CHEAP MAY BE EXPENSIVE

Economists Usually Don't Count All the Costs

The Dutch have a saying: Goedkoop is Duurkoop which translates roughly as: Buying cheap is expensive.

We all know that while not always true, this warning turns out too often to be the sad case. That holds not only for individuals but for corporations and nations as well. What, at first glance, appears to be inexpensive too often turns out to cost more at the end of the day than the high- priced item we rejected in favor of the discounted item that looked good at first glance but turned out in the end to be badly flawed.

The same can be said of what we call “free trade.” At first glance it appears to be totally a win-win proposition. Economists cite the theories of Ricardo, Hecksher-Ohlin, Samuelson, and Krugman along with the calculations of econometric models to bolster their proposition that free trade is always and everywhere a win-win proposition.

In other words, it is really ‘‘goedkoop”, a great bargain that all countries should rush to adopt fcoully.

But despite the urging of the professional economists, all countries have not rushed to embrace their recommendations. Indeed, the fastest growing economies like those of China, India, and Southeast Asia are among those who have embraced the economists’ recommendations the least or even not at all. How can that be?

Because global economics is complex and virtually impossible to model mathematically in all detail, the econometric models and analyses make a number of assumptions. For instance, they assume constant full employment in all economies, fixed exchange rates, absence of production of greenhouse gases,, complete absence of economies of scale (cost of production of items like autos, steel, semiconductors declines as production increases), perfect competition (no producer has any impact on prices and costs so that all industries are similar to global markets for sugar and other commodities), no economies of scale, no potential outbreaks of war or strategic competition, no costs of adjustment such as closing factories and industries or opening new ones, and no need for environmental considerations.

It may in fact be true that in this kind of simplistic, ideal world free trade is always and everywhere the best option. But no one has ever seen or lived in this kind of world and no one ever will.

Let’s look at the aircraft industry. It is not like the commodity industries in which no single producer has any influence on the total amount produced or sold. In fact, there are only two major airliner producers in the world, Boeing and Airbus. There are a few makers of small civilian aircraft and private jets, but the vast bulk of passenger airplanes are made by either Boeing or Airbus. Each of them does have, inevitably, an influence on total production, sales, and profits. It is an oligopoly industry, not a commodity industry. The econometric models do not handle such industries very well, yet they constitute a major part of global trade.

Even more interesting is to look at what happens all real costs are counted. Lets look at the steel industry which has long been an international trade issue and in which the U.S. has a substantial trade deficit and is not considered to be among the low- cost steel industries like those of China, South Korea, and Japan. It is important to understand that making steel requires a great deal of energy that can be generated by burning coal and oil or by using electricity in electric steel mills. Burning coal and oil inevitably creates greenhouse gases that are causing global warming. But the environmental cost of the greenhouse gases is not included in the cost of steel when it is sold to customers. It happens that China is the world’s biggest steel producer and also the biggest burner of coal thereby generating the most greenhouse gases. If the cost to human society of those gases were added to the price of all steel currently being produced globally, the U.S. steel industry would have lower costs and prices than the Chinese industry. Most steel made in America is made in electrically fired steel mills that create little carbon dioxide. Indeed, if the greenhouse gas cost were included in the price of steel, the U.S. industry would probably be the low cost, global steel maker and the U.S. would be a major exporter rather than an importer of steel.

None of this kind of thinking and analysis appears in any of the economics textbooks or journals and certainly is not incorporated into the major econometric models.

We could do a similar analysis by looking at global currency markets and values. The models assume fixed exchange rates despite the fact that exchange rates have not been fixed for nearly fifty years. Let’s take the Japanese yen. A year ago, it was trading at about Y132 per dollar. Today, that has become Y144 per dollar. Thus, in a year the yen has devalued by close to ten percent. Japanese exports cost Americans ten percent less today than a year ago. That is a big shift and the yen is not alone. The Chinese renminbi is today down about seven percent from its value a year ago. These are numbers that can shift trade routes and competition dramatically, but the econometric equations and models do not reflect that. Nor are these shifts always or even mostly random. They often occur because governments are intervening in currency markets to sell their own currencies and thus cheapen them as a way of stimulating exports and maintaining trade surpluses and domestic full employment. This typically comes at the expense of the United States because the dollar is the world’s main reserve currency and is never manipulated by the U.S. government.

