Pat Buchanans Economics Essay Research Paper THE

Pat Buchanans Economics Essay, Research Paper THE FALLACIES OF PAT BUCHANAN’S ECONOMICS Pat Buchanan is currently campaigning to become the Republican representative in the next U.S.Presidential election. He is credited with striking a chord amongst the main stream, blue collar sectorof the country. This is because he has based his economic platform on common myths about free trade andhow it is the cause of the economic problems in the U.S. His theme is that layoffs and the closing ofAmerican plants are the result of foreign companies and countries taking advantage of easy access intoU.S. markets which, in his opinion, is not being reciprocated abroad. This is how he accounts for thecurrent trade deficit that the U.S. is running with countries like Japan. Pat’s economic platformregarding trade policy can be summarized as follows:* Impose a 10% tariff on Japanese imports and a 20% tariff on Chinese imports. This wouldgenerate, in his opinion, $20 billion in government revenue and reduce the trade deficit which could bereinvested into the American economy and help create tax cuts for small businesses.* Impose a social tariff on Third World manufactured goods to protect U.S. workers’ wage rates fromthe foreign laborers who are paid a fraction of what their U.S. counterparts earn. He also resents thatforeign companies do not have to adhere to the strict environmental, safety, and health standards thatAmerican firms do yet get free access to the U.S. market via GATT and NAFTA.It is evident that Pat Buchanan believes that trade deficits and trade with Third World countries are atthe heart of what he perceives to be America’s economic problems. He feels that through tariffs theburden of income taxes paid by U.S. workers and small businesses can be shifted onto consumers whopurchase foreign goods. His underlying sentiment about his trade restrictive policies is, “This is ourland; America is our country; the U.S. our market. We decide who enters here and who does not.” The basis of international trade is that their are gains to be had from partaking in it. This was provenby David Ricardo, an economist in the early 19th century, who introduced the concept of comparativeadvantage. His theory stated that a country’s “absolute advantage (overall productivity differencesbetween countries) should be reflected in differences in income, whereas comparative advantage(variations in productivity differences by sector) will determine the pattern of international trade.”A common misconception about free trade is that it is based on absolute advantage. Comparative advantagealways is applicable when applied to international trade so it stands to reason that there will always begains from trade. The existence of low wages in a country is not by itself a reason for the U.S. to feartrading with them. For one thing, wages generally reflect the productivity levels of workers. If lowwages meant low costs then world trade would be dominated by Th!ird World countries and the U.S. would never export. The fact is that differences in technology causelabor productivity variances between countries which affects unit labor costs. A firm will tend to hiremore workers until the value of the product that the last worker produces is equal to the cost of thatworker. In the less developed countries low productivity, as a result of low levels of technology, isreflected in wages. The significant measure to determine which sectors a country has a comparativeadvantage is not wages, but unit labor costs. A country can have a comparative advantage in a sectoreven if it is more inefficient than any other country. This is because comparative advantage is basednot on who is the best, but rather on where a country’s “margin of superiority is greater, or its marginof inferiority smaller”. As long as a poor country specializes in sectors where it is the leastinefficient compared to a rich country then it will gain from trade. The Ricardian Model, based on differences in labor productivity, is best explained using a simplesituation based on the following assumptions: two countries, one called Wealthy, the other Poor; twogoods, jeans and sneakers; and labor is the only factor of production. Both countries have 40 hours oflabor available but Wealthy has more advanced technology which gives it an absolute advantage in theproduction of both goods. These countries will benefit from trade because pre-trade relative pricesdiffer. For this example assume that sneakers and jeans are traded in world equilibrium on a 1 for 1basis and that there are constant returns to scale. Amount of labor JEANS SNEAKERS JEANS/SNEAKERSWEALTHY hours required to 1 2 1/2POOR produce one unit 5 2.5 2 In analyzing the production possibility frontiers of each country it becomes apparent that Wealthy canproduce only 1/2 a pair of sneakers in an hour. However, in that same hour, they could make one pair ofjeans and trade with Poor for one pair of