Three Chords and the Truth
Remarks before the World Affairs Council and the Texas International Trade Alliance
Dallas, Texas
Sept. 21, 2000

I always hate it when I have to give someone a title for my remarks long before I have a clue. That pressure produced the title "Three Chords and the Truth" two or three weeks ago, when I was on the road, tired and probably in a hurry. "Three Chords and the Truth" was a Sara Evans country song. Country music, as you may know, is my main source of wisdom.

It seems that Sara and her boyfriend had hit a rough spot, and she wasn't buying his line anymore. But he finally broke through and "changed her mind with three chords and the truth." Of course, three chords and the truth immediately reminds me of the perennial debate over free trade. When it comes to trade, economists have known the truth since the publication of Adam Smith's Wealth of Nations in 1776. But they've always had a hard time convincing normal people of that truth. They haven't had the right three chords to change many minds.

I'm also reminded of Mark Twain, who apparently swore too much to suit his wife. One day she decided to teach him a lesson by giving him a dose of his own medicine. So at the first excuse, she cussed a blue streak to show him how repugnant it sounded. His reaction? "Dear, you have the words, but you don't have the music." Economists have the words, but they don't have the music.

Adam Smith, you may recall, wrote The Wealth of Nations as an argument for free trade, internally and externally. He debunked the arguments of the prevailing protectionists of the time, the mercantilists. Mercantilists had fallen for the fallacy of composition and confused money with wealth—not a fallacy at the level of the individual, but certainly one for a nation as a whole.

Smith based his argument for free trade on "absolute advantage." Country A produces X very efficiently and cheaply. Country B produces Y very efficiently and cheaply. Instead of each country producing both X and Y, each country would be better off specializing in what it does best and trading for what the other country does best. The citizens of each country would be better off because specialization would give them more. That's pretty intuitive. But what if some countries do many things well and others do nothing well?

David Ricardo provided the answer by refining Smith's absolute advantage into "comparative advantage"—a tremendous breakthrough in thinking about the advantages of trade, but less intuitive than absolute advantage.

The difference is illustrated by the story of the lawyer and his typist. He's obviously a better lawyer than she is by virtue of his training. But as fate would have it, he's also a better typist, having taken two typing courses in high school to help him maintain his eligibility for football. In other words, he has an absolute advantage in both lawyering and typing. She has an absolute disadvantage in both. Does that mean they can't do business? No. Because, comparative advantage, not absolute advantage, is what's important.

The lawyer's advantage as a lawyer is greater than his advantage as a typist. Her disadvantage as a typist is less than her disadvantage as a lawyer. Comparative advantage is about "most best" or "least worst." He is most-best as a lawyer, and she is least-worst as a typist. They can do business. They can profitably specialize.

(Before I continue with this fascinating tale, I need to pause and apologize to the ladies in the audience—no, make that the women in the audience—for the gender stereotypes. It would just have taken too long to tell like it should have been.)

The economic significance of comparative advantage is that all countries will have either a most-best or least-worst reason to trade. Rich-country fears that they can't compete with low-wage countries, and poor-country fears that they can't compete with capital-rich countries are both misplaced. In other words, all countries benefit from trade. But I'll concede that's a less intuitive line of reasoning than "Let Mexico grow the avocados and let the United States produce the software." Do you know what I pay for avocados at Whole Foods in Plano? $1.99 each. In Mexico City you can probably get 10 for that.

Human nature being what it is, U.S. citizens may be forgiven for doubting that they can "compete" with low-wage Mexico. Mexicans may be forgiven for doubting their competitiveness with the world's only economic superpower. That's a job for three chords and the truth.

Now, a concession. Although both countries are better off with trade, there will be losers in each country—those who produce what's better done elsewhere but are producing it now because of protection. Theoretically, they could be compensated from the gains of trade accruing to their fellow citizens. That's a political decision society has to make.

The most effective proponent of trade and the most effective debunker of protectionist fallacies and economic myths of all sorts was my hero, Frédéric Bastiat of France (1801-50). Bastiat used satire to ridicule protectionist arguments. He wrote the famous fictitious petition asking the French Chamber of Deputies for a law protecting candle makers and those in related industries from the unfair competition of the sun. The law would require that all blinds and shutters be closed to shut out the sunlight. It would benefit not only candle makers but all related industries. It would have huge multiplier effects. It would create many jobs. The prosperity would spread—all based on shutting out the unfair sunlight. When the word "unfair" is invoked, taxpayers better watch out.

