… is from page 156 of Robert Frank’s 2007 book, The Economic Naturalist:

Producers gain less than half the cost imposed on American consumers, yet political support for tariff repeal remains elusive because the benefits of the tariff are concentrated and its costs highly diffuse.

DBx: Frank here refers to a study of the consequences for us Americans of Uncle Sam’s punitive taxes on our purchases of sugar. Yet a core point – which is that the benefits of such special privileges are outweighed by their costs – is perfectly general (even if the specific proportion of always-smaller benefits to always-larger costs varies from tariff to tariff, from time to time, and from country to country*).

……

* Pedants, as well as rent-seekers, will point out that economists have discovered theoretically possible conditions under which the benefits to the nation of a tariff might exceed the costs to the nation of that tariff. Indeed so. A great many things are possible. Sitting here at my desk I can easily describe a scenario in which burglary or arson are socially productive. But public policy is not a laboratory to test the theoretical quirks revealed in papers presented in graduate seminars or in academic journals. Public policy, which is, or ought to be, about rules – must take the world as it is likely to be.

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Here’s an open letter to Cafe Hayek commenter Dan Jennings:

Mr. Jennings:

Commenting at my blog on a point that David Henderson made about Trump’s tariffs, you wrote this: “Yet, if the game plays out as a shrewd business game of getting players to concede their tariffs, it will have been worth it.”

Everyone agrees that a lowering of tariffs globally would be desirable for everyone. But for three reasons I disagree with your comment. The first reason is practical; the second is economic; the third is ethical.

The practical: history shows that governments typically respond to other governments’ unilateral tariff hikes with tariff hikes of their own. For all of their flaws, multilateral trade negotiations – not unilateral tariff hikes – are practically the best means of persuading other governments to lower their tariffs. Don’t forget that tariffs have been falling worldwide for decades now.  If Trump persists in his bullying, the result will almost certainly be a slowing, and perhaps even a reversal, of this happy trend.

The economic: because tariffs, at bottom, are punitive taxes on domestic buyers – and because government grants of these special privileges incite domestic firms to spend more resources lobbying for more such privileges – it is likely that the bulk of the economic burden of tariffs falls on domestic citizens. That is, it is likely that the bulk of the economic burden of Trump’s tariffs will fall on Americans.

The ethical: it is unethical for the U.S. government to hold American consumers hostage in a ‘game’ designed to drum up more sales for American businesses. It might well be true that, say, Boeing not only would sell more airplanes if foreign governments lowered their tariffs but would thereby be able to take advantage of larger economies of scale. If you agree that this prospect is insufficient to give to Boeing the ethical right to obstruct the purchases of others Americans, by what logic do you conclude that Trump has the ethical right to obstruct these purchases?

Sincerely,
Donald J. Boudreaux
Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030

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I likely linked a couple of years ago to this March 2016 Forbes piece by Dan Ikenson on the trade deficit. But a kindly reader this morning reminded me of it, and so I just re-read it. Dan’s piece is so good that I post it here in its entirety (emphasis added):

It’s a presidential election year so the quadrennially-maligned U.S. trade deficit is taking its lumps. Donald Trump says the trade deficit means the United States is losing at trade, and it’s losing because U.S. trade negotiators aren’t smart enough. Bernie Sanders believes the trade deficit deprives the economy of production and good jobs. Meanwhile, some of the economics commentariat argue that trade deficits are bad because they represent a burden on future generations — a debt that must be repaid.

Trump and Sanders are both wrong, but the focus of this analysis is on the last point. Economists, apparently, disagree about whether or not the trade deficit constitutes a debt to be repaid. It’s worth noting that those who take the affirmative position tend also to be economists who are more skeptical of the benefits of trade and who hail, preponderantly, from the philosophical left. One gets the impression that the debt argument is being used to wrap trade skepticism in a moral sheen it doesn’t deserve.

Last week, Bloomberg View columnist (and assistant finance professor at Stony Brook University) Noah Smith and I had a little back-and-forth about this issue on Twitter, which we agreed to suspend with Smith promising to “write a post in simple and clear terms” explaining how the deficit is a loan. Today, Bloomberg posted his column, which is interesting and includes some reasonable illustrations about trade. But it is not convincing in the least that the trade deficit is a debt to repay.

Smith’s central point is that trade has to be in balance because, in his example, the Germans aren’t willing to exchange the cars they produce for pieces of paper (dollars) indefinitely. Eventually, Americans will have to accept the return of those dollars for real output and that, ultimately, running a trade deficit is just an intertemporal shifting of the burden of production and the reward of consumption. A small portion of the accumulated debt, Smith suggests, can be reduced through three channels: inflation, default, and currency manipulation. But, eventually, we are on the hook to come up with the real goods and services to cover most of the debt. In his explanation, Smith conflates debt and equity (one doesn’t default on equity, Noah!) but otherwise makes no mention of the capital account or the fact that foreigners are willing to exchange their accumulated dollars for U.S. assets. He concludes:

So a trade deficit does represent a loan, but that loan doesn’t always have to be paid back in full, and the terms of the loan can sometimes be unfairly favorable to the borrower.