sneakers. Thus, they will gain from trade with their lesstechnologically advanced partner by specializing in the production of jeans. Poor can make 1/5 of a pairof jeans in an hour or produce 1/2.5 of a pair of sneakers which can be traded for 1/2.5 of pair of jeanson the world market. Therefore, through trade both countries are using their labor twice as efficientlythan when they had closed economies. This results in gains being realized from trade. The U.S. signed NAFTA and became trading partners with Mexico much to the chagrin of Pat Buchanan. Hisopinion, and it is a common one, is that U.S. companies will relocate to Mexico where wages and employeebenefits are a fraction of what American workers earn and environmental regulations are quite lax. It isfor this reason that he feels it is impossible to compete with Third World countries and a tariff must beimposed on them for their social injustices. Buchanan should be asking himself what causes Americanfirms to relocate in Third World countries and is it really a problem worth addressing. From ahumanitarian perspective it is concerning that some countries are attracting companies due to the lack ofregulation in their manufacturing industry. It is not an appealing thought to think that a country’scomparative advantage is sweatshop labor and unregulated pollution. However, it is a misconception tothink that trade is only beneficial if both countries receive !high wages. Whether these companies relocate because of low wages or higher productivity is irrelevant.The reality is that it is cheaper for America in terms of its own labor to trade for these goods thanproduce them. The root of the low-skilled job migration problem lies in the fact that America has a highly skilledlabor force. Most politicians and economists would say that this is an enviable position to be inbecause the global economy has a scarcity of skilled labor. This translates into high wages since thereis more demand than supply in the world for high-skilled labor. However, some sectors of the Americaneconomy are based on labor intensive, low-skilled labor. In the U.S. there is a relative shortage oflow-skilled workers so they receive a relatively higher wage than the world wage for low-skilled labor.It is therefore more efficient for companies who use low-skilled labor to move their operations tocountries that have an abundance so that they can reduce their labor cost per unit. Labor productivityis the real reason behind why firms are relocating. Buchanan should recognize that by trying to preservejobs that Third World countries can perform more efficiently, he is! actually weakening the very country he is trying to strengthen. Every country has a comparative advantage in producing certain goods. If a Third World country has acomparative advantage in certain labor intensive industries due to their low wages then America shouldnot focus their efforts in these sectors. It is important to take into account the productivity offoreign workers when analyzing wage rate discrepancies between countries. The Ricardian model has shownthat there is a correlation between labor productivity and comparative advantage. All countries havelimited resources which limits the amount that they can produce. Therefore, the U.S. must decide whereto allocate its factors of production and it faces a trade-off in that when it produces more of one goodit will produce less of others. In choosing which goods to produce the U.S. will have to take intoconsideration what its products can be traded for on international markets. This results in themchoosing to produce goods that have a relatively high value in world mar!kets and abandoning the production of goods that consequently have a relatively low trading value. TheU.S. should be specializing in the production of goods whose relative price exceeds the opportunity costforegone by not producing alternative goods. It is currently accomplishing this by letting varioussectors of its economy, like the textile industry, migrate to Third World countries like Mexico. Therelative labor productivity between the U.S. and Mexico across industries will lead to them specializingin the production of different goods. A country like the U.S. has an absolute advantage in production ofall goods and yet the Ricardian model proves that it still gains from trade because of comparativeadvantage. It is neither efficient nor economical for the U.S. to try and protect industries that can bedone relatively less expensively in other countries. It is cheaper for the U.S. in relation to its laborforce to produce high value goods and trade for lower valu!e goods than to try and produce them both. The free market will guide private enterprise towardindustries where the returns are higher and with higher returns comes higher wages. Focusing on industries that produce goods with a relatively high trading value allows individuals to maximize their earnings, and this is consequently reflected in their wage rate. This is