David R. Henderson  

Mercantilism Dies Hard

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One of the things that economists, whatever their other views, are most sure of is that free trade is a good idea.

The normal way we argue for trade, either between individuals and companies in a country or between individuals and companies across borders, is that both sides benefit. The seller benefits by selling something for a price greater than his supply price. (The supply price is the minimum price that he requires to be willing to supply the item in question.) The seller's gain is the difference between his supply price and the price he is paid, and is called producer's surplus. The buyer benefits by buying something for a price that is below his demand price. (The demand price is the maximum price the buyer is willing to pay for an item.) The buyer's benefit is his demand price minus the price he pays, and is called consumer surplus. The sum of producer's and consumer's surplus is the gain from the exchange.

Notice that consumer surplus is a big part of the story, whether the exchange is within a country or across borders.

But many people systematically leave out the gains to consumers. There are two recent instances.

Henry Olsen, a senior fellow at the Ethics and Public Policy Center and an adjunct professor at Villanova University, in an op/ed in the Washington Post, writes:

Many of Trump voters' priorities can be addressed in ways consistent with Republican inclinations. Immigration can be reduced but not eliminated; trade deals can proceed if they ensure that benefits flow to average Americans, not just those in finance or exporting industries.

Notice Olsen's narrow focus. The implication of his focus on exporters seems to be that trade deals don't generally generate benefits for average Americans except in their role as exporters or employees of exporters. But they do benefit. One of the main benefits of free trade is lower prices, and therefore consumer surplus, on the items they buy.

Take the 25% tariff on light trucks, please. That tariff makes price of trucks, whether new or used, substantially higher. Yes, it has caused most truck production for the U.S. market to move to the United States. But the producers do that to get around the tariff wall and would likely not do that if there were no tariff. So, although 25% is almost certainly an overestimate of the higher price U.S. buyers pay for new trucks, without a tariff they would certainly pay much less. So a trade deal that cuts tariffs on trucks would definitely help "average Americans." And here's the thing: the U.S. government could to that unilaterally without a trade deal. I choose this example on purpose. When I mentioned to my students, while teaching about free trade and protectionism, that there is a 25% tariff on light trucks coming into the United States, that caught their attention. Many of them have bought new trucks and would have loved to have paid much less. They are not literally average Americans--their and their spouses' incomes probably put them in the top 20% of the income distribution--but next time you talk to an "average American" who owns a pickup truck, tell him about that 25% tariff and see if he is indifferent.

Or consider this recent piece in the Wall Street Journal by Harvard economist Martin Feldstein, my boss when I was at the Council of Economic Advisers. He's trying to defend NAFTA. Good for him. But how does he defend it? He writes:

During the campaign Mr. Trump promised to tear up the North American Free Trade Agreement if he could not negotiate a substantial improvement. Revoking the agreement would put more than $600 billion of U.S. exports to Canada and Mexico in jeopardy. According to the U.S. Census Bureau, U.S. companies export more to Canada than they import from Canada. Including Mexico, total Nafta imports exceed exports by less than $40 billion, an amount equal to just one-quarter of 1% of GDP.

So Marty's defense is that exports would be put at risk and he mentions imports only to compare their size to the size of exports. So all that seems to matter to him, when defending free trade, is gains to producers (exporters), not gains to consumers (importers).

Mercantilism dies hard.

The misunderstanding is bipartisan. But also the understanding is bipartisan. Democratic economist Alan Blinder laid out the case for free trade beautifully in "Free Trade" in The Concise Encyclopedia of Economics.


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CATEGORIES: International Trade




COMMENTS (27 to date)
Effem writes:

Consumer surplus accrues to everyone while negative wage impacts only accrue to some. Let's say free trade grows the pie but also dramatically changes the distribution of the pie.

What is the utility function for deciding whether aggregate gains at the cost of disparate outcomes is "good?" Surely you wouldn't be in favor of a trade deal that increased the wealth of 1 person while making everyone else slightly worse off, would you? So where is the line?

