Intro. [Recording date: November 12, 2024.]
Russ Roberts: Today is November 12th, 2024. My guest is economist Scott Sumner. His Substack is the Pursuit of Happiness.
This is Scott’s sixth appearance on the program. He was last here in April of 2015 talking about interest rates.
Our topic for today is his essay on government intervention versus free markets, and industrial policy generally. The title, “What Economists Don’t Know: Why Industrial Policy Will Disappoint.” Scott, welcome back to EconTalk.
Scott Sumner: Thanks for inviting me, Russ. It’s good to be here.
Russ Roberts: What do you mean by ‘industrial policy’?
Scott Sumner: Well, that’s an interesting question. It’s not precisely defined. In some sense, almost any government policy could be viewed as an industrial policy, but the term is usually used for policies that are directed at changing, say, international trade flows or national security issues, environmental issues like global warming, and maybe regional economic problems. So, policies that are directed at reshaping the economy in a different way than a free market would produce to achieve some important national goal. I think that’s usually how the term is used.
Russ Roberts: And, you start off talking about a term I have to say I have a soft spot for: ‘vulgar mercantilism’. What do you mean by ‘vulgar mercantilism’?
Scott Sumner: Well, I would define this as people who advocate generally protectionist trade policies for reasons that reflect a lack of understanding of basic trade theory.
So, they often start out saying, ‘Well, there’s this Ricardian theory of comparative advantage that says free trade is best.’ And then they say, ‘But in the real world, this is wrong because of X, Y, and Z.’ In fact, those arguments are not correct. X, Y and Z do not, in any way, refute Ricardian trade theory. And then they go on to advocate protectionist policies that they believe will solve certain problems like trade deficits, when in fact, typically, those policies will not solve problems like trade deficits, which are reflecting other macroeconomic variables like savings/investment imbalances, and so on.
So, these are policies that are based on, in general, a misunderstanding of trade theory, I would say, and they’ve been refuted many times throughout history. I could point people to Paul Krugman’s book, Pop Internationalism, which does a very effective job of refuting many of these mercantilist ideas. But they keep popping up again because they appeal to a lot of people’s common sense, which is–the common sense view is imports hurt the economy.
Russ Roberts: I would just add that sometimes, trade advocates are criticized for being old-fashioned, not understanding the world has changed in modern times. We don’t want to go back to the world of Adam Smith and Ricardo. Mercantilism precedes both of them. I think the earliest version that I’ve seen is in the 13th century, some time in the 1200s, might be the 14th century. And it’s an argument that the accumulation of, say, gold or some monetary asset is a measure of a nation’s wealth.
And of course, Adam Smith said a lot of things in The Wealth of Nations, but one of them that he spends time on is why that is not the right way to think about well-being, and that monetary measures are not true wealth. It’s really our ability to consume goods and services.
But, as you say, it is a perennial favorite on common sense grounds that trade is not always good for a nation, that it could cost us jobs. Why do you think the economist’s case is so unpersuasive to the average voter or advocate?
Scott Sumner: Well, I think it’s just one of many things in economics where the way the real world works is not consistent with people’s common sense. I mean, we see this in other areas: the public view of price gouging, and many market phenomena. The public often has a common sense view of how things work that just isn’t accurate.
And, unfortunately, trade theory is very counterintuitive. You can see the direct effect of imports. They might be costing jobs in certain domestic industries that are competing with imports. But people aren’t really looking at the big picture of what international trade is about. Every trade is two-sided. We’re receiving something, we’re giving something back. And, people aren’t really thinking through the full implications of international trade.
Interestingly, there’s probably also sort of a little bit of natural xenophobia–that is, distrust of foreigners–involved, because typically trade within the United States, between states, is not viewed with the same sort of suspicion. So, if one state has a big trade surplus with another, the public doesn’t really focus on that fact; and they don’t tend to think in terms of, like, this state is stealing jobs from other states. Like, if that process is occurring, they would often just blame the state that’s losing the jobs. Right?
So, let me give you an example. Let’s say that a lot of auto manufacturing jobs are going from Michigan to Tennessee or Alabama. A lot of Americans might just blame Michigan for not having a good business environment, right?
Russ Roberts: Yeah.
Scott Sumner: But, when it’s a different country, there’s a sort of natural incentive to view foreigners with more suspicion. And, I even think it depends on what kind of foreigner.
Russ Roberts: Oh, yeah. For sure.
Scott Sumner: So, there could be even a little bit of cultural bias. There might be more suspicion about imports from Japan than Canada, of cars, let’s say.
Russ Roberts: No, I think that’s–
Scott Sumner: For cultural reasons or something like that.
Russ Roberts: I think that’s true.
Russ Roberts: I think the hard part is that in modern times, meaning the last few years–because what ‘modern times’ means: like, the last six months–common sense has been vindicated in many settings for many people. And so, I think when some listeners hear you saying that economists understand things that everyday people’s common sense says is otherwise, their natural thought might be, ‘Well, maybe economists are wrong.’ And it’s a good starting place. You should be skeptical of experts in any field.
It would be wrong to use your common sense to figure out whether the world is flat. At least if you’re looking out the window, the world looks flat. So, common sense is: flat. Now if you go a little farther to the seaside, seashore, you might start to get a hint that it’s not as flat as it might be because you can see some of the curvature of the earth, maybe, with the ocean.
But, I think in the case of economics, it’s a complicated issue, and so your common sense can easily lead you astray. You forget to think about the role that exports play. You forget to think about the fact that you can’t have imports without exports. You forget about the fact that there are trade flows in goods, but also in assets and capital. And, running a trade deficit means running a capital account–almost always–a capital account surplus. The words ‘surplus’ and ‘deficit’ have all kinds of emotional senses to them, which are not really accurate.
