by Ian Fletcher
WHY ECONOMIC THEORY MATTERS
This is a book about real-world economic problems. Brutally real problems. But it is also a book about economic theory because in economics, raw facts don’t mean much without a theory to interpret them. This is especially true for parts of economics that are as controversial and theoretically unsettled as trade. Wrong theories helped get America into its current trade mess, so we will need the right theories to get us out of it. Not only theories, of course, but we won’t be able to do it without them.
Can’t we just find a practical solution? That’s the instinct of many Americans, who find economic theory abstruse and often baffling. (To be fair, sometimes it is.) Unfortunately not. To just “do what works” is only an option when what works is obvious, and in trade it isn’t. Common sense tells us that airplanes shouldn’t crash, but it doesn’t tell us how to design a plane that will actually fly. It takes a theory, called aerodynamics, to do that. Luckily, the right economic theories are not all that hard to understand, if one makes the effort. And, as we shall see, all this theory has a payoff in the form of an implied solution.
At an absolute minimum, ordinary citizens need to know enough about the economics that supposedly justifies free trade to hold their ground in confrontations with the experts and not get ruled out of public debate on grounds of ignorance. America can’t be a democracy if one side is intimidated into silence on a question this important. So ordinary citizens need to learn how to criticize the economics of free trade in language that economists (and those who look to them for policy advice) accept as legitimate—and will have to take seriously.
But first, we’re going to look at why we shouldn’t just defer to what economists tell us. Because if we can, then we should just leave our trade problems to these experts, and books like this one have no place. So understanding what’s wrong with economists is our first step.
FREE TRADE ISN’T JUST BOUGHT
Some people believe economists are irrelevant, and that free trade is American policy simply because big corporations and other vested interests have the political muscle to impose it. This is false. For a start, without economics, vested interests can’t tell whether free trade benefits them or not, just as a company can’t know whether or not it is profitable without resort to accounting principles. Vested interests can indeed see money piling up in their bank accounts under free trade. But is this more or less money than what they would have gotten without free trade? Without economics, they can’t tell. When a policy has complex effects, it is not obvious who wins and loses from it—even to the winners and losers themselves, and especially in the long run. They have to analyze trade policy to know this, and one can’t analyze any economic policy without theories about how the economy works. This is why the British economist John Maynard Keynes (1883-1946), arguably the greatest economist of the 20th century, wrote that:
The ideas of economists and philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist...I am sure the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas...But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil.14
Furthermore, vested interests are not infinitely powerful. They have to persuade the rest of the country, especially Congress, to go along with the policies they want. Despite political corruption, all the money in the world couldn’t bribe Congress to pass a law requiring people to roller-skate to work; legislation always requires some non-laughable justification. Therefore, lobbying successfully for free trade requires credible economic ideas that support it. This is why the famous liberal economist and New York Times columnist, Paul Krugman, winner of the 2008 Nobel Prize for his work on trade and a thinker we will draw upon extensively in this book, wrote of his stint in government:
What was more surprising was the way that even strong political considerations could sometimes be held at bay when a proposal seemed clearly without a good analytical foundation. I know of one corporation that had a demand widely supported by other businesses and highly placed friends in the government, yet got nowhere for more than a year, largely because the company’s arguments were so easily torn apart by government economists. In the end the corporation hired some high-quality economists to help produce a well-argued report, and for that or other reasons finally got some action.15
So even if free trade economics is largely a bundle of rationalizations, these are still rationalizations the system needs in order to function. It follows that if opponents of free trade can debunk these rationalizations, these opponents can deprive free traders of camouflage, credibility, and self-confidence they can ill afford to lose. (That is one purpose of this book.)
ECONOMISTS KNOW MORE THAN THEY LET ON
To be completely fair, to some extent economists haven’t been wrong about free trade at all. But the aforementioned seven percent who know better have allowed a mistaken impression of the disciplinary consensus to be foisted upon the public. And when the other 93 percent say they support free trade, this doesn’t necessarily mean they support it without reservation.16 It often just means that they know it has problems, but support it over any likely alternative—which they fear would be worse.
Above all, economists fear that admitting the known problems with free trade might provoke politicians into doing something stupid. As the 19th-century American radical economist Henry George put it, “introducing a tariff bill into a congress or parliament is like throwing a banana into a cage of monkeys.”17 The great fear is that if protectionism is conceded any legitimacy, special interests will seize control and economic logic will fall by the wayside. For example, Congress might enact a 30 percent tariff on imported steel to save Rust Belt jobs that would be disappearing soon due to technological change anyway. This could cost $300,000 per job per year, including the cost of making American manufacturers pay more for steel than their foreign competitors.18 Then every other industry would want in and before we knew it, we would have a crazy-quilt industrial policy set by Congressional logrolling and lobbyist bidding wars. It would be a mess: based on political pull, embodying no rational economic strategy, and costing our economy hundreds of billions of dollars per year.
