We Need Demand, not Protectionism
Fri, Sep 10, 12:32 PM ET, by Bob McTeer
There is demand and there is supply. Alfred Marshall taught us that they work together as in the two blades of scissors, but I guess that was primarily in a micro-economic context. In macro-land there is also a need for both to work together, but that has been difficult recently, in part because each point of view has taken on the aura of religious fervor. Last year I was being copied on an e-mail exchange between a father and a son, both friends of mine. I forgot what the father said to prompt the son's strong response, but the response was intended to be a knock-out blow. The son called the father a Keynesian. Them was fightin' words. Supply sliders remind us of the importance of incentives, especially as they pertain to marginal tax rates. In a deep recession, however, there is also a need for attention to the demand side. Keynes taught us how demand creates supply. Say earlier had taught us how supply creates demand. Why do we have to choose? Why can't they work together? Why can't we all be like the father, who just smiled. Keynes divided total spending into major categories that respond to somewhat different stimuli: consumption, investment, government, and exports, with a subtraction for imports to avoid double counting. Consumption spending, which amounts to about 70 percent of the total, is being constrained by consumers' need to save. Business investment spending could be much greater than it is, given the resources and liquidity of businesses, but business leaders won't invest much as long as consumer spending isn't growing. Besides, the government is creating major headwinds to business investment by the reality and promise of higher taxes and harsh regulation. Government spending is at a very high level, but has reached the public's limit on further major increases to the deficit. Exports are generating domestic income, but import growth has more than offset that recently. That latter point was the subject of an op ed piece in today's New York Times, titled "Trading Away the Stimulus." Its authors point out that so far this year America's trade deficit has hit $289 billion, compared with $204 billion in the same period in 2009." They attribute the lack of effectiveness of the stimulus program to this foreign trade leakage. They point out that ". . . since February 2009, the government has injected $512 billion into the American economy, but during roughly the same period, the trade deficit leaked about $602 billion out of it and into foreign markets." Unfortunately, the authors propose major foreign trade restrictions to plug this leakage. This would be a cure worse than the disease. First, it would sacrifice the many benefits of micro efficiency to plug an apparent macro leakage. We learned this lesson with the Smoot-Hawley Tariff in the early 1930s, which led to a downward spiral of world trade. Second, foreign trade leakages tend to be self correcting since imports and exports are not independent of each other. As we import more and more, foreign entities accumulate dollars, which may temporarily be invested in U.S. financial assets, but ultimately will lead to more purchases of U.S. exports. To doubt that is to assume that our trading partners will forever exchange real goods and services for pieces of paper, so to speak. Likewise, a surplus in U.S. foreign trade would sow the seeds of a reversal in the future. We shouldn't use extreme and destructive measures to solve a "problem" that is ultimately self correcting. The quotes around problem in the previous sentence are a reminder that a temporary trade deficits or surpluses are not per se a good or bad thing. They are usually treated as problems because they represent "imbalances" that probably aren't sustainable over the long run. One aspect of our prolonged trade deficit that does seem problematic is that it reflects a flow of capital to a rich country from poorer countries, the reverse of the text-book model. If it is a problem, however, it will fix itself. 
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