Is There an Unfavorable Balance of Trade?
JULY 01, 1977 by LAWRENCE W. REED
Mr. Reed of Beaver Falls, Pennsylvania, is a recent graduate of Grove City College, now studying for an advanced degree in American history with emphasis on economics.
Economists who believe in the market economy seldom have kind words for the ideas of the late John Maynard Keynes, and understandably so. Keynes, who did so much to make inflation a popular policy worldwide, was no friend of the free market. Scattered here and there in his voluminous writings, however, are passages with which free market advocates can wholeheartedly agree. This one in particular deserves to be carved in stone and enshrined forever:
The ideas of the economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.¹
Today it seems that defunct economists and academic scribblers are making a dramatic comeback. Economics has become burdened with foolish notions that were once thought to be discredited. Some of these notions are put forward as if they are imaginative, new discoveries; too many are designed to turn the clock back to the days before free trade unleashed the creative energies which have built the prosperity of Western civilization.
A leading illustration of this point involves the twin concepts of "balance of trade" and "balance of payments." These two concepts, which sound innocuous in name, often form the basis for erecting barriers to foreign goods. With the demand for "protectionist" legislation on the rise throughout the world, we can expect to hear more about them in coming months.
How are these terms defined? The "balance of trade" is considered to be the difference between the money value of a country’s merchandise imports and the money value of its merchandise exports. The "balance of payments" is regarded as a broader measure of economic activities between nations because it includes merchandise and such "invisible" imports and exports as credit transactions and government payments abroad (for foreign aid or to support military forces, for example).
The definitions are not as important, though, as the actual purpose behind them. Both "balance of trade" and "balance of payments" concepts attempt to fracture the process we know as "trade" so that the resulting fragments can be designated either "good" or "bad." In this way, "trade" is deemed to be "good" if it meets certain statistical criteria and "bad" if it does not. Such value judgments, moreover, are reached independently of the individuals who are doing the actual trading.
The first economists to develop this analysis of trade were the mercantilists, so it is certainly not new with today’s theoreticians. Thomas Mun, a leading mercantilist scholar of the seventeenth century, argued that
The ordinary means, therefore, to increase our wealth and treasure is by Foreign Trade wherein we must ever observe this rule; to sell more to strangers yearly than we consume of theirs in value. For suppose that when this Kingdom is plentifully served with Cloth, Lead, Tin, Iron, Fish and other native commodities, we doe yearly export the over-surplus to forraign Countreys to the value of twenty two hundred thousand pounds, by which means we are enabled beyond the Seas to buy and bring in forraign wares for our use and Consumptions, to the value of twenty hundred thousand pounds; By this order duly kept in our trading, we may rest assured that the Kingdom shall be enriched yearly two hundred thousand pounds, which must be brought to us in so much Treasure, because that part of stock which is not returned to us in wares must necessarily be brought home in treasure…2
Mun and the mercantilists believed that a nation must never buy from foreigners more than it sells to them. If such an "unfavorable" balance occurred, the nation had to pay the difference in gold, the internationally-accepted medium of payment. To prevent that, the government was supposed to actively promote an excess of exports over imports. Mercantilists were so convinced that specie itself constituted the wealth of the nation that they closed their borders to trade and often waged war in order to protect and accumulate vast supplies of gold. That a nation should strive for a "favorable" balance of trade (more exports than imports) is the economic heritage of the sixteenth, seventeenth, and eighteenth centuries.
Mercantilist reasoning did not die with the mercantilists, however. According to the U.S. Department of Commerce, imports surpassed exports for eight consecutive months through January 1977. This situation, disparagingly labeled a trade "deficit," is provoking concern among many orthodox economists. Already, demands are increasing for restricting imports to redress the "imbalance."
Adam Smith and Bastiat
It was Adam Smith who first attacked the notion that exports are good and imports are bad. He postulated a "harmony of interests" in trade, by which both parties to an exchange benefit. With the exception of obvious fraudulent practices, which are minimal in number and a responsibility of the courts, there can be nothing "unfavorable" about voluntary trade from the point of view of the individuals doing the trading, otherwise those individuals would not have engaged in it.
This principle is readily visible when trade involves two parties within a country; it somehow becomes confused if an invisible political barrier separates the two. Introduce more than one currency and the principle becomes all but totally obscured in the welter of economic fallacy. Mercantilists of yesteryear and like-minded economists of today face an impossible dilemma posed by this question: Since each and every trade is "favorable" to the individual traders, how is it possible that these transactions can be totalled up to produce something "unfavorable"?
Frederic Bastiat, the nineteenth-century French economist and philosopher who exploded myths with stunning clarity, once addressed himself to this very point. His analysis remains to this day one of the best critiques of the "unfavorable balance" concept:
M.T. despatched a ship from Le Havre to the United States, with a cargo of French goods, chiefly those known as specialties of Parisian fashion, totalling 200,000 francs. This was the amount declared at the customhouse. When the cargo arrived in New Orleans, it had to pay a shipping charge of ten per cent and a tariff of thirty per cent, which brought the total to 280,000 francs. It was sold at a profit of twenty per cent, or 40,000 francs, for a total price of 320,000 francs, which the consignee converted into cotton. This cotton had to pay ten per cent more, for transportation, insurance, commissions, etc.; so that, when the cargo arrived at Le Havre, its cost amounted to 352,000 francs, and that was the figure entered into the accounts of the customhouse. Finally, M.T. again realized, on this return trip, twenty per cent profit, or 70,400 francs; in other words, the cotton sold for 422,400 francs.
