International Trade and Finance (Chapters 28-29)
1. Trade and Mutual Gain The Midnight
Economist
Everyone in every society does it. They always have. But until less than 200 years ago, no one
could explain why it is done–and Senator Snort and most editorial writers still do not understand.
The activity in question is trade, of course. Why do people do so much buying and
selling? Presumably, they do not exchange just for the giddy fun of the activity. Instead, they
swap in order to gain. Gain what? Well, after the trade, the trader considers himself to be better
off, on balance, because he values more what he gets than what he gives up.
No matter. Each person is the appropriate, relevant judge of his own condition. If it is the
personal, subjective estimation Of Mr. A that he has gained by the trade, then he has gained–no
matter what the preferences and assessments of others may be. And Mr. B is the pertinent judge
of Mr. B’s market options and actions.
Is all this obvious? It is pretty apparent once we see it. But Aristotle did not see it. Nor
did Saint Thomas Aquinas. Nor even Adam Smith. And for centuries, public policy was directed
on the supposition that what one party to a trade gains must have been lost by the other. The
concert of mutual gains, with all immediate participants being made better off, is one of some
subtlety
Questions for Thought and Discussion:
1. In physics, you learned about conservation of mass and energy. Why is voluntary exchange
different–wealth creating rather than wealth conserving?
2. If you are mugged, is giving up your wallet a voluntary exchange? Is paying your taxes
voluntary? Is there any guarantee either of these exchanges will leave you better off?
3. If I sell you an item I would be willing to part with for $50 and you would be willing to pay as
2. The Trade Deficit and Cheap Foreign Labor The Midnight
Economist
Cheap foreign labor is responsible for our enormous trade deficit. That is what many Americans
believe. This myth persists with the tenacity of a hungry dog gripping a bone. It would help to
bury it–the myth, not the bone.
First, the simple contention ignores differences in labor productivity. If, on average,
foreign workers produced half as much per hour as do Americans, then foreigners could earn a
What do exchange rate gymnastics have to do with the argument about cheap labor and
our trade deficit? If the gap between foreign and American wage rates rises above the gap
between worker productivities—i.e., the American money wage more than offsets the American
edge in physical productivity–then foreign labor would be relatively cheap. With American wages
high relative to Korean, our imports would rise, our exports would fall, and the trade deficit would
grow.
But here is a further point often ignored. As foreigners buy fewer American goods, they
demand fewer dollars. And as we import more, we supply more dollars. The result is a surplus of
dollars in international markets. This dollar surplus would cause the prices of the dollar to fall in
Questions for Thought and Discussion:
1. Why do Americans complain about being unable to compete with cheap foreign labor, while
other countries complain they can t compete with America because of our plentiful and cheap
capital stock?
3. Foreign Lessons The Midnight
Economist
Foreign trade is not a simple subject. So it’s not surprising that many find it foreign. And they are
inclined to agree with proposals that superficially seem sensible yet actually produce misery.
Take the popular belief about imports and jobs. Layoffs in the auto industry and
elsewhere seem to confirm that imports are destroying jobs of our workers. So why not put
Americans first and protect their employment by restricting imports?
One problem is, such a policy is more likely to hurt than help American workers. No
wonder a group of over 1,000 economists petitioned President Hoover in 1930 to veto the Smoot–
Recent experience confirms such a relationship between imports and employment. To
measure employment, consider the number of employees in manufacturing, construction and
mining, the so-called goods-producing industries. And to measure imports, take the value of
imported merchandise as a percentage of national output.
Over the past decade and a half and longer, these two measures closely moved together.
When imports increased as a fraction of national output, employment in American industries
producing goods went up, not down.
Put simply, trade helps make the economic pie bigger. When we buy imports, we pay
Foreign trade promotes our nation’s wealth. That was an important lesson that President
Hoover and Congress found so alien in 1930. But is the lesson any less foreign today?
Questions for Thought and Discussion:
1. Is the basic logic of international trade any different than that of domestic trade?
2. Do you worry about a balance of trade deficit with your grocer? If you refused to import
products from a local grocer who offered a better deal than other grocers, would you be better or
worse off?
4. Mouse Wisdom: Import Restrictions and Specialization The Midnight Economist
Recently, I overheard two mice who live in my office, Adam and Karl, discussing import
restrictions on cheese. Karl was muttering angrily.
“Cheese imports from other mouse villages should be restricted,” exclaimed Karl. “More
and more of our mice are buying imported cheese rather than cheese made here in our village.’
“I can understand that,” replied Adam enthusiastically as he licked his fingers. “I just ate
several slices of imported cheddar and its quality was superior. Would you like a slice?”
“No!” sniffed Karl. “I prefer to buy cheese made by our own village workers.”
Adam. “Every time a mouse family buys cheese–even our own village’s cheese–it is importing
rather than producing the cheese at home. Wouldn’t that family be more productive if it were kept
busy making its own cheese?
“That would be silly, responded Karl. “Some mice, like me, don’t even know how to
make cheese. I would rather buy the cheese and spend my time working at the bread factory.”
“Of course it would be silly to produce everything here,” Adam agreed. “Compared to
other villages, we are better in some lines of production than in others. Imports allow our workers
to use their time more efficiently producing the goods and services at which they are most skilled
rather than poorly producing everything we consume. We sensibly specialize, concentrating on
what we produce relatively best.”
“I still think import restrictions on cheese would create more jobs,” retorted Karl.
Questions for Thought and Discussion:
1. Do countries trade? Is there any analytical reason to distinguish the benefits of trade between
individuals from that between countries? Why are such restrictions so much more common in
international trade than the trade within a country?
2. Why would focusing only on the jobs currently held by people in an area tend to overstate the
benefits to protectionism? Why do the numbers of those who lose jobs from eliminating trade
restrictions overstate the negative effects of more open trade on unemployment?
5. Price Control in the Foreign Exchange Market The Midnight
Economist
A market is a procedure through which something is bought and sold at a price.
A market is a very useful institution: it brings demanders and suppliers together for
exchanges which benefit both parties of the trade. And, if people in the market are free to bid and
offer as they please, the exchanges are not only mutually beneficial, but also equilibrating: prices
are agreed to at which buyers can buy and sellers can sell all they want at those prices–the
market is cleared.
The foreign exchange market really is a market. The commodities traded are currencies
of the world; and the prices are exchange rates–the dollar price of the yen, the peso price of the
And since an open market will efficiently equilibrate, with changing prices quickly
reflecting changing supplies and demands, why are there always interventionists eager to decree
prices? There is no reason to suppose that monetary authorities can do the market’s job better
than can the market.
We do not require discretionary intervention by bureaucrats to clear the market; indeed,
such intervention precludes equilibrium for long, if it permits equilibrium at all. Even if the
interventionists happened to specify an equilibrium price–which the market would have yielded,
anyway–that price will not remain the equilibrium price. As incomes and preferences and prices
Questions for Thought and Discussion:
1. Why are the chances that a government-set exchange rate will be at its equilibrium level so
low?