One of the reasons most people’s view of the effects of a tariff are wrong is that they are implicitly imagining a world where everyone uses the same money.
I'm not sure I understand everything about this, economics is hard for me
How bad would it be to summarize the impulse behind tariffs as "we send them our precious money and what do we get in return? Merely goods and services!"
Off topic but David have you considered occasionally having either open threads or “AMA” threads or similar? This one’s more on the quiet side but your posts seem to typically garner at least a few dozen comments, which seems like enough to make such a thing worthwhile. After reading you for, gosh, fifteen years now I sometimes think of something and am curious what your take would be.
My non-expert observation is that pretty much EVERY political figure in the West, (and in China based on what Xinhui prints...) believes that the world works according the the mercantilist model, something that I can't imagine was ever true, not even in the days of warring hunter-gatherer bands.
But naturally it's Easy to point to an unemployed whale flensor and claim that petroleum has a negative effect on employment. In order to do that you have to ignore how much better off oil field workers are than whalers, to say nothing of the cost to the whales, or in the modern world, the alternative to "Nike paying a dollar a day for Vietnamese workers" is "Vietnamese agricultural workers starving because tractors exist."
It's easy to find 20th Century articles complaining about the cost of cotton harvesting which simply HAD to be done by hand, until some clever lad combined a cotton gin with a big diesel vacuum cleaner.
During my stint working in China, one complaint of their mercantilist politicians (but I repeat myself...) was that Chinese workers were becoming wealthier, so that China no longer had the clear cost win in terms of manufacturing they'd enjoyed for so long.
My job there was to teach their new civil aviation industry how to deal with Western safety requirements, now that Smart Chinese people were moving away from "hand assembling iphones" into "aerospace engineering."
But think of all those unemployed manual laborers and rice farmers displaced by (Chinese built!) heavy machinery...
I'm not convinced that "trade deficit" is a good way to think about the world. It seems to me that (voluntary) trade is essentially always balanced, and saying that a country that is comparatively good at producing services has a "trade deficit in goods" or that a country that is comparatively good at producing financial products (USD treasury bills, AAPL shares, & cetera) has a "trade deficit in goods and services" just leads to confusion.
My shortcut response to mercantilists worrying about trade deficits is that dollars out have to equal dollars in, pretty much by definition. There can be detours and lags as other countries use dollars for their own imports and exports, there's a difference between goods, services, and investments, and foreigners can always burn dollars, but by and large, trade ultimate balances, just as heat and cold eventually balance. The only way to avoid that is to isolate the entities, and then there's no trade to worry over.
I think I've said this before, but financial repression is still a thing. China cannot completely prevent money from moving outside the country, but they can and do substantially reduce the flows from what they would be if money were free to move. They can artificially unlink interest rates and other such things from anything to do with the actual state of the international or domestic economy. And much of China is effectively a command economy - banks can be ordered to lend, companies can be ordered to invest, and so on. But perhaps most importantly, foreign companies can be outright forbidden from selling.
Or, to put it this way, your example is between free economies. Your example is convincing - for that case, but not outside that case.
China may need to buy dollars from the US in some form to keep up the deficit - but it chooses what happens with those dollars, and can prevent them from having the effects they normally would, if it so chooses. It pays huge prices for making choices other than what the free market would - but it still so chooses.
I already discussed the dirty float, which is most of what you are describing. The Chinese government can choose to buy US securities in order to push the price of the dollar up or sell them in order to push it down. It is still the case that the US trade deficit equals the inflow of capital.
The Chinese government does not control international currency markets. It, like anyone else, can influence them by buying or selling currency.
The Chinese government can forbid imports or exports, just as the US government can — currently US restrictions in the form of tariffs are larger than Chinese restrictions.
What claims that I made in the post are falsified by the ability of the Chinese government to intervene in the Chinese economy? It means that the outcome of free trade is not necessarily optimal for the Chinese people, but I didn't say it was.
The following parts of my reply I moved to a separate comment, as they were entirely tangential to our main disagreement:
Moreover, that the Chinese government does not control international currency markets is false in two important ways. Those who do not do as the Chinese wish may be retaliated against, and they know it. Moreover, the Chinese feel entirely free to falsify economic data. Still, for the most part this is insufficient to prevent currency changes in the long run.
