On February 6 my IB year 2 Economics classes welcomed Dr. Irene Forichi, former Research Officer for Zimbabwe’s Ministry of Agriculture, and former Regional Emergency Agronomist for the Food and Agriculture Organization for Southern Africa. Dr. Forichi spoke with our classes about the role of agricultural productivity in contributing to human development and economic growth in Southern Africa.

For students or teachers who are interested, she delivered an excellent presentation about the agriculture-related obstacles to and strategies for economic development in the Southern Africa Development Community (SADC). Her presentation can be viewed here, or the PowerPoint she presented can be viewed below.

Related posts:

1. IB: Economic development and fertility rates in India
2. Models of Economic Growth and Development
3. Does economic growth = economic development? Not for China’s rural poor…

In my last post, I outlined the consequences of a nation running a persistent deficit in its current account. In the post below, I will share some thoughts on how a nations can reduce its trade deficit by promoting increased competitiveness in the global economy through the use of expansionary supply-side policies. Earlier in the chapter from which this post is taken, I outlined other deficit reduction strategies, including the use of protectionism, currency devaluation and contractionary demand-side fiscal and monetary policies. In my opinion, each of these methods creates more harm than good for a nation, resulting in a misallocation of society’s scarce resources (in the case of protectionism) and negative effects on output and employment (in the case of contractionary demand-side policies)

Therefore, the following presents the “supply-side” strategies for reducing a deficit in a nation’s current account.

From Chapter 22 of my upcoming textbook: Pearson Baccalaureate Economics

Contractionary fiscal and monetary policies will surely reduce overall demand in an economy and thereby help reduce a current account deficit. But the costs of such policies most likely outweigh the benefits, as domestic employment, output and economic growth suffer due to reduced spending on the nation’s goods and services. A better option for governments worried about their trade deficit is to pursue supply-side policies that increase the competitiveness of domestic producers in the global economy.

In the long-run, the best way for a nation to reduce a current account deficit is to allocate its scarce resources towards the economic activities in which it can most effectively compete in the global economy. In an environment of increasingly free trade between nations, countries like the United States and those of Western Europe will inevitably continue to confront structural shifts in their economies that at first seem devastating, but upon closer inspection will prove to be inexorable.

The auto industry in the United States has been forever changed due to competition from Japan. The textile industry in Europe has long passed its apex of production experienced decades past, and the UK consumer will never again buy a television or computer monitor made in the British Isles. The reality is, much of the world’s manufactured goods can be and should be made more cheaply and efficiently in Asia and Latin America than they could ever be produced in the US or Europe.

The question Europe and the United States should be asking, therefore, is not “how can we get back what we have lost and restore balance in our current account”, but, “what can we provide the world with that no one else can?” By focusing their resources towards providing the goods and services that no Asian or Latin American competitor is capable of providing, the deficit countries of the world should be able to reduce their current account deficits and at the same time stimulate aggregate demand at home, while increasing the productivity of the nation’s resources and promoting long-run economic growth.

Sure, you say, that all sounds great, but how can they achieve this? This is where supply-side policies come in. Smart supply-side policies mean more than tax cuts for corporations and subsidies to domestic producers. Smart supply-side policies that will promote more balanced global trade and long-run economic growth include:

• Investments in education and health care: Nothing makes a nation more competitive in the global economy than a highly educated and healthy work force. Exports from Europe and the US will lie ever increasingly in the high skilled service sector and less and less in the manufacturing sector; therefore, highly educated and skilled workers are needed for future economic growth and global competitiveness, particularly in scientific fields such as engineering, medicine, finance, economics and business.
• Public funding for scientific research and development: Exports from the US and Europe have increasingly depended on scientific innovation new technologies. Copyright and patent protection assure that scientific breakthroughs achieved in one country will allow for a period of time over which only that country will enjoy the sales of exports in the new field. Green energy, nano-technology, bio-medical research; these are the field that require sustained commitments from the government sector for dependable funding.
• Investments in modern transportation and communication infrastructure: To remain competitive in the global economy, the countries of Europe and North America must assure that domestic firms have at their disposal the most modern and efficient transportation and communication infrastructure available. High speed rail, well-maintained inter-state or international highways, modern port facilities, high-speed internet and telecommunications; these investments allow for lower costs of production and more productive capital and labor, making countries goods more competitive in the global marketplace.

