Tag: free trade

Much to his credit, Jake sets aside his “nations don’t exist” position long enough to attempt a courageous defense of the second aspect of Hazlitt’s case for free trade, which consists of an argument against using a tariff to establish a new industry. I have to commend Jake for taking the time to put in this effort, as I vastly prefer to see those who disagree with me honestly attempt straightforward defenses of their positions than to watch them skulk away in stubborn silence. Quotes from my post are in bold while Jake’s words are italicized.

1. The tariff grants $5 in domestic benefit for a domestic cost of $4.25.

It’s all the same. The $0.75 spent abroad is going to wind up buying American exports sooner or later. The only alternative is that they take the $0.75 and bury it, burn it, or otherwise not “cash in” their claim on American goods or resources. This “worse case” scenario amounts essentially to our trade partner “giving” the USA sweaters for nothing but green pieces of paper. Hardly a calamity for the US. I think this is what is happening to account for the oft-mentioned “trade deficit”, basically we’re importing cars, electronics, oil, food, etc and paying nothing but paper money for them. We’ve gotten away with this for a long time because of the Dollar’s status as the world’s reserve currency, foreign nations want dollars not only, or even primarily, for the American goods they can buy, but because every dollar they hold is a base on which they could pyramid more fiat money of their own. I agree this is a bad thing (long-term) and represents a serious disadvantage to domestic manufacturers, but the problem is the monetary policy, not trade. And cutting foreign trade won’t fix our problem or raise our living standards.

It’s not all the same. Jake has made the same error here that Hazlitt made in his primary argument, specifically errors #3 and 4. It’s not just a long-term issue, it is an immediate and more pressing short-term issue as well. Since it is a fact that the money may not come back to the United States for at least 35 years, the purported exports simply do not exist and their benefits cannot be assumed during the expected career of the average worker. And frankly, it should be deeply embarrassing for anyone with Austrian pretensions (referring to Hazlitt here, not Jake), to fail to recognize the massive importance of the TIME ELEMENT in economic transactions.

2. By positing a 50,000 loss of jobs in other industries, Hazlitt is assuming that labor productivity is the same in all domestic industries…. And more importantly, there is no reason to assume that the loss of domestic consumption could not be replaced with foreign consumption.

If exports are going to increase to offset the reduction in domestic demand brought about by a tariff increasing prices then we’re still going to be importing something in exchange the exports. We have to remember that a tariff on imports also harms exporting industries as they find it harder to sell their goods abroad. Also, even if domestic industries can find new markets abroad to offset reduced domestic consumption it will obviously be at a lower profit (else why wouldn’t have have already been exporting in larger quantities?).

Jake repeats his first error here and compounds it by committing new ones. It is totally incorrect to assume that all import tariffs are met with an immediate and equal response with tariffs on exports from other nations. The USA is not about to slap a tariff on Saudi oil simply because the Saudis decide to tax the import of American automobiles. This is the result of either willful theoretical blindness or complete ignorance of the existing and easily verified difference in tariff rates that now exist between countries. Nor must the exports necessarily be at a lower profit, for as Adam Smith pointed out, manufacturers first attempt to sell domestically because it is easier, not because it is more profitable.

3. It is incorrect to state that “the new tariff on sweaters would not raise American wages”

Well it’ll certainly raise wages in the sweater industry, but I don’t think that’s what Hazlitt is getting at here. Rather, he’s saying it will also lower wages in other industries that are harmed by the tariff either through reduced domestic demand for their products or reduced international demand caused by the reduction in trade a tariff brings. My reading of Hazlitt was that wages in the protected sector would rise (obviously) at the expense of wages in all other areas and general living standards. All we can say about the impact of the tariff on net is that because we’re reducing the division of labor and specialization we’d expect a negative net result.

Of course that’s what Hazlitt is saying. But both Jake and Hazlitt are incorrect, because the domestic division of labor is not being reduced, it is being expanded. Jake didn’t even address the point I made about higher wages in the new industry necessarily driving average wages higher. Even if we accept Hazlitt’s incorrect assumptions about jobs being lost, he is simply incoherent on the issue. If 50k sweater jobs replace 50k non-sweater jobs and the new sweater jobs have higher wages than the jobs they replace, average wages will obviously rise.

