Current account deficit hits record (Trade Deficit)

CNN/Money ^ | June 19, 2003 | Reuters

[KDD]

I retract nothing.

Click on the link I provided and learn.

[Cacophonous]

I've learned that Friedman apparently never read (or understood) Adam Smith either.

[Willie Green]

Ever since Adam Smith there has been virtual unanimity among economists, whatever their ideological position on other issues, that international free trade is in the best interests of trading countries and of the world.

Excerpted and condensed from:

Adam Smith: The Wealth of Nations, Book 4, Chapter 2

Of Restraints upon the Importation from Foreign Countries
of such Goods as can be produced at Home

"There seem, however, to be two cases in which it will generally be advantageous to lay some burden upon foreign for the encouragement of domestic industry...

• The first is, when some particular sort of industry is necessary for the defence of the country....

• The second case, in which it will generally be advantageous to lay some burden upon foreign for the encouragement of domestic industry is, when some tax is imposed at home upon the produce of the latter. In this case, it seems reasonable that an equal tax should be imposed upon the like produce of the former....

As there are two cases in which it will generally be advantageous to lay some burden upon foreign for the encouragement of domestic industry, so there are two others in which it may sometimes be a matter of deliberation; in the one, how far it is proper to continue the free importation of certain foreign goods; and in the other, how far, or in what manner, it may be proper to restore that free importation after it has been for some time interrupted....

• The case in which it may sometimes be a matter of deliberation how far it is proper to continue the free importation of certain foreign goods is, when some foreign nation restrains by high duties or prohibitions the importation of some of our manufactures into their country. Revenge in this case naturally dictates retaliation, and that we should impose the like duties and prohibitions upon the importation of some or all of their manufactures into ours....

• The case in which it may sometimes be a matter of deliberation, how far, or in what manner, it is proper to restore the free importation of foreign goods, after it has been for some time interrupted, is, when particular manufactures, by means of high duties or prohibitions upon all foreign goods which can come into competition with them, have been so far extended as to employ a great multitude of hands. Humanity may in this case require that the freedom of trade should be restored only by slow gradations, and with a good deal of reserve and circumspection. Were those high duties and prohibitions taken away all at once, cheaper foreign goods of the same kind might be poured so fast into the home market as to deprive all at once many thousands of our people of their ordinary employment and means of subsistence. The disorder which this would occasion might no doubt be very considerable....

especially by the Smoot-Hawley tariff bill of 1930, which some scholars regard as partly responsible for the severity of the subsequent depression.

The assertion that the Smoot-Hawley tariff was responsible for the Great Depression is a myth based on ignorance of historical facts in favor of pursuing economic textbook theory. The Smoot-Hawley tariff pre-dated the stock market crash, and therefore could not have caused it. There is no convincing evidence that it made the Great Depression more severe, or was responsible for significant retaliation by foreign countries.

Imports formed only 6 percent of the GNP. With average tariffs ranging from 40 to 60 percent (sources vary), this represents an effective tax of merely 2.4 to 3.6 percent. Yet the Great Depression resulted in a 31 percent drop in GNP and 25 percent unemployment. The idea that such a small tax could cause so much economic devastation is too far-fetched to be believed.

Even an effective tax of 2.4 to 3.6 percent is overstating the effects of the tariff. The tariff rates were already high to begin with. One source reveals that Smoot-Hawley raised rates from 26 to 50 percent; another source from 44 to 60 percent. In that case, we are talking about an effective tax increase of 1.4 percent at most.

The "trade war" following Smoot-Hawley did not entirely shut down trade. For the U.S., it fell from 6 to 2 percent of the GNP between 1930 and 1932.  Further analysis of the economy during the depression years reveals that nearly two-thirds of the drop in imports between 1929 and 1933 occurred prior to the Smoot-Hawley tariff. The Smoot-Hawley tariff actually extended the list of imports that entered the country with no tariffs at all compared to the Fordney-McCumber tariff of 1922 (over two-thirds of the goods imported into the United States entered duty-free.) What the Smoot-Hawley tariff did do was raise tariffs on particular import sensitive goods, such as Canadian agriculture, that were already on the tariff list and increase the amount of goods to which no tariffs were applied.

[Cacophonous]

Nice posts. It seems economic "science" ignores the lessons of history.

[KDD]

Friedman answers that...

In all the voluminous literature of the past several centuries on free trade and protectionism, only three arguments have ever been advanced in favor of tariffs that even in principle may have some validity.

First is the national security argument--the argument that a thriving domestic steel industry, for example, is needed for defense. Although that argument is more often a rationalization for particular tariffs than a valid reason for them, it cannot be denied that on occasion it might justify the maintenance of otherwise uneconomical productive facilities. To go beyond this statement of possibility and establish in a specific case that a tariff or other trade restriction is justified in order to promote national security, it would be necessary to compare the cost of achieving the specific security objective in alternative ways and establish at least a prima facie case that a tariff is the least costly way. Such cost comparisons are seldom made in practice.

We could say to the rest of the world: We cannot force you to be free. But we believe in freedom and we intend to practice it.


