The Income Gap by Rick Kelo

The Income Gap by Rick Kelo
“The state is that great fiction by which everyone tries to live at the expense of everyone else”~ Friedrich Bastiat

There is a great problem facing America today.  As a nation we have been voting ourselves more and more benefits for the last 2 generations; benefits we don’t have enough money to pay for.  Any time governments get larger and more activist they drain and distort the economy.  Studies have shown that public policy widens the wealth gap.  A government that is an activist player in a free market economy creates many ill effects opposite of what its “do gooder” intentions set out to do.

Beyond that there are many places where you can read that the distribution of wealth is uneven in a capitalist economy.  It is one of the most common complaints about free markets: that they end up concentrating wealth in the hands of only a small proportion of the society.  Beyond the question of government policies that add to this gap scarcely has a soul considered if it must be this way, why the distribution of wealth occurs, what the alternative is, and whether it is a good or a bad thing.  So I will start by seeing if each point makes logical sense, and then give you some empirical evidence for each.

Must it be this way?  The definition of capitalism is private ownership of the means of production, with the goal of making a profit.  Let’s just imagine a world where there was balance.  In that world the consumer would spend all of his wage on buying things and the business owner would spend all of his on paying a salary.  So every time the worker spends his pay money leaves the economy/the system, every time the employer pays out wages money enters.  In that scenario the amount of goods being produced and trying to be sold just keeps going up.  There is no more money in the system but there are new goods being cranked out every day.  That leads to things being produced for which there isn’t enough money to purchase them. The business owner suffers a loss from the cost of unsold products, and must lower wages.  Now there is even less money able to purchase the rising amount of goods and we have a recession.

Now I hope I didn’t go too fast with that, but it’s a basic example that shows you there cannot be a balanced system.  The business owner must retain some of the money he makes.  If he pays out everything he makes the economy self-destructs.  Savings is what allows there to be spending on research of new technologies, it’s what allows the employee to keep his job when not all the goods he produces are purchased, and it’s what allows the business owner to expand and so on.  You cannot criticize those who have done a lot of saving because the economy that the worker depends on cannot exist without someone being rich.

Why does distribution of wealth occur?  Well in a free market the wealthiest people are the ones who produce something the common man wants to buy.  If you produce a product that only caters to the rich your business will never be very big.  When I drive down the road on any given day I see a lot of Fords; I don’t see a single Ferrari.  Why?  The reason is because capitalism caters to the common man.  In a free market every producer has an incentive to lower the price of their service so more people want to buy it.  The suggestion that capitalism is somehow against the common working person is a lie.
Now let’s look at every other area of human endeavor.  The best chess players could play thousands of games against you and me and never lose.  Professional golfers could golf against the rest of us forever and never lose.  Not everyone has equal talent.  Making money is no different: it is a specialized talent that not everyone possesses.

Now that deals with the entrepreneur… the business owner… and why he makes more than others.  But what about the rate of pay among employees?  Is it somehow unfair that the brain surgeon who can save your life from the most complex disease ever makes 100 times what the cashier performing a job anyone could do makes?  How about the pilot flying the last airplane you were on?  Is it unfair he makes more than the stewardess serving drinks?  Of course it isn’t.  Now compare that to the discussion of the employee named “the CEO.”  It’s no different; only envy of someone in a higher station of life makes it different.  And for that people blame capitalism; especially once they reach the point in their life that they see their more successful peers pass them by.  In reality though we are only seeing an application of the same principle of the pilot and the stewardess.
What is the alternative to wealth inequality?  Easy enough the alternative is “egalitarianism”.  It is redistributing wealth from the rich to everyone else.  There is a fatal flaw to this argument that no one considers.  Wealth inequality exists because of our social arrangement.  It is only because humans are incentivized to produce as much as they can under capitalism that any become rich in the first place.  Remove the incentive and you destroy the productivity that goes along with it.

If we are going to have wealth distributed equally then we are going to have to force people to work for free.  Do you think Steve Jobs would have slaved away for 20 hours a day to produce what he did if he could have been paid the same to sit in a cubicle from 9-5?  Of course not, the incentive of money is what generates advances in mankind.  And look next at how many people his company now provides jobs for, and how many consumers benefit from using their products?

There is a deeper problem at play though: redistributing wealth cannot be egalitarian like its proponents suggest.  Egalitarianism suggests you treat everyone equally.  But if you are only taking from some you are not treating all equally.  If I am taking money from the rich and giving it to the poor I am admitting they are not equal, because if they were equal they would have equal rights.  So if the poor & wealthy are equal human beings under the law then the poor have no more right to lay claim to the riches of the wealthy than do the wealthy to exploit the poor (for which we have a great many laws & protections in place).

Is unequal wealth distribution bad?  No it isn’t.  People who claim it is overlook the fundamental issue.  If it were bad then the quality of life of the average person would not be constantly improving.  Why is that happening?  Because you do not have to own a means of production in order to benefit from it.  If the rich own it the common man still benefits from it.  None of us own a clothing factory yet we have, at our disposal, the widest variety, style, materials and price ranges of clothing imaginable.  We are not in need for clothing even though none of us has a way to produce it.

Now most people default to their opinion that unequal wealth distribution is bad because they equate it to the majority of human history when the common man was unable to change his social station.  He was never going to become a king, or the chief of the tribe.  But not so in the capitalist economy!  There is no job in the American economy any person is employed in that has not produced a millionaire in that industry.  And even beyond that just one change in technology can radically alter the landscape of wealth and make entire functions that had been “sure things” obsolete.  Don’t think so?  Go ask Bill Gates how many people were using Internet Explorer 5 years ago.  Then ask him how he now has only 20% of the browser market and lost it to two free, open source products.  That is the power of the innovation inherently inspired under free market capitalism.

