He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might chuse to impress upon it.
—Adam Smith, The Theory of Moral Sentiments (1759)
In a guest essay in the October 29 New York Times titled “The Only Way to Solve Our Supply Chain Crisis Is to Rethink Trade,” US Senator Josh Hawley (R-Missouri) challenges what he sees as a dangerous reliance on imports from other countries. He claims that Washington politicians from both parties have “helped build a global economic system that prioritized the free flow of capital over the wages of American workers, and the free flow of goods over the resiliency of our nation’s supply chains.” He proposes that the Departments of Commerce and Defense be given the power to determine which goods and inputs are “critical for our national security and essential for the protection of our industrial base.” Once these goods and inputs are designated, Hawley would have the US government require that at least 50 percent of the value of the goods be made in the United States. He would have this requirement enforced by allowing domestic producers to petition the US International Trade Commission to take enforcement actions against violators.
Hawley claims that local-content requirements “will bring jobs back to America, help to revitalize the nation’s depleted manufacturing sector, and foster the domestic production so essential to our economic independence.”
Some of what he claims is true. His proposal, if implemented, would bring some jobs to America—and would cause America to lose other jobs. It would revitalize parts of our manufacturing sector—and would hurt other parts of manufacturing. It would foster domestic production of some goods but, ironically, this could actually make us less independent.
The Free Flow of Capital
Hawley is right that we have a relatively free flow of capital into and from the United States. He is wrong to suggest that this has hurt American workers. He himself notes elsewhere in the article that America has a high trade deficit with the rest of the world. But he doesn’t take the next logical step and point out what this trade deficit necessarily implies: an inflow of capital. It’s a mathematical certainty that when we spend more on other countries’ goods and services than they spend on ours, there is a capital account surplus. People and corporations in other countries that receive more dollars for their exports than they spend on our imports use those dollars to buy US bonds, typically US-government bonds, buy stock, or directly invest in the United States. They might even hold on to the dollars but, if so, that’s a particularly good deal for us because the cost of producing a $100 bill is only 14 cents. As Jay Leno put it in a 1989 ad for Doritos, “Crunch all you want; we’ll make more.” The US government can easily replace those hundred-dollar bills.
More likely, though, foreigners will invest those dollars here. To the extent they directly invest in plant and equipment, they raise the ratio of capital to labor. The more capital that laborers have to work with, the higher are their real wages. So Hawley gets the causal effect of the free flow of capital wrong. More capital makes workers better off, not worse off.
More Jobs or Just Different Jobs?
As noted above, Hawley claims that his proposed domestic-content policy would bring back jobs to America and help revitalize our manufacturing sector. This is true but misleading. It would bring back some jobs at the expense of other jobs. It would revitalize some manufacturing at the expense of other manufacturing.
To see why, consider why we have trade in the first place, whether within a country or across borders. The main driver is the cost of production. We tend to produce items that we are the low-cost producers of and trade them for items produced by people who are the low-cost producers of those items. That way, both sides benefit. If both sides didn’t benefit, they wouldn’t trade.
It is true that the number of jobs in our manufacturing sector has shrunk greatly and has been doing so for more than fifty years. But that’s because US manufacturers have become more and more efficient, producing more output with many fewer workers. Take steel. In 1980, producing one ton of steel in the United States took 10.1 man-hours; in 2017, it took only 1.5 man-hours. That means that one person in the steel industry produced over six times as much steel in 2017 as in 1980. Our manufacturing output actually peaked, not in the 1980s or 1970s or 1960s, but in 2007, before the 2007–9 recession. And in the fourth quarter of 2019, just before COVID and shutdowns hit, our manufacturing output was only 6.7 percent below its 2007 peak.
What would happen to jobs if Hawley’s domestic content proposal were implemented? The law would reduce imports of certain items and some of what was reduced would be replaced by domestic production. (Some, not all. Why? Because the law would make those items more expensive. Low expense was, after all, the main reason we were importing. At a higher price less is demanded.) So jobs would increase in the favored sector but that would mean pulling in workers from other sectors. Among the sectors that would lose workers are the exporting sectors because lower imports would mean that foreigners have fewer dollars to buy our exports. That’s why US farmers are typically among the biggest supporters of freer trade. They understand that more foreigners will buy their soybeans, corn, and other crops if those foreigners have more dollars to spend.
Other US workers would lose jobs too: those in industries whose inputs Hawley’s policy have made more expensive. If, for example, the government singles out steel and requires that domestic value added in steel must be 50 percent or more of the value of steel, and if that means restricting imports of steel, then steel will become more expensive. Most people don’t buy steel as a final consumer good; steel is typically an input into final goods. So a whole host of consumer and other final goods would be made pricier and the number of workers who produce those goods would fall.
The overall effect of Hawley’s policy on jobs, therefore, is probably close to a wash. Some jobs would increase; others would fall. Does that mean we should be indifferent to his proposal? No. Think back to why we trade. We trade to take advantage of cost differences. With costs being higher because the government has restricted the lower-cost imports, the losses to the industries and workers that lose are greater than the gains to the industries and workers who gain.
Our Independence
But, Hawley might say, even if all I say is true, we would still have more independence because we wouldn’t depend as much on foreigners for crucial inputs.
He could be right, but he also could be wrong. Imagine that we buy an important input from a foreign country and that Hawley’s proposed policy would cause us to produce that input here. Then we would be less dependent on that foreign supplier. But now that we buy more from domestic suppliers, we’re more dependent on them. Imagine that a crisis, such as COVID, causes a surge in demand for that product. What might happen next is that the federal government uses the Defense Production Act to limit the price that domestic suppliers may charge. I’m not making that up. That’s exactly what state governments did when their emergency declarations triggered their so-called “price gouging” regulations on personal protective equipment and what Donald Trump did with an executive order. One thing we economists are virtually certain of is that when a government imposes a price ceiling, which is a limit on how high a price is allowed to go, and when that ceiling is below the equilibrium price, less will be supplied than otherwise and there will be a shortage. So our dependence on domestic suppliers, combined with price controls, means that we don’t get as much as we want of the good.
But there is one kind of good on which a government cannot impose price controls: imports. If a government tried to impose a price control below the world price on a good that people in another country were selling, those sellers would simply refuse to sell to people in that country and would, instead, sell in other markets where they could earn the world price. This freedom on the part of exporters assures us that our own government can’t use price ceilings on imports and, thus, can’t cause shortages of imports. Moreover, the very fact that a government of Country A cannot impose price controls on outputs of other countries gives producers in those other countries an incentive to stockpile and to maintain excess production capacity. As economist Benjamin Zycher wrote in “Defense” in David R. Henderson, ed., The Concise Encyclopedia of Economics, “The ‘vulnerability’ issue is far more complex than the common foreign/domestic dependence view suggests.”
Central Planning Doesn’t Work
In the Adam Smith quote above, Smith is describing what he calls “the man of system.” We would refer to such a person today as a central planner. Josh Hawley is a man of system. He assumes that central planners in the Departments of Commerce and Defense would know which items are crucial and should not be bought from foreigners. But except for a few relatively obvious cases, such as military jets, they wouldn’t. Instead, they would end up imposing a layer of regulation that would make producers’ jobs more difficult, not less.
To put it simply, central planning doesn’t work. It didn’t work in explicitly centrally planned economies such as the Soviet Union. It didn’t even work in Japan’s economy when the Ministry of International Trade and Industry (MITI) tried to tilt the economy in favor of industries that it thought would be successful and against those it thought would fail.
Here’s my opening paragraph from my “The Myth of MITI,” Fortune, August 8, 1983:
Early in the 1950s, a small consumer-electronics company in Japan asked the Japanese government for permission to buy transistor-manufacturing rights from Western Electric. Permission was necessary because at the time foreign exchange was controlled by the tax and trade ministries. The Ministry of Trade and Industry refused, arguing that the technology wasn’t impressive enough to justify the expenditure. Two years later the company persuaded MITI to reverse its decision and went on to fame and fortune with the transistor radio. Its name: Sony.
I then noted that in the mid-1950s, MITI exhorted a Japanese industry to develop a prototype “people’s” model of its product. MITI planned to designate the winning firm as the sole producer. The companies rebuffed MITI. The industry? Automobiles.
Men of system, whether Senator Hawley or bureaucrats in government agencies, don’t know enough to make good choices. In his classic 1945 article “The Use of Knowledge in Society,” Nobel Prize–winning economist Friedrich Hayek laid out why: the information that is required for a complex economy to work exists in the minds of the literally millions of participants in that economy and cannot be aggregated in the minds of central planners, not matter how brilliant they are. Moreover, central planners don’t have the right incentives to make good choices. Let’s hope that some of Hawley’s Senate compatriots persuade him to abandon his central-planning protectionist crusade.
