Should trade policy be about "the art of the deal" or about facilitating economic growth?

"We must protect our borders from the ravages of other countries making our products, stealing our companies, and destroying our jobs.  Protection will lead to great prosperity and strength" - Donald Trump, Inaugural Address, Jan. 20, 2017 

How should the Australian government respond to the potential for the crazy trade policies of President Trump to take the world into a new era of trade protectionism? Since Trump’s inauguration the depth of his commitment to trade protectionism has become clearer. In my view we should be prepared for the unravelling of much of the international trade liberalisation encouraged by the U.S. in the latter half of the 20^th Century.

If the Australian government continues with the current directions of international trade policy – viewing trade policy from an economic diplomacy perspective – there is a real risk that it will take ill-considered retaliatory action to foreign protectionism. Politicians who put their faith in trade diplomacy – the art of the export deal – think that they are pursuing the national interest when they make access to the Australian market contingent upon foreigners allowing our exporters to gain access to their markets. In terms of that mindset, if foreigners restrict access to their markets, it would appear logical for us to retaliate.

By contrast, political leaders who view trade policy as part of economic growth policy are more likely to keep in mind that the substantial trade liberalisation effort that Australia has made over the last 40 years has occurred unilaterally, rather than as part of any international deal. A growth policy perspective recognises the contribution that unilateral trade liberalisation has made to our prosperity.

The substantial trade liberalisation efforts made in Australia since the beginning of The Tariff Review, established in 1971, have all occurred for domestic reasons. Except for the 25 percent tariff cut of 1973, which was motivated primarily by macro-economic objectives, all of the reductions in industry assistance have occurred primarily to promote the micro-economic reform objective of providing incentives for greater productivity throughout the economy. That applies to reductions in non-tariff barriers, including reform of agricultural marketing arrangements, as well as reductions in reductions in tariff barriers.

As with other microeconomic reform policies, trade liberalisation efforts in Australia have not been pursued with equal enthusiasm by all governments. However, a sustained push toward trade liberalisation was initiated by Bob Hawke (then prime minister) and Paul Keating (treasurer) in May 1988 as part of a major package of microeconomic reform measures. In delivering the statement, Keating commented:

“The way forward for Australia is not to be closeted and sheltered, but to be open and dynamic, trading aggressively in the world. Only this kind of economy can provide the employment and rising living standards that Australians aspire to”.

In the light of the toxic political environment currently prevailing in Canberra it is worth remembering that those reforms were facilitated by support from the Liberal–National Party Opposition.

The trade liberalisation that was being undertaken in pursuit of microeconomic objectives was subsequently ­offered, and accepted, in Uruguay negotiations as our market-opening contribution to global trade reform. As the Tasman Transparency Group has noted, this approach enabled us to secure all the gains available from trade negotiations — the major gains in efficiency from reducing the barriers protecting our less competitive industries, as well as those available from access to external markets. That exercise should have provided the model for all subsequent international trade negotiations.

Unfortunately, the opportunity for further gains from the pursuit of microeconomic reforms has been missed in subsequent trade negotiations. Australia’s agenda in recent negotiations establishing a range of preferential trading agreements (PTAs) was simply a market access wish list. Following the conclusion of PTAs, governments have measured their success solely on the basis of whether the outcomes improved access to external markets.

The academic research that the Department of Foreign Affairs and Trade is now sponsoring on “the effectiveness of economic diplomacy in contributing to Australia’s exports and inflow of foreign investment” does not seem to be directed at answering a comprehensible, policy-relevant question. Research being undertaken by the Productivity Commission on implications for Australia’s trade policy of possible international shifts towards a more protectionist stance seems more likely to provide a basis for sensible policy development.

Previous research on the consequences of PTAs suggests that there are no grounds for complacency that the economic benefits even exceed costs. For example, using an analytical framework developed by the Productivity Commission to assess our much-heralded trade agreement with the United States, Australian National University economist Shiro Armstrong found that the agreement was responsible for reducing — or ­diverting — $53.1 billion of trade with the rest of the world. He has suggested that “the data shows that … Australia and the United States … are worse off than they would have been without the agreement”. 