The second is the "infant industry" argument advanced, for example, by Alexander Hamilton in his Report on Manufactures. There is, it is said, a potential industry that, if once established and assisted during its growing pains, could compete on equal terms in the world market. A temporary tariff is said to be justified in order to shelter the potential industry in its infancy and enable it to grow to maturity, when it can stand on its own feet. Even if the industry could compete successfully once established, that does not of itself justify an initial tariff. It is worthwhile for consumers to subsidize the industry initially--which is what they in effect do by levying a tariff--only if they will subsequently get back at least that subsidy in some other way, through prices lower than the world price or through some other advantages of having the industry. But in that case is a subsidy needed? Will it then not pay the original entrants into the industry to suffer initial losses in the expectation of being able to recoup them later? After all, most firms experience losses in their early years, when they are getting established. That is true if they enter a new industry or if they enter an existing one. Perhaps there may be some special reason why the original entrants cannot recoup their initial losses even though it may be worthwhile for the community at large to make the initial investment. But surely the presumption is the other way.

The infant industry argument is a smoke screen. The so-called infants never grow up. Once imposed, tariffs are seldom eliminated. Moreover, the argument is seldom used on behalf of true unborn infants that might conceivably be born and survive if given temporary protection; they have no spokesmen. It is used to justify tariffs for rather aged infants that can mount political pressure.

The third argument for tariffs that cannot be dismissed out of hand is the "beggar-thy-neighbor" argument. A country that is a major producer of a product, or that can join with a small number of other producers that together control a major share of production, may be able to take advantage of its monopoly position by raising the price of the product (the Organization of Petroleum Exporting Countries cartel is the obvious example). Instead of raising the price directly, the country can do so indirectly by imposing an export tax on the product--an export tariff. The benefit to itself will be less than the cost to others, but from the national point of view, there can be a gain. Similarly, a country that is the primary purchaser of a product--in economic jargon, has monopsony power--may be able to benefit by driving a hard bargain with the sellers and imposing an unduly low price on them. One way to do so is to impose a tariff on the import of the product. The net return to the seller is the price less the tariff, which is why this can be equivalent to buying at a lower price. In effect, the tariff is paid by the foreigners (we can think of no actual example). In practice this nationalistic approach is highly likely to promote retaliation by other countries. In addition, as for the infant industry argument, the actual political pressures tend to produce tariff structures that do not in fact take advantage of any monopoly or monopsony positions.

A fourth argument, one that was made by Alexander Hamilton and continues to be repeated down to the present, is that free trade would be fine if all other countries practiced free trade but that, so long as they do not, the United States cannot afford to. This argument has no validity whatsoever, either in principle or in practice. Other countries that impose restrictions on international trade do hurt us. But they also hurt themselves. Aside from the three cases just considered, if we impose restrictions in turn, we simply add to the harm to ourselves and also harm them as well. Competition in masochism and sadism is hardly a prescription for sensible international economic policy! Far from leading to a reduction in restrictions by other countries, this kind of retaliatory action simply leads to further restrictions.

We are a great nation, the leader of the world. It ill behooves us to require Hong Kong and Taiwan to impose export quotas on textiles to "protect" our textile industry at the expense of U.S. consumers and of Chinese workers in Hong Kong and Taiwan. We speak glowingly of the virtues of free trade, while we use our political and economic power to induce Japan to restrict exports of steel and TV sets. We should move unilaterally to free trade, not instantaneously but over a period of, say, five years, at a pace announced in advance.

Few measures that we could take would do more to promote the cause of freedom at home and abroad than complete free trade. Instead of making grants to foreign governments in the name of economic aid--thereby promoting socialism--while at the same time imposing restrictions on the products they produce--thereby hindering free enterprise--we could assume a consistent and principled stance. We could say to the rest of the world: We believe in freedom and intend to practice it. We cannot force you to be free. But we can offer full cooperation on equal terms to all. Our market is open to you without tariffs or other restrictions. Sell here what you can and wish to. Buy whatever you can and wish to. In that way cooperation among individuals can be worldwide and free.

[rollin]

Just one problem . . . The clothing is made in Jamaica or Indonesia, not the U.S.

[Willie Green]

Friedman answers that...

Friedman and "free" traders forget that lowering of tariffs to imports while maintaining burdensome regulatory restrictions on use of domestic resources is an act of tyranny by a government upon its own populace.

[CanadianFella]

You never printed money???? Printing money is illegal?????

Yes, it's known as "counterfeiting" in the criminal code.

Did you ever write a check?

Checks transfer money from one account to another, the money supply stays the same.

Do corporations issue common stock????

people exchange existing money for company stock. money supply is invariant

What makes the 'money supply' increase?

the fractional reserve system and debt monetization.

[GOP_1900AD]

We continue to feed the Dragon.....

[GOP_1900AD]

Krups manufactures most of their blenders in the PRC. You lose....

[KDD]

Friedman and "free" traders forget that lowering of tariffs to imports while maintaining burdensome regulatory restrictions on use of domestic resources is an act of tyranny by a government upon its own populace.

