One of the great tragedies of human existence is that so many of the issues which divide the race most sharply, issues which lead to dissension and ill-feeling, and all too often culminate in physical violence, are nothing more than phantoms: illusions that are founded on faulty observation, misunderstanding, or erroneous reasoning. A large part of the industrial strife that now constitutes one of our most serious domestic problems originates from the vigorous pursuit of objectives which fall mainly into two categories: (1) objectives which will be accomplished automatically in any event, irrespective of whatever effort is exerted for or against them, and (2) objectives which are inherently impossible to accomplish. All of the economic loss to the workers, to the business enterprises, and to the nation at large, as well as the social disturbances generated by struggles over such issues, are therefore incurred to no purpose. The participants in these unnecessary and fruitless conflicts are simply victims of misinformation and error.
But however serious the consequences of these futile industrial conflicts may be, they are far overshadowed by the results of equally futile and pointless economic disputes between nations. Industrial strife causes serious economic losses and may even lead to civil disorders, but international economic rivalry often leads to war, that greatest of human calamities. Historians are sharply divided as to just how large a part economic factors play in the origin of wars, but all agree that economic issues rank high among the important causes, and there are those who contend that most modern wars were basically of economic origin. L. L. Bernard, for instance, in his book War and its Causes, gives us this conclusion: “The immediate causes [of wars] are usually political or personal, but they have ordinarily arisen out of underlying economic conflicts and conditions.”128
The costly and destructive wars that have had their origin in the pursuit of economic mirages are doubly tragic in that, unlike the industrial situation where the true economic facts are imperfectly understood even by the specialists in the economic field, most economic and political leaders have a reasonably clear grasp of the basic economic relations between nations, and the problems that are being experienced are due to their inability or unwillingness to transmit this understanding to the general public-largely inability on the part of the economists and unwillingness on the part of the political leaders. As Winston Churchill described the situation existing in the years immediately preceding World War II, “The multitudes remained plunged in ignorance of the simplest economic facts, and their leaders, seeking their votes, did not dare to undeceive them... No one in great authority had the wit, ascendency, or detachment from public folly to declare these fundamental, brutal facts to the electorates; nor would anyone have been believed if he had.”129
The lack of understanding of economic fundamentals among the general public is, to a large degree, the result of a misconception of the role of money in the economy. The value of money is almost always regarded as the fixed item in economic comparisons. As brought out in the discussion of fundamentals in Chapter 4, however, economic value is subjective, and highly variable. Under equilibrium conditions-that is, where there is no net flow to or from the reservoirs-the value of the local currency is an average of the true relative values, and therefore serves as an acceptable substitute for the fixed standard of value that does not exist. But the public perception of the currency is that it is an absolute (rather than relative) standard, and money is therefore regarded as the fixed element in the price structure. It follows that when unbalanced reservoir transactions take place, and prices respond, the resulting “high cost of living” is blamed on the increase in prices, whereas what has actually happened (except in emergencies such as wartime) is that the value of the currency has dropped by reason of wage increases (cost inflation) or diversion of purchasing power to recipients of new money (money inflation). The problem that has developed is not a real increase in prices, but a decrease in the real value of money.
The factor that is responsible for most of the variations in the true value of money is, of course, inflation. As explained in Chapter 12, money inflation is a phase of a cyclic process, and it is not cumulative. The continuous inflation that is characteristic of present-day economies world-wide is cost inflation. As stated earlier, this type of inflation has no effect on real wages (before taxes), or on business profits, and it therefore has little effect on the general operation of the economy. Economists have noted this fact, but have no explanation, and admit that they are puzzled by it. “The inability of analysts to find major costs (of inflation),” says Samuelson, “has led some to think that the aversion to inflation is a social phenomenon.”130
Nevertheless, even though cost inflation does not work to the detriment of the average worker, it does give rise to serious inequities, because the factor offsetting the continuous rise in prices is a continuous series of wage increases, and under present conditions some workers receive earlier and larger increases than others. This eventually results in an unbalanced wage structure that is highly discriminatory, and also has some undesirable effects on foreign trade that we will examine shortly.