If M. Lestiboudois requires it, I shall send him some figures taken from the books of M.T. There he will see, in the credit column of the profit-and-loss account—that is to say, as profit—two entries, one for 40,000 francs and the other for 70,400 francs; and M.T. is fully satisfied that in this respect his accounting is not in error.
And yet, what do the figures in the account books of the customhouse tell M. Lestiboudois regarding this transaction? They tell him that France has exported 200,000 francs, and that it has imported 352,000 francs; whence the honorable deputy concludes "that it has consumed and dissipated the proceeds of previous savings, that it has impoverished and is on the way to ruining itself, that it has given away 152,000 francs of its capital to foreigners."
Some time afterward, M.T. dispatched another ship with a similar cargo, worth 200,000 francs, of products of our domestic industry. But the unfortunate vessel sank while leaving the harbor, and there was nothing else for M.T. to do but to inscribe in his books two brief entries phrased thus:
Sundry goods due to X: 200,000 francs for the purchase of various commodities carried by ship N.
Profits and losses due to sundry goods: 200,000 francs for ultimate total loss of the cargo.
Meanwhile, the customhouse on its part was entering 200,000 francs into its export ledger; and as it will never have anything to enter into the opposite import ledger on this account, it follows that M. Lestiboudois and the Chamber will view this shipwreck as a clear net profit of 200,000 francs for France.
There is still a further conclusion to be drawn from all this, namely, that, according to the theory of the balance of trade, France has a quite simple means of doubling her capital at any moment. It suffices merely to pass its products through the customhouse, and then throw them into the sea. In that case the exports will equal the amount of her capital; imports will be nonexistent and even impossible, and we shall gain all that the ocean has swallowed up.3
In a parting shot, Bastiat again applies reductio ad absurdum logic to the argument. He declares:
Assume, if it amuses you, that foreigners flood our shores with all kinds of useful goods, without asking anything from us; even if our imports are infinite and our exports nothing, I defy you to prove to me that we should be the poorer for it.4
A Two-Way Street
It ought to be obvious that trade is a two-way street. In a free market, where trade is a voluntary, desired, and spontaneous feature of human action, there is a "perfect balance." Professor W.M. Curtiss demonstrates that trade between people of different nations is no different in this respect from trade between people of the same nation:
Suppose you sell a bushel of apples for two dollars. You get two dollars, which you would rather have than the apples; the buyer gets the apples, which he would rather have than the two dollars. A perfect balance!
True enough, our exporters may sell goods to English buyers and get sterling exchange. They may spend this money in
The mercantilists, we have noted, viewed the export of money and bullion as inherently evil. Exports were to be encouraged and imports discouraged by means of tariffs and quotas in order for money to be "kept in" the country. Similar cries are heard today. Many economists and government officials view with alarm any net outflow of money to foreigners.
In the context of individuals engaged in free trade, such alarm is misplaced if directed at the market. Often a net outflow of funds is a symptom of the government’s own policy of inflation which erodes public confidence in the dollar. Professor Ludwig von Mises believed that in any case, this occurrence
… is not the product of an unhappy concatenation of circumstances that befalls a nation like an act of God. It is the result of the fact that the residents of the country concerned are intent upon reducing the amount of money held and upon buying goods instead.6
Furthermore, Mises contended, it is not correct to assume that government must take measures to prevent a total loss of the nation’s money by such an "unfavorable balance." Quoting from Professor Mises again:
No government interference is needed to prevent the residents of New York from spending all their money in dealings with the other forty-nine states of the Union. As long as any American attaches any weight to the keeping of cash, he will spontaneously take charge of the matter… But if no American were interested in keeping any cash holding, no government measure concerning foreign trade and the settlement of international payments could prevent an outflow of America’s total monetary stock.?
Keynes was correct when he said that ideas, right or wrong, rule the world. The undue concern over the "balance of trade" and the "balance of payments" will quite probably produce wider restrictions on international trade. If that occurs, our government’s policy-makers will be treading blindly in the footsteps of the defunct economists and academic scribblers of mercantilist times.
1John Maynard Keynes, The General Theory of Employment, Interest and Money (New York: Harcourt, Brace and World, 1964), p. 383.
3Frederic Bastiat, Economic Sophisms (Irvington, New York: Foundation for Economic Education, 1968), pp. 53-54.
4/bid., p. 55.
5W.M. Curtiss, The Tariff Idea (Irvington, New York: Foundation for Economic Education, 1962), p. 36.
6Ludwig von Mises, Human Action (Chicago: Henry Regnery Co., 1966), p. 452.