Reducing a current account deficit will have many benefits for a nation like the United States, Spain, the UK or Australia. A stronger currency will assure price stability, low interest rates will allow for economic growth, and perhaps most importantly, less taxpayer money will have to be paid in interest to foreign creditors. Governments and central banks may go about reducing a current account deficit in many ways: exchange rate controls, protectionism, contractionary monetary and fiscal policies, or supply-side policies may all be implemented to restore balance in the current account. Only one of these options will promote long-run economic growth and increase the efficiency with which a nation employs its scarce factors of production.

Supply-side policies are clearly the most efficient and economically justifiable method for correcting a current account deficit. Unfortunately, they are also the least politically popular, since the benefits of such policies are not realized in the short-run, but take years, maybe decades, to accrue. For this reason, we see time and time again governments turning to protectionism in response to rising trade deficits.

Related posts:

1. Yeah, we have a trade deficit, SO WHAT?!
2. Trade balances around the world
3. The Marshall-Lerner Condition, the J-curve, and the US trade deficit

World Economic Forum – Latest Press Releases

The World Economic Forum, a group of researchers, leaders, educators, entrepreneurs and others with a vested interest in global economic performance, assembles an annual list of the world’s nations ranked according to “competitiveness”. This year, for the first time ever, the United States does not top this list, instead, Switzerland has been promoted to the status of global competitiveness leader.

What does this ranking really mean?

Competitive economies are those that have in place factors driving the productivity enhancements on which their present and future prosperity is built. A competitiveness-supporting economic environment can help national economies to weather business cycle downturns and ensure that the mechanisms enabling solid economic performance going into the future are in place.”

Competitivness means a nation posesses an evnvironment that leads to improvements in the productivity of its resources, most importantly labor. America, with record budget deficits, in the trillions of dollars, faces a future of tight budgets financed by government borrowing, which eventually means higher taxes and less ability for government to spend on public goods like education and health.

America’s demotion in the rankings is attributable to falling expectations about the country’s future growth potential rather than concerns about its current economic slowdown. Switzerland has also been in a recession for the last year, although due to targeted fiscal policies unemployment has remained low, near its level before the recession begain (around 4%).

The index used to rank countries is based on several factors:

The GCI is based on 12 pillars of competitiveness, providing a comprehensive picture of the competitiveness landscape in countries around the world at all stages of development. The pillars include Institutions, Infrastructure, Macroeconomic Stability, Health and Primary Education, Higher Education and Training, Goods Market Efficiency, Labour Market Efficiency, Financial Market Sophistication, Technological Readiness, Market Size, Business Sophistication, and Innovation.

Discussion Questions:

1. How can a nation’s labor productivity be improved by making policies aimed at improving three of the factors measured by the GCI identified above?
2. How does America’s gigantic budget deficit ($1.8 trillion) threaten its future ability to provide its citizens with the “pillars” identified above?
3. Does economic integration with the global economy improve or limit a country’s ability to achieve economic competitiveness? Explain your answer.

Related posts:

1. The Big “C” – America’s crisis of confidence and the Great Recession
2. Will the Fed’s easy money policy fuel global inflation?
3. Global fiscal stimulus and the plight of Africa: what’s really needed, more aid or more trade?

I wonder how many people in countries like Switzerland, Brazil, Canada, Russia, and China, and the United States would be surprised to learn that prices of products and services in their countries have become much less expensive over the years.