Nevertheless, most of what we get from our trade deficits will have to be paid back someday. The U.S. will almost certainly not default on its sovereign debt. Inflation may rise, but that will only partially erode the amount owed. People in other countries have a lot of U.S. financial assets, and if they decide to redeem them, then at that moment the country will have to give them goods and services that cost Americans’ time, sweat, effort and resources.

Today, Americans may think they’re getting stuff for free by running a trade deficit. But it isn’t free. Someday, we — or, more accurately, our children — will have to give stuff away in return.

Let me assure you that Americans, who part with hard-earned dollars for every transaction, don’t think they’re getting stuff for free. But here’s why Smith is wrong on the broader question. There’s a clearer, more instructive way to conceptualize the issue. The United States runs a trade deficit with the rest of the world because Americans spend more dollars on foreign-produced goods and services than foreigners spend on U.S.-produced goods and services. The dollar value of U.S. imports exceeds the dollar value of U.S. exports, so our trade account is negative. It’s in deficit. That’s straightforward.

A slightly broader measure of international transactions than the trade account is the current account. The current account includes the trade account plus net proceeds on investment (income earned on U.S. assets abroad minus income earned on foreign-held assets in the United States) plus net transfers (remittances and aid, primarily, flowing into the United States minus remittances and aid, primarily, flowing out of the United States). Those two components (net proceeds and net transfers) are much smaller than the value of exports and imports, so the U.S. current account typically isn’t much larger or much smaller than the trade account. In 2015, the trade deficit amounted to $540 billion and the current account deficit was $484 billion.

So, how is it even possible to run a trade deficit in the first place? How can Americans send $540 billion more abroad for goods and services than foreigners send to the United States for goods and services? In Noah Smith’s telling, that $540 billion is a loan to Americans that we have to pay back — unless there’s an all-out default or the value of that debt is diminished through inflation or currency manipulation. Those are the three channels — unsavory, all of them — through which Americans can abrogate some of their obligation to pay back the $540 billion. But Smith is missing a huge part of the picture — the part that clarifies that the trade deficit is not a debt.

Americans are able to purchase more goods and services from foreigners than they sell to them because foreigners buy more assets from Americans than Americans buy from foreigners. There is a positive inflow of dollars on the capital account. Foreigners don’t only buy goods and services from Americans. They buy U.S. assets (equities, property, factories, service centers, shopping malls, machines, other physical assets, corporate debt, and government debt) from Americans. Likewise, Americans don’t only buy goods and services from foreigners. We buy foreign assets (equities, property, factories, services centers, shopping malls, machines, other physical assets, corporate debt, and government debt) from foreigners, as well.

The proper way to account for international transactions is to abide the fact that the value of the goods, services, and assets that Americans purchase from foreigners is approximately identical to the value of the goods, services, and assets that foreigners purchase from Americans. (Smith left out the assets part of the equation.) If there is a difference between the current account deficit and the net capital inflow, it is accounted for by the change in foreign reserves. The United States ran a $484 billion current account deficit with the rest of the world in 2015, and it ran a $484 capital account surplus. The capital account consists of three broad components: U.S. purchases of foreign assets; foreign purchases of U.S. assets; and, the change in foreign reserves. And it is a mathematical certainty that the current account plus the capital account equals zero. Put another way, the value of the current account deficit is identical to the value of the capital account surplus.

So, the U.S. trade deficit is financed by inflows of foreign capital used to purchase U.S. assets. Most of the assets purchased are equities and physical assets (direct investment). Some of the assets purchased are corporate debt and government debt. As of the end of 2014, Americans held a total of $24.6 trillion of foreign assets. Foreigners held a total of $31.6 trillion of U.S. assets. Of that $31.6 trillion foreign asset portfolio, treasury bills and bonds accounted for about $6 trillion — just under 20 percent of the total. It is only this portion — government debt owned by foreigners — that the American public (of this generation or the next) is on the hook to pay back. Corporate debt has to be repaid, but only by the shareholders and employees of the companies issuing the debt — not by you or me or our children, generally. Equity purchases don’t have to be paid back at all — they’re not loans! When European, Japanese, Korean, Chinese or any foreign investors purchase U.S. companies or make “greenfield” investments to build new production or research facilities or hotels or shopping centers, there is no debt to be repaid.

