Free trade, or the first few hits are free?

What was that famous Adam Smith quote, the one that made the case for free trade better and more concisely than ever before, or ever since?

It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy. The tailor does not attempt to make his own shoes, but buys them from the shoemaker. The shoemaker does not attempt to make his own clothes, but employs a tailor.

What is prudence in the conduct of every private family, can scarcely be a folly in that of a kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage.

But, you know, the “prudent master of a family” does not engage his tailor and buy his shoes on credit, for prolonged periods of time and with no forseeable means of repayment. Debt securities do not represent the produce of our industry. Sometimes the wisdom of crowds is not found in central-bank manipulated markets, but in the messy kinds of preferences expressed by voters in elections.

I’m all for free trade. But what many businesses and economists refer to as free trade, in this real world circa 2006, is not trade at all. Trade implies two parties exchanging value. I’m a long-time, knee-jerk anti-protectionist. But at this moment, I don’t know who to be more afraid of: US politicians catering to paleolithic economic xenophobia, or economists who’d describe as “free trade” the United States’ growing addiction to goods and services it cannot pay for and the nation’s ongoing, humiliating “soft default” on debts public and private via real depreciation of the dollar.

A man standing in line at a soup kitchen is involved in a voluntary transaction between two parties. He may think he’s outsmarted the guy with the ladle, working the system, getting something for nothing. But that man in line at the soup kitchen is neither admirable nor prudent, and it is that guy with the ladle who holds the power. The problem with a free lunch is that it may not be there tomorrow. And a free lunch, however long it lasts, is not free trade.

This rant was inspred by a post by the very excellent Mark Thoma.


4 Responses to “Free trade, or the first few hits are free?”

  1. groucho writes:

    “Debt securities do not represent the produce of our industry.”

    Steve, IOU’s, military hardware and McMansions. That seems to be the current output of the US. It looks like debt instruments are the only tradeable that we produce. Debt instrument production in NY and London can be a huge profit center for their respective countries if done with OPM or OCM(other countries money). The comparative advantage that the anglo-american economies have is all in the MCB’s credit slicing and dicing, tranching and churning.

    I think the current credit bubble started with the plaza accord with Japan. Revaluing the yen started the asian tiger miracle because Japan Inc needed cheaper production facilities, which it found through out SE asia. Hot money flowing from NY and London followed suit ending in the asian contagion and shortly after the Russian default/LTCM.

    A little more juice frm EZ AL and the tech bust soon arrived. Then you had the ideal setting for a perfect storm.

    Wall street looking to move some sort of product.(stocks aren’t moving? move some debt products) A CB wanting to fix banking and (personal ?) balance sheets. A W.H. that believes “deficits don’t matter”.

    The grand scheme worked wonderful except for one little problem. The american citizen now has debt up the wazoo and will find it rather challenging to pay down the claims against him or her.

    (Re)training americans to become Quants is probably about the best the US can hope for. Military sales to China looks like a non-starter.

    So, it looks like anglo-american’s future lies in debt pushing. If they are smart they will stop pushing it on their own citizens and start pushing it on productive enterprises, mainly abroad.

  2. Groucho — I’m feeling pretty grouchy myself, and agree with most of what you have to say. I don’t think that “anglo-american’s future lies in debt pushing”, though.

    I think Americans (and other “rich countries”) are actually quite capable of producing more value than they consume, and trading goods or services rather than debt for imports. Poorly structured, manipulable, and manipulated capital markets have made production of tradables appear to be unnecessarily, and have unduly inflated the apparent value of, say, homes and quantitative finance. I don’t think Americans are unconditionally doomed to face declining living standards. Americans will face declining living standards (beyond short term dislocations) only if we don’t get our stuff together and our incentives straight. If we do, real economic growth, rather than leveraged fairy tales, can still carry us forward.

  3. groucho writes:

    “I think Americans (and other “rich countries”) are actually quite capable of producing more value than they consume, and trading goods or services rather than debt for imports.”

    Steve, Commodity producing countries have been able to capitalize on the Chinese led boom. China needs commodities; commodity producers have a comparative(or cartel or monopoly) advantage and can trade with them.

    What products/services do you see the anglo-american countries producing for trade with asia besides commodities?

    I was half joking that we can create and trade credit products that bring profits back to NY and London, but that is one area where we excel.

    Personally, I would like to see an american led “consumer industrial policy” similar to what Japan created with their MITI.

    The US has long had a huge military industrial policy, which worked wonders to defeat Germany, Japan and finally the Soviet Union. If we could now redirect some of our energy into tradeable biz/consumer products/services, I think we would be amazed at how quickly we could reverse the current trade imbalances. Making more military non-tradeables is clearly not the answer.

  4. Groucho — I don’t think we disagree very much. Commodities are always and everywhere a bum rap. Economic dependence on any few commodities, as either and import or an export, is a prescription for bad things. I see anglo-american countries reindustrializing, in a capital-intensive rather than labor-intensive way, and employing human resources in a much more efficient and carefully directed way than traditional mass-laborer/mass-consumption-based industrial nations. We do excel at credit creation, and we excel at Hollywood too, but in neither case are our advantages sustainable, particularly with regard to extracting exorbitant rents for our services.

    A “consumer-industrial policy” would not be my first choice for how to get things moving, though my first choices may be too airy-fairy, and in this real world it might not be such a bad option. Still, my distrust of “wise government” makes me very wary. I think our capital markets are simply poorly designed, that in 30 years we will look back on today’s hyperquantitative finance like we now look back upon Ptolemeic astronomy: elaborately technical, but fundamentally misguided. Capital markets are information systems. Our capital markets mix up so much signal and noise, in easily observable and easily fixable ways, that they create hugely distorted incentives. Our capital markets’ regulators are captured by industries that occupy privileged positions with respect to existing flawed markets, that enjoy hidden government subsidies, and that profit off of foolish gamblers drawn to volatility. Our markets are poorly designed, and they will stay that way until it is impossible to ignore. Which I think will be soon. And then, we’ll have some opportunities. Instead of exhorting China to be just like us (dumb), we can innovate ourselves, and create markets that allocate capital and minimize, rather than manufacture, uncertainty. Once we get our incentives straight, I think we can work miracles. Just imagine if we’d put all the energy and smarts we’ve put into hedge funds, option grants, and McMansions into actually making stuff and doing things locals and foreigners alike would actually pay for! Americans are very capable, it’s just that we’ve been rewarded for doing idiotic things, and so that’s what we have done. As the economists like to say, incentives matter.