Economics III: Trade Balances, AD/AS, the Keynesian and Neoclassical Perspectives, International Trade, Protectionism, and the Major Theorists

This is Unit Fifteen of Social Sciences and History, part two of two: economics from expectations to one recession read two ways. Part one closed on the neoclassical return and on two readings of one diagram. This part finishes the argument, turns to trade, and then names the theorists the exam asks for, and it carries one discipline through all of it: every claim is attributed and none is judged. The anchor's line on labor practices is the anchor's. Its verdicts on the infant-industry argument are its own. Marx's claim of inevitability is voiced as Marx's. And the capstone at the end lets both schools read the same recession and leaves the question they disagree on, how fast the economy returns to potential, exactly where the anchor leaves it, open. By the end you will be able to say how expectations set the speed of adjustment. To compute comparative advantage from two opportunity costs. To name a trade restriction and say who pays. To attribute the theorists to their claims. And to read one recession by both schools.

Four entries on the neoclassical case and the balance: expectations, inflation's benefit or none, growth over recession-fighting, and the two perspectives balanced without verdict.

Expectations.

SSH 1421 Rational Against Adaptive Expectations

How fast the adjustment happens depends on expectations. Rational expectations hold that people use all available information, so price and other adjustments come very quickly, a forecast. Adaptive expectations hold that people adapt gradually from past experience, so adjustment is slow, a habit. Expected inflation is the rate people build into current decisions. These are theories of expectation, not policy.

Inflation's benefit, or none.

SSH 1422 No Social Benefit to Inflation; A Vertical Phillips Curve

Neoclassical economists see no social benefit to inflation. On a Keynesian upward-sloping AS curve inflation arises near full employment; on a vertical long-run curve it accompanies no rise in output, so a vertical aggregate supply curve implies a vertical Phillips curve. Friedman, in the anchor: a temporary tradeoff, never a permanent one. Short-term gains vanish, leaving inflation.

Growth over recessions.

SSH 1423 Growth Over Recession-Fighting

Neoclassical economists put more emphasis on long-term growth than on fighting recessions, which they expect to fade in a few years, while growth determines the standard of living. They focus on reducing the natural rate of unemployment rather than the cyclical unemployment a recession causes: fix the labor market's rules, not the cycle. Physical capital per person is a worker's machinery.

The balance.

SSH 1424 Balancing the Two Perspectives

Keynesians see aggregate demand as the cause of the business cycle and urge active policy against recessions and inflations. Neoclassicals stress aggregate supply, hold that productivity sets potential GDP and full employment returns, and prefer a limited role for stabilization: active against hands-off. Keynesians accept a short-run tradeoff; neoclassicals say none exists. Both positions are voiced, and no verdict is given.

Five entries on trade and its gains: absolute against comparative advantage, the strong country's gain, intra-industry trade, why barriers exist, and the computation from two opportunity costs.

Advantage.

SSH 1425 Absolute Against Comparative Advantage

A country has an absolute advantage in a product when it has a productivity edge, producing more of it. It has a comparative advantage at lower cost in other goods, a lower opportunity cost. Countries that specialize by comparative advantage gain from trade, consuming beyond what they produce. Unit thirteen taught the arithmetic.

The strong country's gain.

SSH 1426 Gains From Trade Even With Absolute Advantage in Everything

Even a country with high productivity in every good benefits from trade, because gains come from comparative advantage. By specializing in the good it gives up least to produce, it makes more to sell, and gains from others' lower opportunity costs: the best lawyer who still hires a typist. Comparative advantage in everything is impossible.

Intra-industry trade.

SSH 1427 Intra-Industry Trade and the Split Value Chain

Much global trade is between similar high-income economies: intra-industry trade, importing and exporting the same products, cars, machinery, computers, at once. Its gains come from specialized learning in particular tasks and from economies of scale. Splitting up the value chain, a good's stages, puts those stages in different countries: designed here, assembled there.

Barriers.

SSH 1428 Why Barriers Exist and What Their Removal Gains

Tariffs are placed on imports to protect sensitive industries, for humanitarian reasons, and against dumping, traditionally protecting vested interests. The World Trade Organization is where nations meet to negotiate reductions in barriers, and unit nine carries GATT to the WTO. The gains from trade are very large, especially for smaller countries, and beneficial to all. Small countries gain most.

The computation.

