Cafe Hayek: You Want Balance?

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August 16, 2007

You Want Balance?

Don Boudreaux

Below is a letter that I sent today to the Wall Street Journal:

Here's advice for your readers: ignore anyone who complains that trade is "imbalanced." I have never encountered any such complaint that makes even a whiff of economic sense.

Exhibit A is today's letter from United Auto Workers' President Ron Gettelfinger. Mr. Gettelfinger grumbles that "the U.S. and South Korea have a huge imbalance in auto trade." Well, duh - that's an inevitable consequence of specialization. Although we cook in our household, my family still has a huge "imbalance" in the prepared-food trade with McDonald's. But we would make ourselves only poorer if my family and I refused to buy from restaurants that do not buy equal amounts of prepared meals from us. In this case, what is true for each household is true for the collection of households that we call the United States.

It's also worth pointing out that General Motors, Ford, and Chrysler each have huge trade imbalances -- to be precise, huge and growing trade deficits -- with their workers: these companies buy far more from their workers than their workers buy from them. Perhaps auto makers should hire workers only on the condition that the trade in each case is "balanced": each and every worker must agree to spend his or her entire salary on products made by the auto maker. For example, a G.M. worker whose total compensation in 2007 is $60,000 must spend $60,000 on G.M. products in 2007. Any worker who fails to do so will be fired because of the resulting imbalance.

Posted by Don Boudreaux in Myths and Fallacies, Trade | Permalink

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Comments

Aren't we forgetting that David Ricardo suggested 3 requirements must be met for free trade and comparative advantage to work to benefit of the people of both countries? Those being capital not being allowed to cross borders,, trade must be balanced and ideally each country should have full employment.

Also what about unequal tariffs. If China imposes a 20% tariff on imported cars and we only have a 2% tariff how is that helping us.

Lastly, can some one explain to me the benefit to the American worker of competing with 1.5 billion low paid third world workers? Is that a benefit for the American worker or for the multinational CEO and their owners of stock (mostly 15% of Americans)

Posted by: muirgeo | Aug 16, 2007 10:24:42 AM

Muirgeo,

The principle of comparative advantage is much more general than you think -- and more general than it appears in Ricardo's explanation of it in Chapter 7 of his Principles. The principle helps explain ALL trade, international as well as intra-national. The principle works whether capital is immobile across any political border or mobile across such borders. The principle explains why butchers and house-painters in Brooklyn trade with restaurants and dentists in Queens.

As for high-wage workers competing with low-wage workers: it's a common, but gross, error to suppose that wages are the only factor that firms look at when choosing where to produce and whom to hire.

I, for example, am willing to play quarterback in the National Football League -- and I'd do so, quite happily, at a tiny fraction of the pay that the likes of Peyton Manning, Drew Brees, and Tom Brady are paid. But I suspect that no NFL team wants my services, even at my extraordinarily low wage rate.

Posted by: Don Boudreaux | Aug 16, 2007 10:36:10 AM

How can trade be free if capital is not allowed to move across borders? If Ricardo says that is a precondition for free trade serving everyone's interests, he is contradicting himself. Of course, it may very well be that Ricardo never said any such thing, and muirgeo is misinterpreting what he said. I never read anything of Ricardo's, just heard of him second-hand from George Reisman.

Posted by: SaulOhio | Aug 16, 2007 11:44:25 AM

Don,

With the GM example, couldn't you say that the GM employees are buying wages and benefits with their labor? I think your example is an excellent way to demonstrate why trade deficits don't matter, but it seems that you are ignoring what the workers receive in return.

Either way, it seems that the idea of "balanced trade" is impossible, because both parties are receiving more than what they are giving up. The word 'balanced' implies that every gain is a loss for someone else, when voluntary trade actually results in a gain for both parties.

Posted by: RBC | Aug 16, 2007 12:13:12 PM

muirgeo, I recommend listening to Russ Roberts' podcast with Ed Leamer. In it they discuss the different trade theories and as I recall, specifically address your concern about capital mobility and "things being different today."

And, how come the moral case against protectionism is not persuasive? My family of three (soon to be 4) is looking to replace our small car with one big enough for all of us plus our 4 dogs. When I went down to my Ford dealer (I'd always been a Ford guy), there was nothing in relatively new condition that would remotely be affordable for us. Forget about their new cars ...

Why is it not OK for me to shop at Kia, Hyundai and the like to find something more affordable to suit our needs? It's not like I can afford to buy the Ford now anyway. Am I costing Ford workers by purchasing a Kia? Hardly. I wouldn't be able to get a new car at all otherwise.

