Veronique de Rugy explains the flaws in the arguments for protectionism and industrial policy

See A Tour De Force, Indeed!

"Michael Brendan Dougherty writes about Daniel McCarthy’s piece over at Law & Liberty. Dougherty seems to think the piece is full of truths about the failure of free-market economic thinking, and I assume, therefore the legitimacy of McCarthy’s call for government intervention in the form of industrial policy. Dougherty calls McCarthy’s piece a “tour de force.” I agree. It is a tour de force of unsubstantiated claims, unwarranted conclusions, economic misunderstanding, and silly straw men.

It is also particularly amusing that Dougherty and McCarthy are so eager to claim that those of us who believe in markets and free-trade are ignorant of reality when that McCarthy’s piece contains so many flaws from the reality side of things.

Below are a few examples of why I’m baffled by the praise of McCarthy’s essay.
1) McCarthy claims that free traders do not acknowledge that many foreign governments, the Chinese one in particular, distort markets with subsidies and industrial policies.

This claim is simply incorrect. In fact, it’s so bizarre that that Don Boudreaux over at Café Hayek has offered to pay McCarthy $100 for every verified example that he, McCarthy, finds of serious economists displaying the kind of naïveté that McCarthy alleges is rampant among pro-free-trade economists.

What’s amusing (or would be if it weren’t so depressing) to any knowledgeable person about McCarthy’s claim is that economists’ centuries-long practice of defending unilateral free trade springs from the explicit recognition that foreign governments often distort their economies — and the global economy — with subsidies, tariffs, and other interventions. The case for unilateral free trade is that we benefit from lowering our trade barriers even in the face of other countries’ protectionism and industrial policies.

2) Behaving like the Chinese government isn’t self-defense, it’s shooting ourselves in the foot.
In a section called Self-Defense in Distorted Markets, McCarthy writes, “Supporters of economic nationalism see U.S. tariffs against China as justified retaliation, and some see them as a means of achieving freer trade in the long run: by punishing trade violations with reprisals, the United States can pressure China into abandoning its bad behavior, which would then free the U.S. to re-liberalize its trade relations.” There is a problem, however.

This is nothing more than wishful thinking, and you have to wear rose-colored glasses to see any of the deals signed so far by the president as anything more than face-saving agreements. This fact is no surprise to those who study trade. But McCarthy’s timing for making this argument is pretty bad. On Friday, the Trump administration admitted that his steel and aluminum tariffs worked exactly as free traders said they would — i.e., they increased the cost of the imported metals used by American manufacturers, and hence increased the importation of goods made with those metals (I wrote about this predictable effect of tariffs months ago here). Faced with this inescapable reality, Mr. Trump is doubling down with new tariffs, this time of derivative products. These same policies will yield the same results, but that doesn’t seem to deter those determined to ignore the lessons of both economics and history.

We can lament the behavior of foreign governments that use tariffs and subsidies because we recognize that these interventions are counter-productive and distortive. But it’s crucial to understand that the main victims of such interventions are not Americans but, instead, consumers, taxpayers, and unprivileged producers in those countries. Such interventions weaken those foreign economies relative to our own. Similarly, it is well-established that the Trump tariffs are mostly shouldered by Americans, many of them manufacturers and exporters, and this new series of tariffs won’t get him any closer than the objective he wants.

For this reason (and for others) McCarthy is wrong to assume that the appropriate response of our government is to mimic those destructive policies. If imitation is the highest form of praise, the last thing we should want is for the U.S. government to model its policies on those dreamed up by the tyrants and mandarins in Beijing.

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3) McCarthy doesn’t understand comparative advantage.

McCarthy writes that “Comparative advantage is yet another reductive philosophical construct with little real-world application.” And in an attempt to prove his accusation, he asserts that the principle of comparative advantage is violated or rendered inapplicable to reality by individuals who work to improve their skills.

McCarthy, to put it bluntly, writes nonsense — and nonsense that proves that he isn’t familiar with the economics of the concept.

First, comparative advantage isn’t a “reductive philosophical construct”; it is, instead, an application of arithmetic. If some economic entity — say, Jim — can produce a peach by giving up fewer hats than Jane gives up when she produces a peach, Jim has a comparative advantage over Jane at producing peaches (and Jane has a comparative advantage over Jim at producing hats). To put the matter in more familiar language, Jim’s cost of producing peaches is lower than is Jane’s. Between them, a larger number of both peaches and hats are produced if Jim specializes at producing peaches and Jane specializes at producing hats.

Unless McCarthy is prepared to argue that arithmetic is a “reductive philosophical construction with little real-world application,” neither has any business asserting that the principle of comparative advantage suffers from any such practical irrelevance.