Seems to me that economists like to get into debates about "good" vs "bad" without even agreeing on a utility function. Rather pointless.

Thaomas writes:

Agreed that lower costs to consumers should be a bigger part of the argument, but it can never pack the punch of the visible pain of the worker who loses his job when a plant closes. Now the right kind of argument ought to be that we have a dynamic expanding economy and the laid-off worker should find another better job in time. But we have NOT had a dynamic expanding economy (thanks in part to the Fed's timid response to the 2008 crisis) that has been creating those jobs. If real median wages (and that includes the lower costs of consumption because of imports) had not stagnated, we might be having a different kind of argument.

By the way, the exports argument IS and anti-mercantilism argument as it addresses the trade agreement lead to trade deficits argument.

David R. Henderson writes:

@Thaomas,
Agreed that lower costs to consumers should be a bigger part of the argument, but it can never pack the punch of the visible pain of the worker who loses his job when a plant closes.
Pack the punch for whom? Put it to a test. Find someone--it shouldn’t be hard--who recently bought a new truck. Ask him how he would feel if he knew the U.S. government could have made that truck 15% less expensive if it had simply removed trade barriers.

jc writes:

Another word for consumers = everyone = the whole (vs. a subset, the few, this or that special interest), etc.

Frame it this way: "Should we do something that favors a minority of people at the expense of the whole?"

One counterargument is that, as Thaomas notes, the benefits experienced by all of us individually are small compared to the material, emotional, and psychic pain of a lost livelihood that is gigantic (no amount of retraining or support can - in the real world, as human beings are actually wired - offset this).

Another counterargument (not saying I buy this one) is that if you add up all the minorities that are affected by this or that trade policy, you end up with a majority.

The counter to these counters that seems to stymie folks I speak with - once we get past the issue of tribal sentiment and felt rivalry w/ foreign organic competitors for jobs (vs. inorganic competitors) - is the analogy to technological job displacement. Yes, the industrial revolution was lumpy and full of pain for displaced workers while the world adjusted, but would we really have been better off w/o it? Should we take away everyone's shovels and give them spoons?

In the end, many seem to settle for saying, "No, don't do that. But the pace of change could be slowed a bit to make it less disruptive while still, in the long run, reaping the fruits of productivity gains. It doesn't have to be either/or. Just slow it down and offer generous benefits to the displaced, either directly or in the form of useful work (e.g., infrastructure), make-work, or a mixture."

It would be interesting to know what the average person thinks/feels if they fully understood the arguments for/against trade (or any policy, really), and if both the costs and benefits were transparent.

Charley Hooper writes:

To "help" average Americans, the government should make their purchases more expensive? That's what it comes down to.

MikeDC writes:
Put it to a test. Find someone--it shouldn’t be hard--who recently bought a new truck. Ask him how he would feel if he knew the U.S. government could have made that truck 15% less expensive if it had simply removed trade barriers.

I think many potential answers to this question would point to deeper support for tariffs than you might expect.

Like, how different is it than saying "the government could have made that truck x% less expensive if it had simply reduced taxes?"

We as economists view international trade as a special case, but all the same lessons can be generalized to domestic trade as well. A tariff is just a special case of a tax, and while most folks would like to have lower taxes, they also, upon reflection, usually recognize that some taxes should be collected.

At that point, if the conversation turned to "who to tax", I think it would be very difficult to convince the average person not to want to give a leg up to domestic producers. He/she would say "Ok, we need to have a tax, so why not have one that encourages us to buy American?".

(I'm sorry if this comes across as just me arguing. Rather, I'm trying to work through why the free trade argument is so hard to make).

Greg G writes:

I like this post but it's not just mercantilism that dies hard. All schools of economics die hard no matter how wrong they are. I think the spectrum of economic ideas is tied in some fundamental way to the spectrum of human intuitions and human heuristics.

I agree with you on free trade David but can we agree that all ideas in economics "die hard"? Or perhaps it's more accurate to say they never die at all.

Charley Hooper writes:

@MikeDC,

All taxes have negative effects. Based on your line of reasoning, it comes down to whether tariffs are better or worse than other taxes.