Say what? You must be crazy, you say! Prices are rising way too fast!

Yes, most citizens see their purchases as becoming more expensive when, in actuality, things are becoming less expensive. Of course, the paradox is that although nominal prices (the actual price tag) are, in fact, increasing, nominal income (the average wage or salary) has been growing faster. This is a topic that in economics is called “real income” or a measurement that compares a nation’s income growth relative to the growth in prices that the same income buys.

Let’s take some specific facts for the United States:
In the United States real median household income grew from $41,318 to $50,811 from 1970 through 2006 for a total percentage gain of 23% (source: Pew Research Center). Both of the aforementioned median household incomes are stated in 2008 or current dollars which makes the comparison valid. Median household income is an attempt to quantify the progress that the “middle American” family or typical family has made. So, in short, the median household in America can buy 23% more with their income today than they could in 1970. In other words, relative prices are lower to income.

If we look at the same United States income data over the same period for real average household income, there is real income growth of nearly 60%. The higher growth (60%) in real incomes for the average household versus the median (middle) growth rate (23%) is explained by the fact that much of the growth in United States’ real incomes has accrued disproportionately to the college educated & entrepreneurs driving up real income growth rates much faster for the average than the median or middle household. (Hint: continue your education!)

Now let’s get back to the main premise of the title of this blog and the opening assertion that prices are lower than ever. What we are really saying is that you have to benchmark price increases to income increases to really understand whether things are becoming more expensive. The vast majority of products & services are cheaper today in all nations than they have ever been before, which helps explain, excluding the effects of the current recession, why more citizens than ever before can afford to own their own houses, drive more and better cars, and are likely to have cable, cell phones, and computers. The reason we are led to believe differently is because we are victims of our own human nature, which often causes us to focus on the problem areas (rising prices) and not the benefits (incomes that are rising faster). Most citizens’ focus expands out to the last dollar of their incomes and they quickly notice those select products that are rising faster than others like health care, gasoline prices, and education! Hey, even gasoline prices are not at an all relative price high. If gasoline prices in the United States are restated for inflation, or set to comparable 2009 dollars, they are $2.60 per gallon today vs. $3.17 in 1981 and $3.50 in 1918!

Now, you may say to yourself that statistics can lie or mislead and you are sure in your gut that things are getting more expensive relatively. You can try to validate that incorrect “gut feeling” by examining whether your country’s middle class is enjoying less or more products and services. “Real income” really is just a measurement of the quantity and quality of products and services that you have. For example, the average American household has larger homes, more cars, more air conditioning, more gadgets, and better healthcare & prescription drugs than, say, 20 years ago.

But let’s end this blog with a concern. Although everything noted above is accurate, the pace of real income growth has been relatively slow over the last 10 years, especially for the middle class in the United States. Most of that growth in real income mentioned above has occurred up until this current decade. For the last 10 years, median family income growth in the U.S. has been very small and the average income growth has been higher but below the U.S. historical experience. There are many reasons for this slowdown in real income growth, but three big reasons are that

1. the U.S. has now had two recessions this decade (2001 and 2007-current, versus our historical average of only 1 per decade), and
2. energy and health care prices have risen much faster, and
3. foreign labor competition and technology advancement has kept the uneducated/unskilled U.S. workers real income relatively stagnant. More than ever before, a good education is the ticket to your economic future!

Discussion Questions:

1. Inflation is bad, right? Well, what if average prices rise by 2% a year but average incomes rise by 3%. What happens to real income in this situation? Is the average household better or worse off in such a scenario?
2. How have trade and globalization contributed to rising real wages in America and Swizerland?
3. How have trade and globalization contributed to falling nominal wages in America and Switzerland?
4. How do improvments in technology contribute to rising real wages in both developed and developing economies? What about health and education?
5. What types of policies can government pursue to help raise the real wages of the nation’s workers?