Also, many of the people who claim wealth inequality is “unfair” are still using the knowledge of what money is that they learned as a child.  I have 3 kids and when the family has a resource it gets divided equally.  When one kid earns an allowance for doing a chore the others have to be given the same opportunity to make an identical amount.  If not, then they claim things are “unfair.”  Sound familiar?  Except the world isn’t the family you grew up in.  You can’t use the viewpoint of a child to understand the world of adulthood.  Why?  Because wealth is not fixed.  Wealth is created all the time.  Back in the Middle Ages if we surveyed an agrarian village we’d see that some people had granaries and some did not.  Why?  Because only some decided to work hard enough to build them.  They created wealth, and the process is no different today.  But please, no one tell Barack Obama that someone “didn’t build that.”

Capitalism vs. Socialism: A Crash Course in World History

On Free Trade 5: Tariffs by Rick Kelo

Tariffs: Free Trade Isn't About Jobs, Its About Which Jobs

This is the most common barrier to free trade.  We allow foreign imports, but we slap a tax on the goods coming in.  This has the effect of protecting the few American workers who make that good at the expense of everybody in the world.  Everyone in America now has to pay a higher price to buy the tariffed foreign good, but they also have to pay a higher price to pay the US made version because now the US companies protected by the tariff can sell their product at a higher price too.  The tariff hurts everyone outside the US because we buy our imported goods with our exported goods.  The tariff makes our trade partners able to buy fewer American made goods.



TARIFF EXAMPLE: ORANGES VS. POTATOES
Ignoring the Constitutionality of it for a moment, just to make this easy to picture suppose Florida & Idaho are engaged in trade.  Florida trades oranges in return for Idaho potatoes.  Id
aho does grow some of its own oranges, but due to the temperatures the trees have to be grown in expensive hot houses.  Florida does grow some of its own potatoes but because of its close elevation to sea level and water tables the potatoes have to be grown in special raised gardens up on stilts.

Article Photo
People are mad!!  The special interest Idaho Orange Growers Union has organized a protest.  They are becoming unemployed because they cannot compete with these low-priced imported oranges from Florida.  If Idaho imposes a high tariff on imported oranges from their trade partner they can prevent job losses at home.  Now tell me how much sense it makes to do that?



This simple example is exactly what all tariff debates are about: the conflict of nonsense over reason. 

Raising a tariff on Florida oranges will protect the jobs of the greenhouse workers in Idaho, but only by making everyone suffer under much higher prices.  Now consider that same effect (protecting the jobs of Idaho orange growers) from the angle of opportunity cost.  If those Idaho workers weren't wasting their time & resources trying to very inefficiently force oranges to grow oranges in huge greenhouses when better, cheaper oranges are available through trade then those exact same people would instead be employed in another area of the Idaho economy.  They would be working in a higher demand area of the economy making something that Idaho has an advantage in.  If there is no tariff against imported oranges then everyone in Idaho benefits because the overall Idaho economy becomes larger and grows more quickly.  True the Idaho greenhouse workers will slowly lose their jobs as the free market naturally shifts them into another area.  Idaho citizens now get cheap oranges and cheaper goods in all the other areas the orange farmers went to work.

TARIFFS, JOBS & ROBBING THE WORKING CLASS
This is what economists mean when they say its about "which" jobs an economy is most benefited by having.  Free trade diverts labor slowly, gradually and naturally into the most efficient areas.  The result is that overall output is increased.  This is HUGE for an economy because an economy isn't made up of all the money in a system, that's why things like trade deficits don't actually matter.  An economy is made up of all the goods and services produced.  Produce more goods & services than before and your whole society becomes richer, cleaner, has less unemployment, more vacation time, a cheaper grocery bill and on and on it goes.

Think about the 2.5% tariff on imported cars.  Government decides it is going to privilege the auto industry by protecting it partially from competition, thereby protecting American workers in the auto manufacturing industry.  This can only do so by hurting workers in every industry outside the privileged industry.

Now the waitress, construction worker and cashier all must pay more for a car.  They pay more not only if the buy the foreign car, they also have to pay more if they buy an American car because now Detroit auto manufacturers can charge higher prices due to the tariff.  We make the waitress pay more of her hard earned tips to buy a less fuel efficient, lower performing, more expensive to maintain car in return for the privilege of protecting the auto manufacturer from competition.

The alternative to the tariff is to force American car makers to compete by producing cars Americans actually prefer.  Here's one example: Honda.  Due to superior entrepreneurial foresight Honda correctly anticipated consumer preferences and started selling very fuel efficient cars in the US about 10 years ago.  Demonstrating very inferior entrepreneurial foresight American car manufacturers were busy peddling gas guzzling SUVs.  We can have a tariff to try and force Americans to buy cars they don't want, or we can eliminate the tariff and force American companies to design cares people actually want for a change.

A tariff is nothing more than a tax paid at the cash register the proponents of tariffs would have you believe that we can make America richer by raising taxes on Americans.  Suppose the government fined you $20 every time you watched a movie at home... that would definitely give a nice bump to the movie theater industry.  People who wanted to watch a movie would go to the theater instead, they would have to hire more workers for the increased demand.  The movie theater industry would pay higher wages in order to reduce business disruption due to turn-over, etc.  In spite of all that no one in their right mind would think it was a good idea for the nation.  Tariffs make as much sense as putting a tax on every meal people cook for themselves at home in order to boost the restaurant industry.

