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Does Free Trade Fail to Adequately Account for the Value of an Industrial Base?

In my latest column for AIER I address in more detail Oren Cass’s mistaken claim that a policy of free trade unleashes the ‘negative externality’ of failing to adequately account for the value of an economy’s industrial base. Two slices:

John Deere, for example, needs factory space, energy, technical know-how, and access to steel and other inputs to operate profitably. If property rights and other legal institutions in the United States are favorable, if the US has a reliable electrical grid and other basic infrastructure, and if enough American workers have a comparative advantage at producing agricultural and forestry machinery, John Deere has incentives to build ‘optimal’-sized and amounts of factories in the US and to hire and train workers to man those factories. Deere’s purpose, of course, isn’t to add to the US “industrial base,” but such an addition is nevertheless a result of Deere’s actions.

Deere’s executives, like all people (including government officials), obviously have only imperfect knowledge of the present and no crystal ball to foretell the future. These executives might – indeed, sometimes will – err. Perhaps the amount of factory capacity that they build will turn out to be too little to enable Deere to maximize its profits – orperhaps the amount of factory capacity that it builds will be too large to enable profit maximization. But the profit motive drives Deere’s executives to be alert to any errors they make and to correct these mistakes. If they discover that they currently have in place in the US too little factory space they will expand it; they’ll shrink this space if they discover that they have too much of it.

Importantly, many of the market signals that reveal to Deere’s executives any errors they make – and that incite these executives to correct those errors – are amplified and transmitted through financial markets. Changes in the price of shares of Deere, Inc., along with the willingness (or reluctance) of banks and other creditors to lend money to Deere, are important and speedy sources of information and incentives for Deere’s executives. With less of this information, Deere’s executives will make more mistakes and correct these errors less speedily and with reduced accuracy.

Yet with no evidence, Oren Cass and his American Compass colleagues assert that financial markets are today too large. Although here isn’t the place to fully assess Cass’s case against modern financial markets, one pertinent point is that these markets gather resources from savers and direct those resources into specific investment projects. Financial markets don’t direct savings into some homogeneous glob called “the industrial base”; these markets direct savings into those particular projects that are judged by participants in these markets to be the most promising. It follows that these markets direct savings away from those particular projects that are insufficiently promising. The industrial base grows economically not by merely being bulked up, but by having resources drawn into its most productive parts and away from its least-productive parts.

Cass gives no evidence of understanding this reality. He writes of the industrial base as if it’s a homogenous glob of factories and capital equipment. He’s unaware of the complexity of the capital structure – unaware of how some bits of capital are substitutes for each other while other bits of capital are complements to each other, and that the structure of capital that is optimal today is unlikely to be the structure that’s optimal tomorrow.

…..

If for whatever reason American consumers come to attach less value to (say) American-made aluminum, artificially arranging to keep resources tied up in producing aluminum in America will prevent resources from being channeled into uses that are more productive. Because the productivity of resources determines their market values, and because the result of artificially protecting industries from competition is to lower overall productivity of the nation’s industrial base, the protectionism championed by Oren Cass would decrease, not increase, the economic size of America’s industrial base.

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