This time it's (really not) different, Part IV

Dumping.

The importance of fixed capital in the 19th century production process gave rise to potentially dangerous dumping practices.
But Chinese dumping isn't a threat, especially given the US's success with the WTO.
Nor is Germany's advantage caused - or best solved - by trade policy.
And the risk of tariffs spreading to broader protectionism is as real now as it was over a century ago - if not more so.

WILLIAM JAMES ASHLEY’S PROTECTIONIST MOVEMENT

William James Ashley’s favourite (and most exhaustively discussed) exception to free trade in the late 19th/early 20th century was ‘dumping’.

Dumping is the practice of flooding a foreign market with produce, often at below cost, so as to drive foreign competitors out of business, or simply to relieve the domestic market of an oversupply. And Ashley suggested Adam Smith and David Ricardo overlooked this possibility because they ignored the role of fixed capital in the economy.

Capital intensive production didn’t really exist in Adam Smith’s time. And Ricardo thought capital was mobile enough that price would always approximate the cost of production. So one could never dump at below cost, because these losses would cause capital to leave the industry until price returned to the cost of production (arguably, Ricardo thought this because his analysis focused on the banking sector, where capital was either mobile or little-used).

But the incidence of mass production, high-fixed capital industries allowed for the possibility of companies exporting at a price below average cost. This is because, even if they shut down operations while prices were temporarily below their total (variable and fixed) costs, they may save on their variable costs (wages, materials, etc.), but they would still have to incur their fixed costs (interest, maintenance, etc.). So as long as the price was high enough to cover their variable costs and any of their fixed costs, it was worth producing. In such a case, “business at any price [was better] than no business at all”. As Ashley put it:

“… industrial mills of the modern age had to keep running at high volumes, and this was, contrary to the Classical vision of the market economy (in which crises induce immediate retrenchment), even more important when the mills were confronted with losses during cyclical downturns.”

And this greater incentive to produce in the face of the “inexorable needs of fixed capital” meant the industry was susceptible to supply gluts. Thus, foreign markets become necessary to relieve the domestic glut, even at low prices (dumping). Even if things “right themselves” in the long run, or it only lasts a short period until prices recover or the glut ends, “it may be long enough to do irreparable damage to competitors”. Ashley foresaw the complete destruction of certain British staple industries (especially metallurgical). And in times of war when import supply is not guaranteed, “a nation that cannot repair its ships and build new ones … is as helpless as a nation which cannot feed itself” (see ‘defence is more important than opulence’ national defence argument in previous blog).

Ashley said this was the case with US and German producers exporting to England. This was especially concerning because even then, the US was an enormous market. And as the US had the largest demand, they'd have the largest capital-intensive production, and thus, probably the "largest periodical surplus", and could flood Britain with just their excess. This made the US the most dangerous to other nations' manufacturers.

Furthermore, lower unit costs from larger scales of operation encourages US firms to spread ther huge fixed costs over large output (e.g. the economies of scale associated with transport, bulk materials orders, better division of labour, etc.). Adding this to the size of the US domestic market, the united structure of US industrial cartels, and the US "tariff wall" (which encouraged even greater production because it supported domestic prices) induces dumping. This is because "a foreign sale at a low price added to a home sale at a higher price may produce a greater net profit than the home sale alone at the high price, since it's costs of production would be relatively higher" at lower levels of output (i.e. average costs are lower at higher levels of output). "These considerations would justify, under certain circumstances, a policy of permanently lower foreign prices, and not simply an emergency policy".

Philadelphia iron production for example, saw massive capacity expansions in the early-to-mid 1870s in the face of strong prices. But when prices plummeted late in the decade, millions of tons continued to be produced at huge losses for six years! “To allow their furnaces to go out of blast was to allow their businesses to go to ruin”. Even the US Industrial Commission Report justified keeping operations “full and steady” via below-cost export prices. And the Carnegie Steel Company admitted that they were looking not just at Germany and England, but also their colonies, as dumping grounds, boasting America’s ability to outdo England and Germany in their own markets.

Ashley argues such a policy had not been heard of before because US firms were too busy with their own market during prosperous times to worry about foreign markets. Dutch merchants in the East Indies too, used to destroy part of the spice crop when the market was in danger of glut. Now, producers/manufacturers seem to export it. Both are ways to avoid domestic gluts.

And “this statement does not signify that the export of domestics is a new thing … but that for the first time the existence of an important outlet for such goods saved manufacturers from a disastrous glut.”

