Category Archives: Global Trade

“Mr. Gorbachev, give us this wall”

Throughout Trump’s campaign he repeatedly promised that “we” would build a wall and that Mexico would pay for it. The details of that boast were conveniently omitted. But class is now in session and the homework is due, so at long last we have been made privy to his “secret” method of getting Mexico to pay for this wall: tariffs. Trump plans on imposing a 20% tariff on imported Mexican goods coming into the US. The proceeds are earmarked for paying for said wall. There’s just one problem with this little scheme of course: it won’t work, or at least not the way Trump imagines. In other words, as with all government actions, there will be unintended consequences. One of the central tenants of economics is that incentives matter. Closing a door just means now the window doesn’t look so bad. Like rats from a sinking ship, there are numerous routes to avoid the tariff. To offset the tariff Mexican exporters may raise prices, which of course means US buyers will shoulder the cost (although magically increases in minimum wage never incline one to increase prices). But higher prices mean US buyers may then opt to forego the purchase or to seek alternative goods; the net effect being no tariff earned and decreased sales for the Mexican company employing, you know, Mexicans (homework assignment: what effect might increased Mexican unemployment have on the demand to enter the US looking for work?). Or if the Mexican company decides to absorb the cost then that means they’ll either have to cut costs by potentially scaling back their work force or slowing the rate of hiring – all of which puts more Mexicans out of work (again see homework assignment above). The more you turn up your stereo to drown out your neighbor’s music, the more he does likewise in a perpetual game of one-upmanship until you both go deaf.

The immigration “problem” is one of positive feedback. Actions designed to decrease an effect actually make it grow. The irony here is that Trump of all people doesn’t see the problem. He is quite fond of blaming China for harming the US economy and putting people out of work by flooding the US market with cheap goods. However, he fails to see the US has been doing the exact same thing to Latin America for decades. That area of the world is less developed and so depends much more on agriculture production to support its economy. Any factors (such as cheap imports) in that agricultural market will have an outsize effect in that region. The US has a long history (since the depression) of agriculture subsidies to US farmers. Subsidies lower the cost of US agricultural products, allowing US farmer to export heavily into the Latin American market where local farmers can’t compete. That darn NAFTA! Yes, NAFTA enabled cheap imports in both directions. These imports had the obvious effect of putting them out of work whereupon they are left with little choice but to move to where there is a demand for low skilled labor – the US.

The inconvenient truth is that the solution to most of the immigration “problem” is to simply end all agricultural subsidies. But no, we’d rather scratch our heads as to why so many keep coming here, shrug our shoulders, and then set about building a wall to keep “them” out. Farm subsidies have become such a political lighting rod in this country that it is actually easier to subsidize foreign farmers (the US sends subsidies to Brazilian cotton farmers!) than to scale back subsidies to our own farmers.

If Trump really wants to stem the tide of Mexicans entering the US he needs to make Mexico great again – great enough that their economy becomes a magnet to all expatriates, drawing them home to where the jobs are. Perhaps Carrier should build that Mexican plant after all.

On Brexit

The recent vote to “Brexit” the European Union in Great Britain has provided an opportunity to cast light on the hypocrisy of one side and the irony of the other. The “leave” (pro-Brexit) camp taps into the natural human disdain of involuntary control. From willful toddlers to headstrong teenagers to entrepreneurs – no one likes being told what to do. This instinct is normal and natural. The problem occurs when one conflates ones own sovereignty with the sovereignty of the “my”, e.g. my town, my city, my state, my country. People erroneously view this “regional sovereignty” through the lens of a primitive territorial instinct that says everything I can see is “mine”. This territoriality or regionalism is hypocritical at its best and downright evil at its worst. Regionalism purports to trump the sovereignty of the individual by placing the interests of the collective above those of the individual. In short, the many tell the few what they may or may not do. Now, were these constraints restricted to bans on murder, theft, and rape there would be no complaints. But it does not stop there. The regional collective (city, county, district, state, nation, or treaty union) dictates rules over every minutiae of life.

Every nation-state that seeks independence is guilty of the deepest hypocrisy, as they invariably see no problem leveling the same type of control on their own smaller political sub-units. So yes, seek independence, but be prepared to give it as well (cough, Northern Ireland, cough, cough).

The stay (pro-EU) camp is actually host to two types of irony. The first is the credulous acceptance that a large bureaucratic body is needed to achieve an end (free trade) that could also be achieved were each member state to simply do nothing to interfere with the free movement of goods. Which is easier: employ a thousand men to drain the lake you are sitting in so that you might be dry, or, simply get out of the lake?

The second irony pertains to their secondary goal – human unity. The Centralizers (anywhere) believe they are an enlightened sort whose high-minded goals of inclusiveness, equality, and community stand in opposition to backwards notions of nationalism or individualism. This conceit leaves them blind to the fact that centralization is itself inimical to their desired goals.

Forcing people together into larger autarkic unions strengthens those unions in a way that leaves them more capable of waging war (indeed, Turkey shot down a Russian jet last year knowing full well the EU would back it up in a potential Turkish-Russian conflict). Numerous, small groups are too weak to do this. Their interdependence through trade guarantees peace; the hand and the arm need each other, it would be folly for one to destroy the other. Counter intuitively; the freest individual is likewise the most dependent individual. No man is an island, as they say. We rely on our fellow man, through trade, to provide all that we need. Large trade unions like the EU or NAFTA are superfluous. Trade is the lifeblood of human civilization and existed long before such pan-national agreements. Indeed these agreements, rather than “freeing” trade instead manage it – to the benefit of the political and economic elites within each territory. They transform former explicit trade barriers into new regulations. These regulations stifle trade and growth by extinguishing the entrepreneurial flame before it has a chance to flourish. The EU has 109 regulations governing pillows; Europe is in economic decline. Coincidence?

Centralization foments a unique kind of conflict. Not allowing or creating barriers to leaving the union can do nothing but foster resentment. In the past (and present) it has lead to wars. Fortunately today in the case of Brexit it has only risen to the level of schoolyard insults. Heaping ultimatums or derision on the party attempting to leave (as many in the EU are now doing to Britain) smacks of the sour grapes hurled by a jilted partner when a romantic relationship ends: “hey baby, you’re nothing without me!”

Decentralization of authority achieves the goals of peace, prosperity, and equality because it depends on trade. Two people that but for ideological or religious reasons would never have cause to interact are more than willing to ignore those differences and engage in the “just business” of trade. Once a trade relationship is established, a human relationship will soon follow. Trade humanizes the foreigner, stripping away their “other group” title leaving behind only the person. Trade then has the power to expand both our wealth in things and in each other.

The path to uniting humanity is more, not fewer, groups. We should be promoting the break up of states, not their mergers. If all countries could dispense with this Trumpian siege mentality that implies a country can’t be “great” unless it is also autarkic, the world could achieve the peaceful utopia that the one-world centralizers dream of. Spontaneous order works in Nature. We are a part of Nature. It will work for us as well if we can make the right choice to the only question that matters: shall our relationships be governed by force or choice?

Crocodile Tears

We often hear that that manufacturing is dying in the US because of unfair overseas competition. US manufacturers are either going out of business or shifting operations overseas. However global competition plays a role across all industries, not just manufacturing. Something else is at play. US tax policy singles out manufacturing (actually nearly any business dealing in tangible goods) with unfair rules designed to extract more tax relative to a service-oriented business with the same income albeit while claiming the same tax rate. As the owner of a small US manufacturing firm, I have sadly gained firsthand knowledge of the severe disadvantage one must contend with if they have the audacity to try and make or sell goods in the United States.

The signs of this are not immediately apparent since the nominal tax rate for all corporations (non-pass through) is 35%. The trick though is in the sleight of hand where the focus is on the tax rate while it is the definition of profit that is critical. The common definition of profit is any money remaining after subtracting all expenses from revenue. And we all know what an expenses is, right? Anything you spend in furtherance of the goal of obtaining said revenue. Well unfortunately it’s not that simple, at least as far as the IRS is concerned. In business there are both overhead expenses and capital expenses. Capital expenses are not immediately deducted against revenue but rather depreciated over many years. So if you buy a $100k piece of equipment you don’t deduct the $100k, you deduct maybe $10k that year and for the next 9 years. There may be legitimate business reasons to view the numbers that way for accounting purposes however beyond a certain minimal size a business may not use the cash method (which does not employ depreciation) for tax computation but instead must employ the accrual method which invariably yields a higher figure by shifting more future income into the present. This puts such businesses (primarily manufacturing which is a equipment intensive industry) at a severe disadvantage insofar as the part spent but not deducted accrues tax. But it gets worse. Manufacturing maintains inventory and the inventory is treated as a capital expenses as well therefore none of it can be deducted until sold. And even when sold it is not taxed at lower capital gain rates but at higher regular income rates. The IRS knows the game of “heads I win, tails you lose” quite well.

Ironically it is a rapidly growing business that is most susceptible to such tax harm as most if not all the profits are invested back into the company in order to grow the inventory to keep up with increasing sales. So if you make a $1 million but use it to buy $1 million in inventory you owe $350k in taxes even though you don’t have $350k on hand. Oops. So you either have to borrow it, incurring even greater costs, deliberately slow your rate of growth, or just go out of business. But wait, it gets even worse. If you do so well that your sales exceeds $1 million the IRS redefines expense once again (Section 263a) and says a certain percentage of your payroll, rent, utilities, insurance, etc that is indirectly associated with producing the inventory must also now be capitalized into the value of the inventory. This shifts even more money from the expense column to the profit column. So based on pure available cash flow you may have made $350k but based on IRS capitalization requirements they say you made $1million. So the entire $350k you made is sent to the IRS on your phantom $1 million income and you end the year with nothing.

Only manufacturing is subject to these absurd redefinitions of expense and profit. Service industries have no inventory and nearly no equipment so their profit more or less equals their cash flow. Farming gets a million loopholes to avoid these issues. The rules governing profit/income are far more germane to ones tax bill then the tax rate itself. If we want manufacturing to flourish in this country again perhaps we should stop punishing those who try to engage in it while crying crocodile tears about how US manufacturers are fleeing this country.