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Free Trade IS Fair Trade

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In November of 2017 at Hillsdale College I debated Ian Fletcher on trade. My – as well as Ian’s – opening remarks from that debate have just been published in Hillsdale’s annual Champions of Freedom series. Below the fold is the version that I presented at Hillsdale (which is close to, but not identical, to the version that now appears in print in the Hillsdale publication):

Free Trade Is Fair Trade

Donald J. Boudreaux
George Mason University

prepared remarks presented at
Hillsdale College
7 November 2017

Free trade is fair trade.  And government acts not only destructively but also unfairly whenever it restricts trade for the alleged purpose of strengthening the domestic economy.  To begin to see why, ask yourself this question: Who has the right to income that you’ve earned and on which you’ve already paid taxes?

This question might appear to be irrelevant to the debate over free trade and protectionism, but I submit that, in this debate, this question is foundational.  At the very least, this question is one of the few foundational questions the answer to which is always at stake when free trade and protectionism are discussed or debated.

Allow me to explain with a simple example.  Let’s say that you and your family decide to eat heathier diets. Among the steps that you take is to eat more fresh tomatoes.  So you start buying more locally grown tomatoes from your town’s farmers’ market. The local tomato growers are happy. Their incomes rise.  They hire more workers.

After several months of eating lots of tomatoes, you and your family decide that you like tomatoes so much, and that you want to spend more time together, that you start growing your own tomatoes.  Now the local tomato growers are upset.  Their incomes fall.  They lay off some workers.

A local tomato grower soon complains to the government about your decision to grow your own tomatoes.  This tomato grower tells the government – truthfully – that your decision caused such a fall in his profits that he had to lay off some of his workers.  “What do you want us to do?” asks the government.

The tomato grower responds that he wants the government to impose a punitive tax on you for each tomato that you grow yourself in your home garden.

What would you think of such a demand by the local tomato grower? And how do you think government should react to this demand?

I’m reasonably sure that you would have no sympathy for this local tomato-grower’s demand.  I’m also pretty sure that the government would be equally unsympathetic.  The tomato-grower’s demand rests on the premise that he, the tomato grower, has a right to a portion of your income – a right that he somehow acquired by your earlier choosing to spend some of your income on his tomatoes.  But surely when you spend your income in whatever ways you spend your income, you do not thereby commit to continue to spend your income indefinitely in those particular ways.  Your choosing to spend your income as you do is not a grant to your suppliers of a perpetual right to that portion of your income that you spend on their outputs.

And yet were the government to tax you for each tomato that you grow for yourself it would lend credence to the false premise that each of the merchants that you patronize today has a right to a portion of your income tomorrow and beyond.  And no decent government would ever do such a thing, right?

Wrong.  Every protective tariff on imports rests on the false premise that certain suppliers have a right to some portion of your income.

I ask: Do you have a right to grow your own tomatoes if doing so causes local tomato growers to lose business?  If you answer yes – as I believe you would and should – then you affirm that local tomato growers have no right to your income.  You affirm that your income belongs to you and not to them. And yet if you have a right to reduce the amount income you spend buying local tomatoes because you choose to acquire tomatoes by growing them yourself, why do you not have a right to reduce the amount of income you spend buying local tomatoes by choosing to acquire tomatoes from a tomato grower who happens to be in Mexico or some other foreign country?

If the local tomato grower has no ethical claim on your income if you choose to grow your own tomatoes, by what mysterious process does he come to possess such a claim on your income if you instead choose to buy imported tomatoes?

Note that in both cases the effects of your choice on the local tomato grower are identical.  Whether you stop buying his tomatoes because you grow more tomatoes yourself, or because you buy more tomatoes from abroad, the local tomato-grower’s sales fall by the same amount.  Also, any employment effects on the local tomato-grower’s workforce are in both cases the same.

And yet while none of us would tolerate the state penalizing us with additional taxes whenever we reduce our demands for domestic outputs by producing more for ourselves directly, many of us tolerate – or even applaud – the state penalizing us with additional taxes whenever we reduce our demands for domestic outputs by buying more imports.

I submit that those who support protective tariffs are inconsistent if they do not also support punitive taxes on home gardening, home cooking, home carpentry, and other do-it-yourself projects.  After all, home gardening, home cooking, home carpentry, and other do-it-yourself projects drain demand from particular domestic suppliers no less than do purchases of imports.

I submit further that those who support tariffs presume that certain select domestic suppliers have rights to workers’ incomes that trump the rights of the workers who’ve earned those incomes.  No matter how much you gussy it up with fancy rhetoric, a protective tariff is a penalty on consumers who choose to make their incomes go further by buying foreign-made goods and services. A protective tariff, being a penalty on you whenever you choose to spend a portion of your income on imports, is premised on the ethical belief that domestic producers have some claim, superior to – or at least equal to -your own claim on some portion of your income.

