Thursday, July 29, 2010

A Magical Machine

Imagine that there was a gigantic machine that sat in Iowa. This machine is somewhat amazing. Magical, in fact. Into it you place things like corn and steel and beef and all the things that we produce in the United States. This machine churns for a little bit and then spits out things like cars and computers and champagne and rice – all kinds of things that are not produced in the US. The machine is really quite useful, because we put into it stuff that we do produce and we get back stuff that we don’t produce. W00t!

Now imagine that the input to that machine or the output from that machine changes. If the input decreases, but the output stays the same, we should be pretty happy. We have to work less to get the same level of stuff from the machine. Perhaps the input stays the same and the output increases. Again, we’re happy. We don’t have to work any harder, but we get more back from this wonderful machine.

On the other hand, maybe the input stays the same, but the output decreases. That’s sad news for us. We have to produce the same amount but we’re getting back less. Maybe the output stays the same, but now to get that output, we have to put more of our stuff in. Again, this is sad news for us. We have to work harder to get the same amount of stuff back from the magical machine.

So for us good news is when the machine is producing more than we are. Bad news is when we are forced to produce more than the machine does.

Now the magic in the machine doesn’t really have anything to do with it being placed in Iowa. The machine continues to work just fine if it’s in San Francisco. It’s a little less convenient for people from the east coast because they have to travel farther to get to it. But it turns out that we can easily put another one of these machines on the east coast, too. And another one in Texas.

And again what we want from these machines is for them to produce more than we do. If the machines produce more and we produce less, we’re better off. We’re richer because we expend less energy & resources while getting back more.

Now, of course these machines don’t exist. They’re fanciful chunks of my imagination. And (hopefully) now yours. But it turns out that I’m lying to you. Because the machines do exist. They’re called ports, and the mechanism by which they operate is trade.  The port in San Francisco deals primarily with trade to and from the far east – primarily China. And the machine is no less magical once it’s called a port. It does exactly what it did when we were calling it a machine. We put stuff into it that we produce and, as if by magic, other stuff that we don’t produce comes out.

But here’s the key: the rules of the port the same as the machine. If we import more than we export, we’re better off. We’re richer. We don’t have to work as hard and we get back the same or more.

Remember this when you hear people bemoan the trade deficit. The trade deficit measures how much work we have to do in order to get back work and products from other people. We are better off when we work less and get more.

The criticism to this view is that “working less” masks what’s really happening – people are losing their jobs. And that’s true. Working less means people losing jobs. But while this is a problem, it’s less of a problem than you might think.

First, people who are unemployed today are dramatically better off than if they were unemployed 100 years ago. Part of this is a result of government unemployment benefits. But those benefits exist only because our society is so wealthy that we can afford to grab some money from the employed and give it to the unemployed. If we were not wealthy enough to afford this, no amount of government imposed rules could make it happen. You simply aren’t going to be able to make the desperately poor better off by taking money from the slightly less poor. To help the unemployed, you need wealth. The point is this: even the unemployed are reaping huge benefits from the trade deficit. Unemployment today is a ton better than it was even just 30 years ago.

Second, while unemployment does cause pain, necessity is the mother of invention. The unemployed are incented to find some niche of production that hasn’t been brought to market yet. So they go searching for something to do. Most will just go looking for another job. But the jobs available to them will have changed. There’s a likelihood that they’ll work in a different industry than they previously had. That different industry is almost certainly newer than the one that they left. It is this mechanism by which entirely new wealth comes into existence. New industry emerges from a new idea that had never existed before. And that new idea, if it’s a good one, makes us all better off.

Don’t be confused: I’m not trying to minimize the difficulty of people losing their jobs. I’ve lost mine before and it sucks. There’s no way around it. But it’s part of a process. And that process is the society of humans re-inventing itself over and over again. Each time slightly better than the last time. And those slight improvements accrue into big changes over time. So much so that, just like today’s unemployed are better off than (probably) everyone from 100 years ago, I would expect that 50 or 100 years from now, the unemployed will likely be better off than most (if not all) of the employed today.

And the key thing at the heart of all this: trade. The more free it is, the more we do, the better off we are. Trying to level the trade deficit will kill the goose that laying the golden eggs.

N.B. I can’t take credit for coming up with the idea of equating a machine with trade. I first read this idea from David Friedman, and more recently read about it from Matt Ridley in “The Rational Optimist”. The purpose of my post here is to solidify the lesson in my head. I’ve discovered that there are a lot of things that I may think I understand conceptually, but that I don’t until I’ve actually written it down. Feel free to point out any errors you find.