Recent Australian governments have at times acknowledged that trade policy should be part of a wider productivity promoting agenda. Nevertheless, the government seems to have been at a loss to know how to counter the argument that Australian governments should be seeking to provide a level playing field for domestic industries vis a vis subsidized foreign competitors. This argument has figured prominently in lobbying in some quarters for further government assistance by way of anti-dumping action and government procurement preferences. The government has been slow to point out that if we are to use a playing field analogy – and our interest is in promoting the wellbeing of Australians rather than conducting trade wars – the relevant basis for comparison is the relative assistance levels of different Australian industries. As a rule, if industries need assistance to compete internationally, they can’t be making efficient use of resources. 

If the Australian government is serious about its commitment to lift national productivity it should place trade policy in the Treasury department – the department with central responsibility for facilitating economic growth. This would add some much-needed economic discipline to the conduct of trade policy as we face a more difficult world trading environment. The last thing we need in this environment is a bureaucratic structure for trade policy that is biased toward mindless deal-making and retaliation

Is a fixed mindset more realistic than a growth mindset?

Before I got far into Carol Dweck’s book, Mindset, I was confronted by the thought that the author might classify me as having a fixed mindset rather than a growth mindset. Dr Dweck is an eminent psychologist who has conducted a great deal of research on mindsets. She suggests that if you believe that your intelligence “is something very basic about you that you can’t change very much” you have a fixed mindset, but if you believe that you “can always change how intelligent you are” you have a growth mindset.

In considering those propositions (along with a couple of other similar ones) my mind turned initially to research showing that for most people IQ tends to remain fairly stable throughout life. That must mean that existing IQ is a good predictor of future IQ. If you choose an individual at random it would be safe to bet that their IQ is not likely to change much. 

However, after a few moments I realized that I was adopting what I call a spectator mindset. I was considering the relevant literature like a spectator who is not personally involved. I had overlooked the fact that the author was asking whether I agreed with certain beliefs about the potential for my intelligence to change.

When I began to think from a personal perspective, books by Norman Doidge on brain plasticity came to mind. From a personal viewpoint, I think it makes sense to view your intellectual capacity in much the same light as your physical fitness. Your brain is like a muscle – use it to make it strong. Or, at my age, if you don’t use it you lose it!

As I read further into the book I discovered that, like many other people, I alternate between fixed and growth mindsets.

I was induced to read Mindset, by an article by Nela Canovic on the Quora site where people were discussing the most important thing they have learned in life. The article got me wondering how closely Carol Dweck’s distinction between fixed and growth mindsets corresponds to the distinction between spectator and player mindsets that enabled me to greatly improve one aspect of my life about 14 years ago. It makes sense for a spectator to focus on what she or he expects to happen, but to be successful at anything you need a player mindset – to focus on your intentions. That is one of the most important things I had learned from life. (I have recently written about it on this blog.)

My concern in this post is with the realism of different mindsets because I don’t think it serves us well to maintain delusions about ourselves.  As I see it, human flourishing depends, to a large extent, on realism – seeking understanding about important aspects of your own life and human life in general, and being disposed to act on that understanding when circumstances permit. As previously discussed on this blog, that view has been reinforced by my reading of Wellbeing: Happiness in a Worthwhile Life, by Neera Badhwar, a philosopher.

As I see it, fixed and growth mindsets must both be closely related to the meanings that people give to their experiences, and how those meanings or interpretations shape their intentions and future behaviour. Is a growth mindset more realistic than a fixed mindset?

Carol Dweck suggests that the fixed mindset – the belief that your qualities are carved in stone – “creates an urgency to prove yourself over and over”. She adds:

“If you have only a certain amount of intelligence, a certain personality, and a certain moral character – well, then you’d better prove that you have a healthy dose of them. It simply wouldn’t do to look or feel deficient in these most basic characteristics”.

The book emphasises is that this mindset gives people one consuming goal – proving themselves: “Every situation calls for a confirmation of their intelligence, personality, or character”. In this mindset people tend to avoid coming to terms with reality if reality doesn’t validate their views of their own qualities.

What about the people who have a fixed mindset which involves labelling themselves as stupid, erratic, neurotic, lacking in willpower, or manifesting some other quality associated with poor performance? The author doesn’t give much attention to the potential for people to develop fixed mindsets which involve labelling themselves as poor performers. That could be because she sees fixed mindsets as stemming largely from attempts by parents and teachers to boost the self-esteem of children by telling them how clever they are, and so forth.