Thaomas writes:

To be clear, with my plant closure v lower consumer costs point, I mean this as public argument, not one one one where everything might in principle be explained. I mean that for Sec Clinton to say that plant closures (alleged to have been caused by NAFTA) is OK because we gut cheaper consumer goods from China probably would not have worked, either. I still think the best defense is to turn the "trade is good in the aggregate" into the that particular losses will be small and transient because lots of other "good" things are going on that will compensate these losses. This is almost a trolley car problem; people are reluctant to cause some kinds of harm even it avoids even greater harm.

Andrew_FL writes:
Many of Trump voters' priorities can be addressed in ways consistent with Republican inclinations.

I agree with this statement, at least, if not the parts that come afterward. Worried about foreign competition for US businesses, workers?

Drastically cut corporate taxes, labor taxes, take Federal Government thumb off the scales of labor negotiations (that is, abolish the National Labor Relations Board). Eliminate the minimum wage. Eliminate burdensome regulations. Any way that the government actually actively intervenes that makes American labor and industry less competitive, get out of the way.

But noooope apparently now the Republican approach is "tax foreign stuff"
Sad!

Tom Nagle writes:

Nice job David. Economists who argue that the main benefit of trade is the ability to export, and who disregard the ability to buy cheaper, are making the case for the other side--since we do import more than we export.

Don Boudreaux writes:

Very nice post, David. It prompted this post by me.

Andy writes:

The main problem with agreements like NAFTA and the TPP is that they are not remotely free trade agreements. At best they are managed trade agreements and one could argue they are actually primarily political agreements that involve trade. Whether such agreements actually promote comparative advantage or provide a net benefit to the people of the US is entirely dependent on the overall effectiveness of the negotiations. We really should stop calling them "free trade" agreements simply because free trade doesn't require thousands of pages of legalese to describe and implement.

Jon Murphy writes:

Re Marty Feldstein's comment:

Could it be he's using the rhetorical technique of using the opponent's argument against him? He's framing the NAFTA question in terms of exports because he thinks that'll be what it takes to convince mercantalist readers? If I were speaking to a particular audience, I would emphasize that point in my talk, but I am no mercantalist.

David R. Henderson writes:

@Andy,
At best they are managed trade agreements
I’ve heard that line a lot and I’ve never understood it. Can you explain? So, for example, in the NAFTA agreement, there are substantial cuts in tariff rates. Is the fact that the rate doesn’t fall to zero what makes it “managed trade?"

David R. Henderson writes:

@Jon Murphy,
Could it be he's using the rhetorical technique of using the opponent's argument against him? He's framing the NAFTA question in terms of exports because he thinks that'll be what it takes to convince mercantalist readers?
I’m sure that’s what he’s doing. I was never accusing Marty of not understanding free trade. But at some point, especially when you’re writing for the Wall Street Journal, you need to decide to educate people and not play to their prejudices. Or, at worst, play to them but then make the point about consumers.

MikeDC writes:

@ Charlie,

All taxes have negative effects. Based on your line of reasoning, it comes down to whether tariffs are better or worse than other taxes.

To the average person, yes. What I think I'm getting at is that arguing the consumer approach is difficult because the composition of pricing quite a bit more obscure to the consumer than it is to the producer.

To put it another way, the prices consumers pay for goods fluctuate a lot more than the prices at which sellers sell them. Some of these are easily understood by consumers (e.g. buying your milk from the grocery instead of from the 7-11) and some (how much of the cost is "profit", and how much of it is attributable to various taxes) is not.

Wild Bill writes:

I don't find this argument convincing. Japan's heavily subsidized (by central bank manipulation of the exchange rate) car companies can sell small, imported trucks cheaper, until there is no domestic competition, then raise the price later. Meanwhile, thousands of manufacturing jobs are lost, while the banks get richer shuffling currency transactions that inevitably skew in Japan's favor. The people who work those jobs aren't too dumb to know that "free trade" isn't good for them, they are simply voting to keep their jobs. Free trade benefits Wall Street more than working America, and American workers aren't too dumb to know when they're getting screwed.

