Monday, 21 September 2009

Free trade and Austrian economics

I have a lot of time for Austrian School economics (AE). Peter Schiff (an Austrian) is one of my all time favorite economists. Austrians believe that the free market sorts out a great many economic problems all by itself, both to the benefit of workers and bosses. From what I have read so far I have realized that there are a surprising number of areas where this appears true. Many more areas than I had assumed before analyzing in detail.

Unfortunately it appears that because this principle is true very often, many Austrians have taken the intellectual leap to assuming that it is absolutely 100% always true. Even to the extent that their answer to all economic problems is "The government should do nothing at all". I firmly disagree with this position and developed the following thought experiment to argue that an AE based economy should not "do noting at all" when faced with a question of whether to control free trade with other countries:

I get the impression that a large part of AE is based on the premise that if A sells B product X then that proves that both sides are happy with the deal. But that's only true at the precise moment of exchange. It may be that B finds out that the product X, wrapped in the shiny paper, breaks after a few days and he wishes he had never purchased it in the first place. Now Austrians then say that if B was disappointed with X then A gets a bad reputation and so the system gradually "fixes" itself. But that's only true if there is a reasonable number of trials of purchasing X from A. But with a big trade imbalance it seems that the side that builds up the pile of IOU's does not really get to have many "trials" to see what they're worth...

Imagine there are just two countries in the world. One base on AE the other is rather like America. In the AE country, people like to save for the future. Oil may be running out, global warming may be coming, people are aging... etc etc, they better save for the future. One way to save for the future is to consume less than you make, sell the excess to the other country in return for IOU's and store your IOU's for the future. After all, when the hard times come they can always cash in their IOU's. Meanwhile the other country (USA) is rather short sighted - their government are interfering with the market, the national philosophy is spend spend spend. They see that this neighboring AE country is willing to swap their real produce for IOU's and they take full advantage. Both economies will gradually become skewed towards this arrangement. The USA will become full of shopping malls and have few factories. This may go on for a few decades. Both countries appear to be doing fine, the people in both countries seem fully employed (the Americans in shops, the AE country in factories). Now fast forward a few decades and some hard times hit the AE country. Oil shortages hamper production. The people are getting poorer... but never mind, they have the big pile of American IOU's. They can make up for their shortfall of produce by buying some from the Americans. But as soon as they start spending their IOU's on American goods the (now very few) American factories quickly reach full capacity and their prices will shoot up. This effectively slashes the value of the IOU's.... Product X, wrapped in the shiny paper, has broken..... Maybe the leaders in the AE country should have seen this coming and taken some kind of evasive action rather than doing "nothing at all".


  1. AE is known as the "praxeological school". Without an understanding of the praxeological approach, it is not possible to make any statements about AE without shooting in the dark.

  2. While I am not professing to be an authority on AE, I believe I know enough for the purposes of this post. If you think I have made an error in the details of my post, please tell me. I write this blog for the purposes of learning - I have, more than once deleted or modified posts on the basis of comments (read through and you will see examples).

  3. If you aren't incorporating praxeology, then it is likely not AE but a strawman.

  4. AE uses praxeology in its arguments to prove certain economic ideas. Almost invariably (actually in my experience of debates on the forums, completely invariably) the outcome of the arguments is that the government should get out of the way and the free market will look after itself. If you can find any evidence that an Austrian school economist has written somethings suggesting that there should be government control of trade between countries then I will reconsider my blog post.

  5. This post is a couple years late, but hey I can't be everywhere at once.

    You're right on the money in terms of consequence. The question remains as to what is "right" for lack of a better term. Let's look at it in deontological terms.

    I think we can all agree that one crucial, essential, and indispensable role of government is to protect property rights. In a "free" country, government's role is also to protect individual liberty. Protecting liberty would necessarily mean protecting property rights as essential to liberty.

    In such a country, it necessarily follows that the government would outlaw the practice of profiting from the infringement of an individual's liberty. One example of such doctrine would be to outlaw the sale of stolen property. In this case, would the economy be better off if the government were to just butt out? Obviously not. A free-for-all of stolen property would quickly destroy an otherwise healthy economy.

    But what is stolen and what is not stolen is a matter of law. A different country may have different laws. What may be legal in one country might be illegal in another. If a country that legitimized the sale of stolen property were to engage in "free trade" with a country which protected individual liberty and property rights, would not that resolve to the same thing?

    Let's take that one step further. In a country where liberty is protected, to coerce or extort work from an individual would be unlawful. The work product of such act would thus be tainted as fruit of the poisonous tree... stolen property. Yet, if another country with different laws were to do precisely the same thing, should the free country regard an import of that product as legitimate, thereby vicariously enjoying what would be unlawful product if produced in their own country?

    Suppose further that this other country's methods allow said product to be made much more cheaply in terms of labor cost, yet to do the same in the USA would be illegal. Should the USA nonetheless import that product freely to compete with its own more expensively made product?

    Or would such practice constitute government abrogating its crucial role of protecting property rights and liberty, for the sake of importing cheap stuff?

    If the latter, would not the importing "free" country eventually meet the same moral end as a country that legitimized trafficking in stolen goods?


  6. I think what's missing from your thought experiment is the effect that sound money (an element that would presumably be present in the AE country) would have on preventing the American economy from losing most of its productive capacity. If, unlike China today, the AE country allowed its currency to float, the trade deficit arising from the enormous surplus of exports to America would cause the value of its currency to rise (in terms of American IOUs), and make the cost of importing goods from the AE economy more expensive. This natural check offered by sound money would prevent trade between these two economies from becoming so perversely imbalanced (as it has become today).

  7. "sound money" is ill defined. Austrians tend to favour free banking which I personally consider very unsound.