Fear of such a debacle gets most (not all) economists off the hook for outright incompetence or dishonesty. But it reveals a deeper problem: this fear is not actually a part of economic science. It is just a somewhat cynical intuition about the American political system. Economists are certainly entitled to their political intuitions (which may even be true) but these intuitions are not part of their actual knowledge as economists. They are not something that they have PhD-level expertise in and the rest of us don’t.19 They are thus not privileged over the intuitions of ordinary informed citizens. The electorate has a right to hear both sides of the debate and make its own decision. That’s democracy.
Economists’ fears may also be false. Our government is sometimes corrupt and stupid, but it is also sometimes effective. The country wouldn’t still be here if it wasn’t. Some foreign governments certainly seem to have had effective protectionist policies in recent decades, using tariffs and nontariff barriers to boost their economies. Japan clearly did not become the second-richest nation in the world practicing free trade. China is conceded from one end of the political spectrum to the other to thumb its nose at free trade, but it is booming.
Even Europe seems to handle these matters better than we do: Germanic and Scandinavian Europe (Germany, Switzerland, Austria, Holland, Belgium, Luxembourg, Denmark, Sweden, Norway, and Finland) usually run healthy surpluses, and the Eurozone as a whole has had its trade within pocket change of balance since the euro was created in 1999.20 Thirteen European countries now pay their factory workers better than we do,21 and Germany (not China!) was the world’s largest e
xporter as late as 2008.22 Do all these countries know something we don’t?
CORRUPT POLITICIANS, VOTERS AND ECONOMISTS
Cynical comments about politicians are also an evasion. In America, we elected them, so what they do ultimately reflects what we want. If we voters are corrupt, and vote for short-term gratification, something for nothing, and sweet deals for our special interests, then the politicians we elect will be corrupt, too. But if we wise up and a sense of national crisis engenders a sense of national purpose, then we may demand (and get) a trade policy sufficiently honest and rational to work. This has happened on other issues before.
Economists can be corrupt, too. Some are simply paid shills of special interests. Economics consulting firms like Global Insight, MiCRA, and Strategic Policy Research basically retail the service of providing whatever conclusions are required, albeit with sufficient sophistication that nobody has to tell any literal lies.23 Sometimes the corruption is more subtle, cumulative, and unconscious; indeed, it is rarely a matter of, “Say X and we’ll pay you $Y.” In order to win clients, economists in private practice (the author used to be one) must cultivate a reputation for saying the kinds of things clients want to hear. Certain ideas, like rising inequality or the problems of free trade, are just best avoided. They are not “economically correct.” So they drop out of circulation and don’t get the attention they deserve. A few years of that is all it takes to skew the consensus, as ignoring facts is just as effective as denying them. (Indeed, it is more so, as it avoids starting a fight that might attract unwanted attention.) As a result, the age-old question of whether bad policy comes from corruption or bad thinking doesn’t really have an answer, as these two phenomena are intimately entwined. Corruption inexorably debases the quality of thinking over time, and a nation that insists on being told what it wants to hear will eventually lose the ability to figure out what the actual truth is.
And, of course, sometimes financial bullying and other outright coercion does occur. Economist Paul Craig Roberts, an Assistant Treasury Secretary under Reagan and today one of the most distinguished critics of free trade, reports seeing, when he was a fellow at the Center for Strategic and International Studies in Washington, memos analyzing what grants that think tank could obtain from the administration of George Bush, Sr. in exchange for firing him.24 (He had displeased the administration by criticizing its economic policies.) Bush’s science advisor, Alan Bromley, was forbidden to talk to the media for six months in 1991 after he told The Wall Street Journal that America needed an industrial policy.25 In 2003, the Defense Department temporarily shut down its own Advisory Group on Electron Devices after this group released a report detailing the destruction of U.S. innovation capabilities in electronics by imports.26 And Bruce Bartlett, one of the early figures of Reagan’s supply side economics, was fired by the conservative National Center for Policy Analysis in 2005 for denouncing George Bush, Jr. as a conservative “impostor,” later publishing a book by that title.27 Who pays the piper will certainly try to call the tune, no government likes to hear bad news, and shooting the messenger remains one of the favored ways of making bad news go away.
Conversely, sometimes The Powers That Be simply avoid the topic of trade problems entirely. For example, in the four presidential and vice-presidential debates of the 2008 campaign, imports were never mentioned, the trade deficit was never mentioned, and exports were mentioned only once.28 China, by contrast, was mentioned 15 times, geopolitical rivalry being much more exciting than economics.
This all raises an important question: do America’s rulers secretly know that they’re making a mess with free trade—but go on doing it for profit’s sake—or do they sincerely believe in the policy? The author cannot pretend to be privy to anyone’s private thoughts, but it seems to vary by individual. Most such people, especially those whose professional expertise isn’t in economics, genuinely believe in the free trade consensus. They instinctively defer to the officially anointed experts, and these all tell them free trade is correct. And establishmentarians who are economists by training are usually among the 93 percent who believe in free trade. Even those who are among the seven percent who don’t, usually keep their mouths shut for career reasons.