Related posts:

1. Deflation: why lower prices spell doom for any economy!
2. Gas prices continue to rise: Who’s worried?
3. GDP made simple…

One of the greatest “ah-ha” moments in all of economics is when an economics’ student or citizen learns for the first time that every time a domestic buyer purchases a foreign product or import that those same U.S. dollars spent on the foreign product go to a U.S.-based company, not a foreign company. Yes, I am telling you that when you (or Wal-Mart) buy Chinese shirts, your same U.S. dollars spent quickly end up in the hands of, say, Apple, Microsoft, Garmin, or General Electric to increase U.S. employment, profits, and U.S. stock prices!

I decided to write this particular blog because of the fact that the recently passed $800 Billion U.S. stimulus bill has some “buy American” provisions within it. Based on an intuitive hunch, I believe that over 99% of adult Americans believe that these “protectionist” clauses somehow help our economy. Yes, the vast majority of U.S. adults believe that it is clearly more advantageous to “buy American” in order to keep the money or wealth within America in order to increase U.S. employment, profits, and U.S. stock prices. In true economic fact, however, if U.S. citizens “buy American” solely out of patriotism (and not because they think it is a superior product) they actually HURT America because the U.S. dollars spent out of patriotism on that American company are, therefore, unintentionally withheld from another more efficient and deserving American country via the “trade loop”.

Let me try to explain this “trade loop” in more detail so that I may actually be able to convince you of this amazing “180 degree” revelation: “Buy American” is Un-American

Let’s say that the United States (we’ll say Wal-Mart) decides to buy many shirts costing $400 from a Chinese shirt manufacturer, in lieu of buying those same shirts from, say, a shirt manufacturer in Elon, North Carolina (USA). The first key point is that when Wal-Mart buys the shirts from China for $400 it can only pay China with US dollars. Why? Because Wal-Mart has only US dollars! It has no Chinese currency (Yuan). It literally drains its bank account of US dollars that are transferred/paid to China! The second key point is that when China receives that same $400 US dollars for the shirts, China cannot, unfortunately, spend any of the $400 in its own economy since only the Yuan is accepted as a medium of exchange in China! China is now forced to either throw the U.S. currency away (not advised!), or immediately spend the money back to the USA (advised!).

In summary, China has initially traded a product (shirts!) for paper (US dollars!), and those US dollars cannot be spent in China. For China to receive any value at all for the shirts it sent to America, China must now spend the $400 back into the US economy for, say, a global positioning system (GPS) from FleetMatics out of Waverly, Massachusetts (USA). Cutting through to simplicity, in essence, it’s almost as if Wal-Mart (USA) just paid FleetMatics (USA) $400 directly!

Yes, the economic “punch line” is that all spending by the domestic nation on foreign products (imports), in turn, are spent immediately back to the domestic nation increasing the domestic nation’s employment, income, and standard of living. (Note; this is also shown and reported in a nation’s balance of payments schedule if you are skeptical about what you are reading!)

And, yes, let’s not forget about that Elon, North Carolina shirt maker that did not get the original $400 from Wal-Mart in our above example! Any good economy promotes competition and I am excited to see if that North Carolina shirt manufacturer can “raise their game” (increase productivity and/or quality), and hopefully get the next shirt contract from Wal-Mart! If not, well, that North Carolina firm may just have to close down. But remember, the key point, the $400 spent for the shirts went to Fleetmatics in Waverly, Massachusetts, in lieu of the Elon, North Carolina shirt manufacturer. If you would have “bought American” even though the Chinese shirts were preferable, you would have prevented the more effective U.S. business in Waverly from getting your U.S. dollars by giving them to the less efficient Elon manufacturer. In short, you would have contributed to American inefficiency and slowing productivity, hurting our country! And that is un-American!

