Tuesday, January 05, 2010

Nations Don't Trade With Each Other;Individuals Do

WASHINGTON (Reuters) -- The United States imported $2.74 billion of "oil country tubular goods" from China in 2008, more than triple the previous year, as a surge in oil prices led to increased demand for the oil well tubing and casing.

MP: The statement above perpetuates a common misconception about international trade that clouds clear thinking about the topic. Technically, the United States did NOT import $2.74 billion of steel pipe from China, at least not as a "country." It was dozens, if not hundreds, of American-owned companies that voluntarily placed hundreds, if not thousands, of individual purchase orders in 2008 to purchase Chinese steel from dozens, if not hundreds, of steel-producing companies in China who filled the orders totalling $2.72 billion, and shipped the steel.

It might be a subtle point, but it's important to realize that countries don't trade with each other as countries - rather it's individual consumers and individual companies that are doing the buying and selling. The confusion gets reinforced when we constantly hear about the "U.S. trade deficit with Japan" or China, which might again imply that the "unit of analysis" for international trade is the country, when in fact the unit of analysis is the individual U.S. company that engages in trade with other individual companies on the other side of an imaginary line called a national border.

It's possible that some of the confusion about international trade can be traced to confusion about the "trade deficit" and the "budget deficit." The relevant unit of analysis for the budget deficit is indeed the country, since it's the entire country via elected officials that is responsible for the "budget deficit." By conflating these two distinctly different deficits, it's then easy to assume that the relevant unit of analysis for both is the "country" when in fact that only applies to the "budget deficit" and not the "trade deficit."

Once one understands that it's individual companies, not countries, that are doing the trading, then it's not so easy to get fooled by statements or headlines like "Punitive tariffs are being imposed on China," or "Obama to hit China with tough tariff on tires." Since China doesn't actually trade with the United States at the national level, tariffs cannot be imposed on the country of China - it's not like the United States government sends a tax bill to the Chinese government.

Rather, since it is companies that are trading, it's companies that have to pay the taxes (tariffs) TO their OWN government. In the case of U.S. tariffs on Chinese tires or steel, the tariffs (taxes) are being imposed not on the Chinese government or even the Chinese steel-producers, but on American companies who now are taxed for buying tires or steel from China, and then those taxes are ultimately passed along to the individual Americans who purchase the tires and purchase the consumer products like automobiles that contain Chinese steel.

Bottom Line: Starting with the fallacy that countries, not individuals, engage in international trade, it's then much harder to realize that it's individual American companies and consumers who are penalized, taxed and disadvantaged by trade protection. By understanding that only individuals ultimately trade, it's then much easier to see that trade barriers typically protect a concentrated, small but well-organized group of inefficient domestic producers from more efficient foreign competition, while imposing huge and significant costs on other Americans - domestic companies that buy imported inputs and ultimately millions of U.S. consumers.

33 Comments:

At 1/05/2010 2:24 PM, Anonymous Machiavelli999 said...

I would agree with your entire post. I don't like trade protectionism. But this seems to be the only way to cajole China into dropping all of its protectionist measures against the US. Starting with its fixed-exchange rate policy.

 
At 1/05/2010 2:41 PM, Anonymous American Delight said...

Thank you for your very clear explanation!

I wish my old econ professors talk & wrote like you do. Most of them were too lost in "theory" to bother explaining real-world aspects of trade.

 
At 1/05/2010 2:53 PM, Anonymous richard said...

Mark,

> it's not like the United States government sends a tax bill to the Chinese government.

Just a thought: Would it be a good idea if the US government would send such a bill?

 
At 1/05/2010 3:00 PM, Anonymous richard said...

Machiavelli999,

You misunderstand.

If the chinese keep their currency down, that boils down to keeping their goods cheap.

Keeping their stuff cheap boils down to a permanent big discount. As if the 'Fire sale' sign is welded to their front porch.

 
At 1/05/2010 3:07 PM, Anonymous Anonymous said...

richard,

This has been explained to him time and time again. He chooses not to see it.

 
At 1/05/2010 3:09 PM, Anonymous TheDude said...

If the government of China has direct control of the steel industry in China (which it does according to the U.S. trade rep) is that dealing with an individual?

I'm never going to be the smartest guy in the room but dude that's not a market. Promote markets, abide.