Jon Murphy writes:

@Wild Bill:
Japan's heavily subsidized (by central bank manipulation of the exchange rate) car companies can sell small, imported trucks cheaper, until there is no domestic competition, then raise the price later.

Have you read John McGee's 1958 article "Predatory Price Cutting: the Standard Oil (NJ) Case"? I highly recommend it. It's a classic of anti-trust literature, and very easy to read.

I bring it up because, in that article, he discusses predatory pricing as a method to secure monopoly power. He shows predatory pricing is an ineffective and extremely costly method of doing so. Even though his focus is solely on the domestic market, we can easily expand his analysis to the international market (if you'll forgive this shameless self-promotion, I did so on my blog here).

In short, if Japan (or China or whoever) were manipulating their currency in order to grab monopoly market share, they will end up hurting their economy far greater than any gain they might achieve.

Hazel Meade writes:

Here's another point worth remembering:
Importers aren't necessarily all end-user consumers. They may be manufacturers who are buying raw materials or components.

When the government imposes import tariffs it's not just favoring domestic producers (working class labor) at the expense of consumers (upper-middle class buyers), it's favoring some domestic producers (say steel workers) at the expense of other domestic producers (say construction workers).

If you extend the logic, it's not always clear where the line between end-user consumption and production is. A truck is a work vehicle. Tariffs on light trucks thus favor auto workers at the expense of various laborers who use them for their jobs.

Lots of protectionist arguements often make the claim that people can afford to pay a couple bucks extra for a truck if it benefits US workers. But would you pay a couple bucks extra for a truck so you can benefit some workers at the expense of others?

Andy writes:
I’ve heard that line a lot and I’ve never understood it. Can you explain? So, for example, in the NAFTA agreement, there are substantial cuts in tariff rates. Is the fact that the rate doesn’t fall to zero what makes it “managed trade?"

Tariff rates are only part of these agreements and I think if they were limited to tariff reductions they could reasonably be considered actual "free trade" agreements. However, the devil is always in the details and for NAFTA and other agreements the tariff reductions are always subject to meeting specific conditions defined in the agreements. For example, NAFTA tariffs must comply with "rule of origin" and other regulations before products qualify for NAFTA tariff rules. Some products (mainly in agriculture) are subject to quota restrictions.

Additionally, especially in the case of agricultural products, tariffs may be reduced or eliminated, but governments may subsidize the domestic production of those products through various means, so the effect of the tariff is somewhat offset.


The various caveats, carve-outs, regulations, loopholes and the arbitration system required to manage disputes are features of a managed trade system. Additionally, those features were also negotiated in a political context with countries (and factions and interests in those countries) trying to get the best deal which means exceptions and limitations on trade. These exceptions are driven by politically powerful domestic constituencies who lobby negotiators and politicians for carve-outs favorable to their interests - this creates asymmetries in the final agreement since less-powerful domestic interests won't have their interests represented by negotiators. Asymmetry is another aspect of managed, not free, trade.


In sum I think NAFTA is a much more liberalized trade system than what existed previously but it is not free trade.

Don Boudreaux writes:

Wild Bill:
In addition to the points made by Jon Murphy (about John McGee's influential and thorough 1958 study of a famous alleged instance of predatory pricing), I draw your attention also to the U.S. Supreme Court's 1986 decision Matsushita v. Zenith Radio Corp., which involved an allegation by an American firm of predatory pricing by a Japanese firm. The Court correctly found that the allegation made no economic sense.

While it's true that government subsidies (when they are real and not merely alleged) change the analysis, I don't believe they save your story. Japanese companies have been selling automobiles now in the U.S. for about 50 years. Surely if these Japanese automakers were involved in some scheme to reap monopoly profits in the future as the fruits of predatory pricing today, we would long ago have had compelling evidence of such monopoly power. And yet the Japanese automakers still compete vigorously in America not only against each other, and not only against G.M., Ford, Chrysler, and Tesla, but also against Korean and European automakers who sell cars in America. Allegations here of monopolizing intent with any real prospect of success at monopolizing are simply too implausible to take seriously.