I do not believe that particular domestic producers gain an ethical claim on, or a right to, your income simply because you once chose to spend it on their outputs. Yet, again, supporters of protective tariffs disagree.  They believe that the right to that portion of your income that you now spend on imports is shared by those particular domestic producers who would sell more output were you to purchase fewer imports.

II.

The protectionist will respond that there is indeed a difference between you choosing to grow your own tomatoes and you choosing to buy imported tomatoes.  Choosing not to buy domestic tomatoes as a result of your choosing to grow your own is asserted to be somehow different, in an economically relevant way, from choosing not to buy domestic tomatoes as a result of your choosing to buy imported tomatoes.

But this assertion is false. There is absolutely no economic difference between you reducing the amount of tomatoes that you buy from domestic growers because you grow more tomatoes yourself, and you reducing the amount of tomatoes that you buy from domestic growers because you buy more tomatoes from foreign tomato growers.  None.  No economic difference at all.

Every ill economic effect that you can point to as being caused by an increase in tomato imports is also caused by an increase in growing tomatoes at home.

Do tomato imports destroy jobs on domestic tomato farms?  Yes.  But so, too, does your growing more tomatoes at home.

Might tomato imports bankrupt domestic tomato growers?  Of course.  But the same is true for your growing more tomatoes at home.

Will tomato imports put downward pressure on the wages of workers on tomato farms?  Very possibly so.  But ditto for your growing more tomatoes at home.

If you fall for protectionists’ claim that the economic consequences of free trade are often too harsh to endure, then you must also conclude that many ordinary, everyday freedoms that you cherish have economic consequences that are often too harsh to endure.  The reason is that anytime you change your spending patterns, for whatever reason, you reduce demands for some domestic producers’ outputs – and, hence, you put some workers’ current jobs in peril.

When about 20 years ago Americans went in a big way for the Atkin’s diet, bakers and brewers suffered while butchers benefitted.  Should government therefore attempt to protect brewers and bakers by obstructing our freedom to change our eating habits?

Would Americans today be wealthier if, to protect the jobs of workers in typewriter factories and those of clerks in secretarial pools, government in the 1980s and ‘90s had obstructed Americans’ freedom to buy personal computers?

And what about the polio vaccine?!  Should government have prevented parents from vaccinating their children against this debilitating and sometimes deadly disease?  After all, the use of that vaccine destroyed lots of jobs in factories producing wheelchairs, crutches, and iron-lung machines.

III.

Many of you will think such examples to be silly or inappropriate.  But they are not.  Each of these examples – and I can offer many, many more – is of economic change that unleashes every one of the economic effects that are asserted by protectionists to justify tariffs and other obstructions on our freedom to conduct peaceful commerce with foreigners.

Now I know from experience how protectionists respond.  They think they can identify differences, but every difference that they identify turns out upon inspection to be no difference at all – at least no difference that is economically relevant.

For example, the protectionist might say that when you grow more tomatoes at home, foreigners don’t receive any dollars, unlike when you buy more imported tomatoes.  True enough. But this fact doesn’t have the economic relevance that protectionists think it to have.

Foreigners are just like us: they engage in trade in order to improve their lives.  They don’t send us tomatoes, or any other stuff, for free or because they love us.  They send us stuff because they want something from us in return.

When foreigners sell us tomatoes, it’s true that we pay them with dollars.  But what do foreigners do with these dollars?  Are foreigners so deeply fond of George Washington, Abraham Lincoln, Benjamin Franklin, and other dead American statesmen that they want to accumulate as many as possible monochrome portraits of these statesmen?  Of course not.  (By the way, if foreigners did want from Americans nothing but pieces of paper smeared with green ink, that would be the best of all possible worlds for Americans  It would be the equivalent of you buying an automobile by writing a check for the sales prices and then the auto dealer refusing to ever cash the check.)

Foreigners do with dollars just what you do with dollars: spend them or invest them.  And dollars are spent or invested in the United States.

Let’s say that you buy tomatoes from a farmer in Mexico.  The Mexican tomato grower might spend these dollars, say, buying an iPhone – which, although assembled in China, is largely American-made if reckoned by the total value of the inputs that American producers contribute to the iPhone compared to the total value of the inputs contributed by foreign producers. That Mexican’s purchase of an iPhone supports jobs in the American IT sector.

Note that if you grow your own tomatoes you might do the same thing. The money you save by not buying tomatoes from a domestic tomato grower might persuade you to buy a new iPhone. The economic consequences in this case of your decision to grow your own tomatoes are identical to the consequences of your decision to buy imported tomatoes: less output from domestic tomato growers and more from a U.S. consumer-electronics firm.

