Monday, February 22, 2010

Trade: Dangers and instabilities

The political and media game in the midst of this Second Great Depression is sadly fixated on real estate and banking. Certainly, these sectors have played a role in the collapse that we have experienced, but it is wrong to attribute the full force and persistence of our malaise on just these sectors. At the very core of the economic problem, it is not currencies that are to blame. Balances of income and expenditure between various regions of the globe and sectors of the economy are what actually determine things like unemployment rates and other numbers of political importance. Additionally, the degree of achievable prosperity is constrained by the rate at which key natural resources are exploited. These two determinants of economic outcomes are aspects of economic geography and market structure.

A firm that follows a neoclassical business strategy will seek to maximize production efficiency by minimizing costs per dollar value of finished goods. Such profit maximizing philosophies are clearly the norm among large scale businesses. This model takes both workers and consumers as essentially being factors of production. The final product of the firm, in the mind of the firm's owner, is not the product for sale but the income stream that firm profits bring to him.

This maximization is best achieved through locating of factories where the necessary natural resources can be plentifully obtained and where costs of labor are low. The degree to which real estate costs affect this calculation seems to be minimal, in part because low cost of labor tends to correlate with low cost of real estate. Delivery of natural resources to the factory and a means of moving finished goods to port are the required infrastructure developments and these are also expressed in the production cost. Low shipping and transport costs (primarily the low cost of shipping on large tanker ships) make the possible market for goods global in scope, making distance to consumer largely irrelevant in all cases except for goods that are perishable. Therefore, manufacturing for non-perishable goods will tend to be concentrated where costs of production are lowest.

Regions that offer ideal locations are invariably those that have both persistent poverty and a well organized government capable of and interested in providing the necessary infrastructure to the factory. The goods produced will be sold on a global scale, directly to nations which are not ideal locations for new factories.

All factories eventually become depreciated to the point of needing to be shut down. Therefore, new economic growth is not a prerequisite for the relocation of these factories to more optimal regions. Rather, over time, industry in general will naturally move into those regions.

Firms in these factories' host countries will have revenue in the goods importing country's currency, but pay their workers in the local currency. Therefore, they must exchange most of the imported currency for local currency. With a floating exchange rate, this is merely the sale of that currency on the market. The imported currency's value is equal to that of the goods it can purchase - that is the value of manufactured goods offered by the goods-importing country.

If a simple system of comparative advantage emerged from this relationship, two effects would result. First, the goods-importing country would experience relatively fewer working hours and relatively lower prices for goods when compared to wages (higher standard of living) than the exporting country. Secondly, over time the exporting country's higher level of savings and lower unemployment would reduce poverty to the point that wages would be bid up, while the importing country's lower (or negative) level of savings and higher unemployment would cause wages to be bid down, effectively leading to a trend toward equilibrium (or, more likely, an equilibrium-centered oscillation) and a progressive reduction in the level of wage differences between the two countries.

This simple system of comparative advantage is complicated by three factors. New technology that is developed will tend to dramatically slow the trend toward equilibrium. Shifting balances of trade with other countries will create chaotic effects that contribute a high degree of uncertainty to the analysis of eventual effect. Finally, changes in output levels will alter the purchasing power of consumers in both countries and lead to a non-unique equilibrium.

New technologies that are available tend to originate through the research of wealthy countries that have the resources to spend on comprehensive education systems and research funding. These technologies become a market good that is exported from the goods-importing countries and slow the rate of convergence toward the equilibrium described above. This effect has the following characteristics: first, firms must save up or receive loans in order to make the costly technology purchases and implement them. This leads to a financial market that mediates (with occasional speculation bubbles) the collection of currency in the goods-importing country's denomination. Firms are unlikely to take loans in their local currency and attempt to then save up imported currency because this time consuming process has a large opportunity cost and may involve costly interest payments as well.