 
At 1/05/2010 3:15 PM, Anonymous Machiavelli999 said...

Machiavelli999,

You misunderstand.


I understand. They are essentially volunteering to be our virtual slaves by accepting less dollars than their goods are really worth.

The problem is if one country produces more than it consumes than someone has to consumer more than they produce.

That someone is us.

I guess it all boils down to whether you think the current account deficit is a problem. I think it is. I think it points to an unsustainable imbalance that will correct itself in a nasty way eventually.

 
At 1/05/2010 3:38 PM, Blogger Low On Prozac said...

Amazingly simple and enlightening.

 
At 1/05/2010 3:52 PM, Blogger Low On Prozac said...

Richard,
I’m not an economist, but selling a commodity below its true cost sounds like a pretty good bargain for the consumer. I’d say if the Chinese government wants to give away resources, that’s fine by me. Why should I work, if the Chinese will support me?

 
At 1/05/2010 4:13 PM, Anonymous Anonymous said...

Low on Prozac, is it not depressing that Chinese elites are taking advantage of their citizens to somehow benefit you?

 
At 1/05/2010 4:29 PM, Blogger Low On Prozac said...

Anonymous,
Yes, and another argument for Libertarianism.

 
At 1/05/2010 4:32 PM, Anonymous Benny The said...

Odd how much space is devoted in the media (including this blg) s in Cuba, a horrible and wretched place, but so little to China, where they just threw a guy in jail for 11 years, as he voiced an opinion.

It's part of the China=commie-fascism=good, but Cuba=commie=bad equation.

Free trade? Trade with China is trade with the state, not necessailry individuals. They use slave labor (lierally) for some basic commodities, such as plastics (prison labor, except the prisoners could be political prisoners).

Like most situations in the real world, ideological "black and white" lenses just don't work.

You can read Ayn Rand or Upton Sinclair, but the real thing is mixed up.

 
At 1/05/2010 4:47 PM, Blogger Walt G. said...

There isn't anything that China does that we can't do in the U.S. if we want to eliminate all of our citizen, worker, business, and environmental protections. Let's pick a couple of lightly populated states out West and try it.

 
At 1/05/2010 5:06 PM, Anonymous Anonymous said...

Low on Prozac, I think I will back slowly away from Libertarinism and reconsider Conservatism. You fight to futher enslavement and the Conservative fights for freedom and by default capitalism.

 
At 1/05/2010 5:07 PM, Anonymous Benny The Man said...

So, the upshot of this is that we should completely wipe out any trade and travel retrictions with Cuba.s

 
At 1/05/2010 6:02 PM, Anonymous Anonymous said...

So, the upshot of this is that we should completely wipe out any trade and travel retrictions with Cuba.s

It turns out that you know as little about U.S. trade with Cuba as you do about military strategy and funding. There is no "embargo" on trade with Cuba, only the stipulation that the "Caribbean deadbeat" pay in cash:

... despite all the scribbling and gabble about the "U.S. embargo of Cuba," or "Blockade" ... the U.S. ... is Cuba's biggest food supplier and fifth biggest import partner, and has been for the past five years. The U.S. has done over $2 billion dollars worth of business with Cuba the last few years-all for cash.

And that's the rub with the politically-connected companies who sell Castro. These U.S. Agri-giants crave the same deal from U.S. officials (via the U.S. Export-Import Bank) that France and Mexico's government elites (among many other nations') gave their business cronies and cocktail guests.

Castro does much of his U.S. business with Archer Daniels Midland. For decades ADM executives and Castro lobbyists ... pined for an end to the "embargo." That long gone, they now whine that restrictions on doing business with Cuba are "too onerous." Again, these "restrictions" stipulate one thing primarily: that Cuba's Stalinist regime pay cash for U.S. imports. That's basically all the "embargo" amounts to nowadays, along with a (quite flexible) travel ban.

American Thinker

Big agribusiness would like the U.S. taxpayer to finance Cuban trade. How ironic that you would come out swinging for the very agricultural subsidies you repeatedly claim to abhor. I guess for leftists it's all about loving Fidel.

 
At 1/05/2010 6:14 PM, Blogger juandos said...

Hmmm, I'm going to throw mach999 a bone...

China reaping financial benefits of US war in Afghanistan

 
At 1/05/2010 6:41 PM, Blogger juandos said...