4. It is simply false to claim that “tariffs reduce wages”…. Even if he was correct and 50,000 jobs in the sweater industry were exchanged for 50,000 jobs outside it, the order in which those jobs would necessarily be gained and lost means that wages would go up.

But I think there would be a reduction in other industries as I discuss above. As well as a increase in the cost of living, which translates into a reduction in real wages.

Jake thinks wrong, as I show above. Moreover, he erroneously concludes that a second order effect must outweigh a first order effect.

5. The fact that American sweater manufacturing is less efficient than English sweater manufacturing does not mean that it is less efficient than any other American industry.

If it were true that American sweater manufacturing could be more efficient than alternative uses of capital within the US (even given still more efficient international production) then why would the tariff be needed? Wouldn’t entrepreneurs freely choose to divert capital from the less efficient US industries into sweater manufacturing if this were the case?

Because the relevant comparison is between the various efficiencies between the sweater-making industries and not between the efficiencies of the various domestic industries. It’s also useful to remember that entrepreneurs seldom operate outside their areas of expertise. It doesn’t matter how much more profitable it might be to make wireless tablets than tablecloths, as the average textile manufacturer is not going to start trying to compete with Apple simply because the profit margin is better in the tablet industry.

6. There is no paradox. Hazlitt’s assertion that a tariff “must” reduce real wages is simply incorrect and he repeats his error about assuming that production in the sweater industry will be less efficient than in other domestic industries on the basis of its inefficiency in comparison with English sweater manufacturing.”

Hazltt doesn’t say there’s a paradox, he says: “Only minds corrupted by generations of misleading propaganda can regard this conclusion as paradoxical.”

He DOES say that the tariff will divert resources into less productive ends and there I think he is right regardless of your assertion to the contrary. As I said in response to 5. If more efficient/productive uses of capital were available we wouldn’t need a tariff to get capital moving towards those uses, it’d happen spontaneously. This is (obviously) not to say that conditions under a free-market represent the perfect allocation of resources, but that it does continuously trend in that direction and that there is no alternative source of information on which one can argue that the market outcome is, in fact, sub optimal. In other words, if the market says the best use of resources is to import British sweaters and export grains, cars and technology then that may not be the absolute optimum perfect approach, but it is the best approach anyone has at that point been able to find, and those who say they know a better way, but require coercion and taxation to get there, are probably self-serving.

Very well, I accept that I should have simply pointed out that there is no paradox and no one actually believes there is a paradox. Hazlitt has erected a straw man. But Jake is still wrong as the spontaneous movement of capital he posits isn’t going to happen because the fact that American sweater-making might be more efficient than American widget-assembling is irrelevant so long as American sweaters can’t effectively compete on price with imported English sweaters. He is merely repeating his earlier error in point 5. Moreover, he doesn’t even attempt to defend Hazlitt’s erroneous statement that a tariff must reduce real wages.

As for the accusation that anyone who doubts that the international free market is the best approach anyone has been able to find is “probably self-serving”, that is simply an invalid ad hominem argument that is irrelevant, and in my case, incorrect. I absolutely benefit from the present US free trade regime and am nevertheless presenting an intellectual case that would be to my material detriment if it were to be adopted as US trade policy. As always, the facts are what they are and the truth is what it is regardless of whatever anyone happens to believe them to be. While there are many genuine reasons to be deeply concerned about the ability of any government to implement restrictions on free trade in a manner that is a net benefit to the entire nation, this does not change the fact that the foundations of international free trade ideology are riddled with flawed assumptions and false logic.

This is the second part of what I expect will be a three-part critique of Chapter 11 of Henry Hazlitt’s Economics in One Lesson. The first part was posted on June 14th in response to Ampontan’s request. While it appears everyone was convinced by my initial rebuttal that Hazlitt’s particular case for free trade is incorrect, (though not that there is no case for free trade), I should fail to live up to my reputation if I did not continue to keep pounding upon the quivering mass of his argument until the critique is not only conclusive, but comprehensive.

