Tag: economy

Understanding Imports and Exports Correctly

Theodore A. Gebhard

Trade association executives are paid to look after their member companies’ interests.  Part of that responsibility is to advocate public policy positions that advance or protect those interests.  Not surprisingly, such advocacy often cherry picks data and characterizes that data in ways that can generously be called suspect.  Nearly always, trade association public policy positions rest on the claim that the interests of the association’s member companies are the same as the interests of all Americans, and therefore what is good for the association membership is good for America.  Rarely, however, is this equivalence the actual case.

A good illustration of this kind of advocacy takes the form of a Letter to the Editor in today’s Wall Street Journal written by Mark Duffy, the president of the American Primary Aluminum Association.  (Canada’s Aluminum Subsidies Hurt the U.S., Letters, Digital July 27.)  Mr. Duffy laments the loss of U.S. aluminum smelting capacity, which he attributes, at least in part, to subsidized Canadian imports.  In so doing, Mr. Duffy makes the error of all those who see production and employment as the end of economic activity.  As Adam Smith taught us two and a half centuries ago, we engage in economic activity in order first to sustain life and then to improve life with ever higher standards of living.  That is to say, the ultimate purpose of economic activity is consumption and the wealth of a nation is the extent of its consumption pie.  Imports therefore are rightly considered benefits to a nation insofar as they add to the nation’s consumption pie, while exports are rightly considered costs as they deplete the consumption pie.  Another way to think about this to consider that when we export, we are utilizing our scarce resources for someone else’s (foreigners’) consumption benefit.  When we import, we are enjoying goods and services produced out of some other country’s scarce resources.  If a country is subsidizing its exports to the U.S., we benefit all the more.

Below is a reproduction of a response to Mr. Duffy’s letter that I submitted to the Journal.

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In his Letter to the Editor, Mark Duffy, President of the American Primary Aluminum Association, castigates Canada for subsidizing its aluminum industry to the tune of $850 million.  (Canada’s Aluminum Subsidies Hurt the U.S., Letters, Digital July 27.)  Mr. Duffy claims that these subsidies have contributed to a fall in the number of American smelters from 23 to four since 2000.  As to Mr. Duffy’s alarm over this development, I suppose it is obligatory that the president of a trade association equate his members’ interests with the interests of all Americans.  Doing so in this case, however, requires relabeling benefits as costs and costs as benefits.  In point of fact, America should be sending a thank you card to Canadian taxpayers who foot the bill for the subsidies, as the subsidies not only enable Americans to consume aluminum-containing products more cheaply but also enjoy a larger array of other products and services.  This larger array comes about because scarce resources, including labor, that are freed up by importing less costly Canadian aluminum become available to expand alternative productive activities and create new ones.  For American consumers and the American economy, it’s a double win — cheaper aluminum-containing goods and greater total national product.

Theodore A. Gebhard

(Mr. Gebhard was formerly a Senior Economist with the International Trade Administration.)

How Does the Debt Stack Up?

Theodore A. Gebhard

According to some estimates, the present value of the cost of Social Security and Medicare’s unfunded promises now stands at more than $175 trillion.  Add $36 trillion more in federal debt ($26 trillion held by the public) and the total is well over $200 trillion.  Even with historical economic growth and productivity increases, there is no way that these obligations can ever be met out of real resources so long as they continue to increase.  What’s worse is that the nation cannot count on growth and productivity maintaining historical trends, as growing debt service and entitlement payments increasingly crowd out private capital investment.  This ever larger burden on the private economy threatens the entire free market system.

So that citizens can get a handle on just how large a trillion is, the Wall Street Journal published three Letters to the Editor this week providing illustrations of a trillion dollars. Hugh F. Wynn’s letter can be viewed here (The Painful Parade of Zeros, Letters, April 7), and William F. Meurs’ letter can be viewed here (A Quiz Question on the Debt, Letters, April 8).  The third letter is from me, which the Journal published today (print edition).  The published version, edited by the Journal for space, can be viewed here (How Does the Debt Stack Up?, Letters, April 11).

Below is my original, unedited submission.

William F. Meurs’ hypothetical of a person spending a trillion dollars a day for 2740 years to illustrate how enormous a trillion dollars is (A Quiz Question on the Debt, Letters, April 8) improves on Hugh F. Wynn’s string of zeros (The Painful Parade of Zeros, Letters, April 7), but still falls short of most people’s real world experience.  How many of us have ever spent a million dollars in a day?  Nearly everyone, however, has walked a mile.  A better question therefore is how high would a stack of a trillion dollar bills (new and crisp, not rumpled) reach?  The answer is 67860 miles, more than a quarter of the way to the moon.  Of course, were it hundred dollar bills, the stack would be merely 679 miles, just one long day’s drive.

