But What The Hell Do I Know...

As part of a speech that was marvelously delivered and, as is typical of such things, coated with pandering and economic nationalism, the President made the proclamation that his trade policy would attempt to double American exports. I doubt this was a Steve Jobs-style teaser for a hot new product coming from the Whitehouse that will fly off the shelves worldwide like the Apple iPad. No, this export goal is going to be sought through restrictive government trade and tariff policy. There is a name for this kind of economic policy and it’s nothing new (and certainly not “change”): mercantilism.

Mercantilism is economic nationalism for the purpose of building a wealthy and powerful state. Adam Smith coined the term “mercantile system” to describe the system of political economy that sought to enrich the country by restraining imports and encouraging exports. This system dominated Western European economic thought and policies from the sixteenth to the late eighteenth centuries. The goal of these policies was, supposedly, to achieve a “favorable” balance of trade that would bring gold and silver into the country and also to maintain domestic employment. In contrast to the agricultural system of the physiocrats or the laissez-faire of the nineteenth and early twentieth centuries, the mercantile system served the interests of merchants and producers such as the British East India Company, whose activities were protected or encouraged by the state.

Mercantilism, at its heart, is a deeply pro-merchant/pro-“business” approach to trade, hence the name.  Mercantile policy uses protectionist tools like tariffs and import quotas to help the narrow group of exporters at the expense of consumers and society on the whole. Why is Coca-Cola made of corn-syrup instead of sugarcane? Mercantile import quotas on sugar that help out the Domino Sugar corporation at the expense of the rest of us is the reason. Mercantilism is a 600-year-old doctrine, which is funny because many mercantile market skeptics critique the free-market liberalism of Adam Smith as being “our of date” and “a 200 year old doctrine”. Based on age, the trade policy of the Obama administration makes Adam Smith look downright hip. 

Smith spent a good deal of his efforts in “The Wealth of Nations” demonstrating, I believe decisively, that the mercantile doctrine was in fact anti-consumer, anti-prosperity and defunct. Consider that the main way in which our balance of trade will be manipulated is through trade protections that prevent American consumers from buying cheaper imports. The impact of this is a transfer of wealth from the broad society of consumers to the narrow collection of domestic producers. It is little more than theft of purchasing power from the average person to the politically connected, be them the British East India Company or today’s unionized tire workers.

Measuring the balance of trade with my Grocer 

Taken locally, the notion of trade “balances” is patently absurd. Consider my home as a “nation” and my local Whole Foods as another “nation”. My balance of trade with Whole Foods is completely, well, out of balance. I give them cash in exchange for food. They buy nothing that I produce. Even worse, they then use my cash to pay their employees, rather than paying my son’s allowance in my home nation. Of course, my son is 4, so I can really buy our groceries from him. So I run a trade deficit with Whole Foods because I don’t make our food in our yard.

Were I to attempt to “balance” my trade with Whole Foods, I would either need to sell them something I make of equal value or stop buying from them. Self sufficiency in the name of balanced trade is a road to poverty and that becomes obvious when you apply the mercantile ideas at the local level.

Did you know that we don’t measure the “balance of trade” among any of the 50 United States. Why? Because it’s pointless information.

It’s all about who spends the money

In reality, the dollars we send across the border to China or the counter at Whole Foods are only accepted there because they can turn around and use them. And when Whole Foods does use my money, it cycles right back into the economy. Now imagine that I create my own currency, “Papola Bills”, which only my family accepts to spend amongst ourselves. If Whole Foods started accepting them for food, those Papola Bills could only be spent right back at home, literally. They’d have to turn around and buy my son’s pre-school drawings or something. 

That’s how the “balance of trade” is balanced in the “balance of payments". The money that flows out to buy imports ultimately flows back into the country in the form of capital investment, or the “capital account”. This is true as a matter of accounting. The current account, which included in it the “balance of trade" and capital account are always equal.

But guess what? If Whole Foods decided to accept Papola Bills for their products and never spent them at all, my home would be even better off! We’d be getting food for free! I don’t know why Whole Foods (or China) would do such a thing, as it would impoverish their company, but so long as they were doing it I’d be the benefit for their generosity.

Where trade balances do seem to become a problem is when cash that flows into other nations gets soaked up by their governments and malinvested. An example of this would be the large amount of sub-prime mortgage debt and US bonds which the Chinese government apparently purchased. But that’s not a problem with the balance of trade, really. That’s a problem of bad government policy.

I will say that a great many economists and experts that know WAY more about trade than I do have pointed to our large trade imbalances as playing an important role in the financial boom and bust of the past decade. It would be unreasonable of me to dismiss that opinion on its face. But my inclination is that the real problem isn’t the fact that Americans are buying more consumer goods from people across our border while foreigners are using that money to buy American investment goods in return.

The Global iPod

Even more problematic for the Mercantilists is the fact that the way our government measures the balance of trade completely misrepresents where and who is contributing the actual value of the goods we import. Our economy is global and so is the supply chain of most of our products. Consider the ipod. Back in 2007 three University of California researchers broken down the value added of the then-new 30gb iPod geographically. From the NY Times:

The retail value of the 30-gigabyte video iPod that the authors examined was $299. The most expensive component in it was the hard drive, which was manufactured by Toshiba and costs about $73. The next most costly components were the display module (about $20), the video/multimedia processor chip ($8) and the controller chip ($5). They estimated that the final assembly, done in China, cost only about $4 a unit.

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This value added calculation illustrates the futility of summarizing such a complex manufacturing process by using conventional trade statistics. Even though Chinese workers contribute only about 1 percent of the value of the iPod, the export of a finished iPod to the United States directly contributes about $150 to our bilateral trade deficit with the Chinese.

The real value of the iPod doesn’t lie in its parts or even in putting those parts together. The bulk of the iPod’s value is in the conception and design of the iPod. That is why Apple gets $80 for each of these video iPods it sells, which is by far the largest piece of value added in the entire supply chain.

Those clever folks at Apple figured out how to combine 451 mostly generic parts into a valuable product. They may not make the iPod, but they created it. In the end, that’s what really matters.

There’s a reason Apple imprints “Designed by Apple in California Assembled in China” on their products. They understand where the real value is being produced. The iPod is just one product among millions that are made in this global supply chain.

The “made in china” label is one of the most deceptive and damaging misrepresentations of the world on earth.

Trade not War

Politicians love to prey on our competitive instincts with jingostic talk of America being “number one” in this or that. “We’ve got to lead the world in X”. This rhetoric is little more than just that. The notion that companies and products are “national” is utterly obsolete, and that’s a very good thing for humanity. Nation’s are NOT in competition with one another for some GDP prize.

We are all interacting with each other and exchanging our ideas in a global marketplace. In the process, we’re living better and cheaper (over the medium and long run) while more and more people are lifted out of poverty to contribute their ideas and innovations to the pool of knowledge. Even more importantly, though, global trade makes all of us more connected and interdependent and raises the costs of going to war with one another. Does anyone honestly expect America and China to go to war? No. Prior to our freer trade relationship, that question was yes. Britain and France were historic military rivals for centuries. That too ended with the opening of trade between them so much so that they fought as allies in WWI and WWII. Free trade is the one true path to peace and prosperity in human history. 

Mercantilism seeks to disrupt all of that in the name of pursuing a largely meaningless and arbitrary paper accounting goal and using faulty data to justify it. More forcefully put, the defunct mercantile doctrine being employed by the president (and former presidents) is a scam used to sound “pro-worker” while in fact transferring wealth from consumers (which is all of us) to a handful of politically powerful and well organized special interests. The United States is not competing with China in some national race. This mercantile rhetoric is the ultimate example of defunct economics driving so-called “practical men"...

…but what the hell do I know?