The benefits and challenges of free trade

Economists are generally in favor of free trade because most of them know the law of comparative advantage but I bet they would quickly change their minds if a “free trade agreement” were to specify that all economic teaching and advice were to be provided by the partner country.

It’s easy to see the benefits of trade but the obstacles can be overwhelming.

The law of comparative advantage tells us that two countries will produce more if they specialize in what they are most efficient and trade even if one of the countries is less efficient than the other in all areas of production.

The first thing to say is that free trade agreements are not what I learned was free trade.  To me free trade should be trade without any restrictions. There should be no tariffs, no quotas and no subsidies.  A country that wants free trade could and should do it unilaterally.  A free trade agreement should be called managed or negotiated trade as negotiations tend to focus on tradeoffs between commodities.  It is my understanding that countries which have conducted unilateral free trade have done very well.

The problem with free trade is that even though the countries as a whole will be better off some people fear they will lose. It becomes an emotional issue because some people are likely to lose their occupations and their income.

The challenge then is to make a win-lose proposition into a win-win so that everyone can share the benefits.  One way to do this would be with a universal income scheme.  The benefits could be in the form of increased income or increased free time for other activities.

Another aspect of trade is that it is a social activity whether we trade with a neighbor or somebody on the other side of the planet.  It is a bit of a stretch to think we have relationships with the Asian people who make our shirts but when some of them died in a workplace fire quite a few of us felt some pain –  for a short time. For relationships to be satisfactory there needs to be a more or less equal exchange.  If we want other countries to buy from us then we need to buy from them.

With the world economy in trouble everyone sees the answer to their problems is  to export more because domestic markets are slowing.  I think there is something wrong in that.  At the same time those who feel threatened by the free trade agreements now in the works will be strongly opposed.  The best bet would be to cooperate and look for win-win trade.

An alien invasion or the consequences of stimulus

With austerity seemingly not working to resolve economic problems and the apparent success of Abenomics and recent announcements that there may be thousands of earth like planets,  it may be time to have a second look at Paul Krugman’s proposal for governments to start preparing for an alien invasion from outer space. On second thought,  the consequences of launching into a major stimulus program may be worse than the slim chance of an invasion.

As there are two sides to the economy, financial and real,  we should look at both of them.

On the real or physical side we need to look at two things – resources and labor reducing technology as the goal of stimulus would be economic growth and full employment.

For there to be economic growth there will need to be an increase in the quantity of goods and services we produce.  The limit on services may not  be clear but regardless of the service economy we all need physical things to survive.    The production of more goods will require more mineral and energy resources and that could be a problem.  There are lots of resources left in the earth’s crust but we have used up the most accessible and those that are left are difficult and require a lot of energy to extract.  That could be a limit on further economic growth.

So what would be the consequences of attempted stimulus on the resource base?  Probably more energy would be required leaving less for other things and probably we would bring forward the timing of a major economic collapse.

Another limit on full employment is labor reducing technology of which we use a lot.  Here I see two questions:  How is the freed up time to be used and who is to make that decision.  Personally I enjoy reading, thinking and writing this weblog and I enjoy wood turning.   I don’t want Paul Krugman telling me and others that we have to spend a lot of time preparing for an alien invasion.   We now have the technology that most people don’t need to spend most of their lives “working”.  I would like to see some sort of universal income scheme which would allow individuals to decide what they want to do with their time.

On the financial side of the economy stimulus means two potential problems – inflation or a financial crash.  A government stimulus program would be trying to increase the production of goods and services.  With limited potential for growth this would put upward pressure on prices.  With all the excess money supply which central banks have been pushing into the economy I wouldn’t want to rule out hyperinflation.

The other potential financial problem is another crash within the banking system.  The way we create money is a Ponzi scheme which has to crash from time to time.  If inflation doesn’t get us a crash will.

I fear that Krugman was only half-joking.  He wants governments to undertake a massive stimulus program and I fear that could bring forward a major economic collapse.

Austerity appears not to be working either and it is causing problems for lots of people, especially the young.  The challenge then is to find a third way and at this point I must refer you to the essay “LETS go to market: Dealing with the economic crisis” on this weblog.

Oh, oh.  Did I just see an armed flying saucer go by my window?

Which is more likely – deflation or inflation?

Conventional economic wisdom, as illustrated by the cover of last week’s The Economist, says deflation is a major threat.  However, this blogger, ever the contrarian,  figures inflation, perhaps even hyperinflation, is a more likely threat.

 The idea that deflation is a threat appears to be  based on the concept of inflationary expectations and the desire by those who make decisions on behalf of he government to maintain mild inflation to help deal with government debt.

That high inflation is a threat is based on the formula MV=PQ, known as the quantity theory of money although I prefer to call it the connectivity formula as it connects the financial and real sides of the economy.

 The case for deflation is made in the November 9, 2013 issue of The Economist. (http://www.economist.com/printedition/2013-11-09)

The above formula tells us that the money supply times the velocity at which it changes hands is equal to prices, or a price index, times the quantity of goods and services produced.  It is not clear everybody accepts this formula but I think it contains a lot of truth.  If one of the four variables changes then to maintain the equality one or more of the others also has to change.  For example if the quantity of goods and services goes up then the money supply also needs to go up.  If the increase in money supply exceeds the increase goods and services, then velocity must go down or prices must go up.  Through recent decades prices have gone up and we have had inflation.