the secondargument against protectionism, especially in low wage, low-skill sectors of industry where Third Worldcountries are attracting U.S. companies. The Stolper-Samuelson theory states that trade affects relativeprices and that the real return to the factor used intensively in the production of a good (labor) willincrease accordingly and the return of the other factor which is used scarcely will decrease. Accordingto this model trade has a significant impact on income distribution within the countries involved. Thiscan be seen in the U.S. where the low skill, low wage jobs are being lost to Third World countries whohave an abundance of these workers. At the same time the U.S. has an abundance of high-skill, high-wagejobs and this is resulting in a serious gap between the up!per and lower classes of American society. Pat Buchanan has gained favor with the lower classes because he wants to apply tariffs to Third Worldcountries and try and protect American jobs from being relocated to other countries. There are seriouslong term ramifications to a country who holds onto industries that are no longer competitive in theglobal economy. It is a painful process when layoffs occur and jobs move south of the border where mostThird World countries are situated but it is necessary for the further development of the AmericanEconomy. Imports and foreign competition have taken a lot of jobs from U.S. workers but this economicchange is also creating millions of jobs at the same time. These new jobs are in small businesses, notthe highly visible sectors of the economy like steel mills or auto plants. None-the-less they are wherethe future lies and they offer higher wages and require new skills. Trade has shifted industry from theassembly lines into complex products with specialized designs a!nd relatively short life cycles which require skilled workers. Through importing, competition hasincreased and this “forces firms to be more productive, and that desperate drive for productivity makesthe entire economy more dynamic.” . A dynamic economy has lower inflation due to intense competition andgives consumers more variety to choose from in stores. Furthermore, since low-wage workers spend ahigher percentage of their income at the store than the high-wage workers they see a greater proportionof their earnings being saved as less is going towards necessities like food. Buchanan should focus hisattention on the real problem at hand which is the retraining of those workers who currently findthemselves in low skill jobs. The Stolper Samuelson effect has shown that low skilled labor is earningless while statistics show that skilled labor wages have risen. The next logical move is to try andclose the gap by retraining workers for the demands required of them i!n today’s work environmentAmerica’s current account deficit with Japan has received a lot of press coverage and been the subject ofpolitical debate in numerous congressional elections. The general conception that the lay person is toldthrough the media and politicians is that by running this current account deficit it costs Americans jobsand indebts them to foreign nations. Pat Buchanan stated in a speech, “our merchandise trade deficit is a $166 billion. As this vast transfer of U.S. wealth and technology was taking place….our share of world GDP had fallen …..and the real income of Americans who work with their hands, tools and machines has fallen 20 percent , in 20 years.” However, without questioning the source of Buchanan’s statistics, it is important to review hisunderlying premise. The current account deficit that the U.S. is currently running is the reason for theblue collar workers’ problems. Furthermore, he has stated that the gains from trading with thesecountries are minimal. Why should it matter where America’s imports are being made as long as it is relatively cheaper in termsof factors of production for foreigners to make them.? Buchanan is concerned that Japan is notpracticing fair trade and this is reflected in the trade deficit the U.S. currently has with them. YetJapan is a member of GATT and as such is subject to the same rules of trade as the U.S. Furthermore,they have never asked the U.S. for voluntary export restraints and did not complain when it was asked ofthem. However, while visible trade barriers are in line with other developed countries Japan is accusedof abusing the use of non-tariff or intangible trade barriers. It is perceived as difficult to exportmanufactured goods to Japan due to their “product standards and testing procedures, the wholesale andresale distribution systems, and government procurement.” A common them in the U.S. is that the current account deficit signifies that exports are being restrictedas a result of non-tariff trade barriers in other countries much like the aforementioned Japan case.Before analyzing the current account deficit it is important to clarify what it is composed of. Thecurrent account consists mainly of imports