Wednesday, June 08, 2005

Introductory econ lecture #10 

Final lecture. All these are now online in one spot on my classroom site.

I wanted to talk a little about trade, and that the balance of payments is always in balance. (A shorter explanation here.) As the text makes clear, theoretically any debit entry is offset with a credit entry, so that the balance of payments is always in balance. If we have a deficit in the balance of trade for merchandise and services, it must either be made up by unilateral transfers -- one-way transactions that act like a gift or a form of aid -- or by issuing an IOU (stocks, bonds, certificates of deposit, or even paper currency, which is an IOU of a country's central bank). If I'm not exchanging goods for goods, I must either pay with gift money or an IOU.

One student asked whether we always wanted the balance on trade or the balance on current account (the balance on trade for merchandise and services plus the balance of unilateral transfers) to equal zero. The answer to this is no -- there can be an equlibrium balance on trade that is different than zero. Perhaps we wish to issue IOUs to foreigners in order to finance investment. And perhaps these are in demand because the economy looks strong, is a technological leader, or seems a safe haven for investment (such as during the East Asian crisis in the late 1990s.) If others want to buy our bonds and stocks, they need to give us something back. It could be their own currency, if we want to hold it, but it's more likely we will take current goods and services in return for our IOUs. The press always seem to portray this in the other way -- that our profligacy in wanting to consume more than we produce causes us to owe the world a lot of money. That's possible, but isn't necessarily the case. It all depends on what you do with the resources acquired by the IOU.

We didn't have time this term to cover exchange rates. Had I another day, that and banking would have come up next.

I did take some time at the end of the lectures to return to a theme I had started at first -- what do we mean by asking for policies that "help economies grow"? I mentioned the One Campaign, which is another of those programs that says if the U.S. will just share a little more of its wealth with the poor countries in the developing world all will be well again. But it seldom seems to help. Bob Subrick and William Easterly each explain. From the latter:

Gordon Brown said in a speech in January that more aid could get 12-cent medicines to children to prevent half of all malaria deaths. Jeffrey Sachs says in his new book The End of Poverty that "ending the poverty trap will be much easier than it appears". At the World Economic Forum in Davos in January, these two got the actress haron Stone so excited about easy solutions that she jumped up and raised $1m (from an audience made up mostly of middle-aged males) for bed
nets to protect against malarial mosquitoes in Africa. Isn't Mr Brown a little curious as to why hundreds of billions of aid have not already delivered 12-cent medicines to dying children? Isn't Professor Sachs a little worried that four decades of aid efforts have not already ended the easy poverty trap? Isn't Miss Stone a little troubled that hundreds of billions in aid have not already got $4 bed nets to potential malaria victims?
Easterly's book, The Elusive Quest for Growth, is highly critical of the World Bank for whom he used to work, and he's gotten a little too acerbic with some of his criticism, but the points here remain: before we dedicate to sending another $110 billion/year into aid for developing countries, shouldn't we first figure out why the money already sent, in the trillions, seems to have done so little? (Students, after the course is over, you are recommended to Easterly's book and the Meltzer Report.)

What economic development is, after all, is not more money given to poor country's leaders, not even the best of them. It's expanding the circle of trading: increasing division of labor according to comparative advantage and the encouragement of exchange with a wider and wider group of traders. Just yesterday on Fraters Libertas, Chad has been sharing letters from a State Department employee named Peter with an apparent expertise in agriculture. He writes:
Successful farming requires the following:
  1. Secure legal ownership of the land by the farmer.
  2. Tax policies that permit the owner to make a profit from farming.
  3. Cultural values that encourage (vs. discouraging) educated people to farm.
  4. Support for high tech agriculture, both in development AND in use (this is a big problem in much of the Third World that largely refuses to use new technologies).
  5. Low or no trade barriers on agricultural products so that they may be exported.
  6. Specialization in agricultural products that are best produced in specific countries, such as cocoa in Ghana.
With few exceptions, none of this exists in the Third World.
I don't quite agree with #3 -- educated people typically don't have a comparative advantage in farming -- but the remainder are all things focused on helping with the division of labor. The textbook in chapter 20 writes as well.
The economic freedom that allows people to cooperate with one another through the voluntary exchange of private property rights -- to buy, sell, and trade as each best sees fit under the rule of law -- contributes to the development of personal and national wealth. It unleashes a process that allows people to seek their comparative advantage, to find ways to produce and deliver scarce goods and services at lower cost, and to tap the entrepreneurial motive that drives the market process.
In the margin it reads "The Wealth of Nations in one paragraph." Indeed. We know other stuff matters, like geography and climate, like culture and history: and as I concluded in class today there isn't a magic formula by which we can even create economic freedom. We can observe correlations, and we can theorize about the connections between freedom and growth. But all we are doing is creating conditions under which economic growth can occur, because growth is the result of individual decisions to specialize and trade.