The Complicated Issue of Free Trade and Balance of Trade Explained.

Sunday, January 27, 2008 12:47 PM

We hear much about ‘free trade’ and laissez-faire[1] economics and other theories, the export of US jobs over the pond, or over the border, high debt from a trade imbalance and other political notions as we spend the next year electing somebody who may be able to influence this process. Politicians offer ‘solutions’ to these problems in exchange for votes we note. Can politicians fix these problems? Did they ever?[2]

Here are the facts, presented before we get sidetracked by meaningless rhetoric and political promises and demands. We need to look at the concept of global markets and such. From Wikipedia[3]  we learn that the advantage associated with making and distributing goods and services is important in determining who will make what and where it will be sold. We have to stipulate that in a ‘free trade’ scenario, that willing buyers and willing sellers will converge in an open market to make purchases and sales. If this is off, then the theory fails. The current world does not exactly conform to this stipulation so the practice and theories of such a trade scenario are fictional.

Adam Smith had used the principle of absolute advantage to demonstrate that traders will attempt to find the lowest cost of items, consistent with quality, so that they can preserve wealth. The only thing that works for those who are allowed to make decisions with their money is that people actually will compare prices and choose carefully so as to not waste their resources. Note that government spending does not fit into these narrow confines. The comparative advantage theory of Ricardo shows that two partners will both increase their output when the advantage is not equal. That works in a limited sense. There is a set of serious criticisms of comparative advantage[4] and all apply today.

We now have to throw in global marketing, shipping, manufacture by having parts produced in numerous countries with electronic and design ease [CAD/CAM or computed aided design and computer aided manufacturing] and lots of other factors. An analysis of the 2007 trade in the world leads us to the necessary conclusion that the absolute advantage mechanism of Smith is now in full force in all markets and participation in markets is price based. As such, those with something less than a highly competitive advantage will lose sales and vanish from the market place. I was studying chemistry at the time I took economics from Professor Jung C. Liu at SUNY, Binghamton in 1971, now, tragically, deceased. I struggled to show, in a mandatory term paper, which is unfortunately lost or forgotten, that free trade would actually favor all countries that could participate in trade in terms of gross world sales, but would not allow even balances of trade accounts among the traders. This notion was rejected in favor of the comparative advantage theory of Ricardo detailed below in the footnotes. Today, I announce that I was right after all.

At this writing, absolute price and supply scale determine who will sell what to whom and the algebraic summation of gross sales and fees among trading countries will define the surplus or  deficit for each participant. Period. Now, there are governmental ways to avoid being overpriced in international trade. I mentioned in 1971 that the cost from Bethlehem Steel of Pennsylvania selling a ton of steel to Brooklyn, New York was $600 a ton, delivered, and that the English could do this for about $500 and the French could plop down the same ton for only $440. We cannot attribute the difference in costs here to some absolute advantage  or innovations in  French steel making. This price was phony. This product was considered a ‘key’ part of the French manufacturing business, hence a national treasure and political obligation and ‘essential’ to the state welfare so that part of the cost of producing such steel was subsidized by the government. It is well known that Japanese companies pick a lucrative market in the US, get money and resources from the government and sell at lower prices until the market sags and the original manufacturer closes down some businesses and they raise prices and take control of the market. All this is known as ‘dumping’ and is ‘unfair’ and the World Trade Organization [WTO] is supposed to be sorting out complaints and offer resolutions to suit the traders. This is the way things work. There is no free trade when governments subsidize goods and services and absorb production costs in order to sell their products at a lower price so as to capture areas in commerce. The subsidy process perturbs the markets and raises prices.

 So, what is happening in Michigan where unemployment is high and the very good union jobs are lost and more will be lost? The politicians announce that they will ‘fix’ the situation in one war or another. Some believe that they can ‘save’ the auto industry and keep the unions in force. They promise full employment. The simple answer is that Michigan’s auto industry is not competitive given the current operating conditions, rules and markets. Thus, it fails the simple tests of absolute advantage where the auto makers cannot meet the market price of a car.  Can we get these jobs back? No, of course not. Global trade with no tariffs gives many a country a chance to buy and sell but does not imply that the  balance of trade accounts will all be zero at the end of any fiscal year. The efficiency and price level control the balance of trade. If we compare what an hour’s labor can produce in a rice paddy to that of a similar hour in a computer assembly operation we can ask: are these two hours equivalent in terms of production and profits, which is units times price? Certainly not. Only some moron like Karl Marx [5] or one of his leftist stooges would attempt to put the value [read price in his rants] of some item in terms of that amount of labor that went into processing it is folly. These promises are worthless.

Politics works such that when voters or special interest groups lose something in the economic sector then they complain to some legislator to ‘fix’ the problem. So, how would this Michigan problem, or other similar ‘problems’ where markets and jobs are lost to the US, be fixed?? There is no hope for any product that cannot meet the competitive price while decent profits are reserved for the manufacturers unless tariffs are introduced. Tariffs do work. Protective tariffs and/or subsidies as in the French model can both be used to allow the seller to ‘adjust’ their price to become competitive in the markets. There are no other ways. You either meet or beat the price levels or you do not sell unless your government is willing to step in as they have done in the US with grain and cheese. We then can understand why rice costs about $16 per pound in Tokyo and a few cents a pound in Cambodia, the Philippines and about a dollar a pound in Arkansas. Cuba can produce sugar for a few cents a pound, but there is a trade embargo there and the world is awash in sugar anyway.