On Free Trade 4: Outsourcing... They Took Our Jobs! by Rick Kelo

Our own econometric work at the IIE refutes, in particular, the contention that US direct investment has the effect of "exporting jobs."  We find that actually new US outward investment stimulates US exports rather than suppressing them.  Thus, outward US FDI (foreign direct investment) results in job creation in the export sector, which generally commands a wage premium in the United States.

Dr. Edward M. Graham, Professor of Economics, Columbia; "The Cause of AntiGlobalists Is Wrong in the Aggregate"

What's that guy in the quote talking about?  I'll translate it:

Industries where workers are more productive pay better wages.  The worker isn't more productive because he works any harder or longer hours than in the other industry, but that industry has a more developed & superior capital structure, which allows for a higher "marginal productivity of labor" overall in that industry.  Its that added efficiency from the capital structure & that added demand of having foreign demand added on top of our existing domestic demand that pays more.  The less efficient industry that loses jobs due to free trade is also the industry that - because it has lower productivity - was paying less.

Example: the guy digging a ditch with a shovel gets paid a lot less than the backhoe operator.  Both can input the same hours of labor in a day, but one is more productive because he has a superior capital structure of equipment behind him (just picture all the machines it took to produce that backhoe).

When foreign companies invest in the US by building, say a manufacturing plant, it obviously creates jobs here.  When we invest abroad, as Dr. Graham points out, it creates jobs here.  So that's the flow of money... but how about the impacts on jobs from the flow of goods?

OUTSOURCING: GAINS VS. COSTS 30:1

When nation's open up to free trade two things happen:

1. There are "adjustment costs" in that nation.
2. There are "welfare gains" in that nation (the country grows in both new jobs & wealth due to trade).

Adjustment costs are commonly called "outsourcing" meaning the country loses some jobs due to trade.  Welfare gains come in two forms.  The first is the country becomes a lot richer because it not only gets cheaper foreign goods thus saving money, but jobs shift into better paying domestic industries creating higher overall wages in the nation.  Those two things together (lower cost products + higher wages) are termed welfare gains.

OVERALL the total jobs in the country DOES NOT CHANGE.  Free trade is never about how many jobs there are going to be.  Its about which jobs.  It's about using the power of the market to shift people into more efficient - and just like the backhoe operator - higher paying jobs.  As you can see in the graph of imports as a % of GDP America's import of goods/services has grown steadily.  Our unemployment rates haven't, on average, changed very much over time because imports don't cause unemployment as we'll look at in more detail below.

We are commonly led to believe that the costs of free(r) trade are much higher than the gains.... except... they aren't.  When a national liberalizes its trade policies (adopts freer trade), then for every $1 of trade adjustment costs that same nation experiences $30 in welfare gains.  That's right.... the benefits outweigh the costs 30:1.

There has never been a single news story reporting this fact.  Ever.  Neither will there ever be one.  Why?  It's very easy to report on 120 people who lost their job because their company was inefficient and couldn't compete with cheaper foreign goods.  That's visible.  But what about the invisible?  It is very hard (and a lot less interesting if you care about ratings) to report on new jobs that spring up due to trade.  

Those new jobs created are in America's most productive, and therefore highest paying, industries.  The jobs lost are in our lowest paying, most outdated, and least efficient industries.  So those are the "welfare gains."  Shown below in Figure 1 are America's trade costs for the last 12 years.  I included this table to demonstrate to you that its mostly a myth that jobs are lost due to them going overseas.  There is some job loss for this reason but its, overall, very minor.... nothing like you've been led to believe. 

Figure 1: Trade Doesn't Cause Unemployment; source: BLS.gov

At its core trade is an issue of using resources more efficiently.  When America gained its independence in 1776 over 85% of the nation worked in agriculture.  Today less than 2% does.  This ability to use resources more efficiently allowed 83% of the labor force to do additional things we couldn't previously do.  Its called the division of labor, and free trade is the division of labor on a multi-national scale.

OUTSOURCING: COSTS VS. GAINSNow that we've considered the 30:1 gains for engaging in trade let's look at the costs of erecting artificial barriers to free trade.  The costs of using these crude & ineffective "protectionist" measures averaged a quarter million dollars for each job we artificially delay adjusting into a higher paying, more profitable industry.

This graph is taken from a study the Dallas Federal Reserve assembled for its Annual Report:

Figure 2.
Source: https://www.dallasfed.org/assets/documents/fed/annual/2002/ar02.pdf

AN EXAMPLE: CARSLet's look at outsourcing. It is the primary complaint levied against free trade.  If we have free trade then all our "good" jobs will leave the country and other countries will get them instead and America will be worse for the exchange.

A 25% Tariff Makes This US- Made Truck More Expensive

As I write this America has a 25% tariff on the price of any imported pick-up trucks and a 2.5% tariff on imported cars.  To take the car tariff as an example the obvious effect it has is to make everyone in America who does not buy from Ford or GM pay a higher price.  So the tariff serves to enrich the special interest of 2 companies by impoverishing the general interest of everyone else who has to suffer higher prices.

That's only the surface level effect, but how about the real effects?

SOCRATES MEETS JOB OUTSOURCINGBefore I delve into this let's apply some good ol' fashion Socratic logic and apply some reductio ad absurdam.  Suppose Americans gave up their interest in pick-up trucks and instead favored some other type of vehicle in the future.  Pick-up truck sales fell to 0.  It would be silly for the Detroit auto industry to keep cranking out Ford F-150s and it would be a gigantic waste for the government to keep a 25% tariff to "protect truck manufacturing jobs."  Why?  Well obviously the purpose of producing something is for it to be consumed.  If people no longer prefer to consume something then it doesn't make any sense to produce.  

Now let's take that same line of thought and dial it back to the partial position: if people decide they no longer prefer American pick-up trucks and instead prefer trucks made in South Korea then those manufacturing jobs have lost their purpose: to produce something people demand to consume.  That labor is no longer being used efficiently and those companies should (and will) switch to making a more desired product.  