SSH 1429 Computing Comparative Advantage From Two Opportunity Costs

The exam gives two countries' output per worker in two goods and asks who should make what, and the anchor's rule is opportunity cost, computed from the ratio. For each country, the opportunity cost of one unit of good A is how much of good B a worker could have made instead: output of B divided by output of A. The country with the lower opportunity cost in A has the comparative advantage in A and should specialize there; the other holds it in B, since the ratios are reciprocals. Absolute advantage, producing more per worker, may belong to one country in both goods; comparative advantage never can. Both gain by specializing and trading at any price between the two opportunity costs. A worker in X makes ten shirts or five phones; in Y, four shirts or four phones: X's opportunity cost of a phone is two shirts, Y's is one shirt, so Y has the comparative advantage in phones, X in shirts, though X has the absolute advantage in both. Trading one phone for a shirt and a half, both consume beyond their production. Ask for the ratio. The trap is picking the bigger producer; absolute advantage decides nothing about specialization. The second trap is inverting the ratio; keep the good you are pricing in the denominator.

Six entries on protectionism: naming the tool, the subsidy from consumers, jobs and wages, the arguments for restriction, agreements, and disruption's price, with the anchor's judgments left its own.

Naming the tool.

SSH 1430 Tariffs, Quotas, Nontariff Barriers: Naming the Tool

The exam describes a restriction on imports and asks its name, and the anchor's three tools are the set. A tariff is a tax on imported goods, raising their price. An import quota is a numerical limit on the quantity that can be imported. A nontariff barrier is any rule, regulation, inspection or paperwork drawn up to make importing costlier or harder. Whichever tool is used, restricting imports is protectionism, and its effect is the same: the domestic price rises, consumers pay more and producers earn more, an indirect subsidy from consumers to producers. Anti-dumping laws block imports sold below the cost of production and impose tariffs to raise them to that cost. A twenty percent duty on imported steel: tariff. No more than ten thousand cars may enter this year: quota. Every shipment must pass a month-long inspection: nontariff barrier. A duty on foreign steel found to sell below its production cost: anti-dumping. Ask whether the restriction is a price, a number, or a procedure. The trap is thinking a quota is free because no tax is collected; the price rises either way, and the anchor's subsidy runs from consumers regardless of tool. The second trap is the WTO's safety rule: a legitimate standard applies to domestic goods too.

The subsidy.

SSH 1431 Protectionism as a Subsidy From Consumers to Producers

Protectionism raises the price of the protected good in the domestic market. Domestic consumers pay more and domestic producers earn more: an indirect subsidy from consumers to producers, in the anchor's title. Whether by tariff, quota or nontariff barrier, the transfer is the same: consumer surplus lost, producer surplus gained, deadweight in between. Unit thirteen's surplus triangles apply.

Jobs and wages.

SSH 1432 Trade, Jobs, and Wages

Trade shifts jobs away from industries where an economy lacks comparative advantage and toward those where it has it. Global trade should raise average wages by raising productivity, though the average includes gains in some jobs and losses in others. The anchor draws a line between unpleasant and morally objectionable labor practices. That framing is the anchor's, voiced as its own.

The arguments for restriction.

SSH 1433 Infant Industry, Anti-Dumping, Environment, National Interest

The infant-industry argument says small domestic industries need temporary protection to grow strong; it worked in some East Asian cases, and often the infants never grow up. Anti-dumping is often an excuse. The environmental argument fears a race to the bottom, and shutting trade seems unlikely to help. The national-interest argument fears dependence, and stockpiling is often wiser. Every judgment here is the anchor's.

Agreements.

SSH 1434 Free Trade Agreement, Common Market, Economic Union; GATT to WTO

A free trade agreement allows free trade among members; a common market adds free movement of labor and capital and a common external policy; an economic union adds coordinated monetary and fiscal policy. GATT was the WTO's precursor, a forum for negotiating reductions, and barriers fell substantially in the twentieth century's second half. Treaties tie governments' hands against their own lobbies.

Disruption.

SSH 1435 Disruption's Price and the Cushioning Role

International trade has income-distribution effects; all competitive market forces, domestic or international, are disruptive, reshuffling winners and losers. Government has a role in cushioning workers against the disruption. But clamping down on foreign trade would be as unwise as clamping down on new technology, since disruption brings benefits. The conclusion is the anchor's, attributed.

Four entries on the theorists: mercantilism, Smith, Marx, and Keynes with the neoclassicals, each named as the anchors name them.

Mercantilism.