Or perhaps the Mexican farmer who sells some of his tomatoes to you instead invests his dollars buying stock on the New York Stock Exchange. This purchase will increase America’s trade deficit.  But contrary to what we’re told incessantly by protectionists, this outcome is not bad for America.  It’s good.

When the Mexican farmer buys stock in American companies the dollars return to America just as surely as when the he buys an iPhone from Apple, or buys lumber from Georgia-Pacific, or takes his family to Florida for a vacation at DisneyWorld.  But in only the first case does America’s trade deficit rise.  The reason for this fact is merely that international investments are recorded on a different account from that on which imports and exports are recorded.  Investments are recorded on the capital account, while imports and exports are recorded on the current account.

Here’s a fact that seems to be a unknown to protectionists, although to economists it’s well-known: another name for a trade deficit is “capital-account surplus” – or simply “capital surplus.”

In the very same official accounts in which it is recorded that America runs a trade deficit it is also recorded that America runs a capital surplus of exactly the same dollar amount.  (The more accurate name for “trade deficit” is “current-account deficit,” but I stick here with the more-familiar term.)  Put differently, the term “U.S. trade deficit” really means “the amount of investment funds that America receives from abroad.”

A U.S. trade deficit means nothing more than that we Americans imported more during some period than we exported during that period.  It does not mean – contrary to the impression conveyed by protectionists – that dollars are draining out of America or that there is a resulting decrease in the demand for the outputs of American firms.

Whoever sold those shares of stock to the Mexican tomato grower now has the dollars – and now that person will either spend or invest those dollars in the U.S.  Let’s say that the person who sold the stock uses the proceeds to buy a new iPhone.  In this case, the dollars that you originally spent on imported tomatoes return to America as demand for an American-made product no less than if the Mexican tomato grower himself had purchased the iPhone.

The only difference is that in one case – namely, when the iPhone is purchased by the American who sold stock to the Mexican farmer – the international accounts register an increase in the U.S. trade deficit, while in the other case – namely, when the Mexican farmer himself buys the iPhone – the U.S. trade deficit does not rise.  Yet in both cases your buying imported tomatoes contributes to increased sales of iPhones for the American firm, Apple.

Now you might dispute my claim that the two cases are the same.  You might say that ‘When foreigners buy stock in American companies or otherwise invest in America, that’s different than foreigners simply buying American outputs.’

I’ll grant your point.  There is indeed a difference, one that I’ll explore in just a moment.  But I here want to emphasize that there is no difference in the two cases of the sort that is frequently asserted by those who stir up fears of U.S. trade deficits.  In both cases – again, that of a foreigner buying American exports and that of a foreigner investing in America – the dollars that Americans spend on imports return to America and are spent in America.

Further, dollars invested in America support American jobs no less than do dollars spent on purchases of American exports.  I’ve already given you one example, namely, when the American seller of the stock uses the proceeds to buy an iPhone.  But consider also the effects on the American company whose stock is purchased by the foreigner.  The purchase of the stock raises the price of that company shares.  Not only does the wealth and spending power of other holders of that company’s shares rise, but that company itself now has an easier time finding resources to expand and improve its operations.

One myth that protectionists spread about trade deficits is that such deficits imply that Americans are becoming less wealthy as foreigners acquire more dollar-denominated assets.  Yet while you can imagine a scenario in which this ill consequence is true, it is neither necessary nor our reality.

The amount of capital in the world, or in any country, is not fixed. In market economies it can and does grow.  Foreign investment in the U.S. generally expands the amount of capital at work in America – such as the number and size of factories, the amounts of research and development, and the specialized training of workers.

Let’s look again at the American who sells shares of stock to a Mexican tomato grower.  Suppose that instead of using those dollars to buy an iPhone, the American adds them to funds that he uses to finance a new, entrepreneurial business here in the United States.  If the business succeeds, the net wealth of this American increases.  Also, America’s capital stock increases.  And – if you care about such calculations – the net wealth of Americans as a group increases.

IV.

Now you can see why a moment ago I granted that there is indeed an economic difference between the case of foreigners spending all of their dollars buying American exports (and, thus, not resulting in a rise in the U.S. trade deficit) and foreigners investing some of their dollars in America (and, thus, contributing to a rise in the U.S. trade deficit).  Investments by foreigners in America are even better for the American economy than are purchases by foreigners of American exports.

Investment directly increases the size and quality of the capital stock. Consumption does not.  Think of the matter this way: when someone cashes out his dollars for American goods, he takes something out of the American economy, away from the rest of us – for example, the food that he eats in a restaurant, the automobile that he drives for his personal use, or the metal and other materials used to produce his golf clubs.  True, it’s something that he earned the right to take out of the economy. There’s nothing wrong with his doing so.  Consumption, after all, is the ultimate purpose of economic activity.  But he nevertheless consumes resources today.  That’s why we call it “consumption”!  Yet had this person instead invested, the resources would not be consumed today but put toward the production of other goods and services.