and exports of goods (visible trade balance), the flow of”services (such as transport and banking); interest or dividend payments to foreign investors (andreceipts on overseas investments);private transfers from workers…and official transfers (such asforeign aid).” When a country is running a current account deficit they are actually becoming indebtedto foreigners. Subsequently, the reasons for taking on this debt should be the main concern ofpoliticians like Buchanan, not the existence of the debt itself. If the U.S. was using this debt tofinance consumption rather than increasing production capabilities then there wou!ld indeed be cause for concern. The increase in ability to produce goods and services through investmentis what gives a country the capability to service and eventually pay off their debt. Another aspect ofthe current account is that it is affected by domestic fiscal policy. This is because the majority ofgovernment expenditure is on transfers and subsidies. Consumption spending of this sort can be dangerousbecause it does not help to generate the necessary resources to repay the debt. Tariffs on Japanese and Chinese goods will have numerous effects on the U.S. economy. The main goal willbe to raise the price received by domestic producers of that good and reduce imports . By raising theprices of imports, U.S. consumers will experience a consumer welfare loss. They will be paying more forgoods that they have incorporated into their lifestyle and will see a decrease in selection.Substituting domestic goods for foreign ones could result in a further loss by consumers if they receiveless value, variety, or substandard products for their money. Competition breeds competitiveness and ifBuchanan makes it harder for foreigners to gain access to the U.S. market then he is creating anuncompetitive environment. If a tariff were put into place it would raise the price of the applicablegoods in the U.S. and create an incentive for domestic producers to increase production. However,consumers will demand less and look for substitute goods. Imports will de!cline because Japan and China will have to lower their domestic prices which will lead to less producersand an increase in demand. The end result is that the U.S. current account deficit will decrease andmight even become a surplus. However, this is the most inefficient way to accomplish such a goal.Increasing savings or reducing the government deficit is the first-best policy to reduce the currentaccount deficit. Unambiguously the terms of trade gain will always be outweighed by the efficiency lossthat results from a tariff. Economies of scale cannot be achieved because tariffs fragment world marketsand attract too many firms to enter the protected industries as a result of reduced foreign competitionand increased profits. Buchanan feels that through tariffs (which he labels a foreign consumption tax)import substitution will stimulate growth in the American economy. The main problem with this mode ofthinking is that tariffs allow an industry to survive but the!y do not promote efficiency. If Buchanan feels that America needs jobs and has lost its dominant role inthe world economy he should focus on promoting exports. The very countries that he is condemning for thedownfall of the American economy all have followed “industrialization oriented primarily toward exportrather than domestic markets.” However, the solution that he should be looking at for the currentaccount deficit is staring himself in the mirror every morning. Politicians must act fiscallyresponsible and reduce government spending because it is the deficit that causes the problem. As thedeficit goes, so goes America’s current account balance. Pat Buchanan feels that protectionism is the answer to re-establishing the U.S. as the world’s dominantindustrial nation. Through analyzing his policies it becomes evident that though his vision is shared bymany his means of achieving it are economically fallible. If he implemented his policies he wouldaccomplish the very result which he is condemning. Buchanan’s economic platform is pandering to thenotions of ill-informed people. If we think of the U.S. as a boat, he is trying to patch a leak, and indoing so, has created two new ones. Lets just hope that level heads prevail and he is not elected or wemight just have to bail water to prevent the mighty U.S. from sinking. BIBLIOGRAPHY Buchanan, Pat, “An American Economy for Americans” http://www.buchanan.org/america.html Buchanan, Pat, “Time for Economic Nationalism” http://www.buchanan.org/econ1.html “In Praise of Free Trade”, Newsweek, July 12, 1993 King, Philip, International Economics and International Economic Policy: A Reader. Singapore: McGraw-Hill Book Co., 1990 “Not so absolutely fabulous”, The Economist, November 4, 1995 Paul Krugman and Maurice Obstfeld, International Economics. New York: HarperCollins College Publishers, 1994 The abuse of economics: Common economic fallacies, UK: The Economist, 1996