Thus, by selling abroad at “slaughter prices” at strategic points of the business cycle to avoid a glut putting pressure on the domestic market, US firms incurred an “immediate temporary loss” to spare themselves lower domestic prices that would only recover slowly.

So they kept producing, covering variable costs but not fixed costs, in the hopes that they’d survive to see better years (which naturally, some did).

Surely this contradiction of traditional economic theory surrounding the notion of free trade justified protection of British industry with significant temporary “defensive and retaliatory tariffs” or outright prohibition (given foreign firms were selling at such low prices), because this US overflow was not guaranteed in the future (only when the US had a glut). So Britain should not rely on it. Even the Economist, “still abid[ing] by the doctrines of State inaction” labelled this behaviour as “unhealthy competition”. And surely Smith, even though such circumstances didn’t exist in his time, didn’t mean “buy in the cheapest market and sell in the dearest” in complete disregard for all other circumstances. Rather, one should buy from those countries which were “continuously and permanently cheaper [because of their] own peculiar advantages”.

Ashley was a well-respected voice for the protectionist movement, even by those on the free trade side. Bertrand Russell respected Ashley for "wisely grasping the historical fact, so often overlooked by free traders, that many economic conditions change over time". "Professor Ashley's work is, probably, the best presentation in existence of the case for Protection and Imperial Preference." His text The Tariff Problem was “the best account of the protectionist position”.

SO WHY WAS THIS SUPPOSEDLY REASONABLE STANCE SO DANGEROUS?

Ashley was also criticised for this argument, even before the additional historical case study of the post-Depression wave of protectionism which seems to support all the below criticisms. Ashley made it sound like there was a vast international industrial conspiracy that England wasn’t ‘in on’ (sound like someone we know?).

Ashley acknowledged that one could see the benefits of free trade but still recommend protective measures where the specific advantages outweigh the losses (in his words, “to put the mischief of individual liberty under restraint”). And this need not represent a betrayal of principle or any form of dishonour, nor risk opening the floodgates to widespread government intervention. Ashley believed “these are antitheses of controversy, but not of real life, [and that free trade and protectionism need not be] … self-complete and mutually exclusive”.

But economist FY Edgeworth criticised Ashley for focusing on the benefits that are possible from protectionism, not the evils that history shows are probable.

“Experience shows that protection, when it has once taken root, is likely to extend beyond the limits at first assigned to it and is very difficult to extirpate. ... Protection, once introduced into the body politic, is apt to increase and multiply; engendering not only its own kind, but also the evils of jobbery and corruption, perhaps more serious than the diversion of industry from its natural course. We might have expected the historical economist to balance, against the benefits which may be conceived in speculation as possible, the evils which are proved by experience to be probable. History … warns us that such attempts elsewhere have established the tyranny of monopolies sustained by the corruption of public life.”

This was a particularly damning criticism given Ashley's preference for historical analysis over abstract theories. I too have written before about the ease with which case-by-case protectionism can spread far beyond its initial intended scope, causing widespread damage. In other words, protection of individual industries is a slippery slope to the protection of less worthy industries, "the loss of purity in politics, the unfair advantage given to those who wield the powers of jobbery and corruption, unjust distribution of wealth, and the growth of 'sinister interests'".

But Edgeworth did respect Ashley's restraint in only wanting temporary import duties and focusing on the “more aggressive forms of 'dumping' which may be conceived”. But he was suspicious that Ashley's suggestion of protection for the purposes of retaliation is just a half-way house to widespread protection.

Bertrand Russell agreed:

"Protection is only electorally feasible if it is universal"; and it would take more than "a mere Executive act" to remove the tariffs - "at least two General Elections, and mountains of agitation" would be required.

Russell also suggested Ashley exaggerated the extent of dumping that was actually occurring, as well as the US’s potential for economies of scale, and underestimated Britain’s ability for them, thereby exaggerating the potential for ‘industrial ruin’. Furthermore, it is next to impossible to structure tariffs to only target dumping.

Also, the British Empire didn’t have a single central government, making it harder to hold everything together once the evils of protection are unleashed. This is relevant now because if national governments start acting in isolation and not as a collective global economy whose decisions affect one another, this suggests such protectionism is apt to get out of control, and will be very hard to reign in again.