For this reason we see that free trade isn't really about America losing jobs... its about people moving from jobs in less desirable areas into jobs in more desirable sectors of the economy.  Does anyone reading this really think the occupation of chimney sweep, a booming job 100 years ago, is going to exist 100 years from now?  Really think Americans are going to be manufacturing cars 100 years from now?   I personally even doubt that human beings of any nation will be manufacturing cars 100 years from now, its likely to all be done by robots and the few humans employed in that endeavor will be in today's undeveloped regions of the world.

As one final point on that note here is a graph of import penetration compared to unemployment so you can plainly see for yourself that the level of imports has no bearing on the level of unemployment:

Figure 3.  Imports Don't Cause Unemployment.

JOB LOSSES TO ROBOTSSince we've talked about jobs being outsourced to other countries what about jobs being outsourced to other methods of production?  A lot of people complain about the use of robots to do work humans used to do so I felt this merits addressing at the same time as job outsourcing since its related.

Picture Robinson Crusoe stranded on his island.  He has to provide his own fish, sheer sheep to make clothes, shepherd them, build his shelter, cook his own food and forage for berries (or whatever else he does).  One day a plane flies over and drops him a robot that will do all his cooking for him.  Now instead of cooking he has more free time to engage in an extra activity he previously couldn't do.  Now maybe he can plant a vegetable garden or build a chicken coop.  

Robinson Crusoe's standard of living is increased by having the robot, and so it is with us.  If America can outsource its least productive work, whether its to a machine or to other nations, our standard of living increases.  Now we get the benefit of the work that we outsourced plus the benefit of the new work we're free to do that we couldn't before.  That brings us to this quote:

“Over the long sweep of American generations, we simply have not experienced a net drain of jobs to advancing technologies or to other nations.”
~ Alan Greenspan

MANUFACTURING
This is one industry I'm going to look at in detail because it is a favorite for protectionist lies & propaganda.  What determines if America has a strong manufacturing sector?  The amount of things produced, or in technical terms "manufacturing output."  The more productively we can produce the higher wages become.  A backhoe operator can dig a hole much faster than a guy with a shovel.  That's why he's paid more.  So if we want a thriving manufacturing sector then we require those two things: more output and greater productivity.  

The quantity of people employed in manufacturing is irrelevant, and to consider why just remember that in 1776 some 85% of Americans were employed in agriculture and food shortages were commonplace.  As productivity improved year after year we eventually ended up in 2013 where less than 2% of the nation is employed in agriculture and we produce more food than we can eat.  The improvements in the manufacturing sector we're about to look at follow along those lines, I just wanted to give you another analogy to help you picture it.

Below is manufacturing output, and productivity is below that:

Figure 4.  Source: http://research.stlouisfed.org/fredgraph.png?g=nP6

On Free Trade 3: Exports Sucking Out American Money By Rick Kelo

On Free Trade 3: Exports Sucking Out American Money
By Rick Kelo

TRADE DEFICITS... UH OH

A nation pays for its imports with its exports.  So what happens when a country (like the US) imports more than it exports.  This is a trade deficit.  In the 1600s mankind adopted a school of thought called Mercantilism.  Mercantilism stated that trade surpluses were good and trade deficits were bad.  Even though mercantilism was refuted around the 1800s this myth has existed in the collective consciousness of many who are still led to believe a trade deficit is bad.  What a trade deficit really means is that our nation is exporting money in return for foreign imports instead of exporting only goods in return for foreign goods.

An example:

Picture a lawyer who lives in downtown New York City.  He eats out every day at the restaurants nearby.  Breakfast, lunch and dinner.  Last year no owner or worker from any of the restaurants hired him to represent them.  He is running a trade deficit with his favorite restaurants: he is spending more money on the things they produce than they are spending on the things he produces.  Is this a recipe for the lawyer's economic collapse?!  Of course it isn't.

Somehow this exact scenario above becomes hard to picture when we are asked to picture a nation instead of our individual lawyer.  By the way, why isn't this lawyer's trade deficit with his trade partners a problem?  The restaurant isn't the only group the lawyer trades with in a year.  He happens to run a pretty big trade surplus with the law firm who employs him.

What if the lawyer was in a total trade deficit though?  If the restaurants were willing to give the lawyer food every day and expect no payment then he has gotten a very good deal.  Likewise if other countries in the world were stupid enough to send us awesome goods that we desire in return for nothing but $100 bills that would be a great deal.  Here's an easy explanation in the video below:

HOW TRADE DEFICITS WORK
Like we mentioned the idea of the trade deficit goes back to the mercantalists who felt the need to stockpile as much money as possible.  In the 1600s they were trading the goods their country made (its economic output) for money.  Except "money" in those days wasn't green pieces of paper, it was pieces of gold.  So, in effect, the Mercantalists were trading goods from their country (say cars & Florida oranges) for gold (also a good produced through mining output in another country).

What happened?

Well as one country ran a trade surplus more gold ended up in that country.  As we now know gold is a commodity.  What happens to commodities when the supply goes up?  Bingo.... price falls.  So as one mercantalist nation would amass a greater amount of gold from a trade surplus the price of that gold fell.  Since money was linked to a gold standard that decline in the value of gold made prices in the nation with the trade surplus rise and prices in the nation with the trade deficit fall.  Eventually the citizens of the nation with the trade surplus (and the big gold stockpile) started buying the cheaper foreign goods and gold flowed out of their country.  