Whoever chooses today to forego current consumption – whoever saves – frees up resources today for use in building a factory, manufacturing a bulldozer, training workers.  Whatever the investment activity, it increases the flow of consumption goods tomorrow.  Whoever saves is among humankind’s benefactors.

Importantly, the straightforward but vitally important distinction between consumption on the one hand, and saving and investing on the other hand, holds regardless of the identities of the persons doing the saving and investing.  It holds whether the saver and investor is male or female, old or young, tall or short, blue-eyed or brown-eyed, Christian or atheist, foreigner or fellow citizen.

Admittedly, the term “trade deficit” has an ominous ring about it. But here we have only a case of highly misleading labeling.  Because every cent in the U.S. trade deficit returns to America on the capital account – that is, as investment – overall American trade is fully balanced.  It is balanced by foreigners adding to the capital stock of America many of the resources they choose to invest here.

If you continue to be dismayed by hearing that America runs monthly trade deficits, an easy way to console yourself is to substitute the term “capital surplus” whenever you encounter the term “trade deficit.”  The two terms have exactly the same meaning.

V.

The case for welcoming trade deficits is even stronger when we take account of the diversity of of ideas and creativity.  Contrary to the opinions of so many people on the political left, productive investment – investment that ‘grows’ an economy – is not a mindless, mechanical, low-risk activity.  It is a creative activity, and one that carries no little amount of risk.

When foreign entrepreneurs and investors commit their funds to the U.S. economy they often share their creativity.  They bring their new ideas for different products to produce and for different and more efficient means of production.  Sometimes these ideas will be inferior to those of American investors. In those cases, those foreign investments will fail.  But in this world of ours of 7.5 billion people, it’s ludicrous to suppose that all of the best entrepreneurial and business ideas are possessed exclusively by us Americans, who are less than five percent of the world’s population.

When foreigners put into operation their new investment ideas that prove to be superior to existing ideas, creative destruction occurs.  This process is no different than when we Americans put into operation our new investment ideas that prove to be superior to existing ideas.  Creative destruction occurs and the economy grows.

The late, great Julian Simon explained that the ultimate resource is the human mind in a free society.  It’s the human mind that turns raw materials into resources – that creates resources.  The likes of petroleum, iron ore, bauxite, rubber trees, even land, are not naturally resources, despite the fact that we call them “natural resources.” They are simply stuff, no more useful to humans than to hamsters without the human creativity that figures out how to transform, in an economical way, that stuff into resources, goods, and services that improve human well-being.

When foreigners invest in the American economy, they often add their creativity to our creativity.  More resources are created.  More goods and services that improve human well-being are created.  Sure, foreign investors profit when they invest successfully in America, just as American investors profit when they invest successfully. But because profit in a market economy is a signal of (as well as the reward for) the successful satisfaction of consumer desires, all the rest of us also are benefitted.  Creative destruction occurs and our economy grows.

To lament foreign investment in the U.S. is to lament not only the fact that foreigners pay us the great compliment of believing that our economy – at least compared to many others – is a promising and trustworthy place to put their funds.  To lament foreign investment in the U.S. is also to lament the inflow into America of capital, of risk-taking, and of the ultimate resource: human creativity.

VI.

There is much more to say on this important matter.  I don’t doubt that you have doubts about my argument. I am prepared to extend and to defend my argument.  But like all resources time and space are limited, so I end with just a few summary descriptions of empirical evidence that will hopefully dispel common fears stirred up by protectionists.

The empirical evidence shows, among other realities, that:

(1) the number of jobs in a market economy is not fixed; it expands with the size of the work force.  For example, in the United States today, both the U.S. workforce and the number of jobs is each about 150 percent larger than each was in 1950;

(2) increases in imports into the American economy have no impact on the the unemployment rate or on the rate of job growth;

(3) increases in imports into the American economy have no negative impact on average wages in the U.S.;

(4) the sustained and large increase in the U.S. trade deficit that began in the 1970s has had no impact on overall employment in America;

(5) manufacturing output in America is today near an all-time high; it is untrue that America is “deindustrializing”;

(6) the wealth of American households – including the wealth of middle-class households – is today at an all-time high.

Free trade is not a sufficient condition for economic growth and prosperity.  Secure private property rights, free markets, and the rule of law are among the other prerequisites for a society of widespread prosperity.  But free trade does indeed further increase the prosperity of any society – and it also better respects the property rights of the citizens of society.

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