Competition and Capital

Dr. Russell, recently retired from a full schedule of academic work, continues free-lance consulting, lecturing and writing from his home in Westchester County, New York.
      This is one of a series of articles examining current interventions of the welfare state in the light of warnings from the French economist and statesman, Frederic Bastiat (1801-1850).

Several of Frederic Bastiat’s parables or satires deal with the theme of unfair foreign competition, usually based on wage differentials (cheap foreign labor) but sometimes on other “unfair” advantages enjoyed by foreign producers, e.g., natural resources, capital formation, and so on.

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* I’ve done my own translating, and I’ve slightly condensed Bastiat’s story to the essentials needed to fully explain his brilliant point, Complete Works of Bastiat, Guillaumin, Paris, 1878 edition, vol. 4, pp. 57-62.

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This argument for restrictions against foreign competitors because of their presumed cost advantages (usually, but not always, cheaper labor) is the basic argument for tariffs, quotas, and other restrictions and prohibitions against international trade. Sometimes lip-service is paid to national defense arguments, health arguments, and a few others. But those arguments don’t really carry much weight; our arms man ufacturers are the world’s best, and no one seriously objects to sound reasons for keeping infectious diseases and destructive bugs out of our country. The basic argument advanced by Bastiat in so many of his parables and explanations is the only argument the protectionists can really depend on, i.e., protection against unfair foreign competition that’s destroying American jobs.

These “unfair” practices are seldom spelled out in advance, since it would be difficult to know what they are until they happen. They are positively identified only after a domestic producer loses business to a foreign competitor. When that happens, a “peril point” has been reached—always due to some unfair foreign practice, of course—and laws are passed (or called into action) to protect the domestic producer against the foreign producer. As a result of this “magician’s tactic” of drawing our attention elsewhere, we never know the real reasons for the high costs of the domestic producer. Behind his protective law, there’s no final incentive for him to improve his operations.

Well, let’s take a look at some of the possible reasons (at home and abroad) that have a direct bearing on this entire problem of competition and capital formation, e.g., “unfair” foreign competition, the effects of capital formation (machines) on jobs and wages, the differences between domestic and foreign trade, and the effect of laws against foreign capital. Since all of these issues are inextricably mixed, I’ll not here try to compartmentalize them but will use them as they come along. First, cheap foreign labor.

Cheap Foreign Labor

The most persuasive argument I ever heard for protection against competition from foreign labor didn’t concern cheap labor at all but protection against expensive foreign labor. You may be as surprised as I was when I encountered that argument while I was a doctoral student at the University of Geneva, where I’d made friends with a student from Egypt.

I knew his country had one of the highest tariffs in the world. As a “free trader,” I sometimes chided him about it and suggested that since labor was already so cheap in Egypt, surely they didn’t need laws to protect them against foreign competition. He said I was wrong, that I was missing the real point entirely, that protection against cheap labor is indeed absurd, that the problem is competition from expensive labor, and that Egypt most definitely did need protection against that type of foreign labor. Here’s how he explained it.

He correctly pointed out that the low production of Egyptian workers was due primarily to their primitive tools, i.e., the absence of capital or machines. As a result of this, he said, the cost of labor in Egypt is one of the highest in the world when correctly measured, i.e., labor cost per unit of production.

He then used the chalkboard to show me a mathematical comparison between the $25 an hour paid to the operator of a bulldozer moving sand—and the 25 cents an hour paid to 200 fellahin with shovels moving the same amount of sand. Even after the low cost of capital (the bulldozer) is paid, the real cost of labor in Egypt is almost double what it is in the United States.

He then argued that the workers in undeveloped nations simply can’t compete against industrial workers with their efficient machines and the resulting high production. Always, he said, the cost of labor is lower (much lower) in nations with much capital than it is in nations with little capital. If it weren’t for laws protecting our high-cost Egyptian labor against your low- cost American labor, you’d move in and most of our low-paid laborers would soon lose their jobs to your high-paid workers with machines.

He’s right, you know, as far as he went. And in any case, it was a most refreshing argument which should (but most definitely won’t) end that fallacious “cheap foreign labor” argument that’s responsible for so many of our disastrous laws.

In reality, of course, it’s the trading itself (not the relative wage scales) that causes real wages to rise in all nations that participate. In order to understand this better, let’s start with a statement that’s not subject to argument: No person in Egypt or the United States will voluntarily trade with a person in another country (or even next door) unless he puts a higher value on what he gets than on what he gives up. And thus both parties in any trade (domestic or foreign) necessarily benefit (or at least expect to benefit) from the trade.

