Today, we’re now moving on from talking about the national economy to the international economy as we dive right into the 21st chapter of Thomas Sowell’s Basic Economics. In this chapter, we begin by talking about international trade.

If you haven’t read my previous summaries and analyses on this book yet, please click here. Otherwise, let’s get to it!

Chapter Summary

In discussing international trade, we must always remember that it’s not a “zero-sum” game, nor is it a “winner vs. loser” dynamic. In trade, all sides wish to benefit from the agreement, or it wouldn’t make sense to continue to trade, since they can just continue to do their own internal trading.

Additionally, we need to remember that all economies rise as buying increases, since jobs are created for workers to produce those additional goods and services. There is no “fixed” number of jobs. Instead, the idea of “a rising tide lifts all boats” applies as countries’ economic prosperity means an increase of jobs on all sides.

Of course, politics often gets in the way of it all. As Sowell explains:

“The basic facts about international trade are not difficult to understand. What is difficult to untangle are all the misconceptions and jargon which so often clutter up the discussion.”

The wealth of a nation consists of the goods and services it provides. Often, the political rhetoric is centered around surpluses and deficits in trade balance, but the reality is that denying consumers the ability to buy things at the lowest prices they want is what hurts an economy. So how does this factor into trade?

The Basis for International Trade

There are three ways countries gain from international trade: absolute advantage, comparative advantage, and economies of scale.

Absolute Advantage is the advantage one country has over another in the production of some kind of good or service. For example, in tropical areas, it is much easier to produce tropical fruits than in colder climates. This advantage means that the production of that good is much cheaper and easier, and thus less costly.

Comparative Advantage is more relative. Because a focus to produce one product often means less focus to produce another product, it’s not always about how much it costs to produce something, but also the trade-off in choosing not to produce as much of something else. This means that even if a country is better than another at producing anything, it can still trade with that other country. In the event this happens, the more productive country can specialize on producing one kind of product while the other specializes in another product, thus benefitting each other immensely. It’s only when one country can produce everything more efficiently that there wouldn’t be any point in trading.

This is a pretty important point. For example, while while Great Britain has been able to provide enough food for all of its people, it does not actually produce the majority of its food. Instead, it produces manufacturing, shipping, and other services, and then buys food from other nations. This gives the British the ability to feed its people far better than attempting to grow the food on their own ever could.

Economies of Scale, as discussed in Chapter 6, is the ability to increase the amount of production or service in a specific area. It is also an important part of international trade, because there are some things, such as car manufacturing, that just aren’t cost effective until you’re making a lot of them at a time. A lot of this depends on how large a population is in a given country, as well as how efficiently it can trade with others.

A key part of participating in economies of scale is when a country attempts to restrict its people’s ability to produce, thereby inflating prices. When such a country begins to trade, its internal small businesses often experience a crash, as their small scale is forced to reckon with the massive production of other countries.

International Trade Restrictions

Thus, a key component of international economics is realizing that, like other kinds of economic activity, it can quickly displace inefficient methods of production and service for more efficient ones, no matter where in the world a country is. Politically, this often ends up with locals calling their government to protect them from foreign competition. And so, let’s look at some of the fallacies that are often brought out to argue against it.

The High-Wage Fallacy is the idea that countries with higher average wages can’t compete with those with lower ones. It might sound correct, but this is false when we understand the complexity of cost. To begin, wage rates, labor costs, and total costs are different things. Wage rates are related to each hour one works. Labor costs are related to each unit of output. Total costs includes labor costs, but also includes things like raw materials, cost of capital, transportation, and things that are needed to bring a product or service to the market.

Thus, the reality of high wages in a prosperous country is that, more often than not, those high wages reflect higher output, which means it actually has lower labor costs. Another way to think about it is that a more prosperous country has a better ability to make labor cost less, even if individuals are paid more wages. Remember, a free market incentivizes the reduction of costs, including paying more wages. However, an employer must pay a wage high enough to retain workers, and experienced workers who stay around are far more efficient than high-turnover workers.

But what about all those jobs like telemarketing and programming in the United States lost to countries like India? While certainly it can be argued that some jobs are shifting around to different countries, this doesn’t mean that there is a net loss of jobs overall in a higher wage country (in this case, the United States). After all, while the programming can be done in India, you would still need international managers, good team builders who can work cross-culturally, and even translators—jobs which are created in the higher wage country because of such shifts in economic activity.

Of course, the reality of this may still hurt those who suffer from the jobs that did go overseas. But the answer IS NOT to restrict domestic or international markets, as that actually often reduces both new job creation and prosperity in the long term, which further hurts those who suffer from the shift in jobs landscape. While it is politically convenient to pitch a story of “us vs. them“, the reality is that the only people who gain from such a pitch are domestic special interest groups. Everyone one else loses.

