Mercantilism is No Free Lunch

80% of the economy should not be sacrificed for 20% of it  

November 2016

Free trade creates winners and losers.  Overall, American consumers benefit because they can obtain goods more cheaply. The export and services industries gain because they now have new markets to sell their wares.  However, domestic producers of goods who compete with global imports are the losers.  Low-skilled laborers lose the most, as their labor is most easily replaced by cheaper workers overseas.  Although the at-large economy is better off and more efficient this way, by exploiting its comparative advantage, the undeniable truth is that not everyone benefits.     

Now with Donald Trump as our President, free trade as we know it may be on the chopping block.  Trade served as one of Trump’s favorite punching bags throughout his campaign.  Since we may all be receiving a tremendous serving of Trumped-up mercantilism, it’s worth taking a look at some of the premises which underlie free-trade criticism.  On closer inspection, bringing back our jobs is not as simple as starting a trade war with China or severing ties with the world. 

Premise 1:  Manufacturing in America is declining; if we manufacture more, we will have more jobs.

This mistaken factual premise seems intuitive: the US doesn’t manufacture as much anymore, so there are not as many manufacturing jobs.  Therefore, if we increase manufacturing in the US, we will have more manufacturing jobs. 

This is not so.  Manufacturing as a share of the U.S. economy has not declined.  The output simply does not require as many employees as it once did.  Although manufacturing employment has drastically decreased, the remaining manufacturing employees are producing just as much.  What may have required five employees in 1960 only requires one employee now due to advancing technology. 

Increasing manufacturing in the US does not imply an increase jobs.  If the past is any indicator, manufacturing employment will continue to drop while manufacturing output remains constant. 

Premise 2:  If we lower labor costs, we will increase manufacturing jobs

This flows from the first factual premise.  The idea here is that, if manufacturing employment did not cost employers so much in the first place – either because of minimum wages, unions, or related labor costs such as insurance – there would be more jobs.  If it costs me $10/hour to have a factory worker in the US, and only costs me $3/hour to have a factory worker in Mexico, then I am quite obviously better off having a factory in Mexico.  By having an employee who is $7/hour cheaper, you can increase the standard of living of the average consumer for less, thereby generating greater wealth.

Most people would balk at the idea of paying American workers as little as workers in Mexico or as little as someone working in a sweatshop in Cambodia.  Yet, we hear time and again that our wage costs lead to unemployment.  Donald Trump stated that wages are too high, before later walking back (and denying he said such a thing).  This reasoning is also the argument against raising the minimum wage, even though such argument is questionable, and 1) requires an assumption that wages are already priced at marginal cost; and 2) ignores the fact that minimum wage increases may actually lead to greater employment in monopsonistic labor markets

Regardless of the merits of the “wages are too high” argument, it ignores the inevitability of technological development.  As technology advances, less human labor is required for the same amount of output; a manufacturer will quite simply need fewer laborers.  Even if we were to get rid of all wage protections entirely, at best this would only slow down the decline in manufacturing employment.  Even if an employer could pay each employee $1/hour, the employer still will not need as many employees as technology advances.  (See figure in Premise 1.)

Premise 3: We can easily replace foreign jobs with domestic jobs

 Ford caught a lot of flak for announcing that it would move its production of small cars from the US to Mexico, and that that factory would employ 2,800 workers.  If only Ford kept their production here, we could employ 2,800 Americans instead. 

One job overseas does not necessarily equate to one job in the US.   This premise works only when the demand for a foreign product equals the demand for the domestic version of that product.  All we need to do is think of this in terms of the traditional supply/demand curve.  If a product ends up costing more to produce domestically, then less people would be willing to purchase the product.  Because there is less demand for a higher cost domestic product, then output of that product (supply) will decrease.  And because the US would produce less of the product, not as many workers will need to be employed.

Let’s take a second look at the Ford example.  Say each small car in Mexico would cost $10,000 to purchase, and Ford predicts it can sell enough small cars at $10,000 to justify employing 2,800 Mexican workers.  What happens if Ford produces these cars in the US instead?  If each small car now costs $15,000, Ford will not be able to sell as many cars, and therefore no longer need 2,800 workers.   Maybe now Ford only needs 2,000 workers for the amount of small cars it expects to produce.  

That is a good case scenario.  If there is no willingness to pay for a Ford small car at $15,000, then Ford will not employ any workers.  Mexico doesn’t get jobs, and neither does the US. 