Well even though Dr. Perry has posted a crystal clear explanation of tariffs, some people are still flailing away and trying to rationalize protectionism...

Listen to Dr. Sowell's explanation of the downsides of Smoot-Hawley...

 
At 1/05/2010 6:45 PM, Anonymous Dr. T said...

"Nations Don't Trade With Each Other; Individuals Do"

That's not quite the truism MP believes. Nations sometimes enact complete trade embargoes. Except for smugglers, no individuals are trading when embargoes are in effect.

 
At 1/05/2010 8:31 PM, Blogger Bruce Hall said...

Since we are talking turkey instead of economic theory, why not look at the results of U.S. individual [not so much] / corporate [you bet] / government [on China's side] trade.

While U.S. manufacturing has recovered slightly from the recession, the BLS projects continued declines in manufacturing for everything from cotton socks to computer sockets. Real growth is occurring in health care services.

So, while Chinese corporations [many owned by the government] accumulate not only U.S. dollars for use elsewhere, but technological expertise for internal and external use... we prefer to graduate fewer students, manufacture fewer products, and spend more on health insurance. Which country has the brightest economic future under that scenario? Which country is experiencing growth in real wealth? Which country [corporations included] have significantly growing currency reserves to compete for critical resources? Which country is expanding their commercial and military presence not only in the middle east, but in Africa and South America?

Which country will be the dominant global economy in the latter half of this century?

Results, not theory.

 
At 1/05/2010 9:26 PM, Anonymous artemis said...

Machiavelli999 - It's an interesting argument as you are now saying that in a master/slave relationship, then it is the master that's harmed. I think history shows otherwise.

 
At 1/05/2010 10:16 PM, Anonymous Noel said...

I agree with you 98%. The people who harp on about trade deficits should learn a lesson from this.

But my 2% of disagreement is the handhold to which they cling by their fingernails: China manipulates it's national currency and susidizes it's industries, hence the unit of analysis is elevated above methodological individualism.

Nevertheless, if the government of China is willing to give us subsidies and extremely low interest loans, why the hell are we complaining?

As I said the other day, the problems of American employment and productivity are the result of decisions WE make, not decisions China makes. Our resources are free to pursue higher value uses. If people can't rise to that challenge, then they need to change hotel linens for the rest of their lives or perfect the phrase, "Would you like fries with that?"

I'm not the slightest bit worried about losing my business to foreign competition, foreign monopolies, or foreign exchange rates. I got hit really hard when the price of rice soared, but if I can survive that I can survive anything.

 
At 1/06/2010 12:25 AM, Blogger PeakTrader said...

Dr Perry makes an excellent point, which many people are unaware of.

Bruce Hall asks: "Which country will be the dominant global economy in the latter half of this century?"

Currently, the U.S. leads the rest of the world combined in the Information and Biotech revolutions (in both revenues and profits). Moreover, roughly 2% of the U.S. labor force works in agriculture. Yet, that small workforce produces more than enough food to feed the entire country. Furthermore, the U.S. continues to produce more output with fewer inputs in manufacturing. I stated before, the only way to move from one economic revolution into the next is through efficiencies (utilizing limited resources).

Third World countries, including China, haven't been able to reproduce high quality goods, e.g. through reverse engineering. For example, China can't produce Toyotas, perhaps, because it can't meet quality standards and low production costs.

Also, I may add, does it matter if a foreign firm or country buys an American firm? (e.g. paying a premium to own IBM, Johnson & Johnson, or Walmart). The owners shift from American to the foreigner. However, the people who made those firms great and make them greater are Americans. That's why the quality of education, training, and experience are so important.

 
At 1/06/2010 1:13 AM, Anonymous Anonymous said...

Bruce Hall,

Name a single product invented and produced in China that every consumer wants to buy. Quickly, name the top three Chinese brands.

China will be an extremely old country in the latter half of this century and the U.S. will dominate the global economy.

More than 30 years after China's one-child policy was introduced, creating two generations of notoriously chubby, spoiled only children affectionately nicknamed "little emperors," a population crisis is looming in the country.

The average birthrate has plummeted to 1.8 children per couple as compared with six when the policy went into effect, according to the U.N. Population Division, while the number of residents 60 and older is predicted to explode from 16.7 percent of the population in 2020 to 31.1 percent by 2050. That is far above the global average of about 20 percent.