In my personal search for effective free trade rhetoric, second prize goes to Henry George. He pointed out that what protectionists want to do to a country in peacetime is what the country's enemies want to do to it in wartime—namely, close its border to imports. Think about it.

Why is all this relevant today? We're enjoying what we at the Dallas Fed call the New-Paradigm Economy. For almost five years now, the economy has had its mojo working. Growth is faster. Unemployment is at its lowest in 30 years or so. And without significant cost in inflation.

If ever there was a time when free trade should be an easy sell, it's now, at a time of full employment and prosperity, a time of strong growth. Yet, the administration failed to get fast-track authority through Congress. We've been unable to bring Chile or any other country into NAFTA. The events in Seattle a few months ago were chilling. Now they're going after the IMF. I didn't think anything could make me sympathetic to the IMF.

When I talk about our New Economy—our new and improved economy—I'm usually asked what's on the horizon that might bring the good times to an end.

I always answer the truth—that I don't know—then mention some of the worries on other people's minds, like the high valuations in the stock market or our record trade deficit.

I believe the stock market is pretty efficient, and I have no confidence whatsoever in my ability to second-guess its millions of investors. As for the trade deficit, I would feel better about it if it were smaller, but I don't lose much sleep over it either. The structure of our balance of payments is determined by market participants, with relatively little interference from nonmarket forces. The trade deficit is largely a result of our strong growth. The matching capital inflow is prompted not only by the need to finance the trade deficit but also by the United States' attractiveness as a good place for the world's investors to invest. It's not clear to me whether the capital inflow is financing the trade deficit or the trade deficit is financing the capital inflow. The answer, of course, is both. But it isn't clear which is dominant.

People are naturally uneasy about it because it seems unnatural. The pattern of our balance of payments resembles that of a developing nation rather than the pattern we would normally associate with a mature, rich country. But here's something for you to think about: The United States is a developing country. Not an underdeveloped country, but a developing country.

Earlier this year, I testified before the U.S. Trade Deficit Review Commission. If you're interested, you can find a copy of my testimony on our web site at www.dallasfed.org.

To help you decide how much you should worry about our trade deficit, or the accumulated external debt from years of deficits and their financing, ask yourself this: In trade between Texas and Oklahoma, which state has the deficit and which has the surplus? You may guess right, but you don't know because no one keeps statistics on interstate trade. If Texas and Oklahoma had their own currencies, we don't know which would be the stronger and which would be the weaker. Aren't we lucky we don't know these things? It would just be one more thing to worry about. Perhaps the best way to deal with our external deficit is to stop measuring it.

One state no doubt has a deficit with the other. It would be pure coincidence if trade were exactly balanced. Adjustments are going on all the time in each of our 50 states as a result, not of their bilateral trade balances but of their trade balance with the rest of the world, including the other 49 states. These adjustments are so subtle we rarely notice them. That's because we've had free trade with the other states so long that imbalances never had a chance to accumulate. Our founding fathers were very wise to include the interstate commerce clause in the Constitution. It is a free trade mandate.

Assume there is at least one protectionist in Dallas who wants to raise our standard of living by restricting trade with foreign countries. I know for a fact that there is more than one because I moderated an all-day NAFTA debate in 1993. I was just the moderator, but I worried that my tires would be slashed.

For the people I saw that day, wouldn't their reasoning also argue for restricting trade with the other states? Why stop there? Why not limit trade with other Texas cities? Let's spend our Dallas dollars in Dallas. Better yet, North Dallas.

There are two ways to get something: make it yourself or make something else (or perform a service) and trade for what you want. The evolution of economies led to more and more specialization. There are a few jacks-of-all-trades left in the world, but not many. I'm almost totally specialized.

When I moved to Dallas almost 10 years ago, one of my priorities was to get a house with no lawn to mow. I had been spending almost three hours every weekend mowing my lawn in tropical Maryland. Now, I don't mow. I also have a garage door opener. Those two things represent the sum total of the increase in my standard of living when I got this job.