Now, you may be thinking the following if you have a little economics’ background: “But the US has a growing trade deficit with China, so China may not immediately buy that GPS system from FleetMatics for $400. And, you are correct, but that is also not a problem for either the United States or China. What China is really doing right now is deciding to temporarily save or invest a minority percentage of their US dollars received form U.S. import purchases. Said another way, China is not buying as many GPS’ as the US is buying shirts and, of course, we call that phenomenon the US trade deficit which immediately seems to speak “problem”. But it is really not as big a problem as most people think! China is still spending their “saved” US dollars back into the US economy, but in different ways. China is saving and investing some of those US dollars directly into the United States economy by building plants in America, buying US stock to fund American companies’ expansions, and temporarily saving some of their dollars, for future US purchases, by buying US bonds to help the US government pay for other US government initiatives necessitating borrowing. Eventually, China will sell these US bonds and be forced to use those U.S. dollars to buy that GPS system or build more plants to employ more Americans!

In summary, when citizens of any country in the world buy the product that is best for them based on a combination of quality and price, they will be taking the most patriotic action possible to help their own country they love so much! If a domestic citizen sees the foreign product as a better alternative to the domestic product, buy it! Your money spent will immediately find its way back through the “trade loop” to another business within your country!

Of course, this is why all economists from around the world know that international trade, and not protectionism, helps a country’s standard of living and promotes efficiency and rising standard of livings!

Related posts:

1. International Trade Made Simple
2. Economics: The 180 Degree Science!
3. Dominican Republic struggles to find its “comparative advantage” as it faces new competition from Asia

Automakers turnaround plans sent to Congress – Dec. 2, 2008

…and hopefully every other American with a functioning cerebral cortex. Ford Motor Company announced today its ambitious plan to cut costs and restore its profitability as it appeals once again to Washington for a $25 billion “low-interest bridge loan” (aka bailout).

The company announced that the salary of Ford CEO Alan Mulally would be cut to $1 a year if Ford actually borrowed money from the government. When Mulally appeared before the House Financial Services Committee last month, he did not agree to the suggestion of such a paycut…

Ford and GM also announced plans to get rid of corporate jets. Mulally, Wagoner and Nardelli were all roundly criticized at a House hearing last month when they admitted they had each flown their corporate jets to Washington to ask for help…

Mulally and Wagoner will be driving to Washington in hybrid vehicles made by their companies when they return to Capitol Hill later this week to make their case for loans. Nardelli is also not planning to fly to Washington but Chrysler has not disclosed any more specifics of his travel plans.

So the CEOs of the three largest auto companies are agreeing to be exploited for one year by accepting a salary of one dollar. The combined savings from the salary cuts of the three companies’ CEOs  equal roughly $6 million, or about 0.024% of the sum the companies are asking for from the government. Selling corporate jets during a recession when demand for such frivolous luxuries is at a record low will also do little to cut the costs of the incredibly inefficient US automakers.

As for any serious cost cutting plans, Ford had little to report:

…the Ford plan is perhaps most notable for what it did not include. The company did not mention that it would be dropping any brand or unprofitable models…

There was also no announcement of additional plants being closed or capacity being eliminated. Ford said it continues to work with its unions and dealers to achieve additional savings, but it did not set any cost savings targets for those discussions.

Ford highlighted many of the cuts it has already made, including closing 14 plants and reducing salaried personnel by 36% over the past three years. The company also touted labor cost savings that would bring the cost of factory workers’ pay and benefits close to those of the nonunion U.S. plants operated by Asian automakers

Real cost savings will only be achieved by the further closing of plants. With the economy in a deep recession and auto sales at their lowest in decades, the demand for new cars is just not there. Until Ford and its American competitors begin adjusting their plant capacities to the realities of market demand, the chances of achieving profitibility seem slim.

Allow me to make a connection between the situation faced by American auto makers and a basic economic concept we are currently studying in Microeconomics class. Firms, as any first year econ student knows, are profit maximizers. In fact, all companies are trying to make the same thing as all other companies, profits. When a firm experiences negative profits, or losses, as American auto makers are today, it can do one of two things to restore profitability: 1) Increase its revenues or 2) Lower its costs. Since demand for new cars is so low, the revenue increasing option is just not there, so American auto makers must reduce costs to restore profits.