In her discussion of willpower, the author’s main emphasis is on the potential for people who believe they have strong willpower to fall into the trap of firmly resolving to do something, then failing to act according to their intentions because they make no special efforts to do so. She doesn’t mention that people who have come to label themselves as lacking in willpower might give up making resolutions to do things that could improve their lives. Perhaps that point is too obvious.

When I went looking in the book for recognition of the potential for people with fixed mindsets to label themselves as poor performers, I did find some. For example, there is recognition of this in the author’s discussion of the higher incidence of depression among students with fixed mindsets, and in her discussion of the learning potential of inner-city children who have been labelled as retarded or emotionally disturbed. The author also writes:

“People tell me they start to catch themselves when they are in the throes of the fixed mindset – passing up the chance for learning, feeling labelled by a failure, or getting discouraged when something requires a lot of effort. And then they switch themselves into the growth mindset …”.

Carol Dweck explains:

“The growth mindset is based on the belief that your basic qualities are things you can cultivate through your efforts. Although people may differ in every which way – in their initial talents and aptitudes, interests, or temperaments – everyone can change and grow through application and experience”.

 

The author refrains from making unrealistic claims about what can be achieved with a growth mindset. She suggests that people with a growth mindset don’t believe that with proper motivation and education anyone can become an Einstein or a Beethoven. They believe that “a person’s true potential is unknown (and unknowable); that it is impossible to foresee what can be accomplished with years of passion, toil, and training”.  As discussed in an earlier post, practice in being alert to opportunities could also be expected to expand growth potential.

In the growth mindset people accept both failure and success as providing learning opportunities. The most important questions: What can I learn from that experience? How can I use it as a basis for growth?

Mindset contains important messages about ways in which parents, teachers and coaches can encourage children to adopt a growth mindset. Carol Dweck considers the message of praising effort rather than outcome to be too simplistic.  She now advises teachers and parents “to praise a child's process and strategies, and tie those to the outcome”. In my view she is encouraging realistic appraisal of personal performance and potential for improvement.

My bottom line: Don’t fool yourself that you are being realistic if you adopt a fixed mindset about your intelligence, personality or moral character. Everyone is a work in progress. We make progress by learning from experience.


Postscript:
My attention has been drawn to a study by Yue Li and Timothy Bates that has failed to replicate Carol Dweck's findings regarding praise of intelligence of children and children's beliefs in the malleability of their basic ability. Please see comments below for further information.

Does Henry George have the answer to funding basic income?

The idea of a government-funded basic income or social dividend has been around for at least a couple of centuries. It has been supported by some prominent advocates of individual liberty as well as by collectivists. For example, it was proposed as an alternative to existing welfare systems by Milton Friedman in the 1960s (as a negative income tax) and by Charles Murray (as an unconditional basic income for all adults) in In Our Hands, published in 2006. More recently Elon Musk among others, has suggested a government-provided unconditional and universal basic income (UBI) as a solution to the hypothetical problem of ensuring that people have adequate incomes when their jobs are displaced by automation.

That problem is hypothetical because it seems reasonable to expect - at a national level and over the longer term - that jobs displaced by automation will be replaced by more highly paid jobs. That is what happened with jobs displaced by mechanisation during the 19^th and 20^th centuries. No persuasive evidence has emerged to support the view that the effects of automation will differ in that respect. Nevertheless, UBIs might appear to be an attractive social/political insurance policy, just in case automation does result in widespread loss of income-earning opportunities.

The idea that one day most of the population will depend on UBIs as their main source of income strikes me as inherently unappealing. Historically, individual human flourishing has been closely related to the self-respect that comes from earning a living, which is absent when people are able to live on “sit-down money” – an appropirate term used by some Australian aborigines to describe welfare benefits.  Robert Colvile has provided references to research relating to disincentive impacts of UBIs in a recent FEE article.

I want to focus here on a question of practicability: Is there some easy way for a government raise sufficient additional revenue to fund a UBI to reinforce expectations that the benefits of future economic growth will be widely shared? How could substantial additional revenue be raised without stifling the economic growth process? As I contemplated those questions the thought crossed my mind that if I was back working in the Australian public service (heaven forbid!) and was asked to recommend a way to raise more tax revenue, I might suggest more reliance on taxes on the unimproved value of land, as proposed in Australia's Henry report, and as suggested much earlier by Henry George in Progress and Poverty (first published in 1879). Land taxes get a fair amount of support among economists, including some who write for The Economist.