And the deal about capital about not being able to cross borders ... the Hyundai we looked at seems to have been produced ... here ... in the USA. I'd like to believe that in this case, capital mobility has improved both my position and that of the American workers down South and the Korean owners of the company.

Posted by: Mike | Aug 16, 2007 12:51:53 PM

Also what about unequal tariffs.

What about them? Imposing a tariff reduces the wealth of those imposing it just as it does on those whom it is imposed upon. So if China has tariffs on our goods, that is certainly a bad thing--but it wouldn't make us any better off to impose tariffs on them in turn.

Say a country refuses to buy steel from us; that blocks our steel producers from a potential market. But if we, in turn, put a tariff on steel, that blocks everyone else who might benefit from cheaper steel from being able to get it.

Tariffs will always result in less overall wealth, no matter who is responsible for them.

Posted by: Adam | Aug 16, 2007 4:10:25 PM

"Perhaps auto makers should hire workers only on the condition that the trade in each case is "balanced": each and every worker must agree to spend his or her entire salary on products made by the auto maker."

I've owned small bookstores for the past 15 years. Of the dozens of parttime employees at those stores, I remember two who regularly spent their entire paychecks on books they found on our shelves.

Posted by: John Dewey | Aug 16, 2007 4:56:58 PM

"couldn't you say that the GM employees are buying wages and benefits with their labor?"

To me that's akin to saying that a fisherman is, in effect, buying fish from the ocean. We don't buy our wages and benefits, we earn them.

Posted by: Craig | Aug 16, 2007 7:32:43 PM

McDonalds just bought my money with a cheeseburger. MMMmmmmm. Glorious Cheeseburger...

Posted by: Tim | Aug 16, 2007 9:14:08 PM

To me that's akin to saying that a fisherman is, in effect, buying fish from the ocean. We don't buy our wages and benefits, we earn them.

If you stop thinking in terms of currency and start thinking in terms of exchange, then you could say that the fisherman is exchanging the time and effort he put into catching fish for the cash he gets paid; just as workers trade their leisure time and efforts for their wages.

You can't just "earn" a wage for nothing--if you walked into a GM factory and started building, without ever being hired, then you would not earn a dollar--simple as that. Without signing a contract with the company, no exchange would take place--although I'm sure they wouldn't mind the volunteer work.

Posted by: Adam | Aug 17, 2007 6:19:38 AM

The union would mind, it would 'cost' America an assembly line worker.

Posted by: Wojtek G | Aug 17, 2007 8:41:29 PM

Don,

Give us a break. Your NFL quarterback example does not even get out of the endzone. There are about 100 or so candidates for professional quarterback in the USA. Of course your not one of them. The analogy is supremely ridiculous and has nothing to do with aggregate labor supply and demand.

Posted by: anonymous | Aug 18, 2007 3:08:18 PM

Trade Imbalance;

A good example of a trade imbalance is one that I have with my local grocery store.

I buy all sorts of items from them, and in return they purchase nothing from me. They just take my dollars.

However, the difference between my example and that of, say, China / US trade is that now China has billions of US dollars. Since money no longer has any intrinsic value and is worth what folks are willing to pay for it (like any other commodity), it is conceivable that China, the Arab countries, etc., which are swimming in US dollars, will no longer wish to hold US dollars and will begin unloading dollars; albeit in a "controlled" manner so they do not hurt themselves economically.

If this should occur, the US dollar will drop even further, resulting in inflation, which in turn will force the Fed to hike interest rates, which in turn will slow the economy leading to higher unemployment and perhaps a recession.

So a grocery store analogy of a trade imbalance omits the role of money and how a trade imbalance can negatively affect the value of the US dollar and the US economy.

I too once thought that trade imbalances mattered not. In fact, there is a zero correlation with historical trade imbalances and the economic well being of this country. But most of the historic imbalances occured when the US dollar was pegged to gold; a commodity that - for better or worse - always has had, and probably always will have intrinsic value. The confidence that people have in gold never wanes. This is not true of paper money.

This dollar / gold peg is no longer extant. The value of the US dollar is based purely on the confidence of other nations in paper US dollars. If they lose confidence in the dollar the proverbial you know what will hit the fan.

But what if China et. al. decide to "diversify" away from the US dollar? Then what?

Perhaps someone out there can enlighten me and tell me where I am wrong.

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