There are two main types of costs we study in microeconomics. Short-run and long-run costs. In the short-run, which in the case of the auto industry we can consider the last few months since the financial crisis began, firms can do one thing to lower their costs: reduce the use of labor. Workers can be asked to take unpaid vacations, jobs can be eliminated, work hours can be cut back. In the short-run, plant size is fixed, meaning firms cannot add nor eliminate capital and land resources. The only variable resource is labor. By “reducing salaried personnel by 36% over the past three years” Ford has taken steps to lower its short-run costs of production.

Long-run costs must also be considered when firms are faced with negative profits. The long-run in the automobile industry is considered the period of time over which auto makers can either add new plant facilities or shut down existing facilities, lowering the costs of capital and land to firms. Long-run cost reductions have also been undertaken by Ford, including “closing 14 plants… over the past three years”.

Clearly, Ford has made an effort to reduce short-run labor costs and long-run capital costs by eliminating some of its work force and closing some of its factories in recent years. But today, as the US officially enters what is likely to be a deep, long recession, the announcement by Ford and its competitors that its new strategy for further cutting costs hinges on paying its CEOs one dollar and making them travel across the country in hybrid cars represents a laughable insult to the intelligence of high school Econ students.

Discussion Questions:

1. What is the “variable resource” that firms can use less of in the short-run if cost reductions are needed?
2. In Microeconomics, we sometimes refer to the long-run as the “variable plant period”. Explain the meaning of this concept.
3. The law of diminishing marginal returns would indicate that if Ford were to close additional factories, it would almost certainly have to simultaneously lay off thousands of additional workers. What is the law of diminishing marginal returns and why does it require firms to lay off workers as plants are closed?

Related posts:

1. Eight basic economic arguments against a bailout of the auto industry
2. Shanghai American School and the imperfectly competitive market for international teachers
3. Looks like the Financial Times could use a high school economics lesson!

One of the many reasons that I find the study of economics so fascinating is that what so often appears to be a negative situation to the average citizen is actually a positive one. In other words: “down is often up” and “black is often white”. One of my favorite examples of this “180 degree moment”, and why I love to teach AP Macroeconomics, relates to the study of unemployment.

Related posts:

1. “Black Monday”
2. Exports, good – Imports, ALSO GOOD!
3. Economics for Citizenship / The 180 Degree Science!

FT.com / Asia-Pacific / China – China to focus on curbing inflation

Growth – the ultimate macroeconomic policy goal. Growth leads to improvements in material well-being; by definition it means more output per person. Growth also enriches society in other ways: more tax revenue for governments means more to spend on public goods like education, health care, and infrastructure, which all contribute to development of human capital, standard of living, and productivity. But is there such a thing as too much of a good thing? When it comes to growth in China, that may be the case.

According to Chinese premier Wen Jiabao:

“The primary task for macro­economic regulation this year is to prevent fast economic growth from becoming overheated growth…”

So, fast growth is good, but overheated growth is bad?

I once had a Jeep Wrangler that when I drove it across the country, anytime it hit 70 mph it started to overheat… is that the kind of overheating China’s economy is experiencing? Well, kind of, yes.

The reason my Jeep would overheat was that the pistons in the engine had to move so rapidly to keep the engine going at enough RPMs that the friction created overwhelmed the engine’s ability to properly cool itself. In China, the pistons can be compared to the manufacturing industry and agricultural sectors, which last year were stretched to their limits to meet not only rising demand from foreigners for China’s output, but record levels of domestic demand as well.