Now let us look at the matter the other way round, and see the effect of imposing a tariff in the first place. Suppose that there had been no tariff on foreign knit goods, that Americans were accustomed to buying foreign sweaters without duty, and that the argument were then put forward that we could bring a sweater industry into existence by imposing a duty of $5 on sweaters.

There would be nothing logically wrong with this argument so far as it went. The cost of British sweaters to the American consumer might thereby be forced so high that American manufacturers would find it profitable to enter the sweater business. But American consumers would be forced to subsidize this industry. On every American sweater they bought they would be forced in effect to pay a tax of $5 which would be collected from them in a higher price by the new sweater industry.

Americans would be employed in a sweater industry who had not previously been employed in a sweater industry. That much is true. But there would be no net addition to the country’s industry or the country’s employment. Because the American consumer had to pay $5 more for the same quality of sweater he would have just that much less left over to buy anything else. He would have to reduce his expenditures by $5 somewhere else. In order that one industry might grow or come into existence, a hundred other industries would have to shrink. In order that 50,000 persons might be employed in a woolen sweater industry, 50,000 fewer persons would be employed elsewhere.

But the new industry would be visible. The number of its employees, the capital invested in it, the market value of its product in terms of dollars, could be easily counted. The neighbors could see the sweater workers going to and from the factory every day. The results would be palpable and direct. But the shrinkage of a hundred other industries, the loss of 50,000 other jobs somewhere else, would not be so easily noticed. it would be impossible for even the cleverest statistician to know precisely what the incidence of the loss of other jobs had been—precisely how many men and women had been laid off from each particular industry, precisely how much business each particular industry had lost—because consumers had to pay more for their sweaters. For a loss spread among all the other productive activities of the country would be comparatively minute for each. It would be impossible for anyone to know precisely how each consumer would have spent his extra $5 if he had been allowed to retain it. The overwhelming majority of the people, therefore, would probably suffer from the illusion that the new industry had cost us nothing.

It is important to notice that the new tariff on sweaters would not raise American wages. To be sure, it would enable Americans to work in the sweater industry at approximately the average level of American wages (for workers of their skill), instead of having to compete in that industry at the British level of wages. But there would be no increase of American wages in general as a result of the duty; for as we have seen, there would be no net increase in the number of jobs provided, no net increase in the demand for goods, and no increase in labor productivity. Labor productivity would, in fact, be reduced as a result of the tariff.

And this brings us to the real effect of a tariff wall. It is not merely that all its visible gains are offset by less obvious but no less real losses. It results, in fact, in a net loss to the country. For contrary to centuries of interested propaganda and disinterested confusion, the tariff reduces the American level of wages.

Let us observe more clearly how it does this. We have seen that the added amount which consumers pay for a tariff-protected article leaves them just that much less with which to buy all other articles. There is here no net gain to industry as a whole. But as a result of the artificial barrier erected against foreign goods, American labor, capital and land are deflected from what they can do more efficiently to what they do less efficiently. Therefore, as a result of the tariff wall the average productivity of American labor and capital is reduced.

If we look at it now from the consumer’s point of view, we find that he can buy less with his money. Because he has to pay more for sweaters and other protected goods, he can buy less of everything else. The general purchasing power of his income has therefore been reduced. Whether the net effect of the tariff is to lower money wages or to raise money prices will depend upon the monetary policies that are followed. But what is clear is that the tariff—though it may increase wages above what they would have been in the protected industries—must on net balance, when all occupations are considered, reduce real wages—-reduce them, that is to say, compared with what they otherwise would have been.

Only minds corrupted by generations of misleading propaganda can regard this conclusion as paradoxical. What other result could we expect from a policy of deliberately using our resources of capital and manpower in less efficient ways than we know how to use them? What other result could we expect from deliberately erecting artificial obstacles to trade and transportation?

Hazlitt does a little better in this second section than he did in the first one, but only a little better. This time, I count six distinct mistakes in his secondary case for free trade.

