06 May 2014

The Infernal Resilience of Economic Fallacies

If only economic fallacies were characteristic of economic goods — and scarce! Unfortunately, this is not so, and fallacies in favour of protection and stimulus flourish and spread their noxious untruths. For Frédéric Bastiat, it was the task of political economists to do battle against them in a ‘perpetual protest’1.

Sometimes, though, the source of the economic fallacy surprises, as it did when reading a brief John Redwood commentary on Britain’s latest Budget from its Chancellor of the Exchequer, George Osborne.

Redwood, once a protégé to Thatcher and a respected scholar and politician, understands the dynamism which underpins the Laffer curve2, writing that ‘tax revenues are rising ... by allowing more tax revenue to arise naturally through the growth of the economy’, underlining the fact that higher taxes do not necessarily result in higher revenues:

Where the government has tried higher tax rates on income and capital gains it has actually damaged the revenues, not increased them. If any government tried to reduce the deficit quickly through a series of tax rate rises, considerable damage would be done to the economy and tax revenues might fall.

Plus, he advocates a route to balanced budgets through such growth, which ‘...has always been the main requirement to help correct the large imbalances in the economy without pushing it into deep recession.’ Yet in the same paragraph, Redwood lauds government fiscal interventions that are just as likely — depending upon the steps taken — to be impediments to the economic growth he favours. ‘We need more exports, more homes, more domestically produced goods to replace imports, ‘he asserts. ‘The budget seeks to help bring that about.’

Export expansion, for instance, can benefit from reductions in regulations that artificially raise the price of British goods. As for housing, such regulatory reform would doubtless be of more benefit than the Chancellor’s ‘help-to-buy’ initiative: ‘The chancellor’s sub-prime subsidies risk further inflating the housing market,’ warns Richard Wellings. ‘More households will take on debts that could become unaffordable should interest rates return to normal levels. Thus significant default risk has been loaded onto taxpayers. There are also potentially very serious implications for the banking sector should government policies ignite another boom-bust cycle.’

All things being equal, Redwood goes off the beam, though, in his condemnation of foreign trade which he views as a threat to domestic industry or, nearer the mark, British employment. The organic ramifications of trade are by no means static, as Geoffrey Wood outlines in Fifty Economic Fallacies Exposed:

Producers are guided by the prices they see confronting them to produce what is most profitable for them and to do so as cheaply as they can. Prices thus direct resources to where they are most useful, as those producers to whom they are most valuable will pay most for them. If an economy is trading freely, without tariffs, its resources are making the most of the opportunities prescribed to them by the patterns of prices in the rest of the world.

The economy’s resources will thus be used where it is most productive, relative to the rest of the world, for them to be. The economy will be making the most of the opportunities available to it.3

In an harmonious trading environment, then, countries produce according to their strengths, and buy from countries with respective productive advantages. Far from a zero sum transaction as Redwood suggests, this is an economic policy with positive sum benefits — and a respectable pedigree: David Ricardo called it ‘the law of comparative advantage’, whereas for Ludwig von Mises it was ‘the law of association’.

But for sheer entertainment in slaying this protectionist bugbear, one must return to Bastiat, who doubtless would have relished a go at Redwood’s economic faux pas. From his essay ‘Domination through Industrial Superiority’, we can imagine how he would set upon Redwood’s admonition against imports:

We produce at home neither tea, coffee, gold, nor silver. Does this mean that our industry as a whole thereby suffers some diminution? No; it means only that, in order to create the equivalent value needed to acquire these commodities by way of exchange, we employ less labor than would be required to produce them ourselves. We thus have more labor left over to devote to satisfying other wants. We are that much richer and stronger. All that foreign competition has been able to do, even in cases in which it has absolutely eliminated us from a particular branch of industry, is to save labor and increase our productive capacity.4

Bastiat acknowledged that even the best are tripped up by economic fallacies, due to their sheer tenacity (and controversy over balance-of-trade issues is among the most intractable). Fortunately for Redwood (and us), there remain those political economists who can diagnose these errors and prescribe the needful antidotes. The Chancellor of the Exchequer himself would do well to schedule an appointment.

ENDNOTES

1. Frédéric Bastiat, ‘Property and Law’, in Selected Essays on Political Economy, George B. de Huszar, trans., Seymour Cain, ed. (Irvington-on-Hudson, NY: Foundation for Economic Education, 1995), 115.

2. See Arthur Laffer, The Laffer Curve and the Failure of Stimulus Spending, Lecture delivered to the Institute of Economic Affairs, London, 27 June 2012.

3. Geoffrey E. Wood, Fifty Economic Fallacies Exposed (London: Institute of Economic Affairs, 2002), 34.

4. Frédéric Bastiat, ‘Domination through Industrial Superiority’, in Economic Sophisms, Arthur Goddard, trans. & ed. (Irvington-on-Hudson, NY: Foundation for Economic Education, 1996), 268.