A Free Market Wish List for the New Administration

Theodore A. Gebhard

[Note: This post originally appeared in American Thinker magazine on July 31, 2024]

For those who believe in the instrumental and moral value of free markets, these are not good times. Both major political parties routinely exhibit ever increasing departures from limited government and economic freedom. It is therefore unrealistic for free-market advocates to expect the next administration to do anything but further expand government’s reach into the economy. Nonetheless, one can wish for better.  Below I identify some action items that would be on my wish list for producing a freer and more efficient economy. The list is far from exhaustive.

Balance the Budget and Address Unfunded Promises

According to some estimates, the present value of the cost of Social Security and Medicare’s unfunded promises now stands at more than $175 trillion.  Add $34 trillion more in federal debt ($26 trillion held by the public) and the total is well over $200 trillion.  Even with historical economic growth and productivity increases, there is no way that these obligations can ever be met out of real resources so long as they continue to increase.  What’s worse is that the nation cannot count on growth and productivity maintaining historical trends, as growing debt service and entitlement payments increasingly crowd out private capital investment.  This ever larger burden on the private economy threatens the entire free market system.  Legislation is needed to replace Social Security and Medicare with free market oriented retirement and healthcare systems, and a balanced budget amendment to the Constitution is needed to begin addressing the federal debt.

Require the Federal Reserve to Follow a Monetary Rule

Sound money is critical to the efficient functioning of a free market economy.  Under the Fed’s watch since its 1913 founding, the price level has increased by over 2,300% and the dollar’s value has fallen by over 95%. During the past two years, we have experienced the highest rate of price inflation in 40 years.  Covid spending programs and massive accommodation by the Fed facilitated this inflation tax on Americans.  Even before Covid, however, the Fed long pursued an easy money policy in the form of multiple episodes of quantitative easing designed to manipulate the term structure of interest rates.  Free market interest rates guide the allocation of capital by coordinating future expectations with the present.  Fed manipulation distorts that allocation.  Given its record of failure, Congress should limit the Fed’s discretionary powers by requiring that it follow rules-based policy.

Make Revenue the Sole Purpose of Income Taxes

Ever since the ratification of the Constitution’s 16th Amendment, politicians have increasingly used the income tax code to advance social goals and industrial policies.  These might include, for example, tax incentives to purchase and install solar panels in one’s home or tax credits and subsidies to certain industries that incentivize activities thought desirable by government.  Using the tax code in these ways expands the size of big government and its reach into the economy, distorts resource allocation, and creates strong incentives for rent-seeking that benefits the few at the expense of the many.  The tax system should be neutral and reformed to make its sole purpose the funding of legitimate federal government functions and services.

Abolish the Federal Minimum Wage

The current federal minimum wage is $7.25/hour, which is likely below market wages in nearly every American community, even for unskilled workers.  Thus, it has little or no effect.  Nonetheless, one cannot count on that benign status to be permanent.  The existence of the minimum wage continues to pose risks that Congress will restore the rate to a level above market wage rates.  When this occurs, minimum wage floors create short-term unemployment by making it illegal for employers to hire workers whose productivity does not generate sufficient revenue to pay the minimum wage and long-term unemployment by encouraging more substitution of capital for labor.  Typically, younger low skilled workers bear the unemployment burden of these laws.  Small businesses too, however, bear a significant share of the burden in the form of higher adjustment costs, and in worst cases, inability to survive.

Amend Federal Labor Laws and Reform National Labor Relations Board Rules

Last fall’s labor strike action in the U.S. automobile industry highlighted the significant economic and political power of big unions.  The economic power was manifested by the ability to shut down much of the industry’s production, and the political power was evident in the United Auto Workers’s capture of key politicians, most particularly President Biden.  Such economic power generates not only short-term production losses and lower current GDP, but also distorts employment opportunities.  Like the minimum wage, union wage contracts that result in wages above the market wage foreclose employment to less productive workers and, over the longer term, encourage the substitution of capital for labor. Federal labor laws and NLRB rules that unduly privilege unions and harm the efficiency of the overall economy and the well-being of low income households should be amended so as to eliminate these harmful effects.

End Industrial Policies

The Biden administration has supercharged industrial policy with subsidies and tax breaks for favored industries and favored production activities, all in the cause of promoting a green economy that reduces human impact on the environment.  Industrial policy inherently diverts resources from uses that would obtain in a free market.  The result is poorer economic performance.  There are free market oriented approaches better suited to achieve environmental objectives, and any free market wish list must include those approaches.

Adopt Full Free Trade

Adam Smith taught us that trade expands the benefits of the division of labor across national borders.  In so doing, it increases the size of the consumption pie for all parties engaged in trade.  Moreover, a nation benefits from free trade even when trading partners impose trade restrictions.  In light of this teaching and setting aside limited export controls respecting goods with national security implications, a free market wish list must include the elimination of tariffs, quotas, and other programs that restrict voluntary trade between Americans and foreigners.

Undertake Major Regulatory Reform

According to one study, complying with federal regulations cost businesses over $3 trillion in 2022.  Some of these regulations are surely necessary and generate sufficient positive benefits to justify their cost.  Complying with many, however, just as certainly costs more than the benefits that they provide.  In these cases, the economy is burdened with less real output and slower growth.  Unnecessary regulations impose burdens on free markets and private productive activities and should be jettisoned.

End the Export/Import Bank

The Ex/Im Bank is primarily in the business of shifting credit risk from foreign buyers of American products to American taxpayers.  In so doing, it also promotes the use of U.S. scarce resources for the benefit of foreign consumers.  Also known sarcastically as the Bank of Boeing because Boeing’s foreign customers are some of the major beneficiaries of the Bank’s programs, the Ex/Im Bank is a clear example of corporate welfare, and its existence is a clear departure from free market principles.

Eliminate Ethanol Mandates

The 2005 Energy Policy Act mandated that a certain percentage of renewable fuel — namely corn-based ethanol — be added to the U.S. gasoline supply.  It is doubtful that this blended product would exist in a free market.  It thus distorts prices and resource allocation, diverting farm land to corn from other crops.  Moreover, it is unclear what the mandate’s benefits are for the broader population.  Owing to extra costs to refiners, ethanol blended gasoline increases pump prices and, as experiments have shown, mileage per gallon is reduced, a double whammy for drivers.  Furthermore, a recent study published by the National Academy of Sciences concludes that the alleged reduction in greenhouse gas — namely carbon emissions — that ethanol blended gasoline generates is non-existent when one accounts for land-use conversions and ethanol processing, and on net may actually produce more greenhouse gases than refining and burning gasoline alone.  There is no net social benefit resulting from this subversion of free markets.

Repeal the USDA’s Sugar Program

A Government Accounting Office report estimates that the U.S. sugar program administered by the Department of Agriculture costs American consumers somewhere between 2.5 and 3.5 billion dollars because of higher prices relative to the rest of the world.  The principal beneficiaries of the program are the U.S. sugar growers and refiners, but the dollar amounts of their benefits are significantly less than the costs to consumers.  Thus, the distortionary effects are a net loss to social welfare.

Summing Up

Of course, it is not realistic to expect either political party to consider this wish list, let alone act on it.  The incentive for politicians to “buy” votes with special favors is too strong.  Nonetheless, for those who share a belief in the instrumental as well as moral value of free markets, my wish list may at least provide grist for discussion and perhaps even future change.

Capital Accumulation and the Reconciliation Package

Theodore A. Gebhard

[Note: This post originally appeared in The Daily Economy, a publication of the American Institute for Economic Research on Oct. 13, 2021]

Americans are rightly concerned about their current and future economic well-being. Since the 2008 financial crisis, middle class household incomes have seen little overall growth. Owing to business lockdowns and other pandemic-related impacts on economic activity, real household annual income actually fell from about $69,000 in 2019 to about $67,500 in 2020. Although hourly wages by month in 2021 have seen relatively high growth rates over the same month in 2020, the increase is explained largely by the pandemic-produced low 2020 base. Longer term, growth in hourly wages has been tepid, and many families continue to live paycheck to paycheck. Add to these trends the current rise in price inflation, and the result is that the purchasing power of incomes for some families has actually declined. It is not therefore surprising that polls show that Americans are distressed about their financial health and their ability to sustain their standard of living, let alone pass on a better standard of living to their children. Moreover, according to a CNN survey taken in August, 69 percent of Americans now believe that the country in general is not moving in a positive direction.   

Should Americans be worried about the future? Indeed, they should. Among other things, as far back as 2017, the nonpartisan Congressional Budget Office was warning that the explosive annual growth in the federal debt over the past several years is unsustainable. Since that warning, the debt has grown by more than $7 trillion (fiscal years 2017-2020). Although not formally debt, ballooning entitlement promises (mostly Social Security and Medicare) are also not sustainable in their present form. Now Congressional Democrats and the Biden Administration are pushing a new $3.5 trillion spending package. Notwithstanding the Administration’s incredible claim that higher taxes on corporations and on high income earners will pay for this spending, the truth is that most, if not all of the spending, will simply add to the federal debt, exacerbating the burden on future generations. 

At some point, the piper will demand payment by means of some combination of formal taxes or hidden inflation taxes that lower the purchasing power of household incomes while simultaneously enabling the government to pay off debt with cheaper dollars. Whatever the form, standards of living can be expected to decrease or at least grow at a significantly lower pace.

Although individually powerless to do anything about the federal debt and unfunded entitlement promises, most Americans, I suspect, grasp that persistent deficit spending and growing entitlement promises are not sustainable and that the burden on future generations will be high. Families can relate to the consequences of spending more than they earn. What is less understood, I believe, is how misguided spending and tax policies exacerbate the problem of rising debt levels by stunting economic growth.

In this regard, lost in all of the current rhetoric in DC about corporations and high income earners not paying their “fair share” of taxes and about the wonders of an expanding welfare state is the potential adverse impact of “tax and spend” policies on capital accumulation. Ignoring this impact threatens future standards of living and exacerbates the debt problem. Indeed, the best way to avoid de facto debt default in the future is to grow the economy faster than additions to the debt. Capital accumulation is critical to that end. Capital accumulation, however, requires short-term sacrifice and a limitation on current spending and tax burdens, something politicians seeking to appeal to what they perceive to be the current appetites of voters are disinclined to acknowledge. Consequently, it is not surprising that this crucial factor is missing from the public discussion.

A Little Econ 101

As most every student learns in the first week of an introductory economics course, a nation’s production possibilities – that is, its total potential output — at any given point in time is determined by its endowment of natural resources (including labor), current technology, and its capital stock. Given these endowments, there is a near infinite range of alternative mixes of final goods and services that can be produced, including the mix of consumption goods and capital goods (productive assets). In a free market economy, the actual mix is determined by consumer preferences signaled via market prices. Significantly, however, at full employment, no more goods and services can be produced in the aggregate. Thus, the only way by which the output of any single good or service can be increased is to take resources away from the production of other goods and services.

At first glance, the concept of production possibilities seems to suggest that standards of living are fixed in place or, possibly worse, must decline over time because of depreciation of the capital stock. In fact, experience tells us that this result need not be the case. New natural resources can be discovered, the labor force can increase through immigration and natural population growth, technology can advance, international trade can allow for more specialization based on comparative advantage, and the capital stock can expand through capital accumulation.

Adverse Effects of Government 

Although misguided government spending and tax burdens can adversely affect each of these factors, they have their greatest impact on the growth rate of the capital stock. To see why, consider that plants and equipment wear out over time. Thus, if the capital stock is not replaced as it depreciates, production possibilities must necessarily decline. Just to maintain current production possibilities, it is essential that some of a nation’s productive factors be devoted on an ongoing basis to replacing the capital stock that is wearing out. What this means is that, at full employment, some amount of current consumption must be sacrificed in order that resources can be diverted to producing capital goods if a nation is to sustain its capacity to produce. Furthermore, if a nation seeks both short-run full employment and long-run growth, it is not enough simply to replace depreciating capital stock. It must also expand the capital stock. In other words, it must accumulate capital at a rate greater than the depreciation rate.

Taxes on savings and investment hinder this process. They reduce the returns on capital and thus make capital less desirable to accumulate. Such taxes include those on capital gains and income from dividends. Taxes on corporate profits also take away earnings that otherwise could be used to fund investment in capacity expansion. At the least, these taxes cause a nation’s capital stock to expand at a slower rate.     

Similarly, government spending that focuses on expanding present services and increasing government’s size consumes resources that free market signals would have directed elsewhere, including private capital investment. Even if some of the spending is not for expanding present services but could arguably be considered investment in future productive capacity – such as various forms of industrial policy and various subsidies to incentivize the flow of resources to specific “infrastructure” activities — the spending, being politically directed, would likely result in resource allocation inconsistent with market signals. This misallocation not only imposes a present cost but also a future cost in that it establishes a continuing path of misdirected resource flows.

Both tax policies and spending policies can then hinder capital accumulation. When they do, they necessarily stunt long-term growth potential and thus rob future generations of goods and services that no longer can be produced because of diminished output capacity. When such policies are claimed by their proponents to be for necessary expansion of government services in the present and to pay for those services, it is simply a claim that current needs are of higher priority than future prosperity. More bluntly, it is a claim that future generations be damned.

In this regard, much of the tax and spending legislation proposed by congressional Democrats is aimed at feeding current appetites for a larger government that funds and advances politically determined social ends. Consider such spending items as “free” community college, expansion of Medicare to include dental and vision coverage, subsidies to support the planning and development of high speed rail projects, grants to energy providers to meet “clean energy” goals, and funding toward the development of charging stations for electric vehicles. With respect to taxes, the proposed legislation calls for increased taxes on corporations, increased capital gains taxes, and increased marginal tax rates on high income earners. One Democratic Senator has even called for taxing unrealized capital gains, an idea for which President Biden expressed support. Each of these spending and tax provisions elevates progressive ideology over long-term growth and the well-being of future generations of Americans.  

Americans are rightly concerned about their economic future. The growing federal debt is a serious problem that needs to be addressed. The best way of doing so without burdening future generations with lower standards of living is for the present generation to ensure strong economic growth. Strong growth in turn requires not only technological advancement and labor force growth but also capital accumulation at a rate sufficient to increase the net capital stock on a continuous basis. This means limiting current consumption, most especially government spending that consumes resources that free market signals would otherwise have directed to private investment. Misguided tax hikes on businesses and individuals that discourage saving and diminish funds for private investment similarly must be avoided. Regrettably, much of the Democrats’ proposed $3.5 trillion “spend and tax” legislation fails on each of these counts. Neglecting the legislation’s adverse impact on capital accumulation means robbing future prosperity for the sake of the present social ends. 

China’s Export Subsidies Are a Gift

Theodore A. Gebhard

[Note: This post originally appeared in The Daily Economy at the website of the American Institute for Economic Research on Sept. 16, 2021]

Instead of making a beeline to the nearest Hallmark store to buy thank you cards to send to the Chinese government for the subsidies it provides to Chinese exporters, the Biden Administration is reportedly developing a strategy to add new sanctions against China, including new tariffs on Chinese imports. According to the Wall Street Journal, the Administration furthermore wants to elicit the assistance in this effort of Japan and other Asian nations as well as seek support within the broader World Trade Organization. Such a strategy would carry on, at least in spirit, the Trump Administration’s conflation of the costs and benefits of trade. It is a policy that not only says “no thank you” to what should be a welcome gift but perversely says that because China chooses to shoot itself in the foot, the United States and its allies must retaliate by doing likewise.

Consistent in spirit with this new strategic initiative, the U.S. International Trade Commission currently has fourteen ongoing investigations of “import injury” in which China is implicated. Imported products under investigation include such items as pipe fittings, flat steel, woven ribbon, wax candles, and tissue paper. These investigations seek to determine whether domestic sellers have been “injured” (i.e., have lost sales) owing to Chinese competition at allegedly unduly low prices to which subsidies may contribute. 

The potential new sanctions, as well as the ITC investigations, rest on the idea that China deliberately engages in “unfair” competition that must be challenged or otherwise punished. Specifically, China’s export subsidies (and also as alleged from time to time, its currency manipulation) are said to be trade practices deliberately designed to enrich its economy at the expense of the United States and other trading nations. Among other harms, it is alleged that these trade practices unfairly cost American jobs and injure American businesses, all to the detriment of the American economy. 

This conclusion, however, is firmly rooted in mercantilist thinking long rejected by sound economics. In particular, it miscomprehends costs and benefits.

Distinguishing Costs and Benefits

In An Inquiry into the Nature and Causes of the Wealth of Nations, Adam Smith, the 18th century Scotsman considered by many to be the founding father of modern economics, expounded his seminal insight, novel at the time, that a nation’s economic well-being – its true wealth – 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 consumption goods and services available to satisfy human wants and desires. Smith makes the point that economic activity takes place so that people can consume. In other words, the ultimate purpose of economic activity is the satisfaction of wants and desires through consumption. 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 are the costs that a nation incurs in order to consume.

Consumption goods and services, however, must first be produced or otherwise acquired from someone else who has produced them; for example through trade. Because consumption takes place over time, resources must therefore be constantly employed to yield goods and services that satisfy ongoing wants and desires.

In the context of trade, exports thus represent a cost to a nation and imports a benefit. Exports require the employment of a nation’s scarce resources for another nation’s consumption benefit. By contrast, imports are a benefit. Importing goods and services allows a nation to consume while conserving its own scarce resources. These resources are then available for deployment in other productive activities, thus expanding domestic output and permitting even greater rates of consumption. That is, the freed up resources expand the nation’s production possibilities. The result is an increase in the nation’s total wealth. Rightly considered then, exports, and the resources that go into those exports, are the price a nation must pay for its imports. 

Notwithstanding this price, however, trade permits a nation to conserve scarce resources on net. This occurs whenever goods and services are able to be acquired more cheaply through trade than the resource cost attendant to domestic production. In this regard, a nation is no different from an individual. To the individual, the lower the price, the greater the surplus value; and the money that is conserved is available to be spent on other items that enrich life even more. In the aggregate, whenever U.S. buyers can obtain goods and services more cheaply by means of importing them than by buying them domestically, consumers in the present are made better off and resources are conserved, permitting expansion of future consumption. The nation’s wealth potential is enhanced.

Significantly, these benefits will accrue regardless of whether the imported goods are cheap, i.e., even if they are cheap because of subsidies or an undervalued currency. Indeed, if subsidies or artificially undervalued currency is the reason (as opposed to, say, Ricardian comparative advantage), the true harm falls on the citizens of the nation providing the subsidies or “manipulating” its currencies. Not only is that nation using up its scarce resources for the benefit of foreign consumers, but its citizens are being taxed to fund the subsidies and are being exposed to higher domestic prices of imported goods because of the undervalued currency. It is a double whammy.

In light of the above, if the Biden Administration carries out its threats to impose sanctions on China, it would add harm on top of harm. Tariffs, for example, would harm U.S. buyers by eliminating the option provided by the cheaper Chinese goods. To the extent that some of these subsidized goods are intermediate goods such as raw materials and other inputs, the resulting higher costs can be expected to generate higher prices over a wide range of output. In the aggregate, U.S. wealth will be less than it otherwise could be as conserved resources that would expand production possibilities are forgone. 

To be sure, export subsidies can result in certain industry-specific disruptions and transactional costs to individuals working in those industries. This inevitable consequence is by all means a basis for a compassionate nation to lend support to those who require retraining and other transitional assistance, but it is not a basis for protectionism and lower living standards on the whole. Instead of forgoing resource savings and the gains to consumers (including industrial consumers) from low-priced imports, would it not be better for the Administration to focus on policies that restore the rapidly expanding domestic economy that preceded the pandemic? The goal should be to accrue all of the gains from low-cost imports while maintaining full employment at home.

Putting the economy back on a post-pandemic growth path will of course include efforts to lubricate global trade that benefits the U.S. Attacking Chinese export subsidies should not be part of that effort, however. Time would be better spent focusing on domestic impediments to restoring growth such as excessive federal regulations on business, leviathan government spending that saps the economy of productive resources, and a tax system that hinders capital accumulation and distorts allocative efficiency. Sadly, the current Administration is moving in the wrong direction on each of these issues, subject matter for further comment in subsequent posts.

Summing Up

Economists do not always agree on everything, but there is little or no disagreement across all schools of economic thought on the foundational principle that the ultimate purpose of all economic activity is to satisfy human wants and desires. In other words, the ultimate purpose of economic activity is consumption.

Chinese export subsidies are a boon for U.S. consumers, permitting them to satisfy wants and desires for less. Moreover, the savings can be redirected to other productive activities, thus expanding U.S. wealth. Misguided retaliation that would eliminate the advantages that cheaper Chinese goods offer would result in unnecessary self-inflicted costs and forgone benefits to the American economy. Better simply to give a hearty thanks for the gift.

Peter Navarro Is Wrong Still Again

Theodore A. Gebhard

Once again President Trump’s trade adviser displays his lack of understanding of how nations gain from trade. In an op-ed in today’s Wall Street Journal, Mr. Navarro contends that China’s trade practices victimize the U.S. (“China’s Faux Comparative Advantage,” 4/16/18) In doing so, he makes two errors. First, he is wrong to suggest that trade with China that diverts from the “textbook” model of comparative advantage always generates harm to the U.S.  To be sure, ever since David Ricardo described comparative advantage in terms of relative resource and knowhow endowments, that example has been a staple of textbook discussions of how trade can produce gains.  The gains arise because comparative advantage permits both sides to conserve resources.  Those saved resources can then be deployed in other productive activities, thus increasing national wealth.  This result holds even when one trading partner subsidizes its exports, gives tax preferences to its exporters, or “dumps” goods by selling overseas at a lower price than at home.  Such policies, though harming citizens and taxpayers in the exporting country, conserve resources in the importing country and benefit consumers with lower prices.  Letting Chinese citizens and taxpayers subsidize U.S. steel consumption, for example, means that resources that the U.S. would otherwise have to deploy to making steel can now be deployed elsewhere, i.e., we get cheaper steel and other stuff instead of just steel.  That the Chinese government chooses to harm its own citizens is no reason for the U.S. to retaliate by doing the same to its citizens.

The second error that Mr. Navarro makes is conflating such activities as cyberespionage and intellectual property theft with export subsidies and tax preferences.  Stealing property, whether tangible or intangible, is categorically wrong, and Mr. Navarro is right to call out such illicit activities.  The error lies in failing to distinguish between these harmful Chinese practices and practices that are beneficial to the U.S.  The former of course should be targeted for reprobation and fully proscribed.  The latter should be left alone.  Regrettably, the Trump Administration’s recent trade initiatives toward China, which Mr. Navarro helped to formulate, aim indiscriminately at both the good and the bad.   

Why Not a Stable Dollar?

Theodore A. Gebhard

In a “Letter to the Editor” in today’s Wall Street Journal, Michael Bird comments on the Fed’s 2% inflation target and on the long term effects on the purchasing power of American’s income. Mr. Bird is correct in his observations. Adding two more points to those observations, however, I submitted the following to the Journal as a follow up letter. I would also recommend that the reader see my longer piece on the Fed’s “Inflation Tax” here.

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To letter-writer Michael Bird’s observations about the Fed’s Orwellian definition of stable prices as 2% inflation and its long term effects on the purchasing power of the dollar, I would add two points. (“Fed’s Sole Policy Should Be a Stable Dollar,” 3/18/2017)  First, there is nothing in economic theory that generates the 2% inflation number as opposed to, say, 0% or 1% or 3%.  It is purely an arbitrary choice based on the idea that it is good to have an inflation rate above zero to incentivize spending and discourage saving, a policy goal of  questionable merit.  Second, designed inflation operates as a tax on wealth as well as a revenue generator for the government insofar as pushes people into higher tax brackets and permits the repayment of bonds with debased dollars.  Yet, Article 1, Section 7 of the Constitution assigns the taxing power solely to Congress and further requires that all revenue bills originate in the House of Representatives, the chamber most accountable to the people.  Even if not legally cognizable as a revenue bill, an inflation tax imposed by unelected central bankers plainly violates the spirit of the Framers’ constitutional framework.

Still More Trade Illiteracy from Peter Navarro

Theodore A. Gebhard

Sadly, President Trump’s instincts regarding trade wherein he believes negative trade balances to be a consequence of other countries’ ripping off the United States is reinforced by his chief trade advisor, Peter Navarro. Economists have long known this view to be specious, and acting on it in policy will only end up making Americans economically worse off. In an op-ed in today’s Wall Street Journal, Mr. Navarro rejects over 200 years of economic learning. In response, I have submitted the following to the Journal as a Letter to the Editor. (See also my earlier Posts on trade economics here and here.)

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As a former economics professor, I am disheartened to see one of Mr. Trump’s chief advisors, Peter Navarro, reject over 200 years of economic learning by speciously using GDP accounting to contend that current account imbalances should be a significant policy concern.  (“Why the White House Worries about Trade Deficits,” 3/6/2017)  Mr. Navarro contends that boosting net exports over imports boosts growth and, implicitly, the country’s economic well-being.  As many economists acknowledge, however, GDP is a poor proxy of economic well-being and, in turn, GDP growth is a poor measure of changes in a country’s wealth.  Indeed, by Mr. Navarro’s reasoning, we can increase wealth simply by enlarging government expenditures financed by fiscal deficits or money printing.

Starting with the indisputable premise that the ultimate end of economic activity is consumption, Adam Smith taught in The Wealth of Nations (1776) that a nation’s well-being is determined by the amount of final goods available to its people.  Exports thus are a cost to a nation (using up its scarce resources for foreigners’ consumption benefit) while imports a benefit (consuming out of others’ scarce resources).  Exports are the cost of paying for imports. 

A nation benefits from trade whenever it can obtain goods from abroad cheaper than it can produce those goods at home.  Obtaining goods cheaper from foreign sellers not only increases the available consumption pie (and thus a nation’s wealth), but it also frees up resources that can be deployed to expand wealth even further.  What’s more, it matters not whether the goods are cheaper because of comparative resource advantage or because other countries inflict harm on themselves by subsidizing their exports. 

Economic history has confirmed Smiths’ wisdom many times over.  One would hope that this wisdom is not entirely lost on our policy makers. 

Theodore A. Gebhard

More Economic Illiteracy on Trade

Theodore A. Gebhard

In the “Letters to the Editor” section of today’s Wall Street Journal, Felix Dupuy of Whitefish, Montana laments that the 41 million U.S. jobs supported by trade come with a $500 million trade deficit, which he claims is largely paid for by the Treasury “in the form of increased debt.” (Letters, July 27, 2016)  The assertion is a non-sequitur.  The connection between the U.S. current account deficit and the U.S. fiscal deficit is tenuous at best.  The former moreover represents neither harm to the American economy nor any debt to the Treasury.  To the contrary, the current account deficit is an indication of the greater prosperity of  the U.S. relative to the rest of the world.  Because Americans are rich, they buy more from others than others buy from them.  Also, the current account deficit does not increase the public debt.  The Treasury has nothing to do with private sector trades that happen to cross borders.  Finally, foreign sellers accept dollars for goods only because those dollars represent claims on American goods.  That the dollars are not repatriated in some arbitrary time frame (one year) is unimportant.  Ultimately, our imports must be paid for with exports when foreign dollar holders redeem their claims.  —  By contrast, the fiscal deficit is real debt arising from unpaid-for federal spending.  It is also cumulative, now standing now at a $19 trillion burden on future generations of Americans.  (See also my earlier Posts on trade economics here and here.)

ZIRP Has Failed; So More ZIRP

Theodore A. Gebhard

If the definition of insanity is repeating the same thing and expecting a different result, the Fed is becoming close to being properly labeled as insane. After some six years of the Fed’s zero interest rate policy (ZIRP), economic growth rates remain in the tank. Plainly ZIRP’s failure to bring about anything close to a robust recovery from the 2008 financial collapse argues for a re-evaluation of the policy. Yet, in a Wall Street Journal op-ed today, Narayana Kocherlakota, president and CEO of the Federal Reserve Bank of Minneapolis and a participant in the Federal Open Market Committee, argues for more of the same. (“Raising Rates Now Would Be a Mistake”)

When I first began reading Mr. Kocherlakota’s op-ed, I thought that it had to be a deliberate parody on the Keynesian groupthink that characterizes the world’s central bankers. Then I realized that Mr. Kocherlakota is dead serious about wanting the Fed to continue with its ZIRP notwithstanding the policy’s proven impotence. He says it is imperative to do so because raising rates now would impede the Fed’s ability to achieve two goals: (1) raise inflation to its 2% target rate, and (2) stimulate spending via credit expansion and bank lending.  He fails to explain, however, how either of these goals arises from sound economic thinking or if met would change the trajectory of the economy and bring about the illusive recovery.  Indeed, both of these goals are highly questionable attributes of a growing and productive economy.

Regarding the first goal, Mr. Kocherlakota merely asserts that 2% inflation is how the Fed defines price stability.  No reason is given as to why 2% is superior to any other number, let alone superior to what most people outside of the FOMC would define as stable prices — zero inflation.  In fact, a 2% inflation rate means that the purchasing power of a dollar declines by almost a third over 20 years.  Not only is financial prudence on the part of households punished, saving is discouraged and debt-taking encouraged.  Diminished saving and increased debt, however, have never been shown to lead to growth and sustained prosperity.

Mr. Kocherlakota’s second goal, increased spending, is similarly misguided.  A focus on spending neglects capital accumulation, which is essential to productivity gains and economic growth. Capital accumulation, moreover, requires saving to finance the new capital.  Hence, incentivized spending and debt-taking, buttressed by lower saving owing to an inflation tax, must result in a lower rate of capital accumulation and ultimately diminished growth prospects.

In the end, price controls never work, and interest rate manipulation will be no exception.  Eventually, the distortions in asset pricing created by ZIRP must be corrected.  When that time comes, the tools that the Fed has in its bag will have been seriously depleted, and the correction could be long and deep. After years of tepid recovery, it is past time to jettison the monetary policy groupthink that Mr. Kocherlakota represents, bury the ZIRP, and return to free market principles in which interest rates are freely determined in the marketplace by peoples’ time preferences and an honest monetary policy.

(See also my earlier related Post here.)

Why Econometric Forecasting Is a Fool’s Errand

Theodore A. Gebhard

In a Wall Street Journal op-ed entitled “Government Forecasters Might as Well Use a Ouija Board” (appearing today, Oct. 16, 2014), Professor Edward Lazear of Harvard University cites several historical examples of gross inaccuracies in government macroeconomic forecasting that nonetheless were critical to policy formation. In light of this history, he properly urges government officials and political leaders to exercise far more humility in making claims based on such forecasts. 

Nonetheless, Professor Lazear leaves out of his discussion the principal reason why econometric forecasts are so notoriously bad.  Unlike models of the physical world where the data are insentient and relationships among variables are fixed in nature, computer models of the economy depend on data grounded in motivated human action and relationships among variables that are anything but fixed over time.  Human beings have preferences, consumption patterns, and levels of risk acceptance that regularly change, making mathematical relationships derived from historical data prone to being grossly inaccurate representations of the future.  Moreover, there is little hope for improved accuracy over time so long as human beings remain sentient actors.  It is no wonder that macroeconomic forecasting is largely an exercise in futility.