David R. Henderson  

Gains from Exchange

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Last month I received this e-mail from a student I taught in the Spring quarter at the Naval Postgraduate School:

Today my [deleted so as not to identify the instructor] instructor pointed out that there was a transfer of wealth going on from America to other oil countries.

You would have enjoyed the response.

I told him that there was no transfer of wealth. Both parties valued what they were receiving far more than what they were giving up. I told him if a transfer of wealth were occurring then the value of what we were receiving would be zero.

It stopped and made him rethink his statement, which was cool.

Even at age 61, I still love teaching. It's letters like this that are one of the reasons. One of my joys in teaching is to find out, after the course is over, that the students learned enough economics to challenge other professors in other classes. We had discussed this point early in the previous quarter when I did the "Ten Pillars of Economic Wisdom." I'm guessing that one reason the student remembered this point so well is that I tested it on my first problem set. Here was the problem:
A couple of years ago, T. Boone Pickens stated that because we (Americans) pay $700 billion a year on foreign oil, this $700 billion is a "transfer of wealth."
(a) Are we transferring wealth from ourselves to others when we buy oil? Explain. (1 point)
(b) One critic of Pickens stated, "But exchanging money for oil at the market price is an exchange of things of equal value." Is this quoted statement correct? Why or why not? (1 point)


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COMMENTS (19 to date)
Ken B writes:

People fall for this I think partly because oil is consumable and gets used up. So at then end of the barrel it looks like we just gave away an asset. Here we are, back where started, $98 poorer!

J writes:

Young man, as you get older, you'll enjoy more and more teaching and giving advice.

David R. Henderson writes:

@Ken B,
Good point. This won’t surprise you but, by the same reasoning, every time I buy coffee at Starbuck’s, I transfer my wealth to them.

Ted Levy writes:

Ken B makes a fascinating speculation, but I wonder...Do people don't think that about their rent payments. "Here we are, a month later, with nothing to show for it..." If they DO think that, they should be happy about rental to condo conversions, and yet people frequently are unhappy about such conversions (so I understand.)

And the foreigners who got the $98 also don't have the money to show for the trade. They spent it, used it up, to buy something, which itself may well be consumable...

I realize Ken B was not providing an economic rationale--he understands the economics are wrong--but a psychological explanation. So perhaps my first paragraph above implies only that psychologically people come to opinions without thinking them through...

Ken B writes:

I only took introductory econ, and that 30 some years ago (From the text Lipsey, Sparks & Steiner, David). I only clearly remember learning two things: opportunity cost and Ricardo's theorem. And something about triangles on graphs! The thing is, I think I really did learn those two things. I can still remember the TA -- struggling to explain it to me and a few others before we twigged. That lesson on Ricardo's theorem is actually one of my clearest memories of first year.

Ken B writes:

@Ted Levy: I suspect people fall for these things more when foreigners are involved. Bryan's anti-foreigner bias theory at work. Plus of course, it's wrong to expect consistency in fallacies!

John T. Kennedy writes:

Wealth transfer comes later when we print more money, devaluing the paper we traded for the oil. Suckers!

KLO writes:

@Ted Levy

People often do seem to think that paying rent is "throwing money down a rat hole." These same people also seem to believe that owning a home one lives in is costless, because the money is "invested" in an asset. Few people seem to realize that structures depreciate in value and that generally only land increases in value over time.

Common thinking on land rent and commodity rent is pretty much the same. Since he who collects the rent did not create the land or oil, it is often thought that the rent paid out is received by an undeserving person. This, more than whether there is an exchange of equal value, seems to be the source of the distaste.

Michael V writes:

There is also a forcible transfer of wealth from the US to Middle Eastern countries in the form of military assistance to Saudi Arabia.

R. Miller writes:

There most likely is a transfer of wealth.

Wealth is the accumulation of assets. The money spent by the US on oil is an asset that either comes from our wealth or deprives a flow into that wealth. With a trade deficit, our wealth is decreasing in order to consume oil.

The oil producing nation is also trading an asset (oil) for an asset (money). The oil is part of their stock of wealth. The money they receive for it is more liquid than the asset they held. (strange that paper money is more liquid than a liquid)

The oil producer could spend that money on consumption, and thus it too is diminishing its wealth in favor of consumption. But if it has a net trade surplus, it is trading relatively illiquid oil assets for relatively liquid cash.