Change is also resisted simply because it is change; in the words of Gregory Tassey, a senior economist at the National Institute of Standards who has criticized free trade economics:29
Those with a stake in the status quo and their defenders in government argue for old models of competitive strategy and economic growth. Specifically, factions with vested interests in economic assets such as physical and intellectual capital, existing labor skills, or simply a fear of the trauma and the cost of change, resist adaptation. This is the installed-base effect and it is widespread.30
But just as the best minds in the Kremlin never really believed in Marxism, some members of America’s establishment are well aware of the harm free trade is doing. They are not stupid people, after all (especially when it comes to money), and, as we shall see, the analyses that reveal that free trade isn’t working aren’t that hard to do. One can sometimes see glimpses of their awareness if one pays attention. This book is littered with quotes from prominent people who have obviously grasped one aspect or another of the defects of free trade, even if they shy away from publicly conceding any recognition of the whole. Eccentric billionaires, who can afford not to care what other members of the establishment think of them, are another highly visible dissident group. Warren Buffet and Ross Perot in the U.S., and the late Sir James Goldsmith in the UK, are the best known. (We will look at some of Buffet’s ideas in Chapter 11.)
ACADEMIC ECONOMISTS VS. THE REAL WORLD
Some academic economists are enervated by sheer ivory tower indifference to the real world. They are trapped in a circular system of publication and promotion procedures that tends to reinforce groupthink: they get published by impressing more-senior economists, and they get promoted based on how much they publish. Their careers are determined by their ability to impress other academics, so it is risky for them to wade into the murky waters of public debate. Nobody gets tenure for picking fights with The Wall Street Journal.
Academic economists often say things that people who actually deal with the realities of trade for a living—executives, diplomats, trade union officials—find they cannot take seriously without risking their own unemployment. Even economists employed by business schools are notorious for being out of sync with other economists on trade. This is no accident, as they have to peddle theories that actually work in practice, which economics department economists generally do not. Among other things, business school economists are much more inclined to see international trade as a rivalry between nations, with winners and losers, than are economics department economists, who tend to see the jungle of commerce as a beautiful rainforest (where everybody wins). If engineers and physicists did not see eye to eye, might we not start questioning physics?
For example, it has been obvious for 35 years now that America’s economy needs to be internationally competitive. But many academic economists disparage the very concept of competitiveness, mainly because it has no accepted definition.31 And indeed it hasn’t, for the simple reason that all competition is defined by winning and losing, and there’s no obvious standard for what it would mean for America to “win” in international economic competition.32 But this doesn’t mean America doesn’t have to be competitive. Happiness doesn’t have a clear definition either.
SOPHISTICATED MATH DOESN’T EQUAL SOPHISTICATED THINKING
When one scratches the editorial-page surface of economics and comes face to face with its intellectual core, one finds a mass of equations. This gives it the appearance of hard fact. How could anything so mathematical be a matter of opinion? (It also looks distinctly like something which people who don’t understand it should keep their mouths shut about.) But in fact, sophisticated math is actually overrated as an economic tool, as hinted by the fact that hedge funds employin
g it fared no better than others in the financial meltdown of 2008.33
The overreliance of contemporary economics upon sophisticated mathematics creates a number of problems.34 The fundamental one is that because it is easier to mathematize some ideas than others, some ideas appear truer than they really are. But the presumption physics enjoys, that mathematically “elegant” theories are more likely to be true, simply doesn’t hold in economics, however much many economists may want it to.35 The aggressive use of simplifying assumptions can deliver elegant math on demand, but only at the price of misrepresenting reality.
Theories which favor free trade tend to be mathematically neat—mainly because they assume markets are perfectly efficient, which makes their outcomes predictable. Theories which favor protectionism, on the other hand, tend to be mathematically messy, mainly because they assume markets are not perfectly efficient and thus not predictable. So economists have often favored free trade simply because the math is neater. As Paul Krugman once put it, “the theory of international trade followed the perceived line of least mathematical resistance.”36
There is actually a serious paradox here, because intellectual rigor (which math provides in spades) certainly sounds like a self-evidently good thing.37 Unfortunately, intellectual rigor can only guarantee that reasoning is internally consistent: its conclusions follow from its premises. It cannot guarantee that those premises were right in the first place, and with bad premises, even the most rigorous reasoning will produce nonsense. Premises don’t even have to be wrong to generate false conclusions, they only have to be incomplete, and no set of premises can prove its own completeness. The more mathematically abstruse economics gets, the more basic truths get obscured behind a blizzard of symbols, making it easy to wander into falsehoods unawares for lack of an obvious sanity check.
