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. Ive 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 Im not going to offer any comment on it and will just let the reader judge for himself whos 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 4999 other people each to contribute $10 to help your protectionist pro-monopoly organization the Coalition for a Prosperous America raise $50000. 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?
Youll 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 wont.
There are important secondary effects and some net/gross issues that may confuse you but thats 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 doesnt go down.
Don
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Don
Thats 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 youre richer than you would be if you didnt have it and I am poorer.
This isnt even a matter of economics. Its just accounting.
Ian
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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 wont." 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 cant 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 Smiths 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:
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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 Id 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 theres a fixed amount of capital in the world. That assumption is mistaken.
Don
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Don
You write Of course Id 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 notcontrary to your assumptionnot necessarily or by its nature debt.
Don
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Don
Once again youre correct but youre 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 isnt.
A $1 increase in Americas 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 Americas trade deficit might very easily not mean that Americans have gone into an extra dollars worth of debt to non-Americans.
Its childs play to give examples of how Americas trade deficit can rise without Americans debt rising or Americans asset holdings falling. Heres just one example: Valerie in Virginia buys $1 of shoelaces from Hans in Hamburg. Hans adds his $1 to $999999 of his German friends dollars that his friends (and now he) use to open a restaurant in Miami. Americas trade deficit rises as result of Valeries purchase of foreign-made shoelaces. Yet no American is any more deeply in debt as a result; this transaction hasnt caused Americans debt to rise by as much as a single cent. And no Americans (or Americans) asset holding are reduced by $1.
Don
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Don
No your example doesnt work. Valerie has $1 less in assets now.
Furthermore since no American gains an asset Valeries asset decline of $1 entails a $1 asset decline for America as a whole.
Ian