Getting Economic Policy Right Actually Matters -- A Lot

It is said that the rise of Donald Trump to presumptive Republican Presidential nominee is the result of anger of the electorate with the Republican "establishment."  I certainly don't have any evidence to the contrary.  But the problem I have is that the term "Republican establishment" has been used to describe what I see as two distinct groups:  (1) one group consisting of a Washington power elite, including many Republican members of Congress and the Congressional leadership, whose interest is in maintaining a large and ineffective federal structure that passes out lots of money and favors (the money and favors of course going to "our people" rather than "their people"), together with businesses, lobbyists and consultants looking to get in on some of the money and favors; and (2) a second group consisting of a principled movement (including many Congresspersons -- mostly younger ones -- think tanks and, yes, many campaign donors) seeking to advance sound policy ideas of limited government, lessening of government restrictions on economic activity, lower taxes and lower spending.  

Admittedly there can be some overlap between the two groups, let alone substantial co-opting of members of group 2 into group 1.  Still, I think the distinction is critically important; but I'm not sure that Trump or his supporters see there being much of a distinction at all.  Certainly, the focus of Trump's presentation is on attacking the "establishment" and "political correctness," while over on the policy side his prescriptions are vaguely-defined and shifting.  What exactly does being a successful businessman who does "great deals" have to do with being a good President?  

At Town Hall today, economist Thomas Sowell reminds us of the last time we had a highly successful Republican businessman as President:  Herbert Hoover (1929-1933).  Sowell's column focuses more on foreign policy issues, but I'll look at the economic policy side.  It turns out that Hoover's main economic policies bear a remarkable resemblance to those proposed by Trump.  The two big ones were trade protectionism and raising wages by government coercion.  They led to disaster.

I don't know if they even teach kids any more about the Smoot-Hawley tariff of 1930.  In my education -- both high school and college -- it was repeatedly cited as exactly what not to do in economic policy; but maybe today it has gone into a memory hole.  The economy had entered a recession by mid-1929, and the stock market crashed in October of that year.  But by spring 1930 the market was edging back to its levels of early 1929, and many were optimistic that recovery was beginning.  Then came the Smoot-Hawley tariff in June 1930.  Here is a brief history of the tariff from the Economist magazine.  Famously, a group of no less than 1,028 economists submitted a petition to Hoover urging him to veto the bill; but he signed it.  Then the bottom fell out of the economy.  Trade relations with other countries were soured, and many retaliated.  Imports to the United States proceeded to decline 40% from 1930 to 1932.  From a Wikipedia summary:

Frantic attempts to shore up the economies of individual nations through protectionist policies such as, the 1930 U.S. Smoot–Hawley Tariff Act and retaliatory tariffs in other countries, exacerbated the collapse in global trade. . . .  By late 1930, a steady decline in the world economy had set in, which did not reach bottom until 1933

Then there was Hoover's policy on wages.  There was no federal minimum wage in 1929 (the first one at the federal level was adopted in 1933, immediately after he left), but that didn't stop Hoover from using government coercion to try to fix wages at above-market rates.  From a summary by economist Lee Ohanian in Forbes in 2009:

Hoover . . .  held [meetings] at the White House with major industry in late 1929 that included General Motors, Ford, U.S. Steel and DuPont, and advised them not to cut wages.  Hoover told industry that maintaining wage levels would minimize the severity of a downturn and help him keep peace with labor. . . .  Following these meetings, industry publicly acknowledged their compliance with Hoover’s wage program as they held wage rates fixed.  But declining prices and productivity, coupled with Hoover’s program of fixing wages, significantly increased industrial labor costs. Shortly after Hoover’s meetings, the industrial sector began to contract rapidly. Between October 1929 and September 1930, industrial hours worked had declined by nearly 30%.

Now I admit that it is not possible to segregate out any one or two things as being the only or even the main factors that caused the Great Depression or led to it being so long.  Some believe that other factors -- such as contraction of the money supply or failure of the government to enact a "stimulus" -- were of equal or more importance.  But few believe that the tariff and wage policies were not at least significant factors in bringing on and then prolonging the Depression.

In his four brief years, Hoover did enormous damage to the Republican brand.  The Republicans lost record numbers of Congressional seats to the Democrats in the 30s, and were locked out of the Presidency for 20 years.  As late the the 1980 election, the memory of the terrible economic times of the early 30s was still used against Reagan ("Hoover with a smile" according to Democrat House Speaker Tip O'Neill).  But Reagan's economic policy was the opposite of that of Hoover.

Trump?  While he has been unspecific, it is clear that trade protectionism, including increased tariffs, is something he plans to pursue.  And according to the Wall Street Journal this morning, Trump spoke favorably yesterday about raising the minimum wage.  How high?  No word.

But the experience of Hoover shows that it is very important to get economic policy right.  To help out Mr. Trump, I'm going to offer my economics lecture of the day.  The simple basis for all sound economic policy is the proposition that all wealth comes from people buying and selling stuff with each other (the term "stuff" here includes both goods and services).  The process of people buying and selling stuff (sometimes going under the name of "capitalism") may not lead to outcomes to everyone's liking, but it is just a fallacy to think that the government can increase wealth by imposing restrictions on people buying and selling stuff. 

In the area of trade, consider this.  Suppose you work for a company that makes widgets and sells them for $100 each.  Now someone in China figures out how to make the widgets there and deliver them to the U.S. for $90 each.  (Or it could be your own company that figures out how to make the widgets in China and get them to the U.S. for $90 each -- it doesn't make any difference.)  The fact is that the customers don't care where the widgets are made and they aren't going to pay more than $90 any more.  This is not a consequence of "bad trade deals."  It is an inevitable consequence of people having the freedom to buy and sell stuff as they see fit.  As for you, the market is telling you that your labor is too valuable to waste it making these widgets any more.  It may be a very painful process for you to find the next thing for yourself, but that doesn't mean that the market is wrong on this.   

But what is the alternative?  Over the years, what policymakers come up with over and over again is a tariff, and that also seems to be where Trump is going with China and Mexico.  Slap a $15 tariff on widgets from China, and suddenly your $100 widgets have a market again.  In fact, the owner of the business may even raise his price to $104.  I'm sorry, but this is a terrible idea.  For you, it means maybe you can hang on in your job for a few more years -- until somebody in China figures out how to make the widgets for $84.  Your wages meanwhile will surely stagnate.  Extra profits will go to the boss, not you, and some will go to the campaign contributions to the pols to keep the tariff in place and increase it.  Everybody else in America has to pay $14 extra for every widget they buy, making all those people poorer.  The higher value jobs that you and your colleagues could and should have found go undone.  And all of this is before China imposes some countervailing tariff on the United States.  Studies of tariffs always find that the costs to others in society exceed the value of jobs "saved" by huge multiples -- often $200,000 or $250,000 in cost per $40,000 job saved.  This is a total loser strategy.

Is there any chance that Trump can come to understand the disaster of tariffs and minimum wages?  Got me.