And as for the ability to preserve (let alone bring back) Britain’s superior manufacturing status, Russell stated that nothing would restore “the manufacturing monopoly [Britain] once possessed”, given the growth of American and European competition in Britain’s staple industries. A similar argument could be used against Trump’s desire to return US manufacturing from China and the developing world – even 19th century Britain knew that lost manufacturing generally couldn’t be brought back. And this is not even necessarily a problem unless "superiority to other nations be more desired than prosperity" to the protectionists. The loss of these staple industries just meant Britain needed to specialise in more sophisticated manufacturing – just like the US does now.

HOW DOES THIS RELATE TO TODAY?

As mentioned above, traditional manufacturing won’t (and shouldn’t be made to) return to the US. It would be a highly destructive and disruptive process, and isn’t what the US should be focusing on. Furthermore, it is still true today that once protectionism has taken hold, vested interests are likely to cause its spread far beyond initial intentions or desires – especially when these vested interests can lobby someone as fond of ‘making deals’ as Trump (is it that hard to imagine Trump telling, for example, the car industry “maybe if a few of your executives stayed in Trump Hotel, I could do something about those pesky Chinese imports that are bothering you so”?).

In terms of dumping specifically, as I’ve mentioned before, China is not even a top 10 steel exporter to the US. What is the dumping concern? Furthermore, historically, the US has been remarkably successful in taking China to the WTO to resolve trade disputes – an international organisation which didn’t exist in Ashley’s time (and which Ashley suggested wouldn't be effective even if it did exist). So this somewhat undermines the notion that the US needs tariffs to stop Chinese dumping (which isn’t happening), when there is a body that has almost consistently ruled against China and in favour of the US on trade issues.

Trump has also accused Germany of ‘cheating’, given its large trade surpluses. While this actually has some merit, it has nothing to do with trade policy. If Germany had its own currency, it would be a lot stronger than the Euro to which it is currently pegged. This is because Germany has been outperforming the rest of the Euro since the debt crisis hit southern European countries so hard. But Germany being pegged to a currency that also has to take into account their weaker neighbours and therefore is too low for Germany’s individual circumstances means it is effectively running an unfair trade surplus (though not entirely deliberately). And this will continue until their internal inflation rates rise (or other Euro country inflation rates fall) enough to re-establish relative competitiveness and reduce their trade surplus. And along with criticising the ECB’s attempts to reflate the Euro economy, Germany also underwent unnecessary and unforced fiscal austerity, which slowed their inflation rates, thereby worsening and prolonging the deflation in southern Europe needed to rebalance the Euro internally, and extending Germany’s trade advantage.

But, this slow process of adjustment in Germany – of reducing their trade surplus through internal inflation or external deflation – that Trump is bemoaning is exactly the process that would happen under a Gold Standard – the thing Trump has toyed with implementing. If Trump is upset that Germany is running a trade surplus because it is temporarily enjoying/sustaining an undervalued currency until the rest of the Euro area internally depreciates and Germany internally appreciates (and that China ran a surplus by artificially undervaluing its currency until a few years ago), then it is hypocritical to propose a Gold Standard where countries that are temporarily stronger than their fixed exchange rate indicates will similarly enjoy (and can choose to artificially sustain) trade surpluses until internal inflation or external deflation eliminates it. It’s the same process over the same time horizon as Germany’s current situation.

So how can the US address this unfair German advantage? Well not by nonsensically accusing a key ally of “horrific barriers and tariffs”. It would be better to, firstly, learn the basics of economics:

·         That US exporters currently enjoy a tariff of just 3% in the EU.

·         That Germany’s 19% sales taxes aren’t an unfair disadvantage to US exporters, because German producers pay them too (see my previous blog). Likewise, both German exporters and US producers are exempt from sales taxes in the US. This is why sales taxes are considered legal by the WTO – because they don’t tilt the playing field at all.

·         That trade surpluses don’t mean ‘winning’ and trade deficits don’t mean ‘losing’ (see my previous blog).

Then maybe the US could help Germany and the Euro to fix their own situation – internal imbalances and that are far more damaging to Europe than the US. Help Europe (and the US for that matter) finally destroy this zombie austerity idea so they can reflate their economy and incidentally, start buying more US exports, helping the US trade balance. Don’t spark a trade war where everyone essentially starts doing the exact same thing, causing everyone to be worse off.

I will end this blog with one final thought. Despite WJ Ashley being well respected by both his supporters and his opponents, and the coherence of his knowledge and historical insights … his protectionist movement failed. Britain opted to maintain its free trade positions. With all the parallels between late 19th/early 20th century Britain, and the modern-day US, I hope the US will make a similar decision and do what it can to de-escalate these trade disputes.