Wild Bill writes:

I'm not saying that monopoly can ever exist in a country like the US. with so many car manufacturers, but currency manipulation allows European, and particularly, Asian car companies to import cars that could not otherwise be sold at a profit, cars that would otherwise be made in the US by American workers. This translates to tens of thousands of jobs, and allows countries with smaller domestic markets to compete freely in a relatively open market, while protecting their home markets by various means. A monopoly is not needed when currency manipulation guarantees you a slice of the American pie. The threat to this arrangement now comes not from Donald Trump, but the huge financial distortions that have arisen from decades of one way trade, and the realization that all those trillions of "surplus" reserves are worthless in stemming the next financial crisis.

Jon Murphy writes:

@Wild Bill-

Assuming countries are manipulating their currency in order to get a slice of the American pie, they do so at their own economic peril. Remember that, while a weaker currency may mean exports are relatively cheaper on the export market, it also means that imports and domestic goods are now more expensive. Such currency manipulations would harm domestic economies for mild gains in the US (or global) economy. Add this to the cost of currency manipulation (it's a large market. In order to truly manipulate currencies, it would cost billions, if not trillions, of dollars every year) and you have a recipe for disaster, not economic growth. For example, Japan exported $139 billion to the US in 2014. By contrast, the currency market trades approximately $5.1 trillion per day. The kind of OMO one would need to do to perpetually keep one's currency "undervalued" would be enormous; certainly larger than $139 billion a year (or 0.8% of the US economy).

Again, I refer back to John McGee's piece. It's truly worth a read. If they truly wanted to grab a market share of the US economy, it'd be far cheaper just to buy up competition.

Wild Bill writes:

Jon, I don't disagree that currency manipulation is bad for the manipulator, but it happens anyway. You mention the cost, but the advantage for exporters is real. But yes, eventually, China and Japan will pay the price for for having such large surpluses when they realize most of it will never get paid. China cashes in various forms of reserves because of the weakening Yuan, $236 billion worth between December and February alone! I don't know about you, but I don't think selling nearly a quarter trillion in three months, only because the financial system is desperately short of dollars, is such a good sign.

Jon Murphy writes:

@Wild Bill-

Considering you agree with me that the manipulation is bad for the manipulator, and the manipulators surely know this (I highly doubt no one can do the math), one must ask if they are really manipulating the currency. As my professor, Walter Williams, says: do not assume people are stupid until they prove it.

The mere fact a currency is relatively cheap (or "undervalued") doesn't necessarily mean something devious like manipulation is underway, especially for the goal of securing monopoly market share, as you originally stated. Currency exchange rates are highly influenced by economic information. For example, Europe and Japan have both struggled to maintain any upward momentum since 2008, both having interim recessions over the past 8 years. The US, however, has generally grown over the same time period (yes, it has been poor growth, but +1% is better than -1%). This alone could explain the currency differences between the USD/EUR and USD/YEN.

I am not convinced there is widespread manipulation of currency for the benefit of exports for the reasons I laid out above and in the McGee article I keep referencing. Additionally, I am not convinced that international trade is responsible for the manufacturing job losses, either. The evidence suggests automation is far more likely the culprit here.

In short, I think the attitude you describe in your original post (" The people who work those jobs aren't too dumb to know that "free trade" isn't good for them, they are simply voting to keep their jobs. Free trade benefits Wall Street more than working America, and American workers aren't too dumb to know when they're getting screwed,") is, while perhaps a popular view, incorrect based on the economic data and theory we have.

Wild Bill writes:

Those trillion dollar trade surpluses are really just various financial instruments and innovative financial products most of which are guaranteed to fail. You can believe that those numbers are a natural result of free trade if you don't know how international trade is financed. China reaped the benefits of a profligate financial system on the way up, now it's paying the price, and all the economic data shows it.

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