This is especially pertinent when politicians propose or are pressured to save jobs as a key component in dealing with international trade. Such a thing usually happens through restricting trade. By increasing tariffs on imports, it is more often the case that unemployment actually increases, and exports in the same industry suffer as well. This is because, in a free market, if it is truly more efficient and less costly to produce something elsewhere, restricting doing such things is enforcing less efficient and more costly methods on the market. This economic fact doesn’t change just because politicians or the public want to help people. Thus, as time goes on, a national market that is forced to be less efficient and more costly must compete on the international stage, and its disadvantage eventually decreases employment for that nation, and other countries buy less of its products as well.

What about temporarily applying economic restrictions to protect infant industries in the interest of fostering growth? While many economists agree this may be a good idea in theory, in practice, most infant industries aren’t really cared for enough by politicians to get protection in the first place. Instead, old inefficient and quickly obsoleting industries often do have the political clout to receive subsidies and favorable legislation, often at the expense of the public and market.

National Defense is another area in which international trade is restricted. Such restrictions are not necessarily due to political shenanigans, but because it’s typically unwise to buy munitions and weaponry from another nation you may be in conflict with in the future. However, many things are done in the name of national defense, though the products being restricted may have very little to do with such things. But when done correctly, both economists and politicians actually agree that the export of domestic military-based products and technologies should be restricted.

Many accuse non-domestic countries of dumping products at prices below cost in order to drive domestic businesses out and allow the foreign market to take over. Of course, it’s pretty difficult to calculate the real cost of production, with all the differing circumstances and environments with which one can produce different goods and services. But again, reality comes to a fore in that, if a company is producing something below cost, it will quickly find itself unable to sustain in the long run (as discussed in chapter 8). Thus, even if such a thing were true, as long as governments aren’t subsidizing these affairs, in the short term there may be some domestic losses, but the market will always rebalance itself out, and those selling under cost will soon be out of business themselves.

In all this, it’s important to distinguish the kinds of restrictions that can be imposed on an economy, especially in an international sense. Tariffs are taxes on imports, and effectively raise cost of imports to help domestic businesses compete. Import Quotas limit the amount of a specific good that can come from a given country. Both generally raise prices. However, a quota makes the cost of an import more obscure to the public, and so people are less aware of its effects. Thus, the effect of quotas often raise domestic prices far more than tariffs, but are just as easily passed by political officials because of the ambiguity of such laws.

Changing Conditions

Just as in national and local economics, we must remember that, over time, things change. The centers for production of various goods and services shift from country to country over time, and industries rise and fall.

A great example is the digital technology and computing industry, which began in the United States, but slowly made its way around the world. As the hardware became easier to produce en mass, computer components went from being mainly made in the US to mainly made in Asia. Similarly, the software industry grew in the United States, and is now making its way around the world. During the rise of the technological era, it was common to see headlines which talked only about the masses of lay-offs happening in the tens of thousands in American industries. Yet, millions of new jobs were being created across the country.

In the current climate, many are in outcry at the “outsourcing” of American jobs overseas. Yet, as given before, when looking at jobs, it’s important to look at the net number of jobs, not just what’s in decline. If the number of jobs created outgrows the number of jobs lost, then it doesn’t matter if outsourcing is happening. In fact, outsourcing could actually produce better economic results and job growth, as there’s plenty of evidence that the outsourcing of jobs actually also lead to newly created domestic jobs.

As Sowell explains, this is why most economists are very positive about free trade internationally, though in the political arena, there is much support for protectionism, and against ‘globalization’. Of course, that term ‘globalization’ is a loaded term, and not all of it has to do with free trade in the international arena.

My Thoughts

The idea of comparative advantage, especially as it relates down to the individual, is a very interesting way to look at economics. I come from a background which admires a ‘self-made’ person. In other words, the more you are able to do-it-yourself, the more respect you generally have (even if it’s just self-respect). But comparative advantage understands that the delegation and specialization of tasks is not about whether you can do-it-yourself, but the economic advantage you gain by not doing everything yourself.

Of course, this all sounds great until you try to rely on others, and those others fail to follow through. I’ll write a blog on this in the future, but such dependencies, and the failure of those dependencies, is a lot of the problem with businesses in general. In today’s modern era, entrepreneurship has been romanticized into this idea of creating a start-up with a brilliant original idea that will take over the world. But the fact is that most businesses are “middle-management” businesses. In other words, they serve to provide expertise in a small field that is interconnected with other things. Rather than being the whole chain, it is just a link in the system.