These scenarios all depend on the elasticity of demand – how much a change in price affects the change in the quantity demanded.  Demand might be inelastic for some goods – meaning that demand will not decrease substantially even if prices of the good increase – it is doubtful that the quantity of goods we import will stay constant if those goods are produced domestically (and presumably at higher cost). 

Premise 4:  Free trade means sweatshops and child labor

Free trade critics say that we should be against free trade because it takes advantage of other countries’ lack of labor protections.  We should be ill at ease that the products we consume are from children working in sweatshops, or from people working 100 hours of weeks for pennies, virtually indistinguishable from slave labor.

This is a moral argument, not an economic one.  Regardless of the argument’s virtues, we can have free trade while still demanding fair labor conditions.  The Trans-Pacific Partnership (TPP) actually includes worker protections provisions, such as minimum wages, work hour, and safety and health issues.  Although some contend that TPP’s worker protections are merely cosmetic, at the very least it demonstrates that we can have free trade and still request that other countries protect their workers.

 

We should be very skeptical that turning away from free trade will actually increase American manufacturing jobs.  Advances in technology will continue to reduce the need for physical employees.  One overseas job does not equate to one domestic job, because given price increases (or a quality decrease), the demand for a domestically produced good does not equal the demand for that same good produced overseas. 

The potential gains of mercantilism are doubtful.  Weighed against a small potential employment benefit are the huge costs to the rest of the country and our economy.  Consumers will pay more for goods they want, and be more willing to purchase luxury goods at lower prices.  Our services and export industries will lose customers.

As TPP demonstrates, we can also have free trade while not exploiting poor labor standards in other countries.  The two are not synonymous.

Free trade has winners and losers.  Instead of returning to 18th century mercantilism, making us worse off overall, we can ameliorate the effects of those who lose.  Robust unemployment programs, job retraining, and creation of new jobs through investment in public infrastructure, will have a much better return on investment than isolating our country from the world markets and benefits of the global marketplace. 


Greece: To Bail or Not to Bail

80% of the Hellenic Republic auctioned at 20% discount

April 2015

Euro

In case the title confused some of you, the intent was indeed to deliver a satirical pun. For those still struggling to understand, the reference is to a decision by the European Union (EU) to bailout Greece or for Greece to depart the Eurozone. Since the beginning of the Great Recession in 2008, Greece has quite possibly been hit harder than any other country. Greek debt is currently 175% of their GDP; the fact that they are threatening their supposed ‘troika’ counterparts in the EU and IMF is simply audacious. However the fact that the EU is permitting Athens to have so much freedom in the matter and walk all over the powerful institution is… well, actually it is fairly consistent with Europe’s lacksadaisical attitude since the Bretton Woods Conference in 1944.

It is no surprise the Syriza Party – or the Coalition of the Radical Left, which includes elements of Greece’s Mao and Trotsky parties – won the most recent Greek elections. Obviously no one wants higher taxes, lower incomes, and a slew of austerity measures. Nevertheless, states must be responsible for their own monetary and fiscal policies, unless that state relies on 18 other members of a monetary union as well as UN loan agencies. In a nation riddled with corruption, overspending, and sovereign debt, Greece should be kissing the EU’s feet. Dare I say a lack of work ethic, without getting in trouble? Germany is Greece’s primary creditor, and now is certainly not the time to ask for Nazi war reparations and forgiveness equitable to that of Germany post-WWII. Etiquette, Greece… were you born in a barn?! Germany will probably wind up forgiving some (not all) debt, but it will come at a price.

As the economic powerhouse of Europe, and fourth largest world economy by GDP, Germany appears to be fed up with a stubborn Greece – as they should. To prevent a reemergence of Euro-contagion, Germany’s Merkel wants to ensure Greece agrees to a debt repayment plan, and stay in the Eurozone. By letting Greece depart, German lending institutions face inevitable Greek default. But if they stay, restructured bailout conditions and repayment must also favor these same lending institutions. Sounds like the Germans want to have their cake and eat it too; this is clearly no simple task. One other interesting topic is Greece’s massive procurement of military equipment. Do the Greek even have any real enemies (no one say Turkey)? In 2012, nearly 15% of Germany’s military exports were to… Greece! And here I was, thinking only the US could capitalize on such hypocrisy.

