At my blog, Café Hayek, I identified some errors that appear in a new piece, in the Atlantic, by Oren Cass. Cass’s essay is titled “Trump’s Most Misunderstood Policy Proposal” – that proposal being Trump’s call for higher tariffs. Key to Cass’s case for tariffs is his insistence that people who are free to buy imports impose what economists call “negative externalities” on their fellow citizens. They do so, specifically, by undervaluing the nation’s “industrial base.” Here’s Cass:
“The basic premise is that domestic production has value beyond what market prices reflect. A corporation deciding whether to close a factory in Ohio and relocate manufacturing to China, or a consumer deciding whether to stop buying a made-in-America brand in favor of cheaper imports, will probably not consider the broader importance of making things in America. To the individual actor, the logical choice is to do whatever saves the most money. But those individual decisions add up to collective economic, political, and societal harms. To the extent that tariffs combat those harms, they accordingly bring collective benefits.”
In my blog post, I wrote in response that
“the value of producing particular outputs in the US as opposed to abroad is captured in the prices, wages, and other market signals that guide corporations’, workers’, and consumers’ choices. Or at the very least, the information and incentives conveyed by the market signals that guide private-sector economic decisions are more accurate and reliable than are the information and incentives conveyed by the interest-group lobbying, electoral bargaining, and retail politicking that guide political decisions.”
Cass then, on X, described my position as being “that there is no externality related to domestic production because market signals fully account for the value to a nation of its industrial base.” Because Cass did not further elaborate, he seems to think that my denying that free trade is a source of the alleged externality that he describes is so obviously mistaken that no elaboration is necessary.
Of course I disagree with Cass. I do indeed deny that that freedom to trade is a source of a negative externality as described by Cass. And the reason for my disagreement is straightforward – namely, no one has stronger incentives to ensure that its access to plant, equipment, and inputs (including labor) is ‘optimized’ than does each firm in a competitive economy. In addition, no one knows better than each firm just what this optimal access looks like and how best to achieve it.
John Deere, for example, needs factory space, energy, technical know-how, and access to steel and other inputs to operate profitably. If property rights and other legal institutions in the United States are favorable, if the US has a reliable electrical grid and other basic infrastructure, and if enough American workers have a comparative advantage at producing agricultural and forestry machinery, John Deere has incentives to build ‘optimal’-sized and amounts of factories in the US and to hire and train workers to man those factories. Deere’s purpose, of course, isn’t to add to the US “industrial base,” but such an addition is nevertheless a result of Deere’s actions.
Deere’s executives, like all people (including government officials), obviously have only imperfect knowledge of the present and no crystal ball to foretell the future. These executives might – indeed, sometimes will – err. Perhaps the amount of factory capacity that they build will turn out to be too little to enable Deere to maximize its profits – or perhaps the amount of factory capacity that it builds will be too large to enable profit maximization. But the profit motive drives Deere’s executives to be alert to any errors they make and to correct these mistakes. If they discover that they currently have in place in the US too little factory space they will expand it; they’ll shrink this space if they discover that they have too much of it.
Importantly, many of the market signals that reveal to Deere’s executives any errors they make – and that incite these executives to correct those errors – are amplified and transmitted through financial markets. Changes in the price of shares of Deere, Inc., along with the willingness (or reluctance) of banks and other creditors to lend money to Deere, are important and speedy sources of information and incentives for Deere’s executives. With less of this information, Deere’s executives will make more mistakes and correct these errors less speedily and with reduced accuracy.
Yet with no evidence, Oren Cass and his American Compass colleagues assert that financial markets are today too large. Although here isn’t the place to fully assess Cass’s case against modern financial markets, one pertinent point is that these markets gather resources from savers and direct those resources into specific investment projects. Financial markets don’t direct savings into some homogeneous glob called “the industrial base”; these markets direct savings into those particular projects that are judged by participants in these markets to be the most promising. It follows that these markets direct savings away from those particular projects that are insufficiently promising. The industrial base grows economically not by merely being bulked up, but by having resources drawn into its most productive parts and away from its least-productive parts.