And, the other thing I think that’s hardest for people to notice is that if you don’t allow imports, you don’t have as much competition, and many of the things that you produce for yourself will be much more expensive than they otherwise would be; and you won’t notice that. You’ll see the expansion in the domestic industries you’ve protected. You won’t notice that you’re poor because your cost of living and your standard of living have been harmed by the keeping out of foreign goods. And, you don’t see the new businesses that get started because of the resource savings you have because you produce things more effectively and efficiently if you allow competition from abroad.
So, I think I’m pretty confident that the economists’ story in general is correct. I think it’s hard. I think you can make that case with logic; I just did my own 90-second version of it. But, I think a lot of people would want to also find some kind of empirical evidence for this. And they tend, as you point out in your article, to point to–they cherry-pick certain countries and say, ‘Well, they’re doing well. They’re not so free trade,’ or, ‘They’re doing not so well and they are free trade.’
And, you make the observation, which I think is a challenge to any thinking person on these topics, which is: every nation does some of this, the protecting of imports. They do some kind of industrial policy. They do some kind of favoring of certain industries. They do some kind of regional subsidies to help places they think are struggling in a otherwise free market system.
So, that makes it much harder to do the kind of empirical work that you might want to do. But that doesn’t stop people. So, talk about how it’s often misleading to just look at the world around you that way.
Scott Sumner: Sure. I could give many examples. And a lot of these relate to people not really understanding the stylized facts or having a misleading notion of the data, basically. So, let me give you a few examples.
South Korea is often cited as a sort of mercantilist success story for encouraging exports and supposedly discouraging imports. And yet, South Korea ran a trade deficit almost every year from 1960 to 1997. Those were South Korea’s high-growth years, their double digit growth years. Most people don’t know that.
Russ Roberts: Yeah. Right. I didn’t know.
Scott Sumner: Another thing that’s often cited–as you say, people will say, ‘This country is doing well and they have a trade surplus.’ But they’re almost always doing less well than the United States. So, why should we copy countries that are lower in per capita GDP [Gross Domestic Product] than the United States?
You also get, I think, a lack of understanding of the data with the effect of trade on unemployment. So, people talk about loss of jobs in manufacturing, mining, and so on; but in a lot of cases, the job loss has been mostly due to either technology or regional shifts.
I’ll give you a couple of examples. People cite West Virginia as a victim of neoliberalism. Right? The blue collar workers in West Virginia are really suffering. And yet, if you look at West Virginia, their major industry is coal mining. Well, the United States exports coal. Without trade, we’d be worse off in coal mining.
So, why have so many jobs been lost in West Virginia? Well, it turns out that it’s a combination of rapid improvements in productivity–so we can produce coal with many fewer workers; and also somewhat of a shift in coal mining to Western states where they do strip mining.
Another example is Michigan. We’ve lost jobs in the auto industry in Michigan. But again, a lot of those jobs have been lost for two reasons. There has been a big increase in new automobile factories in southern states, and even Indiana, below Michigan; and we’ve also had major improvements in productivity in the auto industry. So, we still build a lot of cars in the United States, but far fewer in Michigan. And yet, the perception of the public is Michigan has lost out because of international trade.
So, I would argue even without international trade, the improvement in productivity in auto manufacturing and the big shift in auto factories to the south would have cost a lot of jobs in any case. It’s primarily a regional problem, not an international trade problem.
So, there’s just many examples where people–sort of lazy thinking about the issue. The easiest thing to latch onto is international trade. This is what people complain about. But, manufacturing jobs are being lost all around the world, and it’s mostly due to automation.
Russ Roberts: Well, I thought they were being stolen by Mars because we have a trade deficit with Mars. But–that’s a joke.
Russ Roberts: Bu, I think it’s important to point out–and I have an essay on this called “The Human Side of Trade”; we’ll link to it–trade and productivity changes per trade[?portrayed?] or innovation are really fundamentally the same phenomenon. And, you mentioned it in passing, which is: There are just two different ways to get more from less. There are two different ways to expand your output and reduce your costs of production.
And that’s the only way you get wealthy as a country. You can get wealthy as an individual by, as Walter Williams liked to say, by banging your neighbor on the head, taking his stuff. You can get wealthier that way, but your neighbor is poorer. That’s a zero-sum game.
If you want a non-zero-sum game where everyone gets wealthier, you need to find ways to get more from less. Either you need to find ways to get more output with fewer inputs. Innovation–everybody understands innovation does that. That’s what productivity increases do. That’s what a new manufacturing process does. That’s what an invention does. That’s what a new industrial process can do.
Trade is exactly the same. Trading with someone to produce something by swapping–building something and swapping it–for that product being produced abroad only makes sense to do it with someone from abroad if it’s cheaper than doing it at home.
And that is why–so what happens in your domestic economy doesn’t mean you import 100% of what you need, but the mix of imports–excuse me, the mix of domestic production–versus farm production adjusts because it could be very expensive if we had to produce all our cars here or other products that we import. It doesn’t mean we produce zero, but the mix adjusts. Because otherwise, it would be inefficient–unattractive, would be a better way to say it–to produce the whole thing at home in the domestic economy.
Scott Sumner: The argument against international trade is exactly the same as the argument against automation.
So, the fact that many Americans are opposed to international trade, but support technological progress, to me indicates they don’t understand the issue. Because they obviously see these as two different–
Russ Roberts: They do–
Scott Sumner: issues. And yet they’re both sort of destroying jobs to create a greater prosperity in much the same way as you say.