Also, I disagree that the US restrictions in the form of tariffs are larger than the Chinese restrictions. The Chinese are somewhat willing to buy raw materials, and very willing to buy goods they outright cannot make themselves and cannot do without. Except for that, they place major restrictions on very wide categories of goods they might buy, whether demanding local control, technology transfer, usually both of those, or in sensitive cases, outright bans. For nearly all products, even with tariffs, if China could produce the good for say, 1/3 the cost, they could still sell it, no? The reverse is very much not the case. The Chinese do not treat comparative advantage in producing a good as an opportunity, but as a threat - that is not entirely true, but far more true than the reverse.
I agree that the command nature of the Chinese economy will hurt the Chinese people and economy. But in the same way that was not what you were saying, it was not what I was saying.
You are claiming that exchange rate changes causes trade deficit to balance, either with trade in goods or in capital.
But observe the following alteration to your toy model: Keep everything the same as your model. But Germany is a command economy. Buying French goods is outright forbidden. German companies are ordered to invest in sufficient capacity to fill the French market's demand. Now, as before, if the French buy German goods, gold must flow back to Germany, or else Germany must invest in France, that is, buy French capital stock.
Say France considers either the foreign ownership of its capital stock, or its inability to produce goods by free market mechanisms to be a problem. The exchange rate mechanism you mention will not solve their problem. Large tariffs on Germany, and lesser tariffs on other countries, might.
What I consider wrong about your claims is that the exchange rate mechanisms will do anything about these problems. Add sufficient command to the German economy, and everything you said about prices of goods in Germany becomes false. Add a lesser but large amount of command to the German economy, and what you said is still importantly false.
Also, part of financial repression in China is depressing opportunities of consumers in China to purchase anything, domestic or foreign, so that they must save. In your toy model, you mention that Germany might have more money to spend. But to the degree this is artificial, might more money to spend, but only on causing a trade deficit or production overcapacity, be a problem?
To put it more simply, your model has price signals within Germany play an important role. Sufficient command in Germany's economy can disrupt that role.
What about a situation where there is one currency similar to the gold standard but it is also fiat. I know in the EU area, countries cannot unilaterally print euros and for good reason but maybe a country with a peg towards the EU could get abused by some EU loose monetary policy no?
The situation in the Euro currency area is the same as within the US, basically the specie flow mechanism between EU countries or US states. It's just that the "specie" is fiat money.
I'm not sure I understand everything about this, economics is hard for me
How bad would it be to summarize the impulse behind tariffs as "we send them our precious money and what do we get in return? Merely goods and services!"
Off topic but David have you considered occasionally having either open threads or “AMA” threads or similar? This one’s more on the quiet side but your posts seem to typically garner at least a few dozen comments, which seems like enough to make such a thing worthwhile. After reading you for, gosh, fifteen years now I sometimes think of something and am curious what your take would be.
Good idea. And it saves me having to think up an idea for another post.
My non-expert observation is that pretty much EVERY political figure in the West, (and in China based on what Xinhui prints...) believes that the world works according the the mercantilist model, something that I can't imagine was ever true, not even in the days of warring hunter-gatherer bands.
But naturally it's Easy to point to an unemployed whale flensor and claim that petroleum has a negative effect on employment. In order to do that you have to ignore how much better off oil field workers are than whalers, to say nothing of the cost to the whales, or in the modern world, the alternative to "Nike paying a dollar a day for Vietnamese workers" is "Vietnamese agricultural workers starving because tractors exist."
It's easy to find 20th Century articles complaining about the cost of cotton harvesting which simply HAD to be done by hand, until some clever lad combined a cotton gin with a big diesel vacuum cleaner.
During my stint working in China, one complaint of their mercantilist politicians (but I repeat myself...) was that Chinese workers were becoming wealthier, so that China no longer had the clear cost win in terms of manufacturing they'd enjoyed for so long.
My job there was to teach their new civil aviation industry how to deal with Western safety requirements, now that Smart Chinese people were moving away from "hand assembling iphones" into "aerospace engineering."
But think of all those unemployed manual laborers and rice farmers displaced by (Chinese built!) heavy machinery...
It's whalers and rice farmers all the way down.
I'm not convinced that "trade deficit" is a good way to think about the world. It seems to me that (voluntary) trade is essentially always balanced, and saying that a country that is comparatively good at producing services has a "trade deficit in goods" or that a country that is comparatively good at producing financial products (USD treasury bills, AAPL shares, & cetera) has a "trade deficit in goods and services" just leads to confusion.