 The  current economic crisis is probably mostly a crisis in Q.  While there are still a lot of mineral and energy resources in the earth’s crust we have extracted the most easily accessible.  What is left is difficult to extract and requires a lot of energy.  In the past economic growth has covered a multitude of economic sins.  It is not clear that the economy will be able to return to the type of growth we have experienced since the start of the industrial revolution.

 During the depression of the 1930s the monetary authorities deliberately restricted the money supply (a reduction in M) and this led to a reduction in Q, a recession and a number of financial institutions failed.  This time they are not going to make the same mistake and have been trying to increase the money supply calling it quantitative easing. Large amounts of money have been pumped into the economy.  Consumer prices have not increased and it is tempting to say the formula is not valid.   It could be that velocity has fallen (there are complaints that corporations are sitting on piles of cash) and that price increases have been in paper financial instruments.

 We should note that Wikipedia gives four major examples of deflation in American history and all of them involve contractions in the money supply.  Maybe the formula holds.

 If the formula is correct and with all the excess money floating around the economy, then there is quite a bit of  potential for something unpleasant to happen.   If not high inflation, then a financial crisis in which the money supply is reduced.  In either case the paper used for those financial instruments might have been more useful as firewood.

 Inflation is complicated by the fractional reserve creation of money.  As can be seen from the formula the money supply needs to flexible up or down according to variations in the quantity of goods and services produced.  But our money supply is created when banks make loans upon which interest is charged. Rather than flexibility there is pressure for the money supply to increase continuously.  The result is a Ponzi scheme which collapses from time to time.  Oops, here comes another financial crisis.

 The goal should be price stability or a zero inflation rate.  As loans are in nominal terms when prices go up people who have borrowed benefit at the expense of those who have loaned the money.  If you are a lender, the higher the inflation rate, the more purchasing power you lose.  Deflation works the opposite way, in that a borrower has to repay more purchasing power.  As governments are major borrowers it is hardly surprising that those who set economic policy are anxious for moderate inflation.  Inflation is a tax if not theft.

 Those  charged with setting government economic policy fear that low inflation could easily slip into deflation.  That would  make repaying government debt more difficult and in the past deflation has been associated severe recession.  The difference this time is that there is lots of money available to facilitate the exchange of goods and services.  Hyperinflation would wipe out a lot of savings, fortunes and pensions.

 Whatever happens it looks as if there is a lot of potential for increasing economic chaos.

The difficulties of free market health care

A free market in health care as called for in this video from the Mises Institute would be great, however there are three things that make it difficult:  health care is based largely on crises, competition in the industry is already very restricted and a lot of purchasing decisions are made in highly emotional situations.

Here is a transcription of the last sentence which is the main point.

 

“If we would just allow the free market to work, if we could eliminate the third-party payer system, the government subsidies on the expenditure side that drive prices up there’s no reason why a truly free market in health care goods and services couldn’t be just as effective in the U.S. as the market for computers, the market for software, the market for automobiles or the market for anything else.”

 

One of the things which distinguishes health care from computers, software or automobiles is that health care is largely based on  crises.  Generally most of us seek health care services for an emergency.  We go to a doctor because he/she has specialized knowledge that will help us out of the crisis.  This of course gives the people in the industry a great deal of power over us and creates potential for exploitation.

We go to a doctor for the specialized knowledge but we also go because doctors have a legal license to prescribe the magic pills that sometimes cure us or limit the symptoms of our illness.  To me a free market requires perfect competition   One of the ways the health care industry uses its power to exploit is to get governments to pass legislation which restricts competition.  Governments restrict competition through licensing, copyright and patents all of which are very  much a part of the health care industry.

The third factor which makes the health care industry different from  others is the deep emotions involved with injuries, pain and end of life.  When we purchase health care we are often experiencing deep emotions.  Once again this creates potential for exploitation.

So, how do we deal with the health care industry and how do we ensure everyone has proper access.

If we  were all perfect people we would reduce the demand for health care by living a healthy lifestyle.  We would also all manage our finances so that we always had funds available for emergencies.

As we are not all perfect then insurance, a third-party payer,  becomes an option to consider.  But most of us think and act mostly for the short-term and insurance is expensive and for the long-term.  For me this leaves a dilemma.  I don’t like the government saying we have to have to purchase insurance but neither do I like to see people suffering although I believe ultimately most of us have to take responsibility for our actions.

The man from the Mises Institute says “if we were to allow the free market to work”.  To try this would put us into a power struggle with health care practitioners who benefit from a lack of competition.  In a crisis situation where help requires specialized knowledge, the customer is not always right.

If we do want to take on these guys, then one approach would be to challenge the licensing.  I rather like Milton Friedman’s suggestion of certification rather than licensing.  Certification could be by different agencies and with different standards.  It would be up to customers to check the certification of the people with whom they deal.

In conclusion, it is not clear that a free market in health care is even possible let alone could it be as effective as the markets for computers, software, automobiles or anything else.  Sometimes there are no satisfactory answers.

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