So, yeah: I think there’s a real lack of understanding of the issue.
And I know that, probably to some listeners, sounds condescending. But, you know, the evidence is pretty overwhelming that countries that are open to trade do better than those that are less open.
And, I would say there’s also kind of a lot of excessive pessimism about the situation in the United States. The British magazine The Economist just had a cover saying, ‘The United States is the envy of the world.’ And you have these other economies that are really struggling, like, you know, Germany, let’s say. Well, Germany has a huge trade surplus. So, if trade was really the problem, why isn’t Germany the envy of the world, not the United States, in terms of economic performance?
Russ Roberts: Having said all that, there is an issue that I don’t want to sweep under the rug–I don’t think you do either–which is that, you know, it depends how effectively your labor market works–and your capital markets–for the readjustments that both trade and technological change cause and how long it takes for them to happen, and how much suffering or how intense that suffering is as an economy adjusts to change.
So, when an economy–when there’s innovation, technological progress, new techniques–people lose their jobs. Farmers used to be–3% of America is on the farm, a little less than that today. In 1900, I think it was 40%. All those jobs were lost. But people found other jobs. And they found them fairly quickly; and it wasn’t a great suffering.
And, there were cases that were tragically difficult at various points in American history in response to the improvements in technology and agricultural work. But in general–and this is the way I like to think about it–the people who owned farms in 1900 are not sad about the financial and material well-being of their great-grandchildren a century-plus later, because they can see that they did fine. That the unemployment is not 37% because agricultural went from 40 to 3. There were new things that came along.
And those new things weren’t coincidental in coming along. They came along because we didn’t have to devote 40% of America’s labor and human resources to growing food. And, that’s glorious. It’s not a bad thing. It’s a glorious thing. And if we were able to import food–effectively America doesn’t import much food, but if it did–as long as they weren’t your enemies–and we won’t be talking about the national security issues–importing food is just another way to get food without having to have 40% of your people on the farm.
And so, that’s in a system that works pretty–America’s labor market is phenomenally quick to adjust relative to others, say, Europe.
So, when you do have economic change, either due to trade or to innovation, it could be, if it doesn’t work well–if your labor market doesn’t respond very quickly or fluidly–that transition can be quite challenging for some people.
And the reason I think Americans are tolerant of technological improvements and skeptical about trade is they don’t realize they’re the same; and they accept the technological change, because they see, ‘Wow, there’s a cornucopia of great abundance,’ because of all these changes. They can see that televisions–take one example–are incredibly cheaper than they were because people figured out better ways to do it. And so on and so on.
So then the punchline of that is: If it’s slow to adjust, even though the nation’s well-being may be greater, certain segments of the economy may struggle. Certain regions of the economy–we’ll talk about that in a little bit. So, West Virginia, yes, is not punished by the import of coal. It’s been punished by the coal that came from the west. And it’s been punished by the improvements in technology that made the rest of us much wealthier because coal was cheaper in response to those technological improvements.
So, there is a distributive, regional, sectoral cost to some of either trade changes or technological innovation changes that a country might be concerned about and would have political importance.
Scott Sumner: Yeah, I agree. And let me make a couple other points. Just to be clear: I’m not claiming every case is like West Virginia where it isn’t trade. There are some regional problems that are due to trade. There was a paper, I think it was Card and Autor?
Russ Roberts: Autor. David Autor.
Scott Sumner: On China? The China shock?
Russ Roberts: Yeah.
Russ Roberts: Yeah, and I’ve interviewed David about that paper.
Scott Sumner: What are the names?
Russ Roberts: It’s Card [Dorn, not Card–Econlib Ed.], and David Autor, and I’ve interviewed David about the paper. It’s an interesting paper. I didn’t agree with a lot of it. But it’s a provocative thesis. He tries to measure the impact of China.
Scott Sumner: Although even they argue that the net effect overall for the U.S.-with-China trade was positive, even in that paper.
But, a couple of things I would point out. So, they looked at a period, I think 1990 to 2007. Well, the U.S. labor market did well during that period.
On the other hand, I think when people were talking about the paper, it was after the 2008 recession, which was very severe, as you recall, and the recovery was very slow. So we had many years of high unemployment after 2008. And I think people often conflate problems of unemployment due to the business cycle with trade.
So again, the period they looked at, the United States didn’t have a major overall unemployment problem. We had some regions that were suffering, but the overall employment situation was very good.
And then we went into a situation where we did have an overall unemployment problem, I would argue due to monetary policy mistakes, not due to international trade. But the tendency to conflate those issues when we have 10% unemployment, and people might look around and say, ‘Well, look at those imports coming into the country.’ Well, imports were coming in, in 2007, when we had 4% unemployment. Right?
So, I think those issues can be mixed up in many people’s minds. But I will not deny that some local communities were adversely affected–their labor market–by imports from China, just as local communities can be adversely affected by automation and by regional shifts in factories from Michigan to the South or from earlier, from Massachusetts to the South. So, I don’t think anyone would say Massachusetts is worse off because we lost our textile and shoe making factories to southern states back in the 1950s, right?
Russ Roberts: For sure. Well, they might, but–
Scott Sumner: Well, I mean, yeah. We were worse off, I guess, in Massachusetts, probably for decade or so.
Russ Roberts: For a while, yeah.
Scott Sumner: Yeah, maybe longer. But, I think that, looking back on the process, I don’t think many people would say, ‘It’s too bad they now have this biotech–and etc.–industries. And, instead, if they’d stuck with shoe-making and textiles, they’d be better off.’ Like, even if there was pain, I think most people would look at that change in Massachusetts and say, ‘Long-term, that’s a net positive.’
