and higher wages. And yet reporters and politicians, in their ignorance, invariably regard current-account deficits as omens of Armageddon.

Despite the news media’s juvenile grasp of economics, I watch the evening news and read the newspapers regularly. I do so not for enjoyment, but to keep current on the state of economic ignorance – which, alas, is a far worse curse than economic understanding and illustrates the task confronting FEE and other economic educators.

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