The imbalance is worse in wealthy coastal cities with highly educated populations, such as Shanghai. Last year, people 60 and older accounted for almost 22 percent of Shanghai's registered residents, while the birthrate was less than one child per couple.

Xie Lingli, director of the Shanghai Municipal Population and Family Planning Commission, has said that fertile couples need to have babies to "help reduce the proportion of the aging population and alleviate a workforce shortage in the future." Shanghai is about to be "as old -- not as rich, though -- as developed countries such as Japan and Sweden," she said.

Washington Post

China, like Saudi Arabia, has one thing to offer. For the Saudi's it's oil, for the Chinese it's cheap labor. But as their population ages that advantage will wane. Further, China is a kleptocracy and no nation can steal and cheat it's way to long term prosperity.

 
At 1/06/2010 2:05 AM, Anonymous Dave Thomas said...

The issue really is freedom. The world would be a much better place if I could buy anything that I came across or sell anything anywhere I wanted. I don't worry about borders, but instead worry about producing something that people want to buy. If I'm successful at that then I can buy from someone else what I desire. If only everyone had the self-confidence to truly embrace this freedom. China certainly doesn't allow individuals within its border to do this.

 
At 1/06/2010 10:38 AM, Anonymous Clay Barham said...

From her works, it is apparent Ayn Rand admired the courageous pebble-droppers, the nails standing above the boardwalk that ruling elite might trip over, who challenged the established and accepted way things were done. It was the creative, imaginative individuals who followed a dream, a vision of some better way of living that she wrote about, not the socialist taker who envied the creative few even when enjoying the benefits of the pebble-dropper’s efforts. This was her focus. All other ingredients haters add to the interpretation of Ayn Rand’s ideas are simply mud to cloud the water. Whether she was atheist or Jewish, anti-Christian or self-centered means nothing. She believed she was OK and others, as individuals, were potentially OK as well, but herds were led by the few who would limit individuals and take from those who have to share with those who have not, and they and their leaders were not OK. Those who violently oppose Rand are the ones who want to retain the Old World ideals of a few elite ruling the many, as is being reintroduced to America by the Obama forces. Claysamerica.com

 
At 1/06/2010 11:21 AM, Blogger sethstorm said...

I'd have to disagree due to the idea that one cannot ignore regulatory domains(even as an individual).


Also, I may add, does it matter if a foreign firm or country buys an American firm? (e.g. paying a premium to own IBM, Johnson & Johnson, or Walmart). The owners shift from American to the foreigner. However, the people who made those firms great and make them greater are Americans. That's why the quality of education, training, and experience are so important.

They're called a national security risk. See the attempts by CNOOC, and Dubai Ports alongside the failed attempt at IBM PCD's sale to Lenovo. All the same thing.

At that point, the history doesn't matter since it will be trashed, case in point being Lenovo. Quality goes out the window in ways the original company never would do.

For all purposes and intents, Wal-Mart is foreign owned by the nature of their inputs(being largely Third World). It would take the corporate version of insurrection to undo it.

 
At 1/06/2010 11:45 AM, Blogger Red A said...

A few questions:

1. Is the way China and Chinese companies trade optimal? I mean, if an economist were to set up the rules, would they have the sterilization, the state-run banks, the state-run industries? No, they would not. Thus trade with China or Chinese companies is problematic. Sure, maybe not worth a trade war, but problematic.

2. If you consider the sterilization that keeps the Yuan low, what happens next? Well, the US gets lower interest rates than if there were no program - and this has effects as well. Trade with China/Chinese companies is not just sitting in isolation, but affecting other areas as well - including housing!

3. Austrian business cycle considers that mis-investment in the wrong areas is a big factor in recessions. Now, for both China and the USA, distorted incentives may be making China invest in too many factories and us in too many houses (previously) - is that healthy?

I am not sure what to do about this - a trade war right now is probably not a good idea, and the problems are not only on China's side. Maybe letting them take a hair cut on Fannie/Freddie bonds would have been a nice start.

 
At 1/06/2010 11:49 AM, Blogger Red A said...

Oh, and on point 3. about mis-investment, it takes decades to build up an industry. Once you have the skills and talented workers, its a big advantage. If that industry relocates to China based on incorrect non-market information, like RMB exchange rates, good luck trying to recreate that industry quickly. Yes, the market will work over time once market forces are back in operation, but there are massive transaction costs.

 
At 1/06/2010 11:50 AM, Blogger sethstorm said...


1. Is the way China and Chinese companies trade optimal?

Yes and No.

For trading, it appears to be.

For any non-economic concerns, no.


I am not sure what to do about this - a trade war right now is probably not a good idea,

If it triggers unrest in China that collapses the country, I'm all for it.

 
At 1/06/2010 4:58 PM, Blogger Dave said...

Excellent post. I agree entirely and wish more people knew this lesson. A few responses to some of the comments:

Mach999,

If someone produces more than they consume, then they are able to sell those on the open market and buy things that they are not otherwise able to produce or can only produce by giving things up. There is no master-slave relationship here and this does not imply that someone is consuming more than they produce. In fact, the popularity of a savings account with any positive amount of money is indicative of actually consuming LESS than one produces. Even when you are in debt, you are still only borrowing against your future consumption assuming you pay the loan back. Further, the popularity of leaving behind money/property/things for the kids is indicative of consuming less than one produces.


Dr. T,

Well... embargoes are really just making trade between individuals illegal. The nations still don't trade with eachother or stop trading with eachother. They simply stop individuals from trading, so I don't really understand the distinction that you're making.

 
At 1/07/2010 8:57 AM, Blogger Pete Murphy said...

Our enormous trade deficit is rightly of growing concern to Americans. Since leading the global drive toward trade liberalization by signing the Global Agreement on Tariffs and Trade in 1947, America has been transformed from the wealthiest nation on earth - its preeminent industrial power - into a skid row bum, literally begging the rest of the world for cash to keep us afloat. It's a disgusting spectacle. Our cumulative trade deficit since 1976, financed by a sell-off of American assets, exceeds $9.5 trillion. What will happen when those assets are depleted? Today's recession is the answer.

I am author of a book titled "Five Short Blasts: A New Economic Theory Exposes The Fatal Flaw in Globalization and Its Consequences for America." My theory is that, as population density rises beyond some optimum level, per capita consumption begins to decline. This occurs because, as people are forced to crowd together and conserve space, it becomes ever more impractical to own many products. Falling per capita consumption, in the face of rising productivity (per capita output, which always rises), inevitably yields rising unemployment and poverty.

This theory has huge ramifications for U.S. policy toward population management (especially immigration policy) and trade. The implications for population policy may be obvious, but why trade? It's because these effects of an excessive population density - rising unemployment and poverty - are actually imported when we attempt to engage in free trade in manufactured goods with a nation that is much more densely populated. Our economies combine. The work of manufacturing is spread evenly across the combined labor force. But, while the more densely populated nation gets free access to a healthy market, all we get in return is access to a market emaciated by over-crowding and low per capita consumption. The result is an automatic, irreversible trade deficit and loss of jobs, tantamount to economic suicide.

One need look no further than the U.S.'s trade data for proof of this effect. Using 2006 data, an in-depth analysis reveals that, of our top twenty per capita trade deficits in manufactured goods (the trade deficit divided by the population of the country in question), eighteen are with nations much more densely populated than our own. Even more revealing, if the nations of the world are divided equally around the median population density, the U.S. had a trade surplus in manufactured goods of $17 billion with the half of nations below the median population density. With the half above the median, we had a $480 billion deficit!

Our trade deficit with China is getting all of the attention these days. But, when expressed in per capita terms, our deficit with China in manufactured goods is rather unremarkable - nineteenth on the list. Our per capita deficit with other nations such as Japan, Germany, Mexico, Korea and others (all much more densely populated than the U.S.) is worse. My point is not that our deficit with China isn't a problem, but rather that it's exactly what we should have expected when we suddenly applied a trade policy that was a proven failure around the world to a country with one fifth of the world's population.

If you‘re interested in learning more about this important new economic theory, then I invite you to visit my web site at http://PeteMurphy.wordpress.com.

Pete Murphy
Author, "Five Short Blasts"

 
At 1/10/2010 12:24 AM, Anonymous Ravi said...

I don't have a background in econ but I understood this fairly simple point ages ago. What I don't get is, why is this so hard to understand, or Nobel Winners like Krugman?

 

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