The other major effect of cost inflation is that it reduces the value of fixed interest obligations-bonds, mortgages, pensions, life insurance policies, etc. If there has been a 100 percent inflation in 20 years, which is about the U. S. rate, the true value of these fixed interest assets has decreased by half. This is obvious and incontestable, yet a large segment of the population, probably a majority, refuse to accept it because of their long-standing commitment to the opinion that money is the stable form of value. The U. S. Treasury Department, for instance, proclaims in their advertisements for savings bonds that “no one has ever lost a penny” in these bonds. In terms of money, this statement is correct. But the message that the statement is intended to convey-that the investment retains its original value throughout the life of the bond-is totally false. In twenty years the bond has lost half of its value.
The same concentration of attention on money value rather than real value can be seen in the profusion of arguments in favor of discontinuing the “indexing” of certain payments, particularly social security, whenever the nation finds it necessary to consider reducing expenses. “Why should these people be receiving increases in their income while the rest of us are having difficulty making both ends meet on what we are now getting?” is the complaint that is repeated over and over again. The truth is that these are not “cost of living adjustments,” as they are usually called; nor do they increase anyone’s real income; they are inflation adjustments that are necessary to avoid actual decreases.
If the payments were made in some form other than money, the true situation would be clear to everyone. Let us assume, for instance, that instead of a money payment, the pensioner’s contract with the government called for receiving 1000 gallons of diesel oil at specified intervals of time. Then let us further assume the the government revises the official definition of the “gallon,” reducing its size by one half, so that on the next delivery the pensioner receives 1000 of the new gallons, leaving the tank only half full. Few would deny that in this case the government is defrauding its creditor.
This is exactly what happens if no “indexing” is applied to contractual obligations such as social security. The government, by means of its wage and monetary policies, continually redefines the value of the “dollar” in terms of buying power, the only measure that has any real meaning in economic life. A payment of the same number of dollars after a decrease in the true value of the dollar is no different from a payment of the same number of gallons after a redefinition of the gallon has reduced its size. If the creditors receive no more than the original number of dollars they are being defrauded. Those who see the indexing as an increase in the payments are being misled by the “money illusion” which makes a decrease in the value of money appear to the public an an increase in the price of goods.
The same considerations apply to all financial obligations of the government, but where the transactions are voluntary the terms of the contract usually contain some built-in protection against inflation. For instance, the interest rate on bonds set by the markets generally includes a component representing the anticipated rate of inflation, so that the net return to the bondholder approximates the normal interest rate. Some similar adjustments are applied in private transactions. The principal victims of the continuing cost inflation are the owners of long term obligations, bonds issued when inflation was relatively low, private pensions (which are rarely adjusted for the full amount of inflation, if at all), insurance policies, etc. One of the most unfortunate features of the situation is that these investments that are the most subject to loss of value because of inflation are the types of investment (other than home ownership) in which most of the savings of the less affluent participants in the economy are concentrated.
The misunderstandings described in the foregoing paragraphs illustrate the point that the extent to which economic knowledge has been passed on to the general public is not much greater now than it was in the days to which Churchill referred. It is therefore necessary, in a work addressed to the public as well as to the economic profession, to review the entire international economic situation, with particular emphasis on those aspects of foreign trade that are usually minimized because they are distasteful to the voters.
In beginning this discussion we will look first at a domestic trade example which is closely analogous to foreign trade in almost all respects. Let us examine the economic status of a family operating an isolated farm. This group of individuals produces a certain quantity of agricultural goods. Some they consume, short-circuiting the market cycle. The balance over and above their own needs constitutes purchasing power, which the family is able to utilize to obtain various other goods from the “foreign” merchants in the nearest city. These city goods are not absolutely essential to the existence of the farm family. If necessary the farm operations could be organized in such a way that the family would be entirely self-sufficient. In fact, the normal farm life in pioneer days approached this condition. But the farmers have found that by increasing their production of those items to which their land is best adapted, they can gain a purchasing power that can be utilized in the city markets to purchase goods that would be difficult, if not impossible, to produce with the facilities available on the farm. At the same time, the workers in the city factories and stores get the benefit of the efficient large scale production of food on the farm. Thus both groups are enabled to enjoy a higher standard of living than would otherwise be possible.