Russ Roberts: Yeah. I just want to emphasize the point I made earlier: The reason we can have those tech jobs is because we don’t have to spend so much time and energy and resources and people making sure it’s a choose[?]. That’s another connection, I think, to your common sense–one’s common sense struggles to say[?].
By the way, the paper that we’re referring to is by David Autor, David Dorn, and Gordon Hanson. You were, I think, confusing with something else.
Scott Sumner: Okay, I’m sorry.
Russ Roberts: Yeah, no problem.
Scott Sumner: I confused it with I think a minimum wage paper. Sorry.
Russ Roberts: Yeah, correct. It’s okay. We’ll put a link to the paper: “The China Shock: Learning from Labor Market Adjustment to Large Changes in Trade.” There’s a couple “Labor Market Effects of Import Competition in the United States”, “The China Syndrome,” by the same authors. And we’ll link to the interview I did with Autor and listeners can think about that.
Russ Roberts: So, I want to turn to an issue in these kind of debates: which is national security. And, you call this the more-sophisticated, less-vulgar argument for government intervening and trying to manipulate market outcomes from what they otherwise would be.
I think there are two versions of this; and let’s take them one at a time.
The first is a nation, like China, appears to be on a potential collision course with the United States. So, trading with them, we may want to have a national policy of how we interact with them economically that takes that foreign policy phenomenon into account.
The second issue is: a lot of people will argue that, ‘Oh, trade ensured textiles and various other things are fine, but there’s certain commodities–computer chips and other things–that we can’t let the market determine the outcome because it will jeopardize national security.’
And then, there’s a third argument, which actually gets tied in sometimes to the first two for government intervention, which is the environment, which you alluded to earlier: that, if we let the market do its own thing, the environment will be hurt. And oftentimes, trade with China hurts the environment and risks our national security. So, there’s two reasons we have to intervene.
So, let’s start with the–China generally. Should the potential confrontation in foreign policy between China and the United States affect the way we trade with China?
Scott Sumner: Well, I can’t say there’s necessarily zero potential implications of that, but let me explain why I’m somewhat skeptical about claims in specific areas about foreign threats in general and their implication for U.S. policy.
If you look back in history, over the course of my life, I’ve seen many, many claims made about foreign threats and risks associated with foreign policy that in retrospect proved exaggerated. You go way back to the 1950s–the missile gap with Russia–which turned out not to be the case. Then there was perception that Russia–the Soviet Union, sorry–the Soviet Union would sort of surpass the United States economically; and I think weren’t there statements in textbooks by Paul Samuelson and so on about how the Soviets were doing better than the United States?
In the 1980s, I remember a lot of worry from pundits that Japan was going to surpass the United States, and there was almost a little bit of hysteria about Japanese trade.
Russ Roberts: Oh, yeah.
Scott Sumner: You had films like Rising Sun and so on.
Russ Roberts: And the essence of that, by the way, of that fear was that we, the United States–I was in America at the time–the United States was foolishly just letting markets allocate goods and services and importing things from Japan and elsewhere without understanding that this was a competition. Whereas Japan had this more sophisticated strategic alliance between the government and business, and that’s why they were dominating us, the United States. And, if we didn’t play on the same turf that they did, it was only a matter of time before they would not just surpass us, but impoverish us. In fact, there were all these sinister arguments that they were going to keep all the good jobs.
My first book, which is on all these topics we’re talking about–we’ll link to it–it was called The Choice: A Fable of Free Trade and Protectionism. I wrote that book because I saw a documentary that claimed that Japan was hoarding all the good jobs and giving all the bad jobs to America so that they would be producing some computer game and they would keep all the innovative parts of that industry in Japan, and the call centers were what they dumped on the United States. And, that was–again, not just the result of market forces: that result of a strategy. And, if we didn’t–the United States–have our own strategy for how to counteract that we would be taken advantage of.
Well, that turned out to be a wildly–and I said so at the time; many others did; not like I was a seer or a prophet–I said that was silly. And, obviously as time passed, people forgot about that argument because Japan went into an extended period of stagnation and its innovative edge was lost in many industries. And then, of course, Mexico was next, with NAFTA [North American Free Trade Agreement]. So, carry on.
Scott Sumner: Well, you know, I’d like to highlight your word ‘sinister,’ which I think is important.
Germany also a very large industrial power, also ran huge trade surpluses. The anger was not directed against Germany. And I think that’s worth thinking about.
Now, you might say that’s just coincidence, but go back to World War II. We put Japanese Americans into camps, but not German Americans. The Japanese Americans were viewed as more sinister.
Russ Roberts: Yeah.
Scott Sumner: Right?
Now we have in Europe one of the most important wars since World War II: Russia invades Ukraine. And we’re told the real national security threat is China.
So, what’s going on there? We have American universities banning Chinese students. We have American states banning Chinese people from buying real estate.
So, it’s worth thinking about how these attitudes towards trade are linked to maybe unconscious bias associated with ethnicity.
Now, you’re right. By the late 1990s, 10 years later, nobody worried much about the Japanese threat.
And, I would argue that the fact that the Soviet threat and the Japanese threat didn’t turn out to be what they thought at the time, played a big role in the rise of neoliberalism in the 1990s–the ideology in favor of free market and globalization. Because, the previous sort of statist, interventionist arguments seemed to have been discredited. Right?
Another one is that East Asia–which was relying more on international trade, was surging ahead of Latin America, which relied on import substitution.