To salvage the union jobs in Michigan, the federal government would have to probably subsidize costs in the auto manufacturing business in that state by paying part of the hourly wages and most of the benefits of the workers. That is a bit better than putting up a tariff against Japan or wherever when they might respond with a reciprocal tariff on other items and cause a trade war item by item. The short-term apparent solution is a disaster. What happens is that if the federal government simply subsidizes the auto manufacturer then the actual cost of a car now has two components: the cost of production and the tax or debt burden from the subsidy. As such, the actual cost is now higher than market and even ever higher allowing for the inefficiencies associated with collection of taxes and funding the subsidy. Arguing that workers whose jobs were rescued would now make up the difference in taxes to balance this all out is folly. Those workers will merely buy products from more subsidized industries and the prices will again be higher. If we subsidize failure or try to compensate for an absolute disadvantage with political solutions then we will be come more inefficient and will lose other exports due to the now inherently higher costs. The balance of trade worsens and our dollar’s buying power drops and prices rise. And, so on and so forth in the spiral.

The solution to the problem is to shift the auto jobs into other economic sectors and make something different where we can get an absolute advantage. This means funding education so auto workers can learn new labor skills. This is all predicated on the fact that any new products or services we envision must conform to the market mechanism of absolute advantage. If you cannot make it cheaply, do something else. This economic fact fails in politics. The unions would now face extinction and the loss of all their members in non union jobs.

In order to remain a competitive advantage and increase growth so we can pay for our social needs and stimulate the economy and also sustain our place in the world markets we need to be the innovators. We need to identify the new products and find ways to continue to cut costs and improve the existing products until their useful lives burn out.

This essay, sadly, is based on sound economics and capitalism and is thus unacceptable to the left-liberal politicians and most of third world. The idea that we should stop making cars is political suicide in the Rust Belt and will not happen. Capitalism is despised around the world[6] and in the United States by liberals,  and generates the evil profits that make some of us ‘rich,’ No liberal Democrat can rise to the podium and soundly condemn the societies in North Korea, Cuba, Africa or many parts of South and Central America. Their solution is to tax[7] the capitalists out of existence and use the phony notion of ‘redistribution of wealth’’ to achieve ‘equality’ everywhere.[8] As we run short of oil, the solution by the left is to stop drilling, throw out phantasms about non-existent alternate fuels, which are not competitive in the markets, and to tax profits from oil companies with punitive intent. There is no better example of a world-wide tax system that will conquer capitalism is the phony Global Warming.[9] [10] This will create carbon taxes and ‘markets’ where wealth will be distributed around the world to those who many not have the talent for production and will ensure that the United States will not enjoy any absolute advantage because the government imposed costs and taxes will from foolhardy social micromanagement programs make us noncompetitive. Period.

There is no way that the political left can hope for any future power base as long as the US continues to be innovative and produce products and services that have an absolute advantage. There are several ways to attack capitalism and our culture and a few were mentioned above in this essay. Capitalism has succeeded every place where it has been implemented and communism and most socialist projects have failed. The left cannot survive in an arena where capitalism is allowed so they will strive to suppress it. Capitalism cannot survive in a place where there is big oppressive government,[11] high taxes and restrictive laws[12] and rules, red tape and where degenerated societies exist.[13]

The choice ought to be clear. Vote accordingly.

The auto workers in Michigan must learn new skills. No options.

rycK

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[1] Hands off in the literal. This means government’s  hands, of course.

[2] Shavian Notions Revisited: The Wealth Tax and Other Mistakes

[3] http://en.wikipedia.org/wiki/Comparative_advantage#Examples. “…comparative advantage explains how trade is beneficial for all parties involved (countries, regions, individuals and so on), as long as they produce goods with different relative costs. Usually attributed to the classical economist David Ricardo, comparative advantage is a key economic concept in the study of trade.” “Adam Smith had used the principle of absolute advantage to show how a country can benefit from trade if the country has the lowest absolute cost of production in a good (ie. it can produce more output per unit of input than any other country). The principle of comparative advantage shows that what matters is not the absolute cost, but the opportunity cost of production. The opportunity cost of production of a good can be measured as how much production of another good needs to be reduced to increase production by one more unit.”

[4] Opponents of free trade often point out that globalized communications and transportation unavailable in Ricardo's time invalidate the assumption of capital immobility and cause capital to gravitate toward absolute advantage (though proponents would point out that modern low cost transportation only makes the assumption more sound... unless they'd take the cost of climate change into account[2]).[citation needed] However, transportation is taken into account in advanced versions of the Ricardian model, providing similar results. It has also been argued that comparative advantage may reduce economic diversity to risky levels.[citation needed] Finally, the principle of comparative advantage has been accused of not being possible to falsify. http://en.wikipedia.org/wiki/Comparative_advantage#Criticism

[5] Marxism Again !

[6] Marxism, Communism, Liberals And Progressives And Why They Will Never Change their Assault on Capitalism.

[7] A Sad Story Of Tax Whoring From The New York Times And A New Reason To Raise Taxes.

[8] The Financial Collapse of California and the Need to Hike Taxes

[9] Fat Albert Waddles Off To Bark His Global Warming Follies As The Russians Buy Furs. Comments On Global Warming and Failed Computer Models

[10] The Third World Gets a Chance for a Massive Global Tax from the US.

Paul Krugman and the New York Times Tax Hike Freak Show Menagerie . The Political Hoax and Other Follies Such as Global Warming

[11] The Phony Cuban Health Care System

[12] Bluewater Follies and EcoNazism in Delaware.  EcoNazi Alert: The Phony Bluewater Windfarms and Hidden Costs.

[13] Degenerated Societies, Newark, New Jersey and Liberalism