Tuesday, March 10, 2009

A Radical Foreign Policy Change, Pt. 2: A Story About England and Portugal

In my first posting of March I asked the following question: What is the purpose of foreign policy?

My answer was two-fold: The purpose of foreign policy is to secure the economic interest of a nation and to defend its larger national security as a whole.

So today, we are going to talk a little economics. I am not a professional economist, but the gentleman upon whose work I will be drawing upon was one of the two or three men (with Adam Smith and possibly Thomas Malthus, your mileage may vary) who defined the science of economics as we know it today: David Ricardo. Capitalism owes at least as much to him as it does to Adam Smith, possibly more. Most importantly, he was one of the first modern thinkers to seriously expound the idea of international trade in any kind of systematic, scientific manner. He also deeply explored the ways the economics actually plays out in the real world, as opposed to on the pages of a book. Perhaps unique among the economists of his day, Mr. Ricardo was an extremely successful capitalist: his ideas were solid enough that by applying them to his investment practices, he made money. How many economics professors can say that today?

Ricardo was responsible for two fundamental theories of economic canon that figure prominently into his work on trade: the Law of Diminishing Returns (which, though sadly misrepresented by modern capitalists, says that an increase in wages does not raise prices but merely lowers profits; that is, no, Ford is not forced to raise their prices because of union agreements) and the Labor Theory of Value. The latter is particularly important because it says that a commodity's value is based on the work it takes to produce that product and bring it to market.

Background information shared, this leads us into the economic definition of foreign policy: a nation's foreign policy should include securing and protecting necessary foreign trade. Here, however, we come into a large grey area. Free traders and protectionists agree on how foreign trade is best 'secured and protected' and on the definition of 'necessary.' The free trader's argument is that we must, for the good of our economy, have a healthy export market shipping every product we make into every possible market around the world and thus, to achieve that goal, we must allow other nations free and equal access to our market. If we do not, they will deny us access to theirs. Protectionists say that it is economically necessary to secure a balance of trade in our favor, that we must export more than we important for the security of our economy and that we must limit imports while securing exports. Both experiments have been tried to various degrees, with extreme protectionist policies and extreme free market policies enjoying equal records of miserable failure.

Let me make notes of that here by itself, so it is not missed: both extreme protectionism and absolute free markets have failed the United States. The U.S. economy was built on protectionism, but foreign imports were always a part of it and protectionism was kept from rising to punitive levels. Prohibitive tariffs like Smoot-Hawley, during the Great Depression, and the 1990s steel tariff have always done more damage than good. Increased automotive tariffs have certainly not saved the US auto-makers, even if they have encouraged many foreign companies to build American plants.

This is because modern theories of trade completely forget the real purpose of trade, in much the same way modern supply-side economics entirely forget the purpose of supply. Economies are driven by demand. One cannot sell something that the market does not want. One might be able to convince the market that it wants something by sheer weight of advertising capital, as the supply-side gurus of the United States have been doing for many years now, but such artificial bubbles eventually burst and the economic damage is terrible. Supply must meet demand, or eventually the people in the supply business fail.

Trade follows the same principle. This was illustrated by Ricardo before any of us were even born, and the facts continue to slap world economies in the face again and again.

Let's say that England and Portugal both produce wine and wool. For objective economic reasons, England is able to produce wool at a more efficient ratio of labor to total production than Portugal. It makes sense, then, for England to produce wool and sell the surplus to Portugal. It makes no sense at all for England to buy wool from Portugal when it can produce wool at home more efficiently and for a cheaper final cost. Likewise, it makes excellent economic sense for Portugal to buy wool from England to supplement domestic supply but none at all to try to export wool to England: they need all they can get and England can produce it more efficiently for themselves anyway.

The same is true, in reverse, for wine. Portugal is able to produce more wine, for less work, than England. It can meet domestic demand and sell the surplus to England quite easily. England, on the other hand, is best served by producing for domestic consumption and supplementing its demands with imports from Portugal. Attempting to export wine to Portugal would be silly and counterproductive.

This is a simple example, but it clearly illustrates many of the problems with our modern national trade policies. We do not gear our trade to meet foreign demand and domestic capabilities, but rather oscillate wildly between attempting to trade free access to foreign markets for free access to our own and attempting to deny all access to our market while trying to flood foreign markets. Neither strategy is rational or pragmatic.

The solution is to survey our domestic domand and production capabilities, then to produce based on domestic demand while exporting products of which we produce a surplus to countries with a demand for same. Because we have a primarily capitalist economic structure (though the 'free market' hard-liners have done everything they could to try to change that, with more success than is good for the country), and I don't wish to fundamentally change that (if anything, I want to restore capitalist underpinnings), it is important for the government to confine domestic action to appropriate regulation of business practices. However, our trade agreements can take demand into account and they should. In the long run, pragmatic and fundamentally sound trade policies will do far more good than any 'free trade agreement' or tariff ever could.

Perhaps this sounds like a moderate position, but if you consider how the US has done business for the last twenty years or more, nothing could be more radical.

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