At some point it occurred to me that I should actually read Progress and Poverty – or at least, the 2006 version, edited and abridged by Bob Drake – rather than rely on second hand reports. As I read about Henry George’s theory of wages and interest it became clearer to me why he was viewed as a crack-pot by some of the people who taught me economics. For example, by rearranging the identity, Production = Rent + Wages + Interest, he concludes: “wages and interest do not depend on what labour and capital produce – they depend on what is left after rent is taken out”. Of course, if you rearrange the terms another way, rent would appear as the residual after payment of wages and interest. Modern economists should not be overly critical, however, because George wrote Progress and Poverty before John Bates Clark had made his contribution to the marginal productivity theory of distribution - and Clark apparently attributed his conception of the marginal productivity of labour to George’s theory of rent.

Henry George provides an interesting discussion of the way site rent rises with economic development. He asks readers to imagine a vast unbounded savanna. Every acre seems as good as any other for the first family to arrive, so they make a home somewhere, anywhere. When other families arrive, one location is clearly better than the others, that is close to the family that has already settled. Having a neighbour provides opportunities for the families to help each other. As more people arrive, a village is established to enable people to obtain advantages from local specialization and trade. As the village grows into a town and then into a city, the productivity of the original land increases. As a consequence: “Rent – which measures the difference between this increased productivity and that of the least productive land in use – has increased accordingly”. The original owners of the land become rich “not from anything they have done, but from the increase in population”.

George recognised that advances in technology, improvements in manners and morals and government policy reforms (e.g. free trade) also increase the productivity of land, and increase rents.

Following David Ricardo and John Stuart Mill, George argued that a tax on rent would fall wholly on land owners. He went further, however, in suggesting that all rent could be taxed away for the benefit of society without ill-effect. He suggested that returns to labour would thereby be enhanced:

“When all rent is taken by taxation for the needs of the community, equality will be attained. No citizen will have an advantage over any other, except through personal industry, skill, and intelligence. People will gain what they fairly earn. Only then, and not until then, will labor get its full reward, and capital its natural return”.

Henry George was correct to argue that, from an economic efficiency perspective, rent taxes are superior to most other taxes because they have a smaller impact on productive effort and investment. However, it is hard to see how a large increase in land taxes could be viewed as providing an equitable sharing of tax burden. Consider two people who have equal wealth, the wealth of A is in entirely in land and the wealth of the B is entirely in shares in companies that do not own land. Would you view it to be equitable for a government to introduce a tax that would take away a large slice of the wealth of A, while leaving the wealth of B unaffected?

Perhaps that inequity could be overcome by announcing that the new land tax will only apply to future increases in land values. However, the deadweight costs of a tax on future increases in land values would not be negligible. For example, consider a firm that is planning to build a very fast train and considering whether a stopping point along the route should be at City X or City Y. The firm is buying land along the route because it needs to capture some of the expected appreciation in land values to make its investment worthwhile. The firm’s investment appraisal suggests that City X would be the best location. However, it subsequently learns that City X is contemplating a substantial tax on future increases in land values, while City Y has no such plans. That information obviously has potential to tip the balance in favour of City Y, resulting in a less efficient allocation of investment.

The potential deadweight costs of land taxes have been explored in more depth by others, including Bryan Caplan and Zachary Gochenour.

My bottom line: Land taxes are better than many existing taxes (much better than taxes on land transfers) but they don’t offer a costless way to fund the substantial additional revenue that would be required to fund an unconditional basic income sufficient to meet reasonable expectations of a widely-shared dividend from future economic growth. If land taxes can’t do it, I doubt whether any tax-transfer proposal can achieve that objective. One way or another, even when robots do most of the work currently done by humans, humans will still need to earn the bulk of the incomes they live on - including by inventing and improving robots, servicing and managing them, and owning them.

Does your constitution mandate free trade?

The Constitution of Australia, like that of the United States, mandates free trade – up to a point! Both constitutions mandate free trade between the states, and leave federal governments free to impose barriers to international trade to the extent that they wish.

It is debatable whether a constitutional requirement for free international trade would have made a huge difference to trade policy in either country. The requirements for free trade between the states have not guaranteed free trade between the states - judges have not always ruled against trade barriers imposed by states to protect local interests. Many judges seem to capable of being highly imaginative in their interpretation of concepts such as free trade.  

The relevant constitutional question is whether free trade is mandated by the real constitution - the set of dispositions that influence what most citizens will accept as legitimate actions by politicians and bureaucrats who make up the government. That depends ultimately on the views of individual citizens.