I would venture to guess that the businesses which thrive are the ones that find that niche (even if it is one with a few competitors), and do really really well in them.

Maybe this is why a lot of non-DeFi cryptocurrency businesses fail. Most crypto projects, like EOS, Tezos, and others want to be the whole caboodle. Not only do they want to create their own digital currency, but they want to innovate the tech as well, in addition to wanting to be the dominant force in the crypto world, as well as disrupting the current financial system, as well as creating a better Facebook, or Twitter, or something else. Very few ‘disrupter’ crypto projects build on the back of another cryptocurrency that already exists.

I think that’s part of the reason why the Ethereum ecosystem is successful, despite its current flaws in energy consumption and high gas fees. The projects based in Ethereum are built on an already well-known and well-functioning chain which is being actively worked on. Thus the exchange of coins and software coding platform is already taken care of.

But some projects even on Ethereum have the same problem.

Currently, the Brave project is torn between being a good browser and providing a good, stable digital token platform. Visiting their subreddit is a good place to get discouraged from trying their products, as it’s easy to find many posts talking about the problems with BAT. They have issues sending out tokens to all users, issues with browser bugs, issues with getting advertisers to hop in on the project, etc. While I’m not one to tell anyone what to do with their businesses, this idea of doing everything yourself may be the reason why many of these crypto projects fail. They attempt to tackle too much in the beginning, instead of being really good at one thing first, before venturing on.

This week, in the 20th chapter of Thomas Sowell’s Basic Economics, we finish looking at the national economy by exploring special miscellaneous issues not yet touched.

If you want to see my previous summaries and thoughts on this excellent book, please click here. Otherwise, here we go!

Chapter Summary

The Scope of Government

In many general areas of society, there is an overlap in the abilities of government and economics to overlap. Things like housing, transportation, and education can be decided by either government or the market, and the need to understand the effectivity of each helps us answer which is better in each circumstance.

Political choices are binding until future elections. Furthermore, rather than taking things piecemeal, they are package deals, since politicians stand on multiple platforms. On the other hand, consumers make choices day-by-day, and change them based on their own desires. So the choice is between voting categorically (despite perhaps not agreeing with everything in that platform) and trusting that the policies will do well over time, or being able create change in the national economy little by little.

However, politics incentivize governments to create change, even when change isn’t necessary, or could destabilize the national economy. For example, in recessions and depressions, the public often pressures and expects governments to do something at scale, even if it would be in the best interest of the economy in the long term to do nothing.

This happened in the United States during the Great Depression, where government spent large amounts of tax revenues to intervene in the economy, resulting in massive and counterproductive unemployment and furthering recession. During the years of the Reagan administration, on the other hand, when the stock market crashed once again, the media noted the President’s failure to react, but also 20 year expanse of “steady growth and low inflation”.

The problem, of course, in any kind of monetary and financial policies is the complexities of a national economy, along with the lack of predictable outcomes for such policies. Theorizing what could happen economically is different from what does actually happen. It is more likely that monetary policy negatively effects business viability and employment, since a trial and error process is effective because of correction of errors.

Government Obligations

The public also often has various expectations and obligations for government. Of course, such obligations vary with different individuals and groups, and are impossible to estimate. Should the government compensate for unemployment? Should they loan money and not expect repayment in times of crisis? How should governments provide pension plans? The varied answers depending on who you ask these questions illustrate the difficulty of understanding the role of government.

But in the national economy, the difference between government and market forces can show us which is better. For example, government funded pension programs are paid for by using current tax dollars to pay for current pensions. This is simply money transference (i.e. spending money), and no real wealth builds up over time. On the other hand, private insurance companies which provide pensions and annuities invest customer premiums, and pay pensions through the overflow of those investments. This creates real wealth.

The problem of government pensions is clearly seen in the Social Security system of the United States. The flow of tax payer dollars to retirees works as long as the birthrate consistently increases. But when it declines, resulting in a retiring class larger than the working class, as in most modern nations such as the United States and western European nations, the slow roll of impending crises becomes inevitable. In fact, most people in these and other nations do not expect to receive their pensions when they retire.

Market Failure and Government Failure

As we talked about before, though both markets and government have failures successes, the way they fail and succeed are incentivized and constrained differently. We can see how this plays out when private businesses, like banks, are nationalized or controlled politically. Because politicians are not beholden to economic incentives (their pay is based on what they themselves vote for, as well as what is politically popular), the banks they take over often become less efficient, and collect more risky debt.