That, ladies & gentlemen, is how economic equilibrium works.  The only people willing to ignore this truth are usually special interest groups lobbying for a special government protection to their small group.  They would prefer the federal government interfere with the voluntary spending decisions of American consumers as a special favor to them, while disguising their concern as the lowering of a trade deficit.

AN EXAMPLE: ASIAN TRADEThe Japanese export a lot of cars to America.  Japan also imports things from America.  In fact 80% of its oil is imported from America.  Now suppose America reverts to Mercantalist thinking, gets concerned with our trade deficits, and decides to reduce them.  It is decided we will artificially lower the amount of Japanese cars we bring into the nation.  Government will either restrict them directly by force through an import quota or indirectly by forcing prices artificially higher through a tariff.  In doing this the first order effect is American car sales must necessarily increase to make up the shortage in demand.  The second order effect though is that we have reduced how much oil Japan can buy from workers in Texas & Alaska.

Lastly, let me close by point out that it is a total myth that trade deficits are caused by foreign competition.  They're not.  A trade deficit is only caused by American consumers.  American consumers preferred to buy more goods from overseas than the amount of goods those same Americans produced, then decided to sell overseas.

TRADE DEFICITS AND JOBS
I'm going to close on this idea to shift us to tomorrow's article on outsourcing of jobs.  One of the common, but incorrect, claims about trade deficits is that reducing them will create jobs in America.  That is untrue because the trade deficit is precisely offset by another item called the "capital account surplus."  Explained simply when US investors invest capital in a foreign country, then that dollar value of capital flows out of the US.

Now hold that thought in the back of your mind and think about the trade deficit.  A trade deficit means that the dollar value of imports has been more than the dollar value of America's exports.  Foreign capital has flowed into the US.  The trade deficit is offset by these capital inflows as foreign investors have, in effect, built factories & businesses in the US.  The only way to eliminate the $540B trade deficit America had last year is to also eliminate a $540B foreign investment surplus that creates American jobs.

People who discuss the impact of trade on outsourcing claim jobs are being exported, but they're not.  The jobs that get outsourced move because foreigners have a comparative advantage over Americans in that industry.  That kind of outsourcing is clearly good for America because it has the effect of the American consumer getting to hire cheap foreign labor and collect up the gains from trade.

On Free Trade 2: Sweatshops, Job Outsourcing & More By Rick Kelo

On Free Trade 2: Sweatshops, Job Outsourcing & More
By Rick  Kelo 

It is the maxim of every prudent master of a family never to attempt to make at home what it will cost him more to make than to buy.
~ Adam Smith

The next articles the rest of the week will look at:

• Trade deficits (tomorrow)
• Outsourcing of jobs (Thursday)
• Tariffs (Friday)

First let's look at some popular myths about trade.  Nothing too technical, just a few of the common objections we hear when this subject comes up.  I'll offer you an original thought & expose you to a new perspective on each myth.

TRUTHS OF FREE TRADE
Before the myths I want to share the Law of Comparative Advantage.  It says that its most efficient for you to produce what you're best at.  It doesn't matter if someone else is better at it than you are, so long as its the thing you're best at that's what you should do, then trade for the other things you're not the best at producing.

THE DOCTOR AND THE SECRETARY
Here's an example: imagine a skilled doctor who happens to be an awesome typist as well as awesome at practicing medicine.  It turns out he types twice as fast as his secretary.  It is still to the doctor's advantage to trade with the secretary because while he is 2 times better at typing than she is he is also 100 times better at practicing medicine.  Now take it one step further and tell me how stupid it would be for our doctor to sew his own clothes from scratch just to "create employment opportunities" for himself in the field of clothes manufacturing.

Compare that to the barriers against free trade.  First and foremost, just as the doctor is guided through trade to the most efficient arrangement for everybody the opposite is also true if we set up trade barriers.  They create inefficient resource allocation while also benefiting only a few privileged businesses at the expense of every consumer in America who pays higher prices.

MYTH 1:

• MYTH:Trade is a zero sum game, if we give something up the other country gains and we lose.
• TRUTH: Poker is a zero sum game, trade is a positive sum game.  A review of all 50 nations who have adopted freer trade in the last 45 years revealed the gains were 30 times larger than the costs defined as the domestic losses due to freer trade.  (World Bank: Tarr, Matusz, 2005).
• CONSIDER THIS: Trade is based upon voluntary cooperation.  When we peaceably trade with one another then that is a positive sum game because you are better off AND I am better off.  If we are not both better off by making the trade then we would not have exchanged.

MYTH 2:

• MYTH: Free trade helps multi-national corporations become more powerful.
• TRUTH: Free trade exposes corporations to competition.
• CONSIDER THIS: If the myth were true then why is it always large, powerful corporations & lobbies that ask for trade protection?  Without trade the consumer is limited to domestic goods and large corporations can corrupt or manipulate American politicians.  Anyone who's seen a badly run, inefficient business in a Congressman's district get propped up by an earmark understands this.  Compare that to the treatment large corporations receive under free trade: now the consumer can savagely reject companies who don't measure up by reaching across international borders and choosing the very best option available anywhere.

MYTH 3: 

• MYTH: A nation's economy grows stronger by selling a lot and buying a little.
• TRUTH: "When one nation exchanges a part of its commodities for a part of the commodities of another nation, the nation can gain nothing by parting with its commodities; all the gain must consist in what it receives." ~ James Mill, Elements of Political Economy, 1844.
• CONSIDER THIS: As far as economists are concerned nothing has changed regarding trade for over 200 years.  The more goods a nation imports the better its standard of living will be because imports represent the benefits of trade.  Its exports that represent the cost.