So as long as the US remains a net debtor, it is losing wealth through consumption. The trade deficit will not reverse until the US consumes less of ita wealth.

None of this implies that the gains from trade are not mutually beneficial. Part of the consumption of oil might actually be an investment which increases the growth rate of wealth or decreases its rate of decline.

We certainly get value out of consumption, but do you consider the enjoyment of consumption to be part of your stock of wealth? If you do, then there may be no transfer of wealth. This latter argument is the best support for your thesis, but I haven't ever seen a flow of utility referred to as wealth or even as an asset. I certainly believe that it is an asset, and that changes in the flow of utility are net changes in personal wealth.

James Choy writes:

It's not totally clear what a "transfer of wealth" means, but Saudi Arabia does get oligopoly rents from the sale of oil. It costs something like $2 a barrel to produce oil in Saudi Arabia, but we pay something like $100 a barrel for that oil. If we were to invent a synthetic oil substitute that cost $50 a barrel to make, and if we then banned all oil imports, US social welfare would go up, even though the total world cost of oil plus synthetic oil would also go up. That's because we would be getting back some of the wealth we had previously been transferring to Saudi Arabia.

Ken B writes:
If we were to invent a synthetic oil substitute that cost $50 a barrel to make, and if we then banned all oil imports, US social welfare would go up,

Welfare would go up due to the creation of a lower cost substitute. But then you wouldn't need to ban the oil would you? Nor would you want to. If people can ship us oil for $49 we'd be better off buying it. Plus of course, why would the substitute sell for $50 instead of $99 absent competition?

Imagine we could invent artificial bananas for 5 cents a pound. Should we ban banana imports, to make ourselves better off?

Philo writes:

Let me try your test:

(a) There a $700-billion gross transfer. There is no net transfer. (See (b), below.)

(b) $700 billion is presumably the market value of the oil; and, of course, the market value of $700 billion is $700 billion. So the quoted statement is correct regarding market values: the two are equal. There is also the subjective value of the money (to each set of parties; we can set this at its nominal level) and the subjective value of the oil, the two sets of parties being foreigners and Americans, respectively. Evidently the former group values the oil at less than $700 billion, the latter at more. So the two subjective values are not the same; there is, as usual, a subjective-value gain from trade.

David R. Henderson writes:

@James Choy,
What Ken B said.
@Philo,
(a) There is no transfer of wealth because both sides gain wealth or else they wouldn’t do it.
(b) Trade is always trade of what you value less for what you value more. So the two values are not equal. The reasoning for that conclusion is what you stated in your last two sentences.

Joe Cushing writes:

David,

You do transfer wealth to Starbucks every time you buy a coffee from them. It's self evident that they have somehow drugged or hypnotized you into thinking coffee has more value than it really does. This is why you think you getting an even exchange, when in fact, Starbucks is stealing from you with every cup you buy. You have to resist the temptation to buy your coffee from them. I'm only half joking here. It does seem strange people wold waste so much money on coffee.

EDG reppin' LBC writes:

"It does seem strange people wold waste so much money on coffee."

Not anymore strange than people who spend money on news magazine subscriptions, cable bills, aftershave, Italian sports cars, pedicures, guitar lessons, heroin, mid-century modern furniture, handmade stationery, or baseball cards. My point is, people who are consuming these products don't consider it a "waste" of money. They instead are voluntarily exchanging money for a product they enjoy. It's peaceful, voluntary, and beautiful.

Ken B writes:

DRH:

@James Choy,
What Ken B said.

Words to live by David. :)

(a) There is no transfer of wealth because both sides gain wealth or else they wouldn’t do it.
This seems to be the point everyone misses. It seems somehow related to the mistake everyone makes with prohibitions too, ignoring the desires and rewards to the alcohol/cannabis/pronography/Bible user. I suspect it's related to not seeing value as subjective too. It's a strikingly ubiquitous and persistent oversight.
Ken B writes:

I wrote my last comment before reading this from Joe Cushing, my emphasis:

It does seem strange people wold waste so much money on coffee.

A clearer example of not seeing the value to the user, by ignoring the subjective nature of value, would be harder to find.

[And on top of that Joe, calling the fluid they sell at Starbucks 'coffee' is a stretch! :) ]

heiner writes:

@Ken B:
Nice.

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