1. Hazlitt makes the mistake of assuming that only domestic goods are being consumed. As a result, he neglects to recognize that the additional $5 going towards the tariff might not necessarily be spent on domestic products. On current statistical average, about $0.75 would be spent on imports. This means the tariff grants $5 in domestic benefit for a domestic cost of $4.25.

2. By positing a 50,000 loss of jobs in other industries, Hazlitt is assuming that labor productivity is the same in all domestic industries. However, this is unlikely, since the new sweater industry would presumably be more productive on a per-unit basis due to its more recent capital investment and therefore newer technology. And more importantly, there is no reason to assume that the loss of domestic consumption could not be replaced with foreign consumption. As one who subscribes to Say’s Law, (which states that supply creates its own demand), Hazlitt cannot claim that existing production in other industries will disappear simply because people are spending 20 percent more money on sweaters.

3. It is incorrect to state that “the new tariff on sweaters would not raise American wages”. First, no one is going to leave their job for a new job in the sweater industry unless they get paid more and the new jobs in sweater production obviously have to precede any negative effect that eventually stems from sweater buying. Second, the new industry will require building a large amount of new infrastructure, so there additional demand for labor outside of the industry proper will be created, thereby increasing wages outside of it as well.

4. It is simply false to claim that “tariffs reduce wages”. Since there is an increased demand for labor both in and out of the sweater industry and no concomitant reduction in other industries, there is no rational basis for Hazlitt’s groundless assertion. Even if he was correct and 50,000 jobs in the sweater industry were exchanged for 50,000 jobs outside it, the order in which those jobs would necessarily be gained and lost means that wages would go up.

5. Hazlitt claims that “American labor, capital and land are deflected from what they can do more efficiently to what they do less efficiently as a result of the artificial barrier erected against foreign goods”. But this is a false assumption because it is a binary one. The fact that American sweater manufacturing is less efficient than English sweater manufacturing does not mean that it is less efficient than any other American industry. Especially given that in this case, we are dealing with a brand new industry with new capital investment, it will almost surely be more efficient than existing domestic industries. It is therefore totally false to say “the average productivity of American labor and capital is reduced”.

6. There is no paradox. Hazlitt’s assertion that a tariff “must” reduce real wages is simply incorrect and he repeats his error about assuming that production in the sweater industry will be less efficient than in other domestic industries on the basis of its inefficiency in comparison with English sweater manufacturing.

I’m a little embarrassed to have to note that I missed the errors that Giraffe caught in his first comment. He is correct to point out that Hazlitt was only looking at the $5 of domestic spending that the tariff redirects and not at the $25 that now remains in the American economy instead of leaving it and entering the English economy.

Ampontan posed a free trade-related challenge:

When you can offer a serious critique of Chapter 11 of Hazlitt’s Economics in One Easy Lesson without using buzzwords like “bizarre”, I might begin to take this argument seriously.

I find it rather difficult to resist a direct and substantive intellectual challenge, particularly when it stems from an intelligent and knowledgeable source. Throw in the fact that Hazlitt is an economist for whom I have a good deal of respect – his demolition of Keynes’s General Theory is still one of the most thorough available – so this was practically perfect Voxbait. After reading the chapter through twice, I’ve decided that I’m not going to address the entirety of it in a single post, but will instead address Hazlitt’s core argument in a detailed manner which will not necessarily conclude the case, but should suffice to convince doubters that the anti-free trade argument at least merits being taken seriously by libertarians and Austrians alike.

(Note to self: do not use “bizarre” or other buzzwords in the process.)

Hazlitt writes: An American manufacturer of woolen sweaters goes to Congress or to the State Department and tells the committee or officials concerned that it would be a national disaster for them to remove or reduce the tariff on British sweaters. He now sells his sweaters for $30 each, but English manufacturers could sell their sweaters of the same quality for $25. A duty of $5, therefore, is needed to keep him in business. He is not thinking of himself, of course, but of the thousand men and women he employs, and of the people to whom their spending in turn gives employment. Throw them out of work, and you create unemployment and a fall in purchasing power, which would spread in ever-widening circles. And if he can prove that he really would be forced out of business if the tariff were removed or reduced, his argument against that action is regarded by Congress as conclusive.

But the fallacy comes from looking merely at this manufacturer and his employees, or merely at the American sweater industry. It comes from noticing only the results that are immediately seen, and neglecting the results that are not seen because they are prevented from coming into existence.

The lobbyists for tariff protection are continually putting forward arguments that are not factually correct. But let us assume that the facts in this case are precisely as the sweater manufacturer has stated them. Let us assume that a tariff of $5 a sweater is necessary for him to stay in business and provide employment at sweater-making for his workers.

We have deliberately chosen the most unfavorable example of any for the removal of a tariff. We have not taken an argument for the imposition of a new tariff in order to bring a new industry into existence, but an argument for the retention of a tariff that has already brought an industry into existence, and cannot be repealed without hurting somebody.

The tariff is repealed; the manufacturer goes out of business; a thousand workers are laid off; the particular tradesmen whom they patronized are hurt. This is the immediate result that is seen. But there are also results which, while much more difficult to trace, are no less immediate and no less real. For now sweaters that formerly cost retail $30 apiece can be bought for $25. Consumers can now buy the same quality of sweater for less money, or a much better one for the same money. If they buy the same quality of sweater, they not only get the sweater, but they have $5 left over, which they would not have had under the previous conditions, to buy something else. With the $25 that they pay for the imported sweater they help employment—as the American manufacturer no doubt predicted — in the sweater industry in England. With the $5 left over they help employment in any number of other industries in the United States.

But the results do not end there. By buying English sweaters they furnish the English with dollars to buy American goods here. This, in fact (if I may here disregard such complications as fluctuating exchange rates, loans, credits, etc.) is the only way in which the British can eventually make use of these dollars. Because we have permitted the British to sell more to us, they are now able to buy more from us. They are, in fact, eventually forced to buy more from us if their dollar balances are not to remain perpetually unused. So as a result of letting in more British goods, we must export more American goods. And though fewer people are now employed in the American sweater industry, more people are employed—and much more efficiently employed—in, say, the American washing-machine or aircraft-building business. American employment on net balance has not gone down, but American and British production on net balance has gone up. Labor in each country is more fully employed in doing just those things that it does best, instead of being forced to do things that it does inefficiently or badly. Consumers in both countries are better off. They are able to buy what they want where they can get it cheapest. American consumers are better provided with sweaters, and British consumers are better provided with washing machines and aircraft.

I count seven unwarranted assumptions on Hazlitt’s part that render his primary argument in support of free trade incorrect and therefore invalid. They are as follows:

1. Hazlitt assumes that manufacturers are the primary beneficiaries from barriers to trade and therefore the leading advocates of them. This may have once been true, but it is clearly no longer the case. Economics in One Lesson was published in 1946, when the U.S. balance of trade ran a 35 percent surplus and trade amounted to 6.8 percent of GDP. Free trade was operating to the benefit of most American manufacturers and workers alike; since the industrial infrastructures of Europe and Asia were in ruins, few American sectors were at a competitive disadvantage. Like Ricardo, Hazlitt clearly never imagined a scenario when jobs would not be lost to foreign manufacturing competitors, but to the new foreign factories established by the former domestic manufacturers. The additional profit provided by a $5 tariff is now of less interest to the domestic manufacturer than the opportunity to set up a factory in Bangladesh, make the sweater at a lower cost, then import it and sell it for $25. If we leave out the distribution channel which is the same for both foreign and domestic manufacturers and assume a profit margin of 50 percent, we can compare the profit margins of the various alternatives. At the 50 percent profit margin, we know that the manufacturer’s domestic costs were $15 and his profit was $15 with the protection of the $5 tariff. But Bangladesh has a wage rate that is one-thirtieth that of the USA, so if labor is one-third the cost of production and international shipping is 10 percent of the manufacturing cost, his new production and delivery cost will be $11.17. This reduction of $3.83 in costs means the offshored manufacturer can now afford to sell the imported sweater for 22.34 and still make the same 50 percent profit margin he did before; without tariffs he can compete on price with the $25 English sweaters and actually increase his profit margin by nearly six percent. At the old $30 price, his profit margin has risen to 63 percent, thereby creating a serious incentive to move production to Bangladesh even in the absence of any price pressure from the English sweater makers. Either way, the consumers benefit, the manufacturer benefits, and only the thousands of workers, who lost their $5/sweater jobs, suffer.

So, the $5 tariff not only protects the domestic manufacturer from the English competitor, but more importantly, protects the worker from the domestic manufacturer as it would reduce his potential profit margin from 63 percent to 46 percent. With the tariff in place, the domestic manufacturer has no reason to go to all the trouble and expense to relocate his factory to Bangladesh simply to lose four percent from his profit margin. It is also worth nothing that since Hazlitt was implying a profit margin much lower than the 50 percent I utilized for the purposes of comparison, the difference between going offshore and not going offshore might not be an additional 13 percent profit, but the difference between the survival of the business and its failure. Hazlitt’s error here is the result of the failure of the theory of comparative advantage to account for the international mobility of capital.

2. Hazlitt asserts that the $5 left over from the reduced import price of the sweater will go to help employment in any number of other industries in the United States. It may. Or it may not. Again, Hazlitt was writing when imports accounted for a trivial 2.9 percent of GDP. They now account for 15.8 percent, so that $5 is five times more likely to go towards helping employment in industries outside the United States than it was in 1946. Statistically speaking, what would be $5 of the tariff going towards U.S. employment must be reduced to $4.25. This error can also be traced back to Ricardo’s assumptions, although it is not one of the seven that Fletcher lists.

3. Hazlitt erroneously assumes that the British will buy more from the USA because they will be forced to buy more American goods due to their possession of dollars. This is untrue because the dollar is the world’s reserve currency and is often utilized for trade between foreign countries; the British are no more forced to buy American goods due to their possession of dollars than the Thebans were forced to buy from Athenian goods due to their possession of silver talents.

4. Hazlitt assumes that foreign dollar balances cannot remain perpetually unused. (By “unused” he means unspent in the USA). But there are $610 billion in Eurodollars in foreign banks that will never be used, which is more than the entire amount of annual U.S. exports as recently as 1990! Furthermore, the U.S. has been running a continuous and growing balance of trade deficit in goods since 1976. The $9 billion that went overseas has not only not returned to be spent here, but has increased to $646 billion.

35 years and counting is a long time to wait for this postulated inevitable return, and is unlikely to do any good for the worker who lost his job more than three decades ago.

5. Hazlitt assumes that an American worker who loses his job in one sector will automatically find it in another sector. This is Ricardo’s sixth false assumption identified by Fletcher: “Production factors move easily between domestic industries.” There is no reason to assume that the loss of a job in one sector will create any additional demand in another sector, indeed, to the extent there is worker mobility between industries, all the loss of the job in the one sector will do is create downward pressure on wages in the other sector. There is a hidden and implicit appeal to James Mill here, (or alternatively, to Keynes’s critical formulation of Say’s Law), in the idea that supply somehow magically creates demand. While this can be true in a technological sense, as there was no demand for CD players prior to their invention, it is not an economic law as the excess supply of U.S. housing or the dead inventory stock of any business will demonstrate.

6. Hazlitt assumes that American employment on net balance will not go down and that American and British production on net balance will go up. This is not necessrily true, being an erroneous conclusion based on the previous false assumption. The American worker may well remain unemployed on a permanent basis, as have one-quarter of the once-employed male workers since 1948.

7. Hazlitt assumes that consumers in both countries are better off because they are able to buy what they want where they can get it cheapest. But this is a false assumption because most consumers are also workers or are dependent upon workers. The consumer who is employed can better afford the $30 sweater than the unemployed consumer can the $25 one. Free trade does work to the minor advantage of some Americans as well as to its foreign beneficiaries, but at an inordinately heavy short-term cost to around 25 percent of Americans and a severe long-term cost to the entire American economy.

I shall leave it to Ampontan to determine whether this response justifies taking the argument seriously in the future. I freely admit that I have not yet addressed the entire chapter, only one-third of it, but I expect to do so in another post or two in the reasonably near future.