Every line of reasoning begins with premises. Many premises are so obvious that we accept them unconsciously. When your physician prescribes medicine, you understand that her advice is premised on a desire to improve your health. Other premises are consciously chosen. When medical researchers use lab rats, they presume – perhaps based on past research results – that the physiological similarities between humans and rats are sufficiently large to justify such research.
Premises are unavoidable. But beware: because premises necessarily affect the lines of reasoning that flow from them, faulty premises typically yield faulty conclusions.
One of the most common faulty premises that infects discussions of economic policy is the premise that a country is like a private for-profit company, only larger. Nearly everything that the United States President says about trade makes sense if you understand him to believe that the United States economy is a gargantuan for-profit firm.
Consider Trump’s incessant complaining about U.S. trade deficits. These “deficits” arise whenever the total value of goods and services that Americans buy from foreigners exceeds the total value of goods and services that Americans sell to foreigners. If the U.S. economy really were a company, then America’s four-decades-long string of annual trade deficits would indeed be cause for concern. No business can survive if the amount that it spends on raw materials, factory space, labor, and other inputs chronically exceeds the amount of revenue that it earns on sales of its output.
It isn’t surprising, then, that Trump – presuming America to be a company – interprets U.S. trade deficits as evidence that America, Inc., is failing economically. And just as any competent business executive, upon taking the reins as CEO of a failing company, tries to reduce the company’s expenses and increase the company’s sales, Trump believes that his duty as CEO of America, Inc., is to reduce America’s imports (that is, our purchases) and to increase America’s exports (that is, our sales).
But Trump’s premise is completely flawed.
A Country is Not a Company
Employees of Caterpillar, Inc., all work to help that company earn maximum possible profits. And these workers are directed – “managed” – in this joint effort by Caterpillar’s CEO. The shared, unitary goal of all who work for Caterpillar is indeed to arrange for that company to sell as much as possible while, in doing so, spending as little as possible.
Recognize that Caterpillar’s employees share the unitary goal of helping Caterpillar operate profitably only in their capacities as Caterpillar employees. At the end of every workday, each Caterpillar worker goes home. When at home this person acts not with the goal of helping Caterpillar to further increase its profits but, instead, with the goal of achieving as much satisfaction as possible for himself and his family (however they define ‘satisfaction’).
Each Caterpillar employee works at that company only as a means of enhancing his and his family’s ability to achieve this satisfaction. And central to the achievement of this satisfaction is ‘maximizing’ the amount of real goods and services that his household consumes over time.
The same is true for Caterpillar’s shareholders. They obviously want Caterpillar to sell as much as possible and, in the process, to spend as little as possible. But they have this desire precisely because the profits they earn if Caterpillar succeeds are funds that they, as individuals and members of households, can then spend on real goods and services for their consumption.
In short, the ultimate goal of Caterpillar’s workers and shareholders is not to be part of a company that sells as much as possible and buys as little as possible. Instead, their ultimate goal is to enhance their and their families’ capacities to consume as much as possible. Owning and working for Caterpillar are merely means to this end.
The American economy, though, is not remotely analogous to Caterpillar, Inc. Americans do not work for America, Inc. And there are no goods or services that we Americans are managed as workers to produce for sale to non-Americans. America is not a business that operates according to a shared, unitary plan the success or failure of which is recorded on a meaningful budget. Thus, the American economy – unlike an actual business firm, household, or government – is not an organization that can spend too much or go into debt. In reality, America, Inc., does not exist. Being non-existent, it cannot earn, spend, lend, borrow, or budget.
This point warrants emphasis. Individual people can spend too much and can go into debt. Ditto for individual firms, individual non-profits, and individual governments. The American economy, in contrast, can do neither of these things – a fact that renders silly all talk of U.S. trade deficits pushing Americans further into debt to non-Americans
Aggregates are Not Acting Entities
A hypothetical example will clarify my point. Suppose that you own and live in a condominium. There are 99 other units in the same building – call it “The Harwood” – in which your unit is located. You have a budget. So too does each of The Harwood’s other 99 households.
Now suppose that an accountant takes it upon himself to examine each of these 100 individual household budgets and calculate the sum of all of the 100 annual incomes and the sum of all of the 100 annual expenses.
Further suppose that he discovers that in 2018 the sum of the annual incomes of the citizens of The Harwood fell short of the sum of their annual expenses. The accountant then declares, in an ominous tone of voice, that “In 2018 The Harwood ran a trade deficit because it spent more than it earned.”
Sounds scary. Yet his declaration is meaningless. There is no “it.” The aggregate of the 100 households in The Harwood is not an entity that earns or spends income. Nor is the aggregate of these households an entity that can borrow or owe money to anyone. The aggregate of these households is not an acting economic entity. By adding together 100 different household budgets none of which is connected to another except by the utterly irrelevant fact that each of those budgets is under the control of individuals who reside in the same physical structure, the accountant has conjured up a mere illusion.
You might feel sorry for your neighbor across the hall who took on excessive debt. But his indebtedness is his; it isn’t yours. And although the accountant would state that your neighbor’s indebtedness increases the indebtedness of The Harwood, the meaninglessness of this statement becomes clear the moment you recognize that your neighbor’s increased indebtedness doesn’t increase your indebtedness by a single cent. Similarly if the neighbor who lives one floor below you wins the lottery: her good fortune doesn’t increase your wealth.
The fact that you live in the same building as these neighbors, and that changes in each of their individual economic positions change the accountant’s calculation of The Harwood’s aggregate income and expenses, does not mean that your income, expenses, and indebtedness are thereby changed. The economic fortunes of your household remain under your control and are unaffected by the budgetary decisions of other residents of The Harwood.
We Just Live Here
The American economy is much more akin to the collection of residents of The Harwood than it is to America, Inc. In the U.S. the only economically meaningful units – those that earn income by producing, that spend income in order to consume, and that borrow and lend – are American individuals, American households, American businesses, American-non-profits, and American governments at all levels. The American economy, as such, does none of these activities.
Unfortunately, the fact that accountants use arithmetic to calculate the aggregate of Americans’ earnings, spending, borrowing, and lending causes people to adopt the premise that the American economy is an economically relevant entity that earns, spends, borrows, and lends in the same way as a household and a corporation.
But this premise is false. Regrettably, as long as it continues to be the starting point of discussions of trade and trade policy, it will generate false conclusions that, in turn, spawn destructive government interventions.