Wednesday, March 1, 2017

What Imports Mean for Your Slice of the American Pie

Today, many Americans aspire to be independent of foreign goods. Not only do they choose to “buy American,” they want to ensure that everyone is compelled to do the same. A thought experiment can help us decipher the wisdom of this.
Let’s suppose that umbrella imports are banned in the United States; that is, Americans can only buy umbrellas produced by other Americans. How would lifting the umbrella import ban affect the U.S. economy?
Rather than wringing our hands about this question or appealing to authority figures in economics, let’s reason out the answer with a simple numeric example.
Aside from being a source of competitive pressure, the Chinese have nothing to do with these umbrellas.

For starters, suppose that when completely self-sufficient, U. S. umbrella production/consumption is 10 million per year and that the price of an umbrella is $20. Assume the price of comparable foreign umbrellas is $12. Virtually everyone would agree that if the import ban were lifted, the price of umbrellas in the United States would drift down to the $12 dollar world price.
At the $12.00 price, U. S. umbrella production would obviously fall, maybe even to zero. American producers that decide to continue making umbrellas would be those whose next best alternatives are worth less than $12.00 per umbrella. They “tough it out,” so to speak, and lose $8.00 per umbrella, compared with their earlier sales.
Doing the Math
Suppose domestic U.S. umbrella production falls from 10 million to 3 million. From this, one might infer that American producers have lost $24 million (3 million umbrellas times the $8 price drop).
Do foreign producers of umbrellas, say, the Chinese, receive the $24 million? Absolutely not. Aside from being the source of competitive pressure that drove the price down, the Chinese have nothing to do with these umbrellas.
Does the $24 million vanish? Not at all. It stays in the United States; none of it goes to the Chinese. It is accrued by American umbrella buyers in in the form of lower umbrella prices. The U.S. economic pie is simply resliced. U.S. umbrella producers receive a smaller piece, while American consumers receive a larger piece.
Americans have the 7 million umbrellas and $28 million more of other things.
What about the 7 million umbrellas no longer produced in the United States? Some producers will not be willing or able to accept the new lower price point, and they will leave the umbrella market to pursue superior alternatives, which they value more than the $12 they could receive for each umbrella. Let’s suppose that their alternatives on average equal $16. Their choice results in a loss of $28 million (7 million umbrellas times the $4 drop in average earnings per umbrella).
The fact that these workers can earn $16 per umbrella elsewhere tells us something very important. The opportunity cost of producing the 7 million umbrellas domestically is $112 million (7 million umbrellas times $16).
Alternatively, Americans give up $112 million worth of other things to produce the 7 million umbrellas.
What does it cost Americans to buy 7 million umbrellas from the Chinese? Less than $112 million to be sure; $84 million to be exact (7 million umbrellas times $12). This means substituting lower cost Chinese umbrellas for higher cost domestic alternatives increases the size of the U.S. economic pie. Americans have the 7 million umbrellas and $28 million more of other things.
Giving up less to achieve the same objective means having more of other things.
Producers lose $52 million, while consumers gain $84 million, and the economic pie increases by $32 million.
The now former U.S. umbrella producers still lose. However, U.S. umbrella consumers necessarily gain more than what their producing counterparts lose. That is, consumers were formerly paying $20 for each of these 7 million umbrellas; now they’re paying $12. So consumers are better off by $56 million. The U.S. economic pie gets larger as it’s simultaneously resliced against umbrella producers, in favor of consumers. A rising economic tide doesn’t necessarily raise every single ship.
Now, what about the Chinese? Do they get any of what American producers lose? Do they capture some of the increase in the U.S. economic pie? Nope. They get the $12 per umbrella price. End of story as far as they are concerned.
Additionally, note that, at $12, the lower price of umbrellas will make feasible that which was not economically feasible at a $20 price. What do I mean? At $20, it might not be economic to have an umbrella in your car, office, and home. Not so at $12.
Let’s suppose the additional annual increase in umbrella purchases is 1 million. If the average consumption value attached to these additional umbrellas is, say, $16, then their purchase by Americans from the Chinese increases the economic pie by $4 million (1 million umbrellas times [$16 - $12]).
So in the final analysis, umbrella producers lose $52 million while umbrella consumers gain $84 million. The economic pie increases by $32 million.
Tracing Consequences for All Groups
Many supposedly “in depth” media portrayals present global trade in stark contrast to the above. Usually, media portrayals show only two angles. First, they show pictures of Chinese factories and their workers churning out products at a rapid rate. Second, they appeal to emotions by presenting U.S. factory towns with “for sale” signs in front of homes, U-Haul trucks parked in driveways, and hopeless people who have found themselves unemployed. The message of these supposed “in depth” portrayals is clear: the Chinese gain at the expense of Americans. Through this lens, buying from foreigners is an exercise in international benevolence.
The media repeats this message over and over again regarding imported products. I have to admit that the message has an attractive simplicity. What could be more obvious: those who compete with lower-priced producers lose out to them. But as Henry Hazlitt once observed: “The art of economics consists in tracing the consequences of [a] policy not merely for one group but for all groups.”
That’s where these “in-depth” portrayals fail. Indeed, they barely scratch the surface. Doubtful? Get out some paper and pencils and go through the calculations

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