Trading Across Borders

Actually, when all is said and done, there’s no exclusively economic or theoretical justification for discussing domestic and foreign trade separately; they’re identical in all re-spects-except for the purely arbitrary and artificial interventions of government. For example, in the United States, a manufacturer in southern California has no particular difficulties in trading with a company in northern Maine, some 4,000 miles away. But when the same manufacturer tries to trade with a company in Tijuana, Mexico-perhaps four miles away—he encounters all sorts of frustrating, noneconomic, and cost-increasing prohibitions and compulsions that have been devised by the two governments.

The problems of transportation and distance (as such) are not something peculiar to international trade. Nor do differences of language and religion constitute special problems in trading across national boundaries.

For example, a Catholic manufacturer who speaks only Italian in Lugano, Switzerland, has no problem at all in trading with a Protestant retailer who speaks only German in Zurich. But when he attempts to trade with his Italian cousin just across the border (both speaking the same language and belonging to the same church), he encounters problems that are often insurmountable. All of these problems are created by government and are thus completely artificial, unnecessary, and cost-increasing.

Canada offers an example of how vast distances, different wage scales, different languages, different religions, and different cultural backgrounds present no real trade problems at all. But let a Canadian try to buy an automobile from Detroit just across the border!

Even different monies (yen, peso, dollar, whatever) present no real problem to any trader—if the various monies can be freely bought and sold. But when this is forbidden or restricted, problems do indeed appear. Again, however, they are artificial problems and are due entirely to governmental rules and regulations.

Why Some Are Hungry

In short, I’m convinced that any argument for free trade within a nation is automatically and necessarily an argument for free trade internationally. If a person advocates free trade domestically to increase our level of material living, he can’t logically advocate protective tariffs and other similar measures to prevent goods and services from moving freely across national boundaries; for that would contradict his argument that free trade within a nation is good for all.

It’s simply not true that a nation and a people are made more prosperous by compelling themselves to pay twice as much as they need to pay for goods and services they want. I’m convinced that these policies stem more from lack of understanding than from evil intentions.

For example, hunger is a fact of life all around the world. And since we all want to help, we identify the problem as “hungry people” and send food. You see the touching appeals for more food (money to buy food) quite frequently on your TV set or in your newspaper. But this hunger is the symptom of a problem, not the problem itself. Why are those people without food? Is their inability to produce food (or to produce goods and services to exchange for food) due to their stupidity or laziness? I think not. Then just what causes their continuing hunger, generation after generation?

I suspect the following personal experience goes far in identifying the real problem that causes so much hunger and human misery: I have a small amount of liquid capital, i.e., dollars that can be converted by labor into the real capital of machines, raw materials, and finished products. For various reasons, I would like to use this modest supply of capital in India. I’d like to take advantage of the unemployed (and underemployed) labor found there, to improve my own material well-being, and (since I’m a reasonably compassionate person) to also improve the material well- being of several Indian families who are now actually hungry.

Over the years, I’ve made the following proposal to several acquaintances in India, including two government officials. If you will permit me to come in, I said, I’ll immediately hire at least ten people at better wages than they are now earning. Their working conditions will be more pleasant—and their employment will be steadier—than is now the case for any of them.

It’s self-evident I would have to fulfill those promises before I could possibly persuade anyone to use my machines; for obviously, no one would work for lower wages than he’s already earning. Even so, I always include in my offer the posting of a performance bond.

Solving the Problem

What I propose to do is to try to solve the cause (the real problem) by showing a few hungry people how to produce enough goods and services to feed themselves and their families on a continuing basis. And please note that I propose to back my judgment with my own capital, not the taxpayers’ money.

So why don’t I do it? The answer is shocking. The Indian government refuses to let me in. “No foreign imperialist is ever going to exploit us again,” they proclaim in various words and tones. And they mean it; they’re firmly convinced that India was once a prosperous nation, and then the imperialist British came in and took it all back to the British Isles, thus leaving India poor again. I sure do wish someone would identify that “it” for me.

Anyway, I once visited India and lectured at four universities there. And I was fortunate enough to get interviews with the prime minister of India, the vice president, and two ministers. They were all nice people, even though not one of them understood what I was talking about. They think only in terms of applying to the United States Department of State for more government-to-government grants-in-aid. And they almost always get them. Their threat to turn to Russia is a sure-fire way to get us to agree. And thus they continue to treat the consequences of the problem (not enough food to feed starving Indians) instead of the problem itself (government intervention in the market place).