Cass gives no evidence of understanding this reality. He writes of the industrial base as if it’s a homogenous glob of factories and capital equipment. He’s unaware of the complexity of the capital structure – unaware of how some bits of capital are substitutes for each other while other bits of capital are complements to each other, and that the structure of capital that is optimal today is unlikely to be the structure that’s optimal tomorrow.
Part of Cass’s skepticism of financial markets is rooted in the superstition that there’s something uniquely important in actually making things – that is, in producing physical outputs as opposed to producing services such as financing. But if it weren’t for financiers and the markets in which they operate, too few resources would be directed into building, maintaining, and modernizing those particular factories and mills that are most productive.
Cass’s notion seems to be that if we shrink the number of workers and resources employed in finance, these would be used to strengthen manufacturing. This notion, though, is akin to assuming that manufacturing would also be strengthened if we shrink the number of workers and resources employed in transportation – unaware that delivery vehicles and the many services that keep them moving are a necessary complement to manufacturing. Just as manufacturing would shrink if there were fewer transportation services to support it, manufacturing would shrink if there were fewer financial services to support it.
In short, Cass is inconsistent to allege both that the US industrial base is too small and that financial markets are too large. The industrial base is capital, and therefore an extensive and efficient industrial base requires an extensive and efficient capital – i.e., financial – market to create and support it.
The part of America’s industrial base that will be affected by Americans’ decisions to import more or to import less is largely under the direct control of private producers. If Americans increase their imports of aluminum and, as a result, decrease their purchases of American-made aluminum, nothing directly happens to the physical size or integrity of US-based aluminum plants. What does happen is a fall in the capital value of these plants if they continue to be used to produce aluminum. The owners of these plants could choose to continue to produce aluminum in them. But they won’t. Because the facilities themselves, or the resources that comprise them, now will be more productive if used in other ways, the profit motive incites their owners to shrink these plants and to use the released resources to produce other outputs. And the other uses of resources that their owners will seek out will be those that are expected to yield the highest returns.
Perhaps the resources released from the production of aluminum will be used to produce carbon fiber or machine-tools – or cardboard, or diapers, or house paint, or web-design services. Whatever the alternative uses, these uses will yield higher returns than if these resources all remained in the aluminum industry. Cass’s unstated assumption is that the resources released from industries that compete with imports either are consumed (or simply disappear) or are redeployed in alternative avenues of production that produce less valuable outputs than they would produce if, had imports been restricted, they remained in their previous uses. But there is absolutely no justification for this assumption.
If for whatever reason American consumers come to attach less value to (say) American-made aluminum, artificially arranging to keep resources tied up in producing aluminum in America will prevent resources from being channeled into uses that are more productive. Because the productivity of resources determines their market values, and because the result of artificially protecting industries from competition is to lower overall productivity of the nation’s industrial base, the protectionism championed by Oren Cass would decrease, not increase, the economic size of America’s industrial base.
Not only is Cass’s economics wrong, so too are the facts that he presumes. In reality, America’s industrial capacity – the ability of the American economy to produce value in the form of industrial outputs – is today at an all-time high. This capacity is now 11 percent larger than it was in December 2001, when China joined the World Trade Organization, and 145 percent larger than it was in 1975, the year in which America last had an annual trade surplus. This reality is very difficult to square with Cass’s assertion that under a regime of free trade economic decision-makers fail to appropriately value the factories, mills, mines, and other inputs that form the nation’s industrial base.
Given that the bulk of Oren Cass’s case for protectionism consists of claims that free trade harms the economy, in the above discussion I ignore national-security concerns. These concerns are legitimate. But not only must they be handled with care lest rent-seekers abuse them, clarity of thought requires that they be analyzed separately from the economic case for protectionism. Cass, like most protectionists, routinely fails to keep clear the distinction between protection for purposes of national security and protection for purposes of economic growth.
Made available by the American Institute for Economic Research.