Why should your constitution mandate free trade?  I hope you share with me the belief that individuals have a natural right to engage freely in mutually beneficial transactions with one another, even though third parties may be disadvantaged. If so, you would probably consider it to be objectionable for a government to levy a discriminatory tax on the sales of the producer from whom you wish to purchase, in order to encourage you to purchase from a rival producer. You may well assert that you have a right to choose to buy from whatever source you wish, for whatever reasons you might have, free from any such third-party interference.

The logic of this argument does not cease to apply merely because buyers and sellers may be separated by national borders. National borders are artificial constructs that do not alter the natural right of individuals and firms to engage in mutually beneficial transactions. Donald Boudreaux has written persuasively on this topic: “International Trade Is Simply One Manifestation of Competition”.

Should an exception be made in situations where foreign governments subsidize their exports? No, if foreigners are sufficiently misguided to subsidize their exports there is no reason why domestic consumers should not benefit from any price reduction that this causes. In a market economy, if foreign subsidies result in an expansion of total imports, this can reasonably be expected to result in exchange rate and relative price adjustments to make exporting more profitable and bring about an expansion of exports. Production for the domestic market that is displaced by increased imports will be offset by increased export production.

Some economists still, no doubt, maintain that unilateral free trade is not optimal on grounds such as the optimal tariff argument, and the potential for the use of existing trade barriers as bargaining chips to obtain better access to foreign markets. Policy advisors who recommend departure from free trade to obtain such gains risk opening the way for much larger economic losses because they are dealing with fallible real-world governments, rather than the omniscient and benevolent governments assumed to exist in their economic models. In the real world of politics every departure from a simple rule opens up opportunities for interest groups to advance their interests at the expense of the broader community. 

However, there is one argument that makes it difficult for the real constitution to mandate free trade. With great reluctance, I am now willing to concede that it may be becoming more difficult for politicians to endorse free trade because many people are choosing to cast their votes for candidates who oppose it. Even though the gains from free trade vastly outweigh the losses, the uneven distribution of losses makes the outcomes of free trade seem unfair to many people. A substantial proportion of voters in many countries now seem to be saying that their disposition is to favour protection of existing jobs rather than the opportunities that free trade offers.

Over the longer term, the pursuit of policies to preserve existing jobs will, of course, be inimical to the specialization and technological progress which provide the basis for everyone’s future prosperity. Nevertheless, many voters and their representatives seem to be more concerned to preserve existing jobs than to promote future prosperity. Our democratic systems seem to be mutating from systems of social cooperation to promote the interests of everyone, to arenas for the “war of each against all” that Thomas Hobbes imagined as the only alternative to an all-powerful dictator “to keep them all in awe”. Are we powerless to prevent this war of each against all?

This poses the kind of constitutional dilemma discussed by one of the 20^th Century’s best economists, James M Buchanan, in The Limits of Liberty: Between Anarchy and Leviathan, 1975. Buchanan wrote:

“If there exist potential structural changes in legal order which might command acceptance by all members of the society, the status quo represents a social dilemma in the strict game-theoretic terminology. Even if we consider ourselves far removed from the genuine Hobbesian jungle, where life is brutish and short, the status quo contains within it elements or features that are in principle equivalent. Life in the here and now may be more brutish than need be, and certainly more nasty. If after examination and analysis, no such potential for change exists, the legal-constitutional order that we observe must be judged to be Pareto optimal, despite the possible presence of discontent among specific members in the body politic”.

Buchanan was particularly concerned about ways to reform the rules of the political game to promote fiscal responsibility. That problem has worsened since the 1970s. The type of reforms he hinted at involved agreement by those who sense that they are vulnerable to having wealth expropriated via the political process to a mechanism for limited wealth transfer on condition that others agree to rules that overtly limit governmentally directed fiscal transfers.

I doubt whether rules to promote fiscal responsibility are feasible in the absence of a broad consensus concerning the role of government in distribution of the benefits from economic progress. Perhaps that is also a context in which the real constitution can mandate free trade. Current proposals being advanced in various quarters for guaranteed minimum incomes are relevant to this discussion. It seems to me, however, that proposals to ensure widespread opportunities for those displaced by import competition and technological change to improve their skills, and earn higher incomes, are probably more deserving of support. I might try to spell out reasons for that view in a later post.