[This post originally appeared in American Thinker magazine on March 1, 2016]
In the 1980s Reagan Republicans were fond of wearing Adam Smith neckties. (I personally still have two hanging in my closet that hail from that era.) Adam Smith, of course, was the 18th Century Scotsman who wrote An Inquiry into the Nature and Causes of the Wealth of Nations, a book considered by many to be the founding work of modern economics. Wearing the Adam Smith neckties was intended to display fidelity to Smith’s ideas and, in particular, fidelity to free markets and free trade.
One does not see many Republicans wearing these neckties anymore. Perhaps this loss of ubiquity is to the good, considering how far removed the Party’s front runner in the presidential race, Donald Trump, is from the free market ideas of Smith. For example, in response to the announcement earlier this month by the air conditioning products manufacturer, Carrier Corporation, that it would be closing a U.S. production facility and relocating to Monterrey, Mexico, Mr. Trump stated on Sean Hannity’s Fox News Channel program that, if elected, he would impose a 35% tariff on Carrier products re-entering the United States. In the same vein, Mr. Trump made a similar threat last year with regard to Ford Motor’s announcement that it will double its Mexican-based production capacity. Mr. Trump asserts that the threat of high re-entry tariffs is necessary to discourage these and other American companies from seeking lower-cost production outside of the United States.
Mr. Trump also claims that the Chinese government engages in unfair trade practices by intentionally devaluing the yuan in order to impose a de facto tariff on all imported goods from the U.S., which he says is “costing millions of American jobs.” He says that, unlike the “stupid politicians” in Washington, he will use his superior deal-making skills to stop this job loss by negotiating a U.S.-friendly trade agreement with China. While those negotiations are taking place and to encourage the Chinese to come to the table, he will designate China a “currency manipulator” on day one of his presidency and impose countervailing duties on “cheap Chinese imports.”
Adam Smith would be alarmed by Mr. Trump’s retaliatory threats. The central thesis of The Wealth of Nations is that a nation’s economic well-being is measured not by its store of gold or currency, the amount of goods it exports, or the number of jobs that exist within its borders, but rather by the quantity of goods and services available for consumption by its populace. Smith makes the point that the ultimate purpose of all economic activity is to satisfy human wants and needs. The reason that economic activity takes place is so that people can consume. Work and production are means to that end, but not ends in themselves. In a world in which resources are scarce, employment of labor and other factors of production is the cost that a nation incurs in order to consume.
Thought of in this way, it becomes clear that if a nation can reduce the employment of any resource, including labor, required to yield a given rate of output of consumer goods, those freed up resources can then be used to produce even more goods, thus making the nation wealthier. Such a result can come about because of several reasons, including the discovery and adoption of new technology that raises resource productivity, trade that derives from comparative advantage, and the free flow of capital to those uses and locations where it is employed most efficiently.
Thus, for example, American wealth stands to gain when Carrier can produce air conditioners at lower cost in Mexico and Ford can do the same with cars. The gain comes about in two ways. First, absent re-entry tariffs, as Mr. Trump proposes, more air conditioners and cars can be made available to American consumers at a lower price. Second, the resources freed up in the U.S. become available for other output-expanding uses.
Trade also increases the wealth of nations by permitting them to take advantage of each other’s relative productive efficiencies. So, for example, a nation’s wealth grows whenever it purchases goods from those nations that supply them most cheaply. Hence, notwithstanding Mr. Trump’s outrage at “cheap Chinese imports,” American consumers are better off because of those imports. By their own actions, consumers have revealed that they prefer spending their dollars on the Chinese goods to spending the dollars on anything else. In addition, because the U.S. does not have to use up scarce resources to produce these goods, those resources are available to produce other goods that otherwise could not be produced. Instead of harming the U.S., the “cheap Chinese imports” generate an increase in American wealth.
But what about the trade deficit that is created by importing all of these goods from China? Isn’t Mr. Trump’s alarm justified on this ground? The answer is “no.”
Of critical importance here is the fact that the dollars obtained by the Chinese sellers have value only because they represent a claim on American-produced goods and services. Because in the modern global economy, exchange does not take place by barter of goods for goods but by goods for currency, final settlements need not, and rarely do, occur instantly. Rather, they take place over time, often many years. Ultimately, however, the dollars in Chinese hands will find their way back to the U.S., either directly or through multinational trade, to be redeemed for real goods and services.
What Mr. Trump fails to grasp is that voluntary trade is always beneficial to both sides regardless of current account deficits or surpluses. Moreover, he misses Adam Smith’s key insight, namely that exports are a cost to a nation; imports a benefit. When a nation imports, it is enjoying the consumption of goods produced from the scarce resources of some other nation. Although settlement may not occur immediately, ultimately a nation must pay for that enjoyment with exports of real goods and services produced out of its scarce resources. In the end, trade allows each nation to obtain goods that yield greater consumer surplus than could be obtained if the goods were produced domestically.
The principal lesson here is that a nation that can become more efficient in supplying consumer goods to its people becomes wealthier. The free flow of capital and international trade are two ways that increased efficiency can come about. (There are others, of course.) Tariffs and other policies that impede the potential gains in efficiency ultimately make a nation poorer.
Regrettably, Mr. Trump evinces no awareness of these principles from The Wealth of Nations. His repeated promises to “be the greatest jobs president ever” and seek “fair trade, not free trade” are founded on long-discredited mercantilist ideas that confuse costs with benefits and focus solely on observable metrics while ignoring the less observable perverse consequences.
To be sure, international movement of capital and goods often has severe localized effects on individuals and communities. These are the observable costs that Mr. Trump sees and seeks to prevent. For example, the lives of those individuals who will lose their jobs at Carrier and Ford will be disrupted, perhaps severely so. Far better than Mr. Trump’s steep tariff penalties, however, would be policies that make it possible for these individuals to find other jobs quickly. In the short term, taxpayer funded retraining and other transitional assistance are in order; in the longer term, free market policies that promote a more efficient and expanding economy will assure continuing employment opportunities for everyone.
By contrast, policies that focus directly on protecting and creating jobs, such as Mr. Trump’s tariff penalties and duties, will in the end fail to do either. Although visibly protecting some jobs in the short term, these policies will diminish the efficiency of the economy, make American consumers poorer, and reduce the nation’s wealth. Ultimately, they will cost jobs and harm American living standards. Bearing out Adam Smith’s insights, economic history and experience show that job opportunities expand most when a society focuses first on increasing efficiency over time. This is the recipe for a growing and ever wealthier economy. More jobs are, in turn, the byproduct of this process.
I won’t be sending one of my Adam Smith ties to Mr. Trump.