MYTH 4:

• MYTH: Trade deficits are bad, trade surpluses are good.
• TRUTH: Both imports and exports are gains to the economy, the total quantity of trade matters way more than the balance of it.
• CONSIDER THIS: When America imports cheaper foreign goods (say a Korean TV) we free up resources at home that can now be invested in new products, fund R&D, fund expansion and foster new inventions.  If we were inefficiently producing that TV domestically when a cheaper foreign version was available, then we would still have a TV but would lose all the other extra things we could have also gotten by using those resources to fund domestic growth instead of using them to produce the TV.  With protectionism we get only a TV, with trade we get both a cheaper TV AND additional growth in other areas.
• PS: The more we trade with other countries the more rapidly America imports and gets access to the best techniques & ideas & discoveries.  Instead of only having access to things discovered in our 1 country we get rapid access to the latest discoveries in all 196 other countries on Earth too.

MYTH 5:

• MYTH: Free trade gives other countries the growth in those industries that we should have gotten instead.
• TRUTH: Growth is between 3x & 6x higher in free trade countries than ones that obstruct free trade. (Sachs & Warner, 1995).

MYTH 6:

• MYTH: Americans can't compete with low priced foreign labor.
• TRUTH: Americans are paid more because of an economic concept called the marginal product of labor.  Foreign workers are paid less because their marginal revenue product is less, or in very simple lay terms they are less "productive."  What makes them that much less productive?  America has a vastly superior capital structure.  This refers to the thousands of intermediate stages of production that all have to line up to create a finished product you buy (a "consumer good").  If you'd like to learn more about how the capital structure fuels the economy read On Economic Progress: Raising Standards of Living.

MYTH 7:

• MYTH: Free trade let's multinational corporations run sweatshops.
• TRUTH: When western MNC's come into a nation they set up factories with safer and cleaner conditions than presently exist in that nation.  This puts pressure on other companies to improve their working conditions in order to compete for labor.
• CONSIDER THIS: "American consumers are the main catalyst for better worker rights in China... if Nike and Reebok go - and they very well could if the trade status is rejected this pressure evaporates.  This is obvious."
  - Zhou Lital, China's most prominent labor attorney; Source: Congressional Record p. 7999, Testimony to the House of Representatives.

On Free Trade 1: The Opposable Thumb vs Trade By Rick Kelo

On Free Trade 1: The Opposable Thumb vs Trade
By Rick Kelo

If there were an Economist's Creed, it would surely contain the affirmations "I understand the Principle of Comparative Advantage" and "I advocate Free Trade." For one hundred seventy years, the appreciation that international trade benefits a country whether it is "fair" or not has been one of the touchstones of professionalism in economics. Comparative advantage is not just an idea both simple and profound; it is an idea that conflicts directly with both stubborn popular prejudices and powerful interests. This combination makes the defense of free trade as close to a sacred tenet as any idea in economics.

~ Paul Krugman

In the last 30 years the world abandoned centralized economic controls and has moved toward freer & freer trade year after year.  Still though there is no more divided subject than that of free trade.  As Paul Krugman notes almost every economist for 200 years has supported free trade unequivocally and without reservation.  However, to the common man viewing the world around him the case is far less clear.

So what do those guys know that makes them support free trade that they aren't telling the rest of us?

I assembled to share with you the best explanations of how trade functions.  Analogies in plain English that are interesting, thought provoking and help sum up what it is other humans know about free trade that we haven't yet considered.

I split these ideas into 4 topics around 4 major areas:

• Job losses due to trade: outsourcing
• Trade Deficits
• Tariffs
• Myths about Free Trade like sweatshops

WHAT IS FREE TRADEFree trade is allowing goods to be traded between nations without the use of force to restrain trade.  The opposite of free trade is called "Protectionism."  It refers to the use of government protections to prop up businesses that were otherwise going to die off or not be as profitable because they struggle to perform if they have to compete.  The power of capitalism over all of human history has been harnessing man's capacity for achieving great things through the discipline caused by exchange in the marketplace.

MENTAL SOMERSAULTS
There are a lot of mental gymnastics that takes place around the topic of free trade.  Here are a few examples:

• On one hand every one of the 197 countries on Earth engages in trade with other countries.  
• On the other hand 0 of the 197 countries on Earth engage in free trade.

• On one hand we are told foreign imports are bad because they increase unemployment among Americans.
• On the other hand we are told we institute trade sanctions against North Korea & Iran because it lowers their standard of living.

More than a few contradictions are afoot.... so which ones are right and which are not?  

TRADE VS. THE OPPOSABLE THUMB
Its not man's opposable thumbs or his invention of the wheel or fire that created the modern society we have today.  In fact human beings had all those things 6,000 years ago.  What brought you and I out of the Stone Age and into the incredible society we see around us every day was Trade.  Trading with each another gave rise to the Division of Labor.  It allowed a society to form that contained specialists.  Instead of spending all day hunting/gathering to manage to scrape together just enough calories to survive we can do other work.

And how do we get the food we need to survive that we used to have to work for?  We buy it of course, and not only that but the free market system & free trade creates incredible discipline.  This discipline in the market caused by competition makes all goods become gradually less expensive and higher quality over time.  As one example of these improvements to the left is a graph of the portion of family income used to purchasing food.

Source: Capitalism Makes You Fat

Without trade mankind would be back in the stone age.  Any one who doubts that should remember the predicament of Robinson Crusoe when he had to depend on himself for all of his needs instead of trading his skill as a lawyer with other people who were better fishermen, tailors, and carpenters.

FREE TRADE AND PEACE
If you are against foreign wars then you are in favor of free trade.  When goods don't cross borders soldiers will.  If the time ever comes that mankind needs reminded of this then it can look back to its recent past in the 1930s.  After America enacted the crushing Smoot-Hawley Tariff Act in 1930 other nations around the globe followed suit raising tariffs and forming import quotas to protect business at home.  The hopelessness wrought by crushing free trade not only deepened the global economic depression, but set the stage for World War 2.