For example, in the United States, laws encouraged banks to give ‘subprime’ loans, which led to the disaster of the 2007-2008 mortgage crisis. Similarly, in India in the late ’60s, nationalizing banks led to loans being made only to the rich, though they were called the “deserving poor”. A great quote from Sowell here gives us some perspective:

As an entrepreneur in India put it: “Indians have learned from painful experience that the state does not work on behalf of the people. More often than not, it works on behalf of itself.”

As an aside, the history of using political means to rectify economics is very old. The market alternative, in view of history, is actually quite young, and the combination of the market and democratic societies is even newer, especially if you count the United States as the first one.

Elected officials are not incentivized by failure in their policies. If policies fail, politicians are more likely to blame other factors than themselves and their platform. Thus, if they are able to successfully pass the blame (and in many cases they do), they can stay in office never having truly learned a thing (except how to attack the opposition to stay elected).

On the other hand, the incentive of markets is to admit failure and reverse quickly. If you don’t, your business will very quickly become uncompetitive and bankrupt. And so, the two processes often produce very different results, even in similar situations (like the banking example above).

My Thoughts

I had an interesting conversation on Ruqqus the other day with a netizen who believed that aspects of socialism (centralized control of the economy) and capitalism (market control of the economy) could work together. During our conversation, it became apparent to me that a misunderstanding of the two may have caused him or her to attempt to propose such a thing.

The idea that socialism is simply just government involvement in economics is false. Socialism means centralized control over an economy, meaning that government (which is supposedly the will of the public) determines and pre-plans all or some aspects of an economy. It is not (as the fellow I had a conversation with thought) simply the government providing the market with leases on property with which to build on. Depending on how the latter is done, it could be either capitalist or socialist.

The reason why socialism doesn’t work is not because “governments are evil”, but rather because governments have no incentive to make good, long term economic decisions. I’m not even saying that government officials and politicians won’t try to make good economic decisions. After all, they will at the very least try to appear to do so, so as to make sure they stay in office. But because markets and economies are infinitely more complex than any single entity can hope to understand, any centralized authority will always be less efficient and wasteful, and thus economically deficient, in its decisions.

That, I believe, is the main argument Sowell has against government control in the national economy.

There is also the problem in misunderstanding voting. Or rather, believing that voting as a tool is only available in the political process. The truth is that the electoral process also happens in economics. It’s actually how the market works. In the modern day, we call it “voting with our dollar”.

A win by a candidate usually has lasting effects in the political process. In the United States, once a political candidate is voted into the Executive or a Legislative office, they are there for 4 years at minimum. This means that these political officials have 4 years to do whatever they want. Because most people are interested in keeping their job, the vast majority of what political officials do is prepare for their elections in 4 years. They may try to do what their platform was about (although these days it’s more of what their political party is about), but such things can take much longer than their never-ending desire to get re-elected in 4 years.

And, again, this isn’t exactly an evil thing. Instead, it’s the rational thing. If you truly believe that you (as a political candidate) have the best and most moral ideas to be executed on a public platform, you should do your hardest to make sure that you stay in that office.

The problem, of course, is that markets and economies shift far faster, and in far more unpredictable ways than politics. The idiom “politics is downstream from culture” is pretty true. And culture, as an ever-shifting entity, will also drive markets. When markets are allowed to be free, they willingly adapt extraordinarily fast to changing ideas and opinions, because there is no government or political authority forcing something to stay longer than the market desires, or preventing something from rising that the market wants. And thus, in the tides of change, markets definitively become a better mechanism for the national economy than centralized entities.

This is a very simply argument that anyone can understand. Oftentimes however, people don’t believe they have the capital to participate in the market system. And when they believe such things, they are incentivized to shift to gain political capital instead. Thus, in a rationalistic sense, politics becomes a large focus for the impoverished and working class, because it’s easy to convince them (who are the masses) that they can get their way through politics rather than participating through the market. And politicians take advantage of this fact regularly.

So what is the solution to all this? While I certainly believe technologies like blockchain and cryptocurrency will help toward this direction, we need a more basic and universally applicable understanding here. Namely, that each individual human being is powerful and able to make his or her own decisions to the betterment of their own lives.

When we truly believe and understand this simple thing, everything changes. We don’t need to be celebrities to make a difference, nor to be powerful. We are powerful in ourselves. No longer will we want to rely on politics or government for the betterment of our own lives, because we understand that our individual selves are the greatest and most reliable empowerment. No longer can we be tricked by the emotion of compassion to let politicians take care of the poor and impoverished. We ourselves will go out of our way to help the poor and needy as we see best. Will there be people that don’t help? Certainly. But that doesn’t give us the right to snatch the money from other powerful people to do what we want.

More than any crypto or other technology, this understanding can shift the world.