Well, import substitution is a classic industrial policy. You put up trade barriers to build up your own industry. And that’s what Latin America tried to do in the decades after World War II.
And for a while, they were richer than East Asia. But East Asia decided to go for more open economies focusing on international trade. And they, by the 1990s, it was clear they were outperforming Latin America.
That also led to more prestige with a neoliberal-globalization model versus industrial policy/import substitution/that sort of thing.
And that, I think–in my view–was a good period in global history. It lasted for several decades. We saw that, by far, the biggest reduction in global poverty ever during this neoliberal era–
Russ Roberts: In human history–
Scott Sumner: But, unfortunately, in the last 10 years, much of the world, not just the United States, but much of the entire world has swung away from neoliberalism towards nationalism and nationalistic economic policies.
And this has been occurring in many, many different places.
So, I’m very concerned about the fact that we’ve sort of forgotten some of the lessons that I thought we had learned from failed policies during those periods in the 1960s, 1970s, and so on. And, I feel like I need to sort of remind people of the actual pattern of how policies disappointed, in many cases, earlier advocates of industrial policy.
But, yeah, I think that’s where we are right now, is we’re heading back towards a world of less-free markets, more industrial policy.
Russ Roberts: Well, this whole conversation has been worth it, Scott, just to hear you use the word ‘neoliberalism’ without embarrassment. You know, it’s become a incredible slander that’s invoked to explain all the ills of America and elsewhere.
I do think the world between that time period you’re talking about–let’s say roughly 1980 to 2010–roughly got more market-oriented in terms of globalization. The world got more globalized. China entered the world economy, which had an enormous impact–mostly for the good, not for every single person–but mostly for the good in the form of much less expensive toys, clothes, car, you name it. Amazing numbers of things got less expensive because of Chinese being able to trade with the rest of the world.
Like, having a magic Santa’s workshop is another analogy you can make for trade. These gifts, effectively–things that were once expensive became much cheaper. Which meant people could afford more of other things, which meant people’s standards of living improved.
And it’s not just toys and, say, Christmas ornaments, which people would often often say. Health got better because we could invest more in health technology. And, all kinds of other changes that took place over the last 30, 40, and 50 years have partly, if not significantly, been due to globalization.
But, at the same time, neoliberalism got blamed for all kinds of things that actually never happened. Smaller government, less regulation–the ideology of free marketers, Milton Friedman, Hayek, certain Republican politicians like Ronald Reagan that were invoked in the 1980s, they never happened. People advocated for those things. But, actually over this time period we’re talking about, government got bigger. There are more regulations. There are exceptions in certain pockets of–there’s deregulation in the 1970s under Carter and a little bit in the 1980s under Reagan. But, overall, government got much bigger in the United States.
So, to blame the ills of the United States, whatever they are, on free market policies, I argue is a weird fantasy. It only happened in the little area that we’re talking about, which is globalization. The world did get more open to trade with its foreign neighbors. There were certain improvements with lots of strings in free trade agreements. Many of those–Milton Friedman used to say,’ It’s a very, very free trade agreement–but not NAFTA.’ I said, ‘What are you talking about? Why not NAFTA?’ He goes, ‘It’s not a free trade agreement. It’s full restrictions on trade and the path towards freer trade, and it favors a bunch of different industries.’
So, we did not embrace the laissez-faire, utopian vision of the neoliberals like Friedman and Hayek. And the people who blame them for everything wrong in America, whether it’s inequality or whatever they happen to choose, is absurd. Most of those ideas were rejected by the political process, and were never implemented. I have a long essay on it. We’ll link to that too. But it drives me crazy. So, to hear you defend the globalization, the neoliberals without apology or embarrassment is a treat.
Scott Sumner: Well, thank you. Two points before I forget. One is: you’re right about the United States. Now, it is true that in some foreign countries, there was a major move towards free markets.
Russ Roberts: That’s true.
Scott Sumner: We mentioned China; to some extent in India. There was some privatization in Europe, and so on. So, you can point to–
Russ Roberts: Eastern Europe especially.
Scott Sumner: Yeah. You can point to some examples. You mentioned Israel, is that it? Did you mention Israel in here?
Russ Roberts: I did not. I’m sitting in Israel, but I did not mention it.
Scott Sumner: Oh, okay. Well–
Russ Roberts: But, Israel did become less socialist over this time period, and its economy took off like a rocket. Yeah.
Scott Sumner: Right. And so, if you look at kind of like a cross-sectional test of neoliberalism, it looks a lot better than if you just look at time series. It’s true that in the United States, the GDP growth rate during the neoliberal era was a little bit lower than the 1960s, let’s say. But, there’s many countries around the world that engaged in much more aggressive reforms; and typically, the countries that moved strongly towards neoliberalism did better when you compare to countries that stayed with a more statist model.
The other point I want to mention before I forget is, I don’t think I really answered your question about national security risks. So, I’d like to follow up a little bit more on that–
Russ Roberts: I was going to mention that–
Scott Sumner: I was remembering how, the past some of the threats were sort of exaggerated. But, let’s bring it up a little bit closer to the present, and I’ll try to explain my skepticism.
Take the Ukraine war. So, in, I think it was February 2022, Russia invades Ukraine; and the economists and foreign policy experts that were focusing on this problem made some very confident predictions early on. One was that the Western sanctions were going to be highly effective. Do you remember that?
Russ Roberts: Sanctions on Russia–
Scott Sumner: There were many articles about how devastating Western sanctions on Russia–which were quite comprehensive, incorporating many, many countries–were going to severely hurt the Russian economy. A second confident prediction was that the Russian shutoff of natural gas to Europe would have a devastating effect on the European economy.