The attack on American Capitalism really began with the New Deal, in conjunction with the marxist labor union movement in this country..The tyranny of class warfare. Karl Marx, Pat Buchanan and you are in agreement on the idea of free trade.However...history has proven all three of you wrong.

The extortion of free enterprise by socialist trade union pratices tend to inflate domestic wages to the point of negating employer-employee relations. Carried to it's logical conclusion, it's just more "workers of the world unite" crap. An employer loyal to American principals and ideals would just as soon pull up stakes rather than accept extortion from either government or labor.

[A Vast RightWing Conspirator]

I am sorry, but you clearly do not understand. Money is a lot more than the bills issued by the U.S. Treasury. I know, it's complicated but, to beging to understand, research what is happening in Argentina these days, money-wise. For North-American examples, look into Disney Dollars - exaplain why Disney Dollars are not money. Then you may be able to begin to understand what is happening when a corporation issues common stock, an individual writes a check or when someone buys a car using funds from a home equity mortgage loan.

[Willie Green]

The attack on American Capitalism really began with the New Deal, in conjunction with the marxist labor union movement in this country..The tyranny of class warfare.

That attack continues against the American Middle Class at the hands of neocons, who have their roots in Wilsonian/Roosevelt internationalism.

Transnational corporations advocating managed "free" trade agreements are unworthy of the term "capitalist". Capitalists assume market risk, and with hard work, ingenuity (and a little luck) are deserving of whatever rewards they may reap. Transnational corporatists, OTOH, are averse to market risks. They utilize their resources to corruptly manipulate government policy and subordinate it to their own advantage, and to the disadvantage of peoples whom the government supposedly represents.

"Fascism should more appropriately be called corporatism because it is a merger of state and corporate power."

-- Benito Mussolini

[Cacophonous]

Friedman really addresses only the first argument, i.e., protection of an industry vital to national defense (such as steel or electronics).

First is the national security argument...Although that argument is more often a rationalization for particular tariffs than a valid reason for them, it cannot be denied that on occasion it might justify the maintenance of otherwise uneconomical productive facilities. To go beyond this statement of possibility and establish in a specific case that a tariff or other trade restriction is justified in order to promote national security, it would be necessary to compare the cost of achieving the specific security objective in alternative ways and establish at least a prima facie case that a tariff is the least costly way. Such cost comparisons are seldom made in practice.

Trade policy cannot be considered only in purely economic terms. Even accepting that tariffs are bad economics (which I do not, but will here for the sake of discussion), to just look at it in purely monetary terms without the overall picture of foriegn policy is inherently flawed. Trade policy should never be made strictly on the basis of the ability of the consumer to buy a cheaper widget.

And this really is the crux of the remainder of Smith's remaining justifications: to offset domestic taxes on a product; “revenge” (his word) for tariffs imposed on exports by the other countries (he singles out France in the text); and to recover a foreign market. These are all pretty mercenary. Use trade - and the might of the domestic manufacturing capability as a huge stick.

We could say to the rest of the world: We cannot force you to be free. But we believe in freedom and we intend to practice it.

Yes, we could and should. Would save us a lot of grief.

As for the rest of Friedman's response:

The second is the "infant industry" argument...

I've never been convinced of this as an argument for tariffs, and not necessary.

The third argument for tariffs that cannot be dismissed out of hand is the "beggar-thy-neighbor" argument...this nationalistic approach is highly likely to promote retaliation by other countries.

Other nations already do this, and should reserve the right - as Smith proposes - to retaliate.

As for the level playing field argument, noone has yet convinced me - in purely economic terms or in more useful policy terms - why this is not a valid argument.

Friedman also fails to address history: why the US is better off buying instead of manufacturing, when it was the same (now destroyed) manufacturing might that won two world wars.

[FirstFlaBn]

Friedman also fails to address history: why the US is better off buying instead of manufacturing, when it was the same (now destroyed) manufacturing might that won two world wars

Looks like you've swallowed the union kool aid. The only thing in U.S. manufacturing that has been destroyed is the extortionist conspiracy stranglehold of the labor unions.

The chart below shows a remarkable consistency for the role of manufacturing in the U.S. economy. Try to do your homework next time.

[Cacophonous]

What are we manufacturing?

[Cacophonous]

Let me re-phrase the question:

Why is the US is better off buying instead of manufacturing and selling, when it was the same manufacturing might that won two world wars?

[dennisw]

These trade deficits will eventually tank the dollar as the US loses it's reserve currency advantage. Which has allowed us to buy cheap foreign imports beyond our real means. There is no such thing as a free lunch and no immutable law that the USD must be the preferred reserve currency and accepted international transaction currency.

One reason for our war in Iraq was to prove and project US military might. This shocks and awes foreigners, making them more confident in the USD. Thus permitting us to keep running up these outrageous foreign trade deficits.

 

[Toddsterpatriot]

The Chinese aren't buying ANYTHING, THEY ONLY SELL!

If that were the case they would end up with lots of pieces of paper with pictures of Americans on them.

Personally, I'd prefer to send them paper and keep using their TVs, VCRs and stereo equipment.

[George Frm Br00klyn Park]

Guys, Things are NOT going good for the home team. Peace and love, George.