Now to McCarthy’s example of people actively improving their skills. First, this example — contrary to his suggestion — does nothing to prove his accusation that comparative advantage is an impractical “reductive philosophical construct.” Second — and also contrary to his suggestion — no competent economist or advocate of free trade has ever denied that the pattern of comparative advantage changes over time, that these changes are often beneficial, or that they frequently are the result of conscious human choices.

Like many others before him, McCarthy reveals his ignorance of economics, and of the case for free trade, when he argues that individuals who upgrade their skills, or firms that strive to gain efficiencies in serving new markets, act inefficiently and in ways inconsistent with comparative advantage.
If McCarthy wants to make a case against free trade and for industrial policy, that’s fine. But no such credible case can be constructed from the ashes of the horde of strawmen whom he has slain.
4) McCarthy ignores the actual reality of predatory pricing.

McCarthy is particularly infuriating when he talks about the “reality” of predatory pricing, in a clever story about do-gooding “LawMart” (U.S. producers) getting put out of business by the nefarious “MafiaMart” (Chinese producers) who sells stolen goods at unfair prices. While this makes for a great soundbite, his understanding of how hard it is to actually pull off successful and sustainable predatory pricing is more fiction than reality. In particular, this story ignores the existence of capital markets, third-country producers, and how cutthroat modern global competition actually is (for every company, foreign or domestic, thinking of implementing predatory prices there are dozens of other firms salivating at the idea of entering the market and pleasing those customers with lower prices). This is why, in the real world, predatory pricing schemes rarely succeed, and dire warnings of unfair foreign competition — see, eg, Japan in the 1980s — usually look foolish in retrospect.

Second, for someone who likes to push an approach supposedly grounded in reality, McCarthy ignores the fact that the United States has loads of policies already in place that are meant to protect our “LawMarts” from dumping and other predatory behavior, such as the anti-dumping and countervailing duties administered by the Commerce Department and International Trade Commission to police “unfairly” priced or subsidized imports that injure American companies.  These protective “trade remedies” are used a lot, as demonstrated by the fact that we have over 500 AD/CVD measures on the books already targeting all sorts of goods and countries (including, especially, China).

And that leads me to my third, and perhaps most important point: contrary to what McCarthy claims, in the real world, the legal system in place has actually been captured and corrupted by LawMart (as public choice 101 predicts it would).  Indeed, for decades now the “LawMarts” of America have routinely colluded with government officials of all stripes to design a system that has little to do with policing actual “unfair” trade or predatory pricing but instead simply doles out protection from fairly traded imports at U.S. consumers’ expense. So if anyone’s acting like the “mafia” in this case, it’s sure not the foreigners.  So much for “reality”!

5) McCarthy hasn’t read the whole passage, from Adam Smith’s Theory of Moral Sentiments, from which he quotes Smith’s warning about the “man of system.”

In a move that can be described only as Orwellian, McCarthy accuses opponents of conscious state direction of large swathes of the economy of failing to grasp the wisdom of Smith’s warning of the pretentions of the “man of system.” This is nuts. Judging from Adam Smith’s quote, the man of system isn’t the proponent of free trade but the protectionist, such McCarthy.

 

 

Indeed, it isn’t us opponents of protectionism and industrial policy who wish to engineer the economy, as if it were a machine, into some pre-conceived appearance and pattern of performance. Those who are deluded with such a conceit are the likes of McCarthy and others. It is they, not us, who arrogantly believe that if the prevailing detailed pattern of a free market doesn’t match the ideal image they’ve conjured in their brains, than the problem is with the market rather than with their necessarily limited imaginations. It is they, not us, who suppose that government officials possess the Promethean knowledge and skill necessary to replace the results of decentralized competitive markets with better results, ones arising from an allocation of resources consciously chosen by those charged with systemizing what the economically ignorant mistakenly regard as the disorderly pandemonium of free markets. And it is they, not us, who ignore the baneful influence that special-interest groups inevitably have on the decisions of government officials who have the power to grant privileges with tariffs and subsidies.

In short, it they, not us, who are the men (and women) of system against whom Smith warned — a reality that would have been crystal clear to McCarthy’s readers had he quoted in full the passage from Smith about the man of system. Here’s the part that McCarthy left out:

He [the man of system] seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might choose to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful.  If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder.

Everyone is entitled to their opinions, but McCarthy’s lack of economic training is painfully obvious. As such, I would suggest that maybe next time Dougherty is impressed with McCarthy’s economic claims, he may want to it check out with his economist friends. I know he has a few."