For the first time last year, China’s domestic consumption made up a larger component of the country’s GDP than investment. Returning to our metaphor, the engine was forced to work harder than usual, but I hadn’t spent enough to maintain the engine, so it was not properly lubed and tuned for the stress of long-distance travel. Maintenance on an engine is important, otherwise it will wear out and overheat while driving at high speeds over long distances. Likewise, investment in new capital is vital for an economy to keep from overheating as it grows at high rates over long periods of time.

Rising consumption and exports, without a corresponding increase in investment, means capital depreciates too quickly to meet Chinese and the world’s demand for output. In terms of our macroeconomic model, AD shifts out more rapidly than AS, causing inflation:

“the premier said the political priority was to tame consumer price inflation, which hit an 11-year high of 7.1 per cent in January.”

Rising consumption and net exports puts upward pressure on prices in China. To worsen matters, food prices have experienced record increases in the last year, making the matter especially hard for China’s urban poor, separated from the farmland and its produce as they are.

Investment, while an expenditure itself, tends not to contribute to inflation (as might be thought, since it shifts AD outward), but mitigate it, due to the supply-side effect attributable to the increase in capital and productivity that it creates. To combat rising food prices in China, Mr. Wen plans to encourage investment in the agricultural sector through targeted government intervention:

The government would expand agricultural commodity production, strictly control industrial grain use, establish an early-warning system to monitor supply and demand, and strengthen “market oversight” and “price inspections”, he said.

Subsidies for the poor would be increased and provincial governors and mayors held directly responsible for ensuring basic food supplies, said Mr Wen.

Overall China’s picture is looking rather rosy, it would appear. While 7.1% inflation is certainly something to fear, it seems to be manageable in the context of a global slowdown in income growth, and the corresponding decrease in demand for Chinese exports that implies. Combined with a strengthening RMB, China can look forward to a slower rate of growth in 2008, (“a now routine annual ‘target’ of 8 percent expansion in [GDP]“). The trick for the government is to foster investment and productivity growth in the agricultural sector to keep food prices down in the face of growing demand for meat products among China’s middle class.

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Related posts:

1. “China Chokes”: A look at the effects of China’s massive economic growth
2. Could a US recession be good for China?
3. China: formerly the world’s factory, now a nation of consumers…

Foreign Policy: Why We Trade

Professor Russ Roberts, host of the EconTalk podcast, has an essay in the latest issues of Foreign Policy journal titled “Why We Trade”. In this piece, Roberts defends the benefits of trade from a broad perspective, beyond the popular political view of trade, usually along the lines of “exports, good – imports, bad”. Roberts compares this line of thinking (characteristic of presidential candidates of both the Republican and Democratic parties), to the 14th century, pre-Adam Smith view of world trade, known as mercantilism.

Mercantilism was a view of global economic interaction that placed emphasis on the accumulation of gold and other precious metals from abroad in exchange for your country’s exports. The doctrine failed to recognize the importance of imports from abroad, as this was viewed as a loss of wealth to foreigners. Mercantilists viewed wealth in terms of bullion or the amount of precious metals a country owned. Today, of course, our understanding of wealth has evolved to account for the amount of output, or products (goods and services), we are able to consume. Herein lies the flaw in the rhetoric of modern politicians who, “are always talking about the necessity of other countries’ opening their markets to American products. They never mention the virtues of opening U.S. markets to foreign products.”

In response to the mercantilist tone of modern policy makers’ rhetoric, professor Roberts points out:

The logic of “exports, good—imports, bad” seems straightforward at first—after all, when a factory closes because of foreign competition, there seem to be fewer jobs than there otherwise would be. Don’t imports cause factories to close?Don’t exports build factories?

But is the logic really so clear? As a thought experiment, take what would seem to be the ideal situation for a mercantilist. Suppose we only export and import nothing. The ultimate trade surplus. So we work and use raw materials and effort and creativity to produce stuff for others without getting anything in return. There’s another name for that. It’s called slavery. How can a country get rich working for others?