SWEATSHOPS
As a segue into tomorrow's look at common myths about trade including a look at sweatshops let's hear what people in the third world actually think about multi-national corporations who come and open up shop in their nations:

DAILY LAUGH: Hitler vs. Confederate States of America

Not even from the south myself but this is hilarious.  It especially gets good at about the 2 minute mark when Hitler starts speaking.

Krugman Calls for Death Panels & Middle Class Tax Increases By Rick Kelo

Krugman Calls for Death Panels & Middle Class Tax Increases

By Rick Kelo

Paul Krugman has been the nation's single biggest advocate for Obamacare.  Even after we spent a half billion dollars of your money in order to create a website capable of enrolling 6 people he has still been adamant in his near daily defense of Obamacare.  

Now let's look at what does Paul Krugman knows about what it will take to make Obamacare financially solvent.  Also, FYI America presently has an unfunded liability of $42.8 trillion in Medicare funds shortage and an unfunded liability of $20.5 trillion in Social Security shortage.  The federal government brought in $2.5 trillion in tax receipts last year.  So if you think there is somehow money laying around to fund Obamacare without measures like the one's Krugman secretly suggests.... well.... its time for you to reconsider the logic of that position.

Before launching into a partial transcription below let me make one point of clarification.  One of the things you will hear Paul Krugman call for is a Value Added Tax to especially extract money from the Middle Class.  In the OECD nations who have a VAT the average is 18.97%.  So in Krugman's ideal world we slap you with a 20% additional tax on everything you buy.  His second point is the distinctly un-American idea of death panels.  The fact it smacks of Animal Farm where the pigs send the horse to the glue factory is why its not surprising to hear it roll of the lips of a guy like Paul Krugman.  To all the naive out there though let me make this general point: whenever government is given scarce resources then it must decide how to allocate them.

Eventually we do have a problem. That the population is getting older, health care costs are rising, and all of that.  So there is this question of how we're going to pay for the programs. The year 2025, the year 2030, something is going to have to give.

My vision of how I want it to be done is that we're going to need more revenue.  Surely it will require some middle class taxes.  We won't be able to pay for the kind of government the society will want without some increase in taxes, not a huge one, but some increase in taxes on the middle class, maybe a value added tax.

And we're also going to have to make decisions about health care, doc pay for health care that has no demonstrated medical benefits. So the snarky version, which I shouldn't even say because it will get me in trouble, is death panels and sales taxes is how we do this.

On Mainstream Media, Monsanto & the Tea Party By Rick Kelo

On Mainstream Media, Monsanto & the Tea Party
By Rick Kelo

In the morning I was listen to the Michael Smerconish program on POTUS on Sirius XM while driving.  I like hearing Michael's point of view because he is very centrist and takes a very practical non-dogma based approach to issues.  A couple months ago he took a call from a caller who made a point I felt was very interesting.  I mulled on it, I think the caller's point was excellent and worth sharing and elaborating on.

The program was discussing a speech former Governor & Secretary Tom Ridge gave last night to Log Cabin Republicans.  In it Ridge, a moderate Republican, had some very direct comments about Republican ideologues and their insensitive attitude on gays and various other topics.

HOW AMERICA CHANGED

So after discussing Ridge's speech the caller told her story.  She is a Democrat, her parents are/were Republicans.  As a teenager they would have delightful political discussions.  Despite their big differences on issues the conversations were never unpleasant.  Then the program discussed why it is conversations like that can't, or don't, seem to take place in America any longer.

WHY IT CHANGED?This is an open-ended question I leave to all of you.  On the show the caller & Michael discussed the sound bite world we live in.  If you can't make your point in 8 seconds or less people lose their attention.  Smerconish discussed how when he does programs on Hardball for Chris Matthews that a very very long program is 8 minutes, but most segments are 2-3 minutes.  His point was that there are a lot of issues that are complex enough they don't lend themselves to such a short treatment.

THE ROLE OF MAINSTREAM NEWSOne of the points that came up in this radio conversation caused me to stop and pause.  They discussed the fact that almost all news that is forwarded around on the internet between both mainstream websites along with Twitter and other non-mainstream sites is not written by reporters who have investigated the issue.  In the very large majority of stories that hit the AP wire they are written with the sound bite mentality in mind.  In order to get picked up off the AP wire they have to be sensationalist and make strong polarizing points.  

TESTING THIS THEORY WITH TODAY'S PAPER 
As I considered it more and more and reflected back on the last 20 or so stories I've read over this week I see that trend at work in every one of them.  To put it to the test I have a copy of USA Today sitting in front of me as I write this.  The cover story is:

Tea Party Backers Set New Target: Farm bill subsidies.

The article proceeds to explain that the only people who oppose the huge agri-business subsidies are far fringe Tea Party radicals!  I think if we polled registered Democrats and asked them if they support an $18 billion dollar check from the federal government being given to Montsanto, a profitable Fortune 500 company.... most would vote no.  So how is it the cover story on a major newspaper reflects no diversity of opinion on a very obvious issue most Americans oppose?  Very few people, regardless of political persuasion, would say they support corporate welfare like the farm subsidy program.

