Saturday, 12 January 2013

The Government's Home-Made Fallacy

I don’t know how much longer we are going to have to keep hearing from politicians that they plan to appease the electorate (they never use those words, of course) by artificially creating industrial jobs in Britain (particularly in the north of England).  When they tell you this, you know they are either lying, or they don’t understand how industry works.  Industries and services are effective for one reason – the economy has a price system that almost perfectly balances the interests of the buyer and seller.  Consequently, it cannot be interfered with artificially with any predictable success because the competitive marketplace aligns private and public interests (and prices) far more effectively than any Government can by means of artifice (some forms of regulation excepted, but they are not important here). 

I do admit, though, this self-governing system is quite rare; in most areas of life the needs of the individual and the greater good are not ideally matched.  In a football stadium when an exciting incident occurs everyone stands up for a better view, which means nobody succeeds in improving the greater good.  At busy house parties, every individual talks louder than they need to, due to everyone else talking louder than they need to – so all guests strain their voice boxes more than they would need to if attendees were mindful of the greater good.  In a fuel crisis the majority over consume, leaving many with no means of consumption.  The economy is the rare exception to the rule; if you invent a brand new product, and have no idea how much to sell it for, the system of supply and demand will soon put your product at a rate that matches the value the consumers place on it.  So despite what you are frequently told, MPs cannot easily interfere with the supply and demand balance of the market economy.  That’s the first mistake made, or lie told, by too many politicians.

The second is even greater – they make mistakes, or tell lies, about our own industry.  As much as it rankles people in Britain (particularly those outside of London), there is one simple reason why British manufacturing has gone downhill; manufactured goods acquired from other countries makes Britain richer (by the way, it also makes the exporting countries richer too).  How do I know that things would be worse if anyone tried to change Britain’s manufacturing exports artificially?  I know because in the vast majority of cases the price system in the competitive marketplace couldn’t have favoured the companies that are no longer manufacturing in Britain – quite simply because consumers started to buy from cheaper manufacturers abroad.

This is the essence of a global trade system that ideally aligns supply and demand.  Amazingly there are people who deny this is true.  I can offer a schoolboy example that shows the logic is correct.  Pretend that instead of two countries we have two schools – School A and School B, neither of which is permitted to trade with the other.  Johnny at School A has a monopoly on pencil cases.  Johnny can sell Billy a pencil case for £5.  Now because of a new policy which enables School A to trade with School B, Billy can now buy a pencil case from Charlie in School B for £3.  Johnny has two choices, he can match Charlie’s £3 selling price or he can find something else to trade in.  If he chooses the latter he will ensure he is no worse off than a £2 loss, otherwise he might as well choose to match Charlie’s £3.  So the worst case scenario is that Johnny carries on trading, losing £2 per unit. Billy’s £2 gain matches Johnny’s £2 loss, so there is no net gain or loss.  But now consider Freddy at School A.  Freddy, who was never willing to pay £5 for a pencil case, buys one for £3 from Charlie in School B, and goes home happy (as does Charlie with another sale). 

Billy’s gain and Johnny’s loss cancel each other out, but Charlie’s gain amounts to a net gain.  The logic is compelling and simple – in net terms both School A and School B benefit from being able to trade with each other.  Instead of two schools, relate that model to every country in the world, multiply that simple pencil case model by factors of billions to allow for an open and competitive market, and different countries’ resources, strengths and geographical positions, and it is obvious that each country benefits from unconstrained trade potential. 

But that’s not the whole story; I have only said why free international trade is good for economies.  There is another important factor in this picture – impeding the process of free international trade actually harms the people the Government wants to protect – its own industry (and thus, its own citizens).  Here’s how it happens.  Let’s use a simple and extreme illustration to explain what is a more complex but no less valid truth about why Government interference is bad.  Let’s suppose there is a car factory in Newcastle that isn’t doing as well as the Executives or the Government would like, due to consumers’ preference for cars in Japan.  The Government introduces a policy that favours car production in Newcastle over car imports from Japan.  How on Earth could that not be good for the British economy – Britain’s gain is Japan’s loss, right?  Wrong.  Quite simply, what you put into the pockets of the car factory in Newcastle you take out of someone else’s pockets elsewhere in Britain (as well as having people probably paying more for their cars).  Consider Slough’s boiler factory; what you don’t see is an almost invisible chain of events; the boilers made in Slough are shipped off to Japan and sold to a company that makes its money producing nuclear reactors, the buyers of which are companies who trade in mineral oils, and those companies deal with companies who make cars in Japan and ship them to Britain. 

In other words, there is a complex economic process that is going on outside of your peripheral vision, whereby both the car factory in Newcastle and the boiler factory in Slough are both bringing cars into Britain.  That is to say, if you protect the car factory in Newcastle from competition you must damage Slough’s boiler factory because somewhere down the line they are the competition.  So the next time you hear a politician announcing how much he or she wants to do to protect British producers in one industry from foreign competition, be aware that he or she is unknowingly proposing an action that hurts other industries in Britain, and amounts to a net loss in economic efficiency.