Okay: I saw these predictions widely disseminated in the press. From experts.
Both predictions turned out to be completely wrong. The Russian economy has done fine, and the European economy got through those winters, finding substitutes for Russian natural gas.
So, we have to be very, very cautious in interpreting these claims about how sensitive we are to risks of being cut off from something during wartime.
Now, if you look at Russia, for instance, they’re still getting a lot of important manufactured goods from countries like Germany, which are supposed to be participating in the sanctions. Well, what’s happening is German exports go to–I don’t know–Kazakhstan or Kyrgyzstan. And then you look at the trade accounts for these central Asian republics, and their trade with Russia skyrocketed after 2022–of industrial machinery. Well, it’s clear what’s going on, right?
I saw a short bit on how some of these real advanced computer chips that were supposedly denying China are still widely available in Chinese wholesale markets. And in fact, they’re actually very cheap. There’s so many there that they’re not even causing any stress for China.
Now, obviously, these are anecdotes, and you can say, ‘Well, there’s other situations where maybe we are vulnerable.’ But, I would also point out that–I would say the United States is by far in the strongest position of any country in terms of foreign policy risks.
And I am not exaggerating when I say ‘by far.’ When you look at things from the position of other countries, the U.S. position seems enviable. Like, energy is a key resource, right? Well, we’ve become basically self-sufficient in coal, oil, gas, everything. Or we get a little bit of oil from Canada, but that’s very reliable. Food, another essential good: we’re basically self-sufficient in food, right? Well, what about industrial equipment like chips? That’s where a lot of the focus is now.
Well, think about not individual countries, but blocks of countries. Like, who are the allies that we can rely on when there’s an international conflict? We have good relations with South Korea, Japan, Canada, Europe. Well, South Korea and Japan are important chip makers. We still make some chips. China does make computer chips, but what are the countries that China can rely on in a conflict? North Korea? What are the countries that Russia can rely on? Belarus?
So, the United States has strong connections with a wide range of important industrial countries around the world that are our allies and sources of economic strength in an international conflict. Our other major adversaries actually have very few real friends that they can rely on.
We also dominate the global financial system. We can use our banking regulations to shut off countries from money flows and so on. We have so many advantages in terms of strength in a potential conflict, compared to other countries that are far more exposed to international trade and have far fewer reliable allies, that I think we tend to lose sight of that.
And, when I hear about how devastating it would be if we lost access to Taiwan’s computer chips, I just think back to what we were told about what the cutoff of natural gas would do to Europe. Maybe that’s correct. I’m not an expert on computer chips. But I think we underestimate the ability of industry to find substitutes, to find other ways of doing things; and I think we tend to exaggerate the extent to which the United States is in a fragile position in terms of geopolitics. I think we’re in an extremely strong position, even as it is.
Now I’m not saying that the people that favor some modest industrial policies are always wrong. Perhaps it was correct to do some subsidies for chip-making factories in the United States.
What I’m saying is these arguments should be very strictly limited. There are probably very few cases where there’s resources that are so essential that we can’t rely on a free market.
So, when I see people argue for very expansive industrial policies–making the U.S. economy much more interventionist–that’s when I get nervous. That’s where I feel like the foreign policy argument is being abused, and people aren’t recognizing the true position of the United States, the true strengths we have in geopolitical competition. Does that make sense?
Russ Roberts: Yeah. No; the only thing I would add is that national security is often invoked as the justification for some restriction. But of course, that ends up often benefiting a domestic producer and insulating them from some competition that would otherwise make them poorer. And, one should always ask, is this really a national security issue or is it the security of a particular player?
In the 1990s and 2000s, the big argument was the U.S. economy is, quote, “being hollowed out.” We can’t get rich doing each other’s laundry; that, we’ve gone from a manufacturing economy to a service economy. And to a large extent, that was not true. Manufacturing output was actually quite high, although we have an episode with Susan Houseman that’s very interesting–I recommend you listen to it–that calls some of this into question about just how healthy the output part is.
It turns out–I think her point was that it’s almost all in computing: that, in other parts of the manufacturing sector and manufacturing part of the economy, they did do relatively poorly. But they certainly do poorly on unemployment–which is, again, this issue of whether it was driven by trade or whether it’s driven by innovation. I don’t think it’s a bad thing that we lost a lot of manufacturing jobs due to innovation or trade. And in fact, we have lots of output.
Again, whether the mix is too heavy toward computers–whole separate question. I want to put that to the side.
The point I want to make is that this idea that somehow we can’t grow or have a decent standard of living unless we have real jobs–manufacturing jobs–is a myth. It’s not true. It’s a misunderstanding of where growth comes from.
My joke version of it is: Well, if salaries in the NBA [National Basketball Association] are really high, let’s expand the NBA to more teams because more employment and high wages make us wealthier. Well, we understand that if we have 3000 basketball teams instead of 30, the wages won’t be high. People won’t pay to watch me play basketball–or even you, Scott, who I assume is taller than I am. I’m 5’6″.
So, the point is, is that this whole scary, sinister, conspiratorial argument that foreigners are stealing our jobs, hollowing out our economy–the data aren’t consistent with it. Our economy, over this time period when manufacturing shrunk as a proportion of employment–which is 1950 to 2024–were fabulous years for the U.S. economy.
Again, hard on some people when those transitions took place, when improvements in technology or trade flows made some businesses close. That was hard on the people who lost their jobs. But overall for the economy, it was very large and positive. And for those who lost their jobs, many of them found new jobs that were pretty good; and certainly, their children and grandchildren–when we think back to 1950–benefited tremendously from this willingness to accept economic change due to either trade or technology.