My shortcut response to mercantilists worrying about trade deficits is that dollars out have to equal dollars in, pretty much by definition. There can be detours and lags as other countries use dollars for their own imports and exports, there's a difference between goods, services, and investments, and foreigners can always burn dollars, but by and large, trade ultimate balances, just as heat and cold eventually balance. The only way to avoid that is to isolate the entities, and then there's no trade to worry over.
I think I've said this before, but financial repression is still a thing. China cannot completely prevent money from moving outside the country, but they can and do substantially reduce the flows from what they would be if money were free to move. They can artificially unlink interest rates and other such things from anything to do with the actual state of the international or domestic economy. And much of China is effectively a command economy - banks can be ordered to lend, companies can be ordered to invest, and so on. But perhaps most importantly, foreign companies can be outright forbidden from selling.
Or, to put it this way, your example is between free economies. Your example is convincing - for that case, but not outside that case.
China may need to buy dollars from the US in some form to keep up the deficit - but it chooses what happens with those dollars, and can prevent them from having the effects they normally would, if it so chooses. It pays huge prices for making choices other than what the free market would - but it still so chooses.
I already discussed the dirty float, which is most of what you are describing. The Chinese government can choose to buy US securities in order to push the price of the dollar up or sell them in order to push it down. It is still the case that the US trade deficit equals the inflow of capital.
The Chinese government does not control international currency markets. It, like anyone else, can influence them by buying or selling currency.
The Chinese government can forbid imports or exports, just as the US government can — currently US restrictions in the form of tariffs are larger than Chinese restrictions.
What claims that I made in the post are falsified by the ability of the Chinese government to intervene in the Chinese economy? It means that the outcome of free trade is not necessarily optimal for the Chinese people, but I didn't say it was.
The following parts of my reply I moved to a separate comment, as they were entirely tangential to our main disagreement:
Moreover, that the Chinese government does not control international currency markets is false in two important ways. Those who do not do as the Chinese wish may be retaliated against, and they know it. Moreover, the Chinese feel entirely free to falsify economic data. Still, for the most part this is insufficient to prevent currency changes in the long run.
Also, I disagree that the US restrictions in the form of tariffs are larger than the Chinese restrictions. The Chinese are somewhat willing to buy raw materials, and very willing to buy goods they outright cannot make themselves and cannot do without. Except for that, they place major restrictions on very wide categories of goods they might buy, whether demanding local control, technology transfer, usually both of those, or in sensitive cases, outright bans. For nearly all products, even with tariffs, if China could produce the good for say, 1/3 the cost, they could still sell it, no? The reverse is very much not the case. The Chinese do not treat comparative advantage in producing a good as an opportunity, but as a threat - that is not entirely true, but far more true than the reverse.
I agree that the command nature of the Chinese economy will hurt the Chinese people and economy. But in the same way that was not what you were saying, it was not what I was saying.
You are claiming that exchange rate changes causes trade deficit to balance, either with trade in goods or in capital.
But observe the following alteration to your toy model: Keep everything the same as your model. But Germany is a command economy. Buying French goods is outright forbidden. German companies are ordered to invest in sufficient capacity to fill the French market's demand. Now, as before, if the French buy German goods, gold must flow back to Germany, or else Germany must invest in France, that is, buy French capital stock.
Say France considers either the foreign ownership of its capital stock, or its inability to produce goods by free market mechanisms to be a problem. The exchange rate mechanism you mention will not solve their problem. Large tariffs on Germany, and lesser tariffs on other countries, might.
What I consider wrong about your claims is that the exchange rate mechanisms will do anything about these problems. Add sufficient command to the German economy, and everything you said about prices of goods in Germany becomes false. Add a lesser but large amount of command to the German economy, and what you said is still importantly false.
Also, part of financial repression in China is depressing opportunities of consumers in China to purchase anything, domestic or foreign, so that they must save. In your toy model, you mention that Germany might have more money to spend. But to the degree this is artificial, might more money to spend, but only on causing a trade deficit or production overcapacity, be a problem?
To put it more simply, your model has price signals within Germany play an important role. Sufficient command in Germany's economy can disrupt that role.
What about a situation where there is one currency similar to the gold standard but it is also fiat. I know in the EU area, countries cannot unilaterally print euros and for good reason but maybe a country with a peg towards the EU could get abused by some EU loose monetary policy no?
The situation in the Euro currency area is the same as within the US, basically the specie flow mechanism between EU countries or US states. It's just that the "specie" is fiat money.