True enough, two of those Indian acquaintances informed me that I can enter India with my machines, under certain conditions. First, I must produce what the government wants produced; I’m not permitted to make the decision alone. And I must locate where the government specifies; I can’t make that decision for myself. Further, I can’t just rush out into the street and hire whom I please at whatever wages we agree on; those are important matters that must be cleared with the proper government official.

While I will be permitted to try to earn a profit, it must be “reasonable”; the figure of a four- to-eight per cent return on my invested capital was mentioned. But in return for all this, the Indian government is also willing to sacrifice a bit; it will guarantee not to nationalize my company for at least ten years.

And then the leaders of the Indian government wonder why (private) foreign capital doesn’t flow in! And the empty bellies continue to multiply far faster than any “green revolution” can possibly increase the rice and wheat yields. And our government officials (as well as the officials of the Indian government) continue to treat the symptoms of the problem rather than to face up to the problem itself. In all fairness, I suspect the fault is lack of understanding, not joy in observing hungry people.

Until quite recently, I taught a graduate course in International Business Problems. Naturally there were several lectures dealing with the material covered in this article—foreign competition, foreign investments, how to measure and compare wage rates, the effects of capital formation on standards of living, the effect of governmental intervention on capital formation, and so on. At the end of the course, however, students always got my “never trust a politician” lecture. Since most of those students were already working for companies with considerable international business, I offered them a single idea they could take back to the boss, if they wished.

If you are ever involved in selecting a foreign country in which to build a new plant or distribution center for your company, I advised them, begin by ranking the “candidate countries” according to the extent of controls imposed by the respective governments on their own domestic economies. Since this is the most important measurement of all, do it first, before any other criteria are applied. The leaders of any government can logically be expected to lean internationally in the same direction they deliberately follow internally. You can depend on it. Thus before you commit your company’s capital (the final security for your own job) to an enterprise in another country, know what’s likely to happen to it politically

Ephemeral Promises

I’m increasingly astonished at how many leaders of private business in the United States ignore the clear evidence of what the leaders of foreign governments choose to do in their own countries, and believe instead in their ephemeral promises. What’s the attitude of the Russian leaders toward private capita]? We]], that’s their attitude toward your capital, whatever they may say to you. Since private capital is not permitted in Russia, what causes you to imagine your capital can be safely invested there?

“But they promised . . . ,” you say. Yes, I know. And they can “unpromise” just as quickly and sincerely.

“But my own government leaders promised me that if . . . . ,” they continue. Again, yes I know. I also know that the old American axiom “Never depend on political promises” is not just a joke; it’s based on hard reality, long observed.

There’s another “old saw” I recommend to your attention: Look at what they do, not what they say. That applies to the leaders of all governments.

I frequently use just two countries to illustrate my point—both close to home and reasonably well known, Mexico and Canada. When I examine the attitudes of those two governments (their laws and traditions) toward private domestic capital, I have a reasonably good guide concerning what’s likely to happen to my own capital. I don’t much care what promises the leaders of the respective governments make. Even if they’re sincere (they may well be), I put no faith at all in their promises. They simply can’t be trusted. It’s not that they’re bad people; they’re just ordinary people who earn their livings being politicians.

If the leaders of a “controlled economy” offer you great tax concessions, beware. If the leaders of a free economy don’t offer you any tax concessions at all, put that down as a plus, not a minus. Always look at the real picture, not the postcard; look at the internal controls over domestic capital, which is what your own capital becomes when you send it there.

Do you really believe that the leaders of a foreign country will favor you above their own people? If you’re that gullible, I would say to my students, this “investment advice” isn’t for you; the odds are you don’t have any capital anyway.

Why should they offer concessions to get your money in, when all they need do to raise large amounts of capital is to repeal the restrictions on domestic capital? I’m baffled as to why our banking leaders (who may well rank higher in “intelligence tests” than any other group of leaders) didn’t ask themselves that question years ago.

Not too many of the students took my advice, of course. They mostly wanted to know if that idea would appear as a question on the final exam. I can’t fault them for that; it’s always good thinking when you try to find out as much as you can about events that can be profitable to you. Whatever, when I finished with that particular lecture on “capital formation and international investment,” I always felt they had at least gotten something for their tuition money in addition to an A or B in my gradebook.