I asked Smith during our Twitter exchange to explain how my children are on the hook for Honda’s investment in production facilities in Marysville, Ohio. He wrote: “Simple. Honda owns the factory. Future profit from the factory goes to Honda. Honda uses profits to buy U.S. goods.” Huh? This is clearly not an outcome involving repayment of debt by me, my children, or anyone. Americans simply benefit from Honda’s success, earning wages and profits they would not have enjoyed without Honda’s presence — essentially, without the trade deficit that enabled Honda to invest in the United States; create value; hire Americans; support parts and other suppliers; create demand for retail establishments, restaurants, and homebuilders; pay taxes, support local little league teams, and reinvest proceeds in this virtuous circle.

Selling equity or property or even entire U.S. companies to foreigners does not constitute debt and it is not akin to subsidizing our consumption by draining down our assets, as some suggest. It’s not a reverse mortgage. By the simple logic of supply and demand, the presence of foreigners in U.S. asset markets is good for U.S. asset holders. Foreign participation constitutes greater demand in the market, which increases the price of the assets in question. And, there are some real knock-on benefits associated with foreign-headquartered companies operating in the United States. These “insourcing” companies tend to perform well above the average U.S. company in terms of value creation, capital investments, research and development spending, compensation, employment, and many other metrics, as this paper documents.

In fact, there is a compelling argument that a trade deficit is actually good for the U.S. economy because the quality, experience, and successes of the foreign companies that actually come and operate in the United States are better, deeper, and more numerous, respectively, than the average U.S. company. But that’s a topic for my next column.

Let me conclude this one by reiterating that only a portion of our trade deficit needs to be repaid by the American public to foreigners, and it is that portion used to finance government budget deficits — roughly one-fifth of the annual trade deficit. If Noah Smith and other economists worry about this debt, they should advocate reducing wayward government spending instead of restricting trade.

……
DBx: What Dan says! I add only this small codicil for emphasis: when non-Americans increase their holdings of dollar-denominated assets, they often do so, not by acquiring existing assets, but by creating assets in the United States – by creating productive assets that would otherwise not exist.

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… is from page 114 of Steven Pinker’s excellent 2018 book, Enlightenment Now (all dollars below are 2014 dollars; link added):

The study found that in absolute terms, Americans have been moving on up. Between 1979 and 2014, the percentage of poor Americans dropped from 24 to 20, the percentage in the lower middle class dropped from 24 to 17, and the percentage in the middle class shrank from 32 to 30. Where did they go? Many ended up in the upper middle class ($100,000-$350,000), which grew from 13 to 30 percent of the population, and in the upper class, which grew from 0.1 percent to 2 percent. The middle class is being hollowed out in part because so many Americans are becoming affluent.

DBx: Note that the study to which Pinker here refers, one done by Stephen Rose, was published in 2016 by the Urban Institute – an organization not known for possessing any libertarian or conservative biases.

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Quotation of the Day…

by Don Boudreaux on June 9, 2018

in Doux Commerce, Trade

is Mark Perry’s closing on this recent post at Carpe Diem (original emphasis):

Conversely, protectionism is an agent of stagnation; it retards the arts and sciences; it destroys bonds of common interest; it corrodes the understanding of foreign peoples and appreciation of their merits; it lowers a commercial and moral barrier to war; and it diminishes the ideal of a world federation, the brotherhood of man.

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In the Fall 1990 issue of Regulation, I did my best to expose flaws in the bizarre and extreme twists of antitrust policy.

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Truly Medieval

by Don Boudreaux on June 9, 2018

in Adam Smith, Trade

Here’s a letter that I sent several days ago to the Washington Post:

Catherine Rampell is correct that Trump’s trade policies are a nest of fallacies that, as she says, were all the rage in the 1680s (“Trump’s trade policy is stuck in the ’80s – the 1680s,” June 1).

But these fallacies are far older than even that. They were current in the 1380s!  In 1381 Richard Leicester worried about the fact that the English were importing more than they were exporting and, therefore, were paying for these extra imports with money. Save for the archaic language in which it is couched (and that it refers to England rather than to the U.S.), Leicester’s solution to this non-problem sounds as if it were from a Trump White House press release: “Wherefore the remedy seems to me to be that each merchant bringing merchandise into England take out of the commodities of the land as much as his merchandise aforesaid shall amount to; and that none carry gold or silver beyond the sea, as it is ordained by statute.”*

What Adam Smith called the “absurd” doctrine of the balance of trade** is literally a medieval superstition.

Sincerely,
Donald J. Boudreaux
Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA  22030

* Quoted in Jacob Viner, Studies in the Theory of International Trade (1937), p. 6.