It is evident that this process of exchange does not increase the total amount of work that has to be done on the farm; that is, it does not create any more jobs. Indeed, the ability of the farmers to buy good cloth or soap at a low price, instead of spending long hours making inferior products with their own inadequate equipment has actually reduced the amount of work necessary to maintain the same living standards, and if they so desire they may reap the benefit of the “foreign” trade in the form of increased leisure. But they also have the option of devoting all or part of the time thus saved to further production by means of which they can raise their standard of living.
It is also apparent that money is not essential to the transactions between farm and city; it is merely a convenience. The same final result could be reached by direct barter. The use of money to facilitate the process does not alter the fact that what has been accomplished is an exchange of farm products for city products. The farmers exchange their products for money, then turn around and exchange the money for city goods. The money was in the hands of the city merchants to start with-part of their working capital-and it is back in their hands when the transactions are complete.
In this case the use of money as a medium of exchange does not prevent us from seeing very clearly that the amount of city goods which can be obtained by the farm group is limited to the value equivalent of their farm products. Of course, they may have a small amount of cash on hand at any particular moment, representing the incomplete portion of a previous exchange transaction, which can be used in addition to their current production, and they may be able to get a certain amount of credit on the strength of anticipated future production, but it is obvious that they cannot continue buying in excess of their income from sales of their products. They cannot pay for goods in any other way than with goods (Principle II).
Here, as always, purchasing power is created only by production. It can be borrowed by means of a credit transaction, but only temporarily and in limited amounts. If the “foreign” merchants in the city are very anxious to sell greater quantities of goods, they may work out some kind of a long term credit arrangement whereby for a time the farmers may buy more than they can pay for; that is, more than the value of their current production. Such credit may be fully justified if it is extended for the purpose of financing the purchase of fertilizer, tractors, or other goods which will ultimately increase farm production enough to pay off the loans in goods, but aside from this type of tvansaction, the merchant who extends credit to a farmer (or anyone else) for the purposes of enabling him to buy more than he produces is lacking in intelligence. He is certain to be left holding the sack in the long run.
Even in the case of loans extended for the legitimate purpose of increasing production, repayment will have to be made in goods. In order to be reimbursed, the city merchants must sooner or later buy more goods from the farmers than they sell to them. There is no kind of magic whereby payment can be made in any other way. If a merchant closes his eyes to this fact and continues to insist on selling more goods to the farm group than he buys from them, the ultimate result can only be cancellation of the debt through bankruptcy of the farmers.
Now, where does this situation differ from trade between countries? From an economic standpoint the only major difference is that the two countries have separate currencies, and the bankruptcy, if it takes place, comes about gradually by a progressive depreciation of the currency rather than suddenly by court decree. Otherwise, the same considerations apply. The benefits of foreign trade are exactly the same as those accruing from trade between farm and city. Each participant is able to enjoy a higher standard of living by reason of his ability to trade goods that he can produce efficiently for goods which he could produce only inefficiently, if he could produce them at all. This exchange of goods does not require either party to the transaction to do more work; that is, contrary to popular belief, foreign trade is not a job producer. In fact, the use of specialized goods produced on an efficient basis as purchasing power for buying foreign goods actually enables the same standard of living to be maintained with less work, as was pointed out in connection with the farm situation. Money in foreign trade is still only a medium through which goods are exchanged for goods, and above all, it is just as true in the case of foreign trade as it is in trade between farm and city that only goods can pay for goods. Any juggling by means of credit or other devices can only postpone the day of settlement and increase the amount of goods that must be transferred from debtor to creditor to balance the accounts when that day finally arrives.
We can get a clear picture of the foreign trade situation by the same method of analyzing the flow of goods and purchasing power that was employed in the study of the domestic economy. As emphasized in the earlier pages, the basic economic transaction is an exchange of goods for goods. Thus foreign trade is essentially an exchange of domestic goods for foreign goods. But here, as in purely domestic trade, it is convenient to use money as a transfer medium. This separates each transaction into two parts, an exchange of domestic goods for money, which we call an export, and an exchange of money for foreign goods, which we call an import.
An export is an exchange of domestic goods or services for foreigners’ money An import is an exchange of money for foreign goods or services.