The more advanced version of this argument, which I want to put on the table, is that the reason we have to have, say, automobile manufacturing, is because that’s for national security. Why? Because if we don’t have an automobile factory, eventually we might lose the know-how of the industrial processes that we’ll need for certain military products–fighter planes, tanks, and so on.
And, I look at that argument and I think two things. One is, well, the next war, I’m never sure what really is going to be the key product. We thought in 1945 that tanks were really important. They’re less important to the United States in 2024. The United States does not need as many B-52s or bombers as the United States needed in 1945.
But, I even question whether we couldn’t regain that know-how if had to. If the United States was relatively factory-free, is it really the case that engineers–and we have–I keep saying ‘we.’ I moved to Israel three years ago, and I still tend to think of the United States as ‘we.’ But the United States–and I’m still a citizen so I can say ‘we’–if the United States lost all of its factories and suddenly found itself at the mercy of a foreign threat and didn’t have the network of friends that you talked about to provide certain things and products that are crucial–whether it’s computer chips or some titanium or some obscure raw material that’s only found a few places–you make the point, which is fantastic, there are often substitutes. But, I’m asking the question: Is it really that hard to restart industrial know-how in an highly-educated country of world-class, first-rate engineers?
I don’t know the answer to that. I encourage listeners to weigh in on it. But, do you have any thoughts on that, Scott? And, have you heard that argument?
Scott Sumner: Well, I think if you think of it in a realistic sense, obviously we’ve had some losses in manufacturing, but we still have a gigantic manufacturing sector. If it went to zero, then I think you could argue, yeah, it might be hard to restart. But, from where we are now and likely to be for decades, I don’t think that’s a big problem.
And I would add a few points.
So, when we think of foreign policy threats, you can think in terms of, like, conventional, World-War-II-style military conflict, and you can think of uncertain high-tech futuristic conflict. Right? So, let’s take those two.
If we think of the old-style conventional conflict, kind of like the Russia-Ukraine war–I mean, that does have modern things like drones, but it’s also a little bit like a World-War-II-style war–we can see that Russia is having trouble with a small, impoverished country, head-to-head, in a conventional, World-War-II-style war.
In my view, there’s almost zero chance of either Russia or China landing a D-Day-style invasion on the shores of the United States. Like, that’s not the real, actual foreign policy threat.
There is a nuclear threat, which might even be a threat associated with miscalculation, not something intentional; and that’s something to worry about.
There’s also a lot of people talking about potential future threats associated with high-tech AI [artificial intelligence]. What kind of weapons could AI develop? All of that. And, I’m not really qualified to talk about that in detail. I don’t know exactly what those threats might be. But I would point out that–you mentioned earlier how our industrial growth had been oriented towards computers and not the old-style industries. And I think that’s true; but that actually works in our favor in terms of these futuristic threats, right?
So, right now, I believe the U.S. stock market capitalization is 60% of the entire world. We’re only like 20, 25% of world GDP, but we’re 60% of stock market capitalization.
Why is that? Basically, the answer is very simple: our high-tech industries. That’s the primary reason why we have 60% of the world’s market capitalization. We completely dominate the cutting edge of high technology.
Now, there are individual sectors–like Taiwan in high-end computer chips and the Netherlands in machines that make computer chips–where other countries do very well. But we overall dominate high-tech. And we have innovative, new defense firms that are putting these to use, coming up with new military weapons, and so on, based on our advantage in high technology.
So, in that kind of world, our ability to make tanks is much less important than our ability to keep on the forefront of artificial intelligence and things like that.
So again, I think if you look at the world that way, our position is much less fragile than it looks to a lot of people and the impression you get reading the press about all these threats out there. I think if–people sitting in these other countries that are supposedly a threat to the United States probably feel exactly the opposite–that they’re in the inferior position right now, in terms of the global pecking order.
So, yeah: I think technology is actually an enormous foreign policy strength for the United States at the moment. And, I think probably going forward, given all the recent developments that have been occurring here in areas like artificial intelligence.
Again, the one area where I think the industrial people maybe have an argument is maybe the subsidies to move a few chip-making factories here. That might have made sense for national security reasons. It’s hard for me to say. It’s hard to speculate as to what might happen between China and Taiwan going forward. If there was an invasion, would the Taiwanese chip-making factories be destroyed? I don’t know what the Taiwanese government plan is in that regard.
But I would say this: If you take the Taiwanese chip-making off the table, I still think the United States is in a pretty strong international position relative to China and Russia because of our ability, plus South Korea, Japan, Europe and so on, in combination, versus any adversary outside of that block.
Russ Roberts: Well, I think the argument with respect to AI is similar to the kind of arguments we heard in the 1990s with respect to Japan, which would go something like this: Yes, the best AI companies and incredible innovation is taking place in the United States; and the talent that is being poured into that sector in the United States–startups–is enormous. But we’re not doing it in a systematic way. That would be the scary thing. It is going to give you better memos, and it will write some poems for you, and it will help you plan your dinner recipes. But, in China, they’re doing it not for those day-to-day, mundane, simple things. They’re doing it to dominate the world. And therefore, we have to have a similar top-down control of this new technology.
Now, as you pointed out, that could be true. As you admitted in your case, I’ll admit in mine: I don’t know if that’s a plausible threat or not.