This example really made the discussion stick with me.  Once I saw today's farm subsidy article on USA Today it just absolutely drove the point home.  Now not only am I not a Republican but I oppose almost every item line by line on the far right ideology.  I am pro-gay rights, pro drug legalization, pro abortion, against the growth of military spending, against foreign wars and a number of other traditionally quite liberal ideological areas.  I'm also against farm subsidies and even published a detailed look at how the Farm Bill causes sugar prices in America to be double the price the rest of the world pays.  If you'd like the names of the 4 largest sugar companies in America (they also take home 71% of the sugar subsidies).... corporate welfarism at its worst.... I describe it in detail here: 

Sugar = Big Business Wins, You Lose, Government Laughs (Part 2)  

However, in keeping with the question about why there is so little middle ground in political discussion.... why issues have become so polarized.... I realize that in mainstream media, like the cover of USA Today, there is no place for a voice like mine.  Or yours.

Voting Patterns & Gun Violence

The Black Market: Organized Crime, Indians & NY Cigarettes By Rick Kelo

The Black Market: Organized Crime, Indians & NY Cigarettes
By Rick Kelo

There are some irrefutable laws you just can't escape, especially gravity, death and taxes.  Just like the law of gravity the law of taxes is that whatever you tax you get less of.  Just as New York recently found out.

The underground tobacco market in New York has been exploding since the state levied a $4.35/pack tax on cigarettes.  For New Yorkers unfortunate enough to buy their smokes in New York City the city tacks an additional $1.50/pack on top of that.  Always interested in championing the benefits of higher taxes President Obama's first action upon taking office was to add a $1.01/pack tax which really starts to pile up on poor New Yorkers.

So what's a New Yorker to do?  Well there's always Option A: pay $12/pack for some smokes.  Then there's Option B: buy on the black market.

RISE OF THE BLACK MARKET

After just 5 months under the increased tax, which went into effect the summer of 2010, the New York Post reported:

Sales of taxed cigarettes have plummeted 27 percent since July, when state lawmakers raised the excise tax to $4.35 a pack on top of the city’s tax of $1.50, making the average price of Marlboros here $11.60, with some shops charging as much as $14.

Sounds optomistic, we've encouraged people to quit smoking!  Chalk up a win for government forcing its morality onto an unwilling citizenry, right?  Well the story's not quite finished, let's pick up a couple other points from the New York Post article:

The underground tobacco market is spreading like a fast-growing cancer in the wake of tax hikes that make New York cigarettes the most expensive in the nation — and it’s costing the state tens of millions a month in lost tax revenue, a Post analysis has found.

Government data show that New York state is being smoked out of as much as $20 million a month from all these illegal cigarette purchases — an estimated 7.3 million packs a month sold off the state tax radar.

"Goodfellas" A young Henry Hill sells blackmarket
cigarettes in NYC.

As it turns out New York (and numerous other states around the country) happen to have Indian reservations.  Those Indian reservations happen to transact more commerce than just running roulette tables; they also grow tobacco.  Seems some of that tobacco might be leaving the reservations and entering the black market.  Now if back alley abortion doctors taught us anything as a nation it was, hopefully, that trying to legislate your morality onto others by making a thing illegal or highly taxed only pushes it into the shadow economy: the black market.

Also, a great many smokers have also taken to rolling their own cigarettes from pipe tobacco as a means to bypass the per carton cigarette taxes.  In my own none-too-scientific look around I noted that a 1-pound bag of rolling tobacco was $16 (Source).  In comparison a package of cigarettes has about 0.7 ounces so that $16 bag should produce about 20 packs of cigarettes.  Quite a fair improvement from the $14.50 per pack of cigarettes that is now the average in New York (Source).

THE TAX LESSON

Politicians are always eager to have more of our money to spend.  What they forget in their eagerness is that people change behaviors to avoid paying taxes.  The technical term is.... not too surprisingly... "tax avoidance behavior."  So increasing the tax rate on something does not necessarily mean that tax will now bring in more money.  As New York found out with its excise tax on cigarettes, many times it means you're going to bring in less money under the new, higher tax.  This is a concept we understand thanks to the work of Dr. Art Laffer and his Laffer Curve; a technical concept he perfected based on ideas he drew from the writing of John Maynard Keynes.

The other lesson comes in the form of what's known as "Public Choice" economics.  Politicians love programs that produce visible short-term effects, but are always oblivious to the long-term distortions they cause.  That idea brings us to the next area:

ENTER ORGANIZED CRIME

As anyone who's ever watched Goodfellas was already aware tobacco is nothing new to organized crime.  At the moment the FDA is mulling over a ban on methanol that it would very much like to enact.  However, just like America's War on Drugs has shown, making a product people demand illegal does not make it go away.  What it does do, however, is give a monopoly to existing criminal cartels.  Prohibition in the 1920s is a classic example of this effect.  In fact drugs are present in every town in the entire country, and given how well the "War on Drugs" has increased drug availability I recommend the government launch a "War on Fitness" next.

Thankfully, at least a few respondents to the FDA's announcement seem to present a voice of reason against more harmful & needless government intervention.  In a letter to the FDA dated August 28th, 2013 the Chief of Enforcement for Virginia's Cigarette Tax Board said this:

The contraband market would thrive under a ban and would increase criminal activity, including activities by organized crime and terrorist groups.  Federal and state law enforcement efforts already are under tremendous pressure.  They will not be able to handle the resulting increase in criminal activities.

Paul J. Carey III; Chief of Enforcement/Enforcement Coordinator; Northern Virginia Cigarette Tax Board  

I agree with Paul Carey.  Prohibitions have never worked, and hopefully America ceases its trend toward a prohibition on tobacco or methanol.  Legislating our morality as non-smokers onto other people is immoral.  People have a basic human right to their bodies and to their private property.  I am in the 81% of American adults who don't smoke, however, having a majority does not make it moral to aggress against the minority 19% who are smokers - even if they are engaged in a practice that hurts themselves.

The video below is one investigative journalists look at the black market that has sprung up in New York in response to high taxes: