The Ignorance of the Economists: the Case of Donald Boudreax

An exchange with a professor of economics about the trade deficit. 


Like most academics, professors of economics are not generally stupid people, IQ-wise.  But they do have a remarkable ability to lose sight of basic  realities. I’ve seen this over and over again.

 

I just had an extended e-mail exchange with one Donald Boudreaux, a professor of economics at George Mason University, about the trade deficit. Now I’m not going to offer any comment on it, and will just let the reader judge for himself who’s right in the back-and-forth below. (Feel free to post a comment or e-mail me if you think I was mistaken.)

 

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Dear Mr. Fletcher:

 

I received your e-mail today asking me, along with 4,999 other people, each to contribute $10 to help your  protectionist pro-monopoly organization, the Coalition for a Prosperous America, raise $50,000. Understandably, you attempt in that mass e-mail to persuade us to make net investments in your organization by assuring us that our investments will make the CPA more productive and, hence, better able to achieve its goals.

 

Yet among the promises you offer in your fund-raising pitch is that the CPA will work to “eliminate the trade deficit” – that is, to prevent non-Americans as a group from making net investments in America.

 

Query: if the CPA benefits when non-CPAers invest in the CPA, why do you think that America suffers when non-Americans invest in America? That is, can you explain why the productivity of you and your colleagues at the CPA will rise if I make a net investment in the CPA while the productivity of you, me, and other American workers will fall if someone from Toronto or Tokyo or Timbuktu makes a net investment in America?

 

You’ll receive my $10 upon my receipt of a satisfactory answer from you to my question.

 

Sincerely,

Donald J. Boudreaux

Professor of Economics and Martha and Nelson

Getchell Chair for the Study of Free Market

Capitalism at the Mercatus Center

George Mason University

Fairfax, VA 22030

 

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Don,

 

Your challenge was forwarded to me.

 

The reason trade-deficit-induced foreign investment in the  U.S. is bad is that it is not net new investment. It is merely the transfer of  existing American investments to foreign ownership to

compensate foreigners for  shipping us more stuff than we ship them. And because ownership

of assets is transferred, their net worth goes up and ours goes down: they are richer than they would have been, and we are poorer.

 

Furthermore, they will receive the future returns on those assets and we won’t.

 

There are important secondary effects, and some net/gross issues that may confuse you, but that’s the nub of it.

 

Best Regards,

Ian Fletcher

Senior Economist

Coalition for a Prosperous America

 

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Ian,

 

Nope.

 

When Ikea builds a store in the U.S. our net wealth doesn’t go down.

 

Don

 

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Don,

 

That’s not the issue.

 

When Swedish, rather than American, investors *own* an Ikea store in the U.S., Swedish investors are richer, by the size of the  investment, than they would have been, and American investors are correspondingly poorer.

 

Ian

 

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Ian,

 

That is simply untrue.

 

Don

 

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Don,

 

If you, rather than I, have a certain $100 bill, you’re richer than you would be if you didn’t have it, and I am poorer.

 

This isn’t even a matter of economics. It’s just accounting.

 

Ian

 

*************

 

Ian

 

Many thanks for your two replies to my e-mail of yesterday.

 

You write in your first e-mail that a U.S. trade deficit “is merely the transfer of existing American investments to foreign ownership to compensate foreigners for shipping us more stuff

than we ship them.  And because ownership of assets is transferred,  their net worth goes up and ours goes down: they are richer than they would have been, and we are poorer.  Furthermore, they will receive the future returns on those assets and we won’t.” In a follow-up note you claim that when the Swedish furniture retailer  Ikea builds a store in America “Swedish, rather than American,  investors *own* an Ikea store in the U.S., Swedish investors are  richer, by the size of the investment, than they would have been, and American investors are correspondingly poorer.”

 

With respect, there are so many mistakes and misconceptions lurking in your replies that a response much longer than a routine e-mail note is required to address them all.  Yet although I*

(and scholars far more knowledgeable and articulate than I am) have written extensively on this issue, I welcome the opportunity, in coming days, to do so again, because a faulty understanding

(such as yours) of the trade deficit fuels calls (such as yours) for  protectionist policies whose adoption would make us less  prosperous, less peaceful, and less free.

 

But I can’t resist here just one quick query: when my Virginia neighbor Mr. Jones opens a successful retail shop in Virginia, does his success make me poorer?  If not, why am I made poorer when my global neighbor Mr. Ikea opens a successful retail shop in Virginia?

 

This letter, though, being already too long on a holiday weekend, I close simply with a quotation from Adam Smith’s Wealth  of Nation —a quotation that proves nothing except that concerns such as yours are ancient, have proven false again and again, and have been  addressed by serious economists since the launch of our discipline:

 

“There is no commercial country in Europe of which the approaching ruin has not frequently been foretold by the pretended doctors of this system from an unfavourable balance of trade. After all the anxiety, however, which they have excited about this, after all the vain attempts of almost all trading nations to turn that balance in their own favour and against their neighbours, it does not appear that any one nation in Europe has been in any  respect impoverished by this cause.  Every town and country, on the contrary, in proportion as they have opened their ports to all  nations, instead of being ruined by this free trade, as the  principles of the commercial system would lead us to expect, have been enriched by it.”**

 

 Sincerely,

Donald J. Boudreaux

Professor of Economics and

Martha and Nelson Getchell Chair for the Study of Free Market

Capitalism at the Mercatus Center

George Mason University

Fairfax, VA  22030

 

* http://cafehayek.com/category/balance-of-payments

 

** Adam Smith, An Inquiry Into the Nature and Causes of the Wealth of Nations (Indianapolis: Liberty Fund, 1981 [1776]), Vol. 1, pp. 496-497.  This quotation appears in Book IV, Chapter  3:

http://tinyurl.com/cw4beec

 

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Don,

 

You are giving the right answer to the wrong question.

 

If a neighbor opens a store which he then owns, you are 100% correct that this act does not make you poorer.

 

But you are still poorer than you would be if *you* owned it.

 

Ian

 

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Ian,

 

What does this answer have to do with trade?  Of course I’d be richer if I consumed less and invested more.  But nothing that a  foreigner does prevents me from doing so. You seem to assume that there’s a fixed amount of capital in the world. That assumption is mistaken.

 

Don

 

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Don,

 

You write, “Of course I’d be richer if I consumed less and invested more.”

 

You are correct. Which is why consuming more than we produce, by  means of a trade deficit that must be financed by asset sales or  debt assumption, makes us poorer.

 

Ian

 

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Ian,

 

Your understanding of the trade deficit is faulty.  If Mr. Ikea builds a store in New Jersey, capital is created. No American goes into debt as a consequence of such a transaction.

 

Sometimes the trade deficit becomes debt, but it is not—contrary to your assumption—not necessarily or by its nature debt.

 

Don

 

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Don

 

Once again, you’re correct, but you’re answering the wrong question.

 

A trade deficit is, granted, not always financed by debt. But it *is* always financed by either debt or the transfer of existing  assets.

 

Foreigners must be given *something* of value to compensate  them for the fact that we export less to them than they do to us.

 

If this were not the case, they would be playing Santa Claus and giving us stuff for free.

 

Ian

 

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Ian,

 

No it isn’t.

 

A $1 increase in America’s trade deficit might be evidence that Americans’ debt to foreigners rose by $1. (Whether or not such an increase in debt to foreigners is a bad deal economically for Americans is a separate question: it might or it might not be.) But a $1 increase in America’s trade deficit might very easily not mean that Americans have gone into an extra dollar’s worth of debt to non-Americans.

 

It’s child’s play to give examples of how America’s trade deficit can rise without Americans’ debt rising or Americans’ asset holdings falling.  Here’s just one example: Valerie in Virginia buys $1 of shoelaces from Hans in Hamburg. Hans adds his $1 to $999,999 of his German friends’ dollars that his friends (and now he) use to open a restaurant in Miami.  America’s trade deficit rises as result of Valerie’s purchase of foreign-made shoelaces. Yet no American is any more deeply in debt as a result; this transaction hasn’t caused Americans’ debt to rise by as much as a single cent. And no American’s (or Americans’) asset holding are reduced by $1.

 

Don

 

*************

 

Don,

 

No, your example doesn’t work. Valerie has $1 less in assets now.

 

Furthermore, since no American gains an asset, Valerie’s asset decline of $1 entails a $1 asset decline for America as a whole.

 

Ian

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