The terms “goods” and “money” are used in this definition in the broad senses in which they were previously defined; that is, “goods” includes services as well as commodities, and “money” includes everything that is accepted as money. Ordinarily exports and imports are visualized in geographic terms, commodities shipped out of the country being called exports, and those brought into the country being called imports. But there are other international transactions which are identical with commodity exports and imports, so far as their economic effects are concerned, although they do not have the same geographic aspects. Services rendered to foreign tourists, for example, are exports on the basis of the foregoing definition, while the services received by American tourists in foreign countries are imports.
The economic activities of resident aliens are part of the domestic economy, unless they send some of their earnings out of the country, or take them along when they leave. In that case the productive services corresponding to the money that leaves the U. S. are imports. Gifts of goods to foreigners are merely a form of consumption, and have no foreign trade implications. Gifts of money are claims against our future production, and therefore have the status of imports. In this case we are, in effect, importing, and paying for, goods of zero value.
An investment in a foreign country is a purchase of capital assets located in that country, and has the same immediate economic effects as the purchase of foreign consumer goods; that is, it is an import. However, those capital assets that remain in foreign countries participate in the economies of those countries, and therefore have a continuing effect on the international economic relations. Net earnings from foreign investments (payments for the services of capital) are exports from the U. S. standpoint, unless withdrawal of the funds is restricted, in which case the amount that cannot be withdrawn becomes an additional investment.
If foreign trade is kept on an even basis; that is, exports equal imports, the money purchasing power stream is not disturbed in either country. The total utility of the goods secured by means of this purchasing power increases, but the effect is the same as if domestic productivity rose a similar amount. Here there is no reservoir transaction, and the market price level remains in balance with production price.
Now suppose that we export more than we import. The flow of goods into our domestic markets decreases by the amount of the difference. But the exporters receive some kind of payment, money or credit instruments convertible into money, which can be used in the domestic markets. The flow of money purchasing power to the domestic markets therefore does not lessen, in spite of the decrease in the quantity of goods available for purchase in these markets. The price level consequently rises, and the American people have to pay the bill for the excess goods that have been exported. It may be hard to believe that we have to pay for these goods at the same time that the foreigners are paying money for them, but a close consideration of the market relations developed in Chapters 9 and 10 will show clearly that this is true. The inflow of foreign purchasing power, not balanced by a corresponding flow of goods to the domestic markets, is equivalent to an input into the purchasing power stream from one of the domestic money reservoirs, and it has the same effect in creating an inflationary unbalance in the system.
Looking at the situation mathematically, we begin with the normal relation B/V = P. If there is no change in production, then the diversion of goods to the export trade causes the volume of goods flowing to the domestic markets to drop from V to eV, where e is a fraction, while the amount of money purchasing power available for use in the domestic markets remains at B. The new market equation for the United States, the exporting country, is then
B/eV = P/e
Since e is fractional, the equation shows that the price level in the domestic market rises.
If production is increased to take care of the export business, the volume of goods entering the domestic markets remains at V, but the money purchasing power available for use in these markets rises to aB because the increased production generates a corresponding increase in money purchasing power. We then have
aB/V = aP
The factor a is greater than unity, so again the result is a higher price level in the domestic markets. Thus, regardless of whether the export demand is met from existing production or from increased production, the result of an excess of exports over imports is an increase in domestic prices, an inflation of the price level.
Conversely, we find that an excess of imports reduces the domestic price level, irrespective of whether the imports replace domestic production or are in addition thereto. If the imports replace domestic goods, the total volume of goods entering the domestic markets remains constant at V, whereas the diversion of a portion of the money purchasing power stream to pay for the imports cuts the money available for use in the domestic markets from B to cB, where c is fractional. The market equation in this case is
cB/V = cP
If domestic production is maintained at the original level the money purchasing power in the domestic markets remains at B, but the total volume of goods entering these markets increases to eV because of the imports, and we have
B/ eV = P/e
In either case prices drop, and the consumers get more goods for their money. This is another result of the basic principle that only goods can pay for goods. Imports and exports are incomplete transactions, and each remains incomplete until it is counterbalanced by a transaction of the opposite kind. Thus the consumers in an exporting country are temporarily subsidizing the consumers in the importing country.
Here we meet one of the strange paradoxes of modern economic life. The country which has an excess of imports is, for the time being, living partly at the expense of the exporting countries. Presumably goods will have to be exported at some later date to settle the accounts, but in modern practice the the ultimate payments are often substantially reduced by inflation or some international agreement. From this, one would naturally expect that an import excess would be highly popular, but the fact is that all nations fight tooth and nail to increase their exports, and impose all manner of restrictions on imports.
The explanation for this contradictory behavior is that as long as the true cause of inflation and deflation is not recognized, and the cyclical movements of business are allowed to continue unchecked, exports contribute an inflationary effect and imports a deflationary effect on the domestic economy, as can be seen from the equations just presented. Money inflation is popular in business circles, since it has a favorable effect on profits. There is usually some grumbling about the “”high cost of living” from the consumers who have to pay the higher prices, but this is offset to a large degree by the increase in employment that accompanies money inflation. Deflation, on the contrary, is unpopular with everyone. The businessman finds it difficult to maintain a profitable operation, or even to continue operating at all, while the consumers, even though they have the benefit of lower prices, are continually faced, in their capacity as workers, with the menace of unemployment or reduced wages (“give-backs”). As long as the domestic economy remains uncontrolled, it can therefore be expected that exports will continue to be promoted and imports restricted.
But the attempt to maintain a continuing excess of exports over imports, a “favorable balance of trade,” is, in itself, a costly mistake. It gains nothing, and creates problems of payment or debt repudiation that will cause trouble sooner or later. In reality there is no “favorable” balance of trade in either direction. Any balance whatever is unfavorable from some standpoint. The only favorable condition, the only one that can persist indefinitely with full justice to all participants, is an equilibrium between exports and imports. What should be done is to take care of employment, and the other domestic problems that are now entangled with the foreign trade situation, by the means appropriate to each of them, and then deal with foreign trade problems on their own merits.
As indicated in the foregoing discussion, foreign trade is a money reservoir, so far as its effect on the circulating purchasing power stream is concerned. Government borrowing from foreign sources is also a reservoir withdrawal. The net amount of the foreign transactions is therefore one of the components of the total reservoir inflow or outflow, the quantity that must be counterbalanced in order to stabilize the economy.
One of the prolific sources of economic controversy in many countries, including the United States, is the extent to which some, or all, domestic industries should be protected against foreign competition by means of tariffs, quotas, or other devices. In the United States the principal argument for protection originally offered was that “infant” industries need to to shielded until they are strong enough to hold their own in the world market. This has gradually been replaced by the argument that the relatively high wage rates in the United States cannot be maintained unless there is some protection against competition from low wage foreign products. The opposing view is that the protective measures would simply invite retaliation by foreign countries, with the eventual result of stifling what would otherwise be a mutually profitable exchange of goods.
In analyzing this wage protection argument, we again need to take note of Principle II, that only goods can pay for goods. If foreigners sell us certain goods valued at x dollars, the only way in which they can receive payment for these goods is to buy x dollars worth of U.S. goods or other assets at U. S. prices. Thus the loss of employment at U.S. wages in the industries affected by the imports is counterbalanced by an equal gain of employment at U. S. wages in the exporting industries. It follows that the relative wage levels in the United States and foreign countries have no detrimental effect on employment if the self-balancing features of the international trade system are allowed to operate.
Unfortunately, they have not been allowed to operate. In recent years the United States has followed fiscal and monetary policies that have greatly favored imports over exports, with a consequent adverse effect on employment. The acute problem that exists at the time these words are being written is primarily due to the heavy borrowing from foreign countries that has been undertaken to finance the large budget deficits. This money that our nation is now borrowing is money that would otherwise have to be used for the purchase of U.S. goods. Unless the foreign holders of our currency are willing to accept more of it, and just pile it up in their vaults for future use, which is unlikely, in view of the large amounts of that currency that they already possess, there is no way in which they can use the proceeds of their exports to us than by U.S. goods or other assets. Thus every billion dollars that we borrow from foreign sources reduces foreign purchases in the United States by one billion dollars.
We are being told that in order to regain the export market we must “improve our competitive position” - produce better products more efficiently. There may be some truth in this assertion, but this is not our primary problem. The result of losing business to competitors is a decrease in the volume of trade. Our problem is not a lack of volume, but a large unbalance between exports and imports. This is a money problem, due to excessive borrowing.
Of course, some of the money now being borrowed from foreign sources, had it been available for purchases, would have been invested in American business enterprises or in real estate, but internal economic conditions in the foreign countries limit the amount that can be applied to investment. The lion’s share would have gone toward keeping exports in line with imports. In soaking up the exchange balances that are needed to finance purchases of U. S. goods we are not only imposing a huge debt burden on future gnerations, but are also destroying existing American industries and depriving our working population of employment.
The ordinary citizen can hardly be expected to understand this cause and effect sequence. Some economists do, but many others are prevented from so doing because they have lost sight of the fact that the basic economic process is an exchange of goods for goods, and have accepted the concept of an autonomous demand. This is a graphic example of the need for, and the importance of, the kind of a factual analysis of economic processes that is here being accomplished by the application of scientific methods.
One of the reasons why the loss of export business due to diversion of foreign buying power to deficit financing has had such a serious effect on American industry is that this new problem has been superimposed on some long-term trends that have been increasingly significant in recent years. In earlier days, the United States was far enough ahead of the rest of the world technologically to be the only satisfactory source of many specialized items, and American goods in general had world-wide acceptance as high quality products. More recently there has been a diffusion of this technological knowledge among many nations, and the monopolistic position of the United States has largely disappeared. As a result, some of the features of the domestic economy that have a bearing on foreign trade have assumed an importance that they did not have in the era when American technology was well ahead of the field.
Under present conditions, the most significant item of this kind is the existence of large wage differentials between our domestic industries. The existing wage structure in the United States is not a product of the forces operating within the economic system; it is an arbitrary and highly unbalanced result of application of coercion and political pressure by the participating groups. The existence of this unbalance opens the door to exploitation by foreign producers. They are able to sell their products at, or near, the prices prevailing in the high wage industries such as automobiles and steel, and buy at the prices of the low wage industries, profiting by the price differential.
It follows that under a free trade policy the high wage industries will continue to have difficulty competing with foreign producers, since at least some countries will maintain more balanced wage structures. Allowing this situation to continue is certainly not in the national interest. Thus the real issue is not between protectionism and free trade, but between protectionism and reform of the wage structure. The choice between these alternatives is a matter of opinion and judgment. As such it is beyond the scope of economic science. It is interesting to note, however, that Japan and some of the European nations have taken steps in the direction of control of wages. As reported by Galbraith, this “has been their socially better answer to the wage-price dynamics and the resulting inflation.”131
The unbalanced wage structure has had a devastating effect on some of the industries that have to buy their equipment and supplies at the high wage prices and sell their products at the low wage prices. The farmers’ problems are the most visible effects of this kind, but the maladjustment is widespread. To the extent that this situation has been officially recognized, the usual method of dealing with it is to provide subsidies coupled with restrictions on production, all at the taxpayers expense. This is a political problem, not a problem of economic science, and like most political problems it has no specific answer, but it should be noted that the analysis of economic fundamentals in the preceding pages shows that when we subsidize the status quo we are not actually subsidizing the farmers. They are in their present unfavorable situation only because of the unbalanced wage scale. What we are doing is subsidizing the high wages of the more favored industries. Whether or not such a subsidy is advisable is a political question, not an economic question, but in any event the economic facts bearing on this matter should be recognized.
Our finding that the real cause of the loss of employment in automotive manufacturing and other high wage industries by reason of foreign competition is not primarily due to the trade policies that the foreign nations and their manufacturers have followed, but to our own highly unbalanced wage structure, and our policy of living on borrowed money, illustrates an important feature of international economic relations; viz., that most of our problems in the foreign trade area are products of our own actions, or failure to act.
If we have our own affairs in order, we cannot be seriously hurt by any commercial action of a foreign country. Any country that sells us goods at less than normal prices is doing us good, not harm. Any country that asks an exorbitant price for its products simply does not sell us anything. In dealing with third parties, we may be undersold, either on price or on quality, but if so, we have no one to blame but ourselves, and our losses cannot be serious in any event. It is possible that some foreign nation might take an economic action that would inflict what we would consider an unfair loss on some individual producer or industry, but as long as such actions have no adverse effects on the economy as a whole we should be able to work out some means of compensating the individual losers.
In some instances it may be considered advisable, as a matter of national policy, not to rely on foreign sources for certain kinds of goods, and even though our government may wish to encourage foreign trade in general, it may impose tariffs or import restrictions to prevent or reduce the importation of these goods. Economists generally recognize that such restrictive policies are costly to the nation that adopts them, but since they are put into effect for specific purposes, the issue in each case is whether the benefits obtained are sufficient to justify the cost. Such questions will not be considered here, as they involve mainly non-factual issues and are therefore outside the scope of economic science.
International trade is beneficial to all countries which take part in it, and consequently we are serving our own best interests, as well as contributing to the welfare of the rest of the world if we gain a better understanding of the true economic relationships, and arrive at a realization of the desirability of removing the artificial obstacles that have been placed in the way of free trade between nations. But we should not exaggerate its importance. Foreign trade is not essential to our economy. In the case of a large and self-sufficient economy such as that of the United States, even a complete elimination of all international transactions would have very little effect after the initial dislocations were ironed out.
There are, it is true, some items which we use but do not produce, and it would be necessary to find domestic sources of such items or find acceptable substitutes, but these problems could be met without any serious difficulty, just as we met the rubber shortage during World War II. The oft repeated statement that we must have foreign markets is pure rubbish. To put this statement into its proper perspective we need only to consider what would happen if the rest of the world suddenly ceased to exist. Would we face a dire catastrophe? Certainly not. We would have a few annoyances until we became adjusted to substitutes for such items as coffee and bananas, but in general, life would go on just about the same as before.
If we set our own house in order, stabilizing the economy to eliminate booms and depressions, and maximizing employment by appropriate measures of the kind discussed in The Road to Full Employment, the only effect of foreign trade on our economy will be that we will gain the amount of the difference in value between our exports and imports. This is an appreciable amount, to be sure, and we would not want to sacrifice it unnecessarily, but it is not of sufficient consequence to be allowed to stand in the way of peaceable and friendly relations with foreign countries.
The whole issue of international economic competition is sorely in need of a thorough reexamination. We are constantly being exhorted to take actions that will make our products “more competitive,” and disputes over trade issues are a familiar feature of the political landscape. As brought out in the preceding paragraphs, the remedy for any irregularities that may exist in bilateral trade lies in correcting the economically unsound practices in our domestic economy that are leaving openings for foreign producers to exploit. We do not necessarily have to abandon these practices. But if we decide that we want to continue a policy that affects foreign trade-the highly unbalanced wage scales, for instance-then we should apply appropriate countermeasures to our own operations, rather than expecting the foreign nations to solve our problems.
When the problems of bilateral trade are thus smoothed out, the remaining trade issues will be those involving competition in selling to third parties. The prevailing concern about this situation is actually a relic of earlier days when the political organization of society was very different from what it is today. Some small independent political units-city states such as Venice, for example-adopted trade as their primary activity, and competed with each other for the available foreign business, just as rival firms do today. Under these conditions it was indeed necessary to be competitive. But as nations of the modern type emerged, foreign trade has decreased in importance relative to economic activity as a whole. And since only a fraction of that trade is subject to third party competition, the strong emphasis on being competitive is no longer warranted. If we adjust our economic policies to get the best results from the domestic economy, our foreign trade will not suffer much, if any. In any event, the vulnerable portion of that trade is too small in proportion to our total economic activity to be a serious concern.
Recognition of these facts will remove a major cause of international friction and thus make a significant contribution to the cause of international peace and amity. One important result will be to eliminate any excuse (aside from debt settlement) for interfering with the internal economic affairs of another country. All too often, as matters now stand, a nation that has been following a sound economic policy is subjected to pressure to modify that policy for the benefit of other nations that are having difficulties because of their own actions. For instance, as these words are being written, West Germany and Japan are being urged by the United States to “expand demand” (which means adopt an inflationary policy) to ease some of the U.S. problems. These are problems which have arisen mainly because the United States has been following its own bad advice. The remedies are in our own hands. We should not expect foreign nations to bail us out of our troubles.
This is not an exceptional case; it is an example of a general situation. The results that we obtain from our economy depend on the nature of our economic policies, not to any significant extent on the actions of foreign countries, except insofar as they take advantage of openings that we have created for them. Once this is generally understood, there should be no obstacle to peace in international trade relations, even though rival firms will continue maneuvering for advantage. As Keynes once said, “If nations can learn to provide themselves with full employment by their domestic policy... there need be no important economic forces calculated to set the interest of one country against that of its neighbors.”132