Another uncounted cost is that of lost skills. For example, when Apple produced all most of its products in California, its workforce had a unique variety of skills that were difficult for possible competitors to imitate and that also often led to new methods of production and even to entirely new products. After Apple decided to move all of its production activity out of California to China and dismissed all of its manufacturing workers in California, the unique skills of the Apple California work force were lost forever. Even if Apple wished to return some manufacturing to the U.S., it would be quite expensive to do so because of the loss of the skills of the workforce. When the skills of a significant work force are once thrown away, the potential for innovation or the return of production in that industry are dramatically reduced.

Of course, once again, the economic theories and models do not count or consider these factors in their calculations.

Finally, there are the costs of adjustment that are never counted. The Japanese defeat of the American textile industry in the 1950s-60s led to the demise of most of the U.S. industry and thus to the loss of employment by many American workers, especially women workers in the South of the United States. Economists agree that this kind of loss of work, is indeed a cost, but they argue that it is far outweighed by the benefits of lower textile prices that extend to the entire U.S. population as opposed to the loss of wages by only a relatively small portion of workers. Thus, the argument is made that there could be some compensation for “adjustment” of the workers losing their jobs.

In the past, I have somewhat bought into this argument. But, increasingly I do not. Why? Because of the imbalance in real value as well as the potential long- term impact. Let’s look at value. Sure, if I can save a few dollars by purchasing shirts from Bangla Desh instead of those from America, I might be pleased. But the amount of my pleasure is far, far less than the amount of loss and dismay experienced by the workers and regions which are losing jobs. The small pleasure of even two or three hundred million buyers does not really offset the huge displeasure and pain of lost jobs that also lead to lost lives, lost dignity, loss of unique skills, and loss of hope.

Over the past forty years, I have often visited the city of Detroit. For many years it was one of America’s most prosperous and lovely cities, sited as it is on the Detroit River that connects Lake Huron with Lake Erie. It was the auto capital of the world, with General Motors, Ford, and Chrysler all headquartered there. But it began to decline in the 1980s as German, Japanese, and Korean auto makers began to make big inroads into the U.S. auto market. There are many reasons for the decline of the U.S. auto industry over the past forty odd years. One major factor has been the persistent over-valuation of the U.S. dollar during that entire period, and another has been the protection of the European markets by the imposition of a ten percent tariff on auto imports and of the Japanese market by a hermetically sealed auto dealership structure. The U.S. system of industry wide labor unions and of negotiations between a monopoly worker union and individual auto companies rather than with all the companies at once, has also tended to keep U.S. auto wages too high thereby undercutting the industry’s competitiveness.

Whatever the causes, the fact is that the U.S. auto industry has been in constant decline over this long period. I have sat in meeting after meeting of economists discussing the industry’s decline, its causes, and its costs. A tariff on imports could have dramatically slowed and perhaps even have stopped the erosion, but the economists always argued that doing so would raise prices for consumers, a step that would be more costly than that of standing by while the industry shrank and laid off its workers while Detroit and other major auto making cities died and rotted. The cost of a rotting major city doesn’t decline as the years pass. Rather, it increases so that it is not at all clear that the pleasure granted to a large number of relatively well off consumers is equal to the ultimate pain to those same consumers of the costs of a dying major city like Detroit.

I deeply believe that there must be a better way. The Japanese, Germans, South Koreans, French, and others do not play the game in the American way and they seem to be doing fine. Maybe we could learn something from them.

The bottom line is that when the global trading system was initially established, world leaders anticipated that each country would have essentially balanced trade over time. No one anticipated today’s reality in which the U.S. would be the buyer of last resort with a chronic trade deficit of about three percent of gdp annually while countries like Germany, Japan, China, Taiwan, and Singapore would run chronic trade surpluses as high as sixteen percent of annual GDP.

The United States must get real and stop listening to the theoretical blather of professional economists wielding econometric models that bear no resemblance to reality. It is time to go back to our future.