Grexit is the media-derived slang for a ‘Greek Exit’ from the Eurozone. Certain media outlets are claiming this would devastate the EU and destroy the Euro currency. Realistically a Grexit would immediately raise the value of the Euro by cutting the lowest contributor and dead weight. But we must remember that Italy, Spain, and Portugal are not far behind, and whatever the outcome of the Greek financial crisis, it will set a powerful precedent for ailing European economies. Global investors may also think twice about Europe, since the EU will have masses of defaulted Greek debt on its books.  In a realist world, Greece should be punished whereby deterring future EU countries of similar actions. If Greece Grexited, they should probably start auctioning off large swaths of property and its natural resources to pay off debt. A fire sale of Greek property could be in high demand… I hear the Chinese are seeking some Aegean shoreline this time of year.

Athenian democracy is widely believed to be the first form of modern democracy in the world. Rewind. The Greek military junta dictatorship only ended in 1974 – at least stick with modern socialism like the rest of Europe and stay in the EU. Syriza’s Marxism push will set Europe back decades, and hurt the EU’s unique, but successful, mesh of free-market collectivism. Greece is not a first world country, and please do not counter that by referencing Mykonos or Santorini.

On an entirely separate note, why is it the radical left Greek leader never wears a tie? Maybe if the Brussels talks are a success, Tsipras will be able to wear the fancy tie snidely afforded to him by the Italian Prime Minister. Let us hope the European Central Bank can figure this one out fairly, and be clear that Greece does not make the rules for the EU.


Economic Necessity or Geostrategic Soft Power?

20% of the global community making 80% of the global decisions

April 2015

Graph

The price of oil has dictated American policies, both domestic and abroad, for over a century.  It is safe to say that Americans, and probably most Western nationalities, are luxuriating in the discounted fuel prices, which according to CNBC approximately equates to a $1 Billion per day tax cut to the public.  The average American is already spending more cash on consumer goods, and empowering the domestic economy.

However, most tend to disregard the reasons behind the sharp decline in petroleum prices, particularly during a time of global unrest and unsettling economic environments.  Saudi Arabia is chiefly responsible for the heightened oil output and consequentially low prices, being the 800 pound gorilla in OPEC.  The Organization of the Petroleum Exporting Countries (OPEC) is effectively the largest legal cartel in the world and is primarily responsible for determining pricing and production of petroleum.  But of course we all know that nations have different interests. In a realist world, the powerful players will selfishly enforce their interests and the weaker players will attempt to leverage their resources in order to remain relevant.  While the West conceivably views declining oil prices as a blessing, others are less than excited.

Economic Necessity:

The Saudi Arabian Minister of Oil has repeatedly stated that a drive-down in production is necessary to sustain a global demand for oil.  US oil companies are not as pleased with reduction in profit [and don’t get me started on airlines], nor are the emerging market producers operating in alternative/renewable energy with specific emphasis on domestic shale exploration.  Many economists believe this is a Saudi attempt to weed out all US energy producers, ensuring their long-term position in the energy sector. In the late 20th century when oil production was low and then spiked, Saudi Arabia felt cheated by many OPEC producers for not following quota and pricing rules.  The Kingdom acted as a ‘swing state’ by artificially sustaining prices on behalf of OPEC.  In 1986, Saudi Arabia increased output to full production, which in-turn lowered energy prices and angered many producing countries.  This action was so powerful that it was a contributing factor to the fall of the Soviet Union.

Geostrategic Soft Power:

This move by Saudi can be considered the country’s initial foray into the realm of power politics. As a regional hub for military and economic power, Saudi Arabia has rarely taken any direct or offensive action toward an external party – in fact when the shit really hits the fan, the Saudis are notorious for standing on the sideline, while their Western allies take action.  Just as the US uses the titular UN as a platform to project its power, Saudi Arabia may have finally recognized OPEC as a collusive platform to project its power.  The West (and let’s be honest we mean the US) and Saudi Arabia have long enjoyed a relationship strictly based on economic interests and ignored the Kingdom’s abominable human rights record.  Now, it almost appears as though Saudi Arabia and the US are conspiring against their geopolitical adversaries; Iran, Russia, and China.  As the OPEC daily basket price per barrel is hovering around $43, downward pressure on oil prices will only make the situation worse for a sanctioned Iran and a bankrupt Russia, while the Saudi economy can withstand this profit decline.   Is the Kingdom trying to force Iran to actively negotiate terms of a nuclear deal? Punish Russia even further for Ukrainian unrest and new pipeline ambitions?  Or to take this even one step further, are they countering conventional and renewable energy exploration in the US?

In either case, the majority of the US will benefit from this macroeconomic phenomenon.  As to what the underlying motives are, perhaps only time will tell.