These new technologies will bring about three types of improvement for the firm that implements them: 1. Labor usage reduction; 2. Natural resource usage reduction; 3. Greater market share. For this reason, new technologies can accelerate the rate at which markets become monopolized, and can actually lead to lower levels of employment within markets.

Additionally, this process will affect both economies in different ways at the macro level. For the goods-importing country, the tech industry will sustain higher levels of employment. This will sustain higher goods importation rates for longer. For the goods-exporting country, the higher rates of market monopolization and lower employment levels that technologies bring will actually slow the rate of poverty reduction. Thus, the trend toward equilibrium is slowed by technology. Both of these factors, however, will eventually dissipate unless new technologies are introduced at a constant rate, or if a technology development industry develops in the exporter country. Because new technologies are actually developed erratically, markets will tend to spurt toward equilibrium, then stall, then spurt again, rather than moving smoothly. This can lead to oscillatory effects that prevent the existence of steady states.

The comparative advantage equilibrium is further complicated by the effects of the comparative advantage of other countries. If natural resource costs increase, or if exports to another sector increase or decrease, the labor and natural resource markets will transmit these effects throughout the market, affecting the balance of trade between all trading partners. The demonstration of oscillatory effects in complex equilibrium systems is a topic of high mathematical sophistication, but oscillating reactions have been discovered in chemistry, a discipline in which the units are approximately 21 orders of magnitude finer and therefore statistically better behaved than an economy.

Finally, the simple model is inaccurate in part because drops in exports, caused either by a loss of relative currency value of the importing nation or a drop in incomes due to higher unemployment, typically leads to an increase in unemployment or decreases in wages in the exporting country. This effect implies that increases in measured comparative advantage can lead directly to a diminished economic outcome.

Taking these things into consideration, where does our current economic position fit into this model? Likely, the United States and most of Europe have survived the past decade only by taking a technology provider role. As China and India and other major exporters develop science and technology programs of their own, what we have to offer in exchange for the constant stream of cheap goods becomes increasingly limited. The uses for US dollars correspondingly diminishes. Most likely for geopolitical reasons, the Chinese government has artificially stimulated demand for US dollars by buying US treasury debts. This has lessened the loss to Chinese manufacturing to some degree. Similar activity by other exporter countries all over the world, concerned with preventing collapse of their industries, has propped up the exchange values of importer country currencies. This has, in turn, prevented oil prices from going up. Ultimately, though, these measures will reach their limit. This is not unlike the catastrophic collapse of the globalized markets in the first great depression, but in our case, the supply of oil is not as plentiful nor can it be readily expanded, making the situation dire.

The root cause of this problem is really the false steady state model that seems to dominate economic thought. This model typically takes aggregates as stable objects and firms as permanent fixtures. In reality, firms are not permanent fixtures. Rather, they have a finite but indeterminate lifespan. Employment results from specific tasks that are undertaken by the firm during its lifespan. The natural trend in economies is toward wealth concentrations and high productivity. This inevitably leads to low employment and low quality of life. This is where the "equilibrium" rests. In truth, there is no guarantee that a job will last for the 30 years that our tradition defines as a career. Nor is there a guarantee that a person will be able to live off of the wage they are paid. Nor is there a guarantee that housing will exist for each citizen. And amid all of these human concerns, the environment will be exploited to the point of complete destruction, permanently reducing the possible quality of life for all future generations, over and over again.

In order to lift the masses out of squalor, a government must be able to occupy a strong negotiating position. The guarantee of high employment is not really possible unless productivity is artificially reduced, a deliberate endorsement of waste. However, high quality of life is possible through rigorous efforts at wealth redistribution and rules limiting working hours (such as shorter work weeks). But regardless of the solution proposed, the actual production of goods cannot occur outside of the jurisdiction of the government, so that reasonable regulations can be imposed. For this reason, and this reason alone, foreign trade ought be severely confined. But if a thinking person looks in detail at its actual effect, it is also clear that it is undesirable for other reasons.

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