Then there’s the mercantilist nightmare: We import from abroad, but foreigners buy nothing from us. What would the world be like if every morning you woke up and found a Japanese car in your driveway, Chinese clothing in your closet, and French wine in your cellar? All at no cost. Does that sound like heaven or hell? The only analogy I can think of is Santa Claus. How can a country get poor from free stuff? Or cheap stuff? How do imports hurt us?

We don’t export to create jobs. We export so we can have money to buy the stuff that’s hard for us to make—or at least hard for us to make as cheaply. We export because that’s the only way to get imports. If people would just give us stuff, then we wouldn’t have to export. But the world doesn’t work that way.

Roberts goes on to address that popular view that imports “hurt us” because they destroy jobs. It is true that free trade eliminates jobs in certain industries, but only in those that cannot achieve the level of efficiency and low costs that our trading partners can achieve. If workers are being tied up in inefficient industries at home, then perhaps trade is actually beneficial to these workers (and certainly society as a whole) since their loss of work may result in their finding new work in an industry that is cost competitive and produces at a level of efficiency that allows us to be competitive with our trading partners. Trade allows our economy and our workers to shift it focus from inefficient to highly efficient industries. As students of economics, you surely know by now why efficiency (both productive and allocative) is good for society.

There is something to be said about the role of government in free trade, after all. If it is not in the best interest for the government to protect American jobs by erecting barriers to trade aimed at keeping cheap imports out, then what can the government do to soften the impact on those whose jobs are lost do to globalization of our economy? How refreshing it would be to hear presidential candidates speak not of “protecting” us from low price imports (after all, who really wants to pay more for anything), but instead shift their rhetoric towards the discussion of retraining and helping structurally unemployed workers find their way into an industry in which the US still maintains a competitive edge.

If the government were to assist workers displaced by free trade in the realm of education and training, then the shift from jobs in which their productivity was relatively low to ones in which their productivity is relatively high could occur more easily and fears of long-term structural unemployment could be put aside.

And the outcome should such training programs succeed in placing workers in high efficiency jobs? Clearly, greater productivity means higher income and greater access to wealth. In a world where wealth is measured not by the amount of gold bullion locked up in your safe, rather by the amount of physical output we’re able to accumulate, then higher productivity, higher wage jobs at home and low price goods imported from abroad is a recipe for increased wealth; not, as many politicians seem to think, a lower quality of life at home.

Perhaps the government should do more to soften the impact of globalization on American workers. But as professor Roberts points out, blocking the entrance of cheap imports will help no one in the American economy, even those workers who remain employed in high cost, inefficient and unproductive industries. For in the long-run, through effective design and implementation of re-training programs and the embracing of free-trade policies, everyone in American should benefit through the creation of high-productivity, higher wage jobs and access to lower priced manufactured goods imported from abroad. Higher incomes and lower prices means greater wealth.

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Related posts:

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How the World Works: Who Invented Calculus? – Salon.com

IB students, here’s a blog post you’ll want to read closely once we start studying economic development later this semester. Andrew Leonard at Salon.com refers to a study titled “Does Economic Growth Reduce Fertility? Rural India 1971-1999″.

Interesting stuff. Leonard points out a peculiar paradox of growth in India:

India’s Green Revolution has been criticized by those who wonder if an agricultural model reliant on large inputs of fertilizers and pesticides is environmentally sustainable over the long run. But if in the short run these spikes in agricultural productivity contribute to population stabilization, then we have a nifty paradox: a (possibly) unsustainable agricultural model contributing to (possibly) sustainable population levels.

This article and the study it refers to might make for an interesting commentary for your internal assessment, or as a source for an extended essay on growth and development. Any opinions on the supposed correlation between economic growth and decreased fertility?

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Related posts:

1. Dr. Irene Forichi on Agricultural Productivity and Economic Development in Southern Africa
2. Does economic growth = economic development? Not for China’s rural poor…
3. Models of Economic Growth and Development