** Adam Smith, An Inquiry Into the Nature and Causes of the Wealth of Nations (1776), Book IV, Chapter 3, paragraph 31.

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Some Links

by Don Boudreaux on June 8, 2018

in Myths and Fallacies, Reality Is Not Optional, Trade

Daniel McCarthy (for) and Matt Ridley (against) debate the merits of Trump’s tariffs. A slice from Matt Ridley’s essay:

But the impact of retaliation on American producers is in some ways the least of the problem. Consumers will suffer most from the tariffs, and everybody is a consumer, including, of course, those who work in the steel industry. Deliberately raising the price to the American economy of steel, a crucial ingredient in everything from cars to cables, is self-harm.

In my latest column in the Pittsburgh Tribune-Review I call for trade policy based on realistic assumptions. A slice:

Freedom to trade is nothing more than the freedom of those who earn incomes to spend their incomes as they choose regardless of the nationality of suppliers. Because your ultimate purpose of working to earn an income is for you to use that income to acquire goods and services that improve your family’s standard of living, if you choose to buy an import you obviously believe that your buying that import helps to raise your family’s standard of living. It follows that if you are prevented from buying that import, you are thereby prevented from using your income to maximum effect in raising your family’s standard of living.

So, as a rule, each of us should be free to spend our incomes as we judge best. As a rule, obstructions of this freedom make us poorer. And while a vivid imagination can concoct scenarios in which such obstructions make us richer, such scenarios are no more realistic than that of burglary being good for society.

Writing in the New York Times, Dan Ikenson counsels Republicans not to be patsies for Trump’s tariffs punitive taxes on Americans who buy imports. A slice:

Why don’t the president’s trade transgressions elicit meaningful resistance from party leadership? His trade views are disdainful of freedom and informed by economic fallacies, yet Republican leaders have watched quietly from the sidelines as Mr. Trump misappropriates his authorities to disrupt global supply chains, inflict pain on American trade partners, generate enormous amounts of domestic collateral damage and make the United States an international scofflaw.

David Henderson argues that even if Trump’s goal in raising U.S. tariffs is to make global trade freer – an “if” that I find to be unbelievable – he, Trump, is playing a horribly dangerous game.

Simon Lester correctly advises us to be wary of claims that Trump’s tariffs punitive taxes on Americans who buy imports are ‘working.

Here’s my Mercatus Center colleague Dan Griswold on the most-recent U.S. Commerce Department monthly report.

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Quotation of the Day…

by Don Boudreaux on June 8, 2018

in Seen and Unseen

… is from page 167 of the late University of Washington economist Paul Heyne‘s 1985 paper “The Concept of Economic Justice in Religious Discussion,” as this paper appears in the 2008 collection of Heyne’s writings, “Are Economists Basically Immoral?” and Other Essays on Economics, Ethics, and Religion (Geoffrey Brennan and A.M.C. Waterman, eds.):

Capitalism is thus by definition an impersonal system. It is not altogether an impersonal system, because the individuals within it do participate in families and small, face-to-face associations, where they can know other persons well enough to be concerned with and to care for their unique qualities. But the distinguishing characteristic of capitalism is the impersonal nature of the social interactions that make it up. It can be described paradoxically as a social system in which people do not care about most of those for whom they care. The farmer who feeds me does not even know I exist, and while he wishes me no ill, he does not and cannot care about me in any subjective sense. Nonetheless, he cares for me, and very effectively, in an objective sense.

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Mr. Decker:

A fellow economist sent to me today a Breitbart piece from February reporting with approval your fear that the U.S. trade deficit with China is (as the title of the piece says) “underwriting China’s military and infrastructure buildup.” In this piece you are quoted as asserting the following: “What are our dollars doing? We’re building, paying for, and underwriting [China’s] military buildup. We’re building their infrastructure We’re making their country stronger for the future, sort of at the long-term expense of our own. We’re not making the investments in our own infrastructure.”

Breitbart describes you as an “Asia expert.” Perhaps you are that. But your assertion that the U.S. trade deficit with China funds investment in China reveals that you clearly are no economics expert. You see, whenever the U.S. runs a trade deficit it necessarily is on the receiving end of global capital flows. A U.S. trade deficit – more precisely, current-account deficit – means that more investment funds are flowing into the U.S. than are flowing out of the U.S. In trade lingo, when the U.S. runs a current-account deficit it runs an identically sized capital-account surplus. Furthermore, China’s trade surplus implies that China is running a capital-account deficit – meaning that on net the Chinese invest more outside of China than foreigners invest within China and, thus, there is a net outflow of investment funds from China.

In short, your assertion that the U.S. trade deficit is funding investment in China is complete nonsense. The truth is exactly the opposite of what you assert.

Sincerely,
Donald J. Boudreaux
Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030

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