SSH 1436 Mercantilism and Its Critics

Mercantilism held that the world's wealth was finite, measured in precious metals, so a nation gained only what another lost and should export more than it imported behind tariffs and colonies. Hume and Smith answered that it hurt consumers and that wealth could grow. Units six and nine carry the same argument. It is taught first so Smith has an antagonist.

Smith.

SSH 1437 Adam Smith: Division of Labor, the Invisible Hand, Free Trade

Adam Smith, in the course's anchors: the division of labor; the invisible hand, self-interested behavior leading to positive social outcomes; wealth not finite but created, so all nations can prosper; competition, not government, as regulator; and Locke's property rights extended to free trade, against monopolies and tariffs. The Wealth of Nations, seventeen seventy-six. Four anchors, one figure.

Marx.

SSH 1438 Marx: Class, Capital, and the Claim of Inevitability

Karl Marx, with Engels, in the anchors: society divides into the bourgeoisie, who own the means of production, and the proletariat, whose labor they exploit; class struggle is the root of all historical conflict; capitalism is inhumane and destined for replacement by workers' revolution; nationalism divides workers. The Manifesto, eighteen forty-eight, with socialism as remedy. Voiced as Marx's, no verdict.

Keynes and the neoclassicals.

SSH 1439 Keynes and the Neoclassicals: The Short Run and the Long

John Maynard Keynes names the perspective: aggregate demand causes recessions, sticky prices, the multiplier, and fiscal policy to fill the gap. Milton Friedman summed up the neoclassical answer in nineteen sixty-seven: a temporary tradeoff between inflation and unemployment, never a permanent one, and monetarism is his constant-money-growth rule. Hayek, in the political science anchor, dissented from planning.

One entry to close: one recession read by both schools, with the question the diagram leaves open.

One recession, two diagnoses.

SSH 1440 One Recession, Two Diagnoses: The AD/AS Model Read by Both Schools

The exam's aggregate-demand-and-supply item and its theorists item meet in one exercise: take a single recession and let each school read the same diagram. The event first. Confidence collapses, consumption and investment fall, aggregate demand shifts left, and the intersection with short-run aggregate supply moves down and to the left: output below potential GDP, cyclical unemployment above the natural rate, the price level lower or, with sticky prices, unchanged. That much both schools accept, because it is the model. The Keynesian reading: the economy is now in the flat left zone of the supply curve, where Keynes's law holds; wages and prices are sticky, so the market will not clear on its own, quantities adjust rather than prices, and a macroeconomic externality keeps firms from cutting; the recessionary gap calls for expansionary fiscal policy, which the multiplier enlarges, and a little inflation is an acceptable price along a downward-sloping Phillips curve. The neoclassical reading: the same recession is a detour; prices are flexible in the long run, expectations, rational or adaptive, govern how fast, and the economy returns to potential GDP on its own, since the long-run supply curve is vertical; stimulus in the steep right zone, where Say's law holds, moves only the price level, so the Phillips curve is vertical and Friedman's temporary tradeoff becomes permanent inflation; the wiser policy is long-term growth and a lower natural rate. The anchor's balance: most mainstream economists are Keynesian for the short run and neoclassical for the long, and the dispute is over which zone the economy occupies and how fast it moves between them, a question the diagram poses and does not settle. Behind the two stand the older schools the exam names: mercantilism's finite wealth, Smith's invisible hand and free trade, Marx's class conflict and inevitability, and the twentieth century's argument between Keynes and the monetarists over what a government can do with demand. Both readings are voiced as the anchor voices them, and the course gives no verdict between them; the theorists are named as the anchors name them and their claims attributed. Attributed, and unjudged: the discipline this lecture opened with, at its end.

Look at what you can now do. You can say rational expectations make adjustment fast and adaptive ones slow, that neoclassicals see no benefit in inflation, and that the two perspectives are balanced without verdict. You can compute comparative advantage by putting the priced good in the denominator, and say the strong country still gains, like the lawyer who hires a typist. You can name a restriction as a price, a number or a procedure, and say consumers pay for it whichever tool is used. You can attribute finite wealth to mercantilism, the invisible hand to Smith, class struggle to Marx, demand-driven recessions to Keynes, and the temporary tradeoff to Friedman, each as the anchors name them. And you can read one recession by both schools and leave open the question of speed, which is attribution without judgment, this lecture's discipline. Unit sixteen opens on the exam itself.