TheMarketForIdeas

Ideas have consequences. Wrong ideas have disastrous, deadly consequences. Adam Smith got the theory of value wrong. Starting from the mistaken premise that prices are causally explained by costs and identifying labor as the homogeneous element that is present at different stages in the production chain of a good, he developed the labor theory of value. A flawed theory that had very serious consequences in the real world.

From Adam Smith, the theory was taken up by David Ricardo and from Ricardo by Marx. When the value of labor did not seem to Marx to equal the value of final goods, his explanation was that something was wrong with the capitalist mode of production. Hence his theory of exploitation and irredeemable conflict between the classes calling for a radical change of the system. Hence the socialist revolutions, communism and the more than 100 million lives sacrificed on the altar of a simple error in economic thinking.

Contrary to Marx, there is actually nothing wrong with free market capitalism. It was Smith who erred in his reasoning, but the error has since been exposed and corrected. Prices are not formed by costs, but by the subjective value assigned by those who will buy the goods. Costs are formed by entrepreneurs bidding in anticipation of the final demand, so things are the other way around: costs are the ones in fact caused by prices. And, more importantly, they don’t have to be equal one to the other. Profits and interest are perfectly explicable and it is natural for workers to not receive the full value of their output in wages.

The errors of socialist thinking have been criticized and corrected since the 19th century, since their inception, but that has not been enough to stop the evolution of the mistaken idea of the exploitation of the working class by the capitalist class. That bad idea took root and could not be stopped before it bore its fruits of abysmal tragedy and megadeath.

However, Adam Smith was not wrong about the division of labor, the benefits of specialization and free trade. Correct ideas have beneficial, life-giving consequences. The Industrial Revolution that started in Britain, the abolition of internal regulations and customs, and especially international free trade agreements that have been concluded between Western nations since the 19th century, are manifestations of these correct ideas and have made possible an exponential increase in the average prosperity of people globally, doubled by concomitant exponential increase in the global population, the emergence of prosperous middle classes, and the gradual escape of more and more people from extreme poverty. An exponential evolution multiplied exponentially, a situation beyond any imagination of the world from three or four centuries ago.

We are now on a pinnacle of material progress, although the ideas of freedom, respect for the individual and his property, free markets, and international free trade have not been put into institutional practice to anywhere near their full potential in any place and time. Nowhere in the world did we have and yet do not have pure capitalism, a free market and completely open international trade. On the contrary, the forms of institutional aggression through which ownership and prosperity generating free market mechanisms are impeded and diminished have always been in an ebb and flow, with the statist burden on the economy’s productivity ratcheting up for long periods. Crises and wars have been moments of such leaps in the power of state against society, and only the embrace of correct ideas and the rejection of popular error have made possible reforms that restored the proper institutional arrangements for prosperity and peace.

In terms of the current tariff war, the Trump Administration is placing America and the world in a regression that throws it ideologically back into the mercantilist, pre-Smithian era. Donald Trump thinks, talks and acts like a mercantilist. He doesn’t seem to understand a simple thing Adam Smith explained nearly 250 years ago. From a freely agreed exchange, both the seller and the buyer stand to gain. The gains do not have to be symmetrical, both sides do not have to gain equally. But if both parties didn’t understand that each stands to gain something – and that they would be worse off if they didn’t make the exchange than if they did –, then the exchange wouldn’t really take place.

Well, Trump doesn’t seem to understand this, he has a long-standing obsession with the exploitation of the buyer by the seller, especially and when the seller is a foreigner. Just like the mercantilists of the pre-modern era that we hoped we’d outgrown, Trump wants to sell the world more than he buys, and he wants to force all his countrymen to do the same. Mercantilism has never been a coherent system of thought, but a somewhat heterogeneous collection of contradictory pamphlets by businessmen and statesmen rather than thinkers or philosophers. And often they were in fact attempts to justify special interests, lobbyists interested in profiting – not contractually, but with the backing of the law; not by offering something in a market where demand can freely manifest itself, but by forcing people through monopolies, restrictions, taxes or customs duties. This could also explain mercantilism’s lack of coherence. It’s not an attempt to discover universal economic laws, the truth, but pretentious lies meant to justify the petty and obtuse interests of some power-hungry individuals who thirst for power and profit, not by serving but by oppressing others.

I think that those looking for the ingenuity and strategy behind Trump’s actions have much more rummaging in the dark to do. It’s rather vain to hope that Trump-the-tariff-man raised tariffs just as a negotiating tool that would finally get the US in a free trade situation. For him, free international trade in which the US will continue to run deficits with the rest of the world – and especially bilateral deficits with China or other countries – is simply unacceptable, no matter how small the reciprocal level of taxation.

The obtuseness of the tariff policy being pursued by the Trump Administration is all the greater because the US dollar’s status as an international reserve currency is and has been chronically abused. Control of the US dollar printing press creates the temptation and privilege of “deficits without tears”. Dollar inflation alone would be enough to explain a Cantillon-type international redistribution from other countries to the American elites that first come into possession of the new inflated money and can buy anything anywhere at the old prices, before monetary inflation in priced in. Such an effect is of a temporary nature but, to the extent that inflationary policy is continued, the effect becomes permanent. Add to this the way mercantilist ideas are at work in other countries, China in particular, which have been known to pursue export subsidy policies at the expense of their own citizens, and we cannot escape the image of an America that is like a brat: the world falls over itself to spoil him with cheap goods while accepting in return the colored paper scraps he produces freely. And all this does nothing but provoke his sulkiness and angered raising of the tariffs that would stop world trade in its tracks.

If Trump were wise then he would limit himself to cutting regulations, public spending and taxes and, in particular, end the fed and the dollar’s inflation. Those would be the steps that would make America great again. In no way would this be achieved by reviving the protectionist policies that were a causal factor in the Civil War, plunged America into its Great 1930s Depression, and led to the global generalization of tariff barriers that culminated in World War II. But it seems that Donald Trump has learned nothing from the tariff war he started in his first term.

The immense prosperity that the world has gained from globalization, i.e. from expanding international trade and deepening specialization, is not to be taken for granted. It will disappear along with the world’s willingness to trade more freely. On the other hand, however large the share of US international trade, economic logic tells us that the policy of free trade makes sense and bears fruit even when adopted unilaterally. If the rest of the world keeps tariffs low despite Trump Administration’s policies – and if steps are taken to further open up trade and investment across the globe in contrast to these policies –, then poverty effects from Trump’s tariffs will be minimized.

As for US policy, we can only hope that it will curb the abuse of executive power and that this intellectual error – Trumpism, also knowns as bad old mercantilism – will be stopped before it wreaks more havoc than it has already wrought, primarily in the wealth and lives of ordinary Americans.

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Further reading: Adam Smith, The Wealth of Nations; Ludwig von Mises, Human Action: A Treatise on Economics; Murray Rothbard, Mercantilism – A Lesson for Our Times; Gottfried Haberler, The Theory of International Trade; Douglas Irwin, Against the Tide: An Intellectual History of Free Trade.