What I do know is what you know, which is that–and you’ve hammered on this and I think it’s really a really an important point so I’m going to hammer on it a little bit more–which is: having been alive for the last 50 years of people trying to scare people, most of those scares were exaggerated because they forgot something. In the case of the sanctions or cutting off access to raw materials, they forgot that there’s substitution. And people can find ways around this, either with new products or by importing it from a third party that isn’t part of the sanction deal.
And, in the case of China–everyone just assumes China is this flawless juggernaut of economic well-being. They’ve got ghost cities with uninhabited buildings. To assume that because they’re trying to develop an AI that can take over the world, that therefore they’ll be able to, despite the lack of incentives in their system and their attempts to create those artificially through rewarding productivity and their friends, is maybe wildly, wildly overstated.
You know, I think–sitting here in Israel, when we heard about the sinister nature of Iran–the world has been afraid of Iran for 40 years. Well, they don’t have any missile defense right now. Israel took it out in one night. They are totally vulnerable to anything Israel wants to do.
Now, we can’t do everything we want to do. It might be very hard for us to destroy their nuclear capability. They’re smart. They put them in very deep bunkers.
But it’s very clear that their threat to this country was exaggerated. They launched–they’ve launched 400, 500 missiles at Israel since I’ve been, in the last six months. And they, I think the first attack, they injured a Bedouin nine-year-old; and, thank God, she’s fine. She went to the hospital and she’s okay.
The last one, they tragically killed an Arab-Israeli citizen with a piece of shrapnel. A piece of a rocket fell out of the sky that was shot down by a much superior technology of Iron Dome.
So, it’s just amazing how easy it is to be terrified by things that aren’t true.
Of course, the flip side is we didn’t think Hamas was a threat. And on October 7th, 2023, they proved us very, very wrong.
So, I don’t want to suggest you should never be worried about anything.
But, in these cases of large national policy, it’s often the case that paranoia is stoked and fear is stoked by people who have a different agenda than what appears to be the case. And it’s not obvious that–just as Japan did not dominate the world economy ultimately–it’s not obvious China will, either.
Scott Sumner: Yeah, I agree. I would add a few points about China. You mentioned this perception that China wants to dominate the world. I agree that perception is out there. I think there’s actually very, very little evidence to back it up.
Just to be clear, I’m not saying China is not a foreign policy threat. I absolutely think China is a major foreign policy threat to Taiwan. That’s a major risk. And, if there were a war between China and Taiwan, it would have a devastating effect on the world because of its indirect effects.
So, I don’t mean to speak lightly of that potential threat. But, beyond Taiwan, I actually don’t think China is a particularly expansionist power. People will point to the little islands in the South China Sea; but those are uninhabited, not very important. And, by the way, the largest of them is controlled by Taiwan, which is almost never reported in the press, right?
But China, really throughout its history, has not been a particularly expansionary power–given its size. Certainly nothing like Russia. Right?
And so, what’s going on is–I keep coming back to this term ‘sinister.’ I think that the perception–there’s much more suspicion about China’s intentions than about Russia’s intentions.
Now part of that perhaps can be justified by the fact that the Chinese economy is much larger than Russia’s. The population is larger. But, you know, China has–even today, China’s per capita GDP is about the same as Mexico.
Now, its high-tech sector is more advanced than Mexico. So, that’s a point that might be important in terms of military potential.
But, overall, its economy is at about the level of Mexico. It’s likely to grow further; but it’s almost certainly going to remain well below U.S. levels on a per capita basis.
As far as their population is concerned, it is very large; but it’s also declining rapidly. It’ll probably fall more than in half during the 21st century. More than in half. A hundred years from now, it’s very possible that Pakistan and Nigeria will have each more people than China. That’s where things are headed based on current birth rates.
So, I think that, obviously, China is a major power. It is a foreign policy threat–to Taiwan, certainly. But I don’t think they have expansionist aims much beyond that.
Unfortunately, China is often its own worst enemy. They’re very prickly about criticism. So, they sometimes will put trade sanctions on a country that criticizes the Chinese government. And, I think these–the thin-skinned nature of their government–creates a perception that they’re more of a threat than they really are.
So, I mean, obviously, we have to have a defense capability in the United States to meet any potential threat, whether it be China, Russia, whatever. So, we need a strong military to deter. But I think a lot of the concerns that are driving industrial policy are driven by an excessive degree of fear about what the Chinese are actually interested in doing in the future. [More to come, 1:06:24]
Russ Roberts: I hope you’re right, but–
Scott Sumner: Let me just interject. I see claims that, you know, China might attack Japan and invade Japan. These seem very fanciful to me. I could not even imagine any rationale for China attacking Japan. Or South Korea.
Russ Roberts: You might be right. I always worry about the downside risk. So, I think one should be prepared for worst-case scenarios, whether you’re South Korea, Japan, or the United States, or Israel. And I think Israel’s security failure of 2023 in October was a failure to remember that. It was an overconfidence.
So, I know you’re not saying it’s nothing to worry about; we shouldn’t be prepared for it.
The question is: should it be front and center all the time? Should it drive other policy areas–policy outcomes? And be the main decision-maker, the main factor that drives decision-making in, say, economic policy? Right now–
Russ Roberts: Yeah, go ahead.
Scott Sumner: Let me give an example.
So, Japan responded to the Ukraine war by dramatically increasing its defense spending. Right? I think that was appropriate. Japan looked at the situation, saw, ‘Oh, we’re in a new world where countries are willing to go back to World War II-style invasions for territorial conquest.’ That’s something that had fallen basically out of favor since World War II, other than maybe Iraq taking Kuwait or whatever. But, most wars since then have been civil wars, okay? [More to come, 1:08:15]