I don't do home repairs that can't be done with tape. When that number 12 starts blinking on our electric clocks and VCRs, I just put a little black electrical tape over it.

My wife, Suzanne, calls it being lazy. But I'm not lazy. I work very hard; I work long hours. But I understand comparative advantage. I work at what I do best—whatever that is—and trade for the rest. To be consistent, protectionists should not behave like me. They should do everything for themselves.

What protectionists think they are protecting is jobs. But trade—domestic or international—is not about jobs. At least it's not about the total number of jobs. It's not about the job count. Trade—domestic and international—is about making jobs count, about maximizing the standard of living we can achieve with the earnings from our jobs.

If the job count were what is important, you could raise it by replacing bulldozers with shovels. If that doesn't get it, take away the shovels and use spoons. Or dig holes on Monday, Wednesday and Friday and fill them up on Tuesday, Thursday and Saturday. No, jobs are too precious to waste like that. There's more important work to be done. There's no shortage of jobs, only a shortage of people.

Here's a thought for you to mull over. We raise our standard of living not by creating jobs but by destroying jobs. Let me repeat that: we raise our standard of living by destroying jobs. That truth is easier to see from a distance than up close and personal.

Take farming, for example. We're rightfully sad when a family farm can't make it. I wish Willie well in his Farm Aid efforts. But does anyone really believe we would be better off if it still took almost 90 percent of our population—like it once did—to grow our food? Less than 3 percent of our population now grows more food than the 90 percent did. It's called productivity. We call it labor productivity, but it's more about capital.

Do we have a whole bunch of unemployed farmers on the dole? Of course not. When it comes to farming, the dole is for the employed farmers, not the unemployed farmers. I'm sorry. The devil made me say that.

What are all those missing farmers doing—or, more accurately, the sons and daughters of the missing farmers? They are now working in all those areas that still require workers, the areas that haven't yet had the benefit of job losses.

What happened to agriculture—productivity—has been happening to manufacturing for years. Our manufacturing output has grown rapidly, but manufacturing employment has not. That's not a sign of decline. That's a sign of vigor. If present trends continue, the factory of the future will have only two employees, a man and a dog. The man's job will be to feed the dog. The dog's job will be to keep the man from touching the computerized machinery. Everyone else will be Down Under watching the Olympics.

I repeat: the real measure of progress is job losses, not job gains. It's the quality—not the number—of jobs that matters. The number of jobs will always be approximately equal to the number of people willing and able to work. And wages will reflect that supply of workers interacting with the demand for workers. As investment continues and the amount of capital per worker continues to rise—economists call this capital deepening, for some reason—so will wages and other compensation continue to rise and reflect the higher productivity.

Protectionists seem to believe there is a fixed number of jobs to go around and if we create a job abroad by our imports, that's one less job that will be created at home. That may be true for that particular job, but as the foreigners spend their proceeds from exporting to us, we will end up exporting more to them. The jobs lost in the industries that compete with imports will be offset by new jobs in our export industries. Imports and exports rise and fall together, so their net impact on jobs is close to zero. Again, the total number of jobs will be determined by the number of people willing and able to work. Trade—whether domestic or international—doesn't determine the number of jobs. Trade determines the mix of jobs.

At the national level, the change in the mix will be a change for the better since the jobs lost will be in areas of our comparative disadvantage and the jobs gained will be in the areas of our comparative advantage. With the greater specialization that results, total output and total income will rise.

Again, I concede that some workers—those without the education or the skills the new jobs require—will be worse off. The displaced factory worker may not take well to computer programming. But again, since workers in the aggregate are made better off, the losers from trade could be compensated from the gains of trade.

Our economy is doing wonderfully. But in the area of trade, our confidence must be waning. We're winning and losing our nerve at the same time. We need all the help we can get to spread the word. Let's all look for the right three chords to change some minds on free trade. After all, free trade is part of freedom. Economics aside, why should a free people be told whom they can trade with and whom they can't?

The current issue of Business Week calls me a preacher, in effect: "Brother McTeer." When I saw that yesterday, I didn't understand it. But after this little sermon, I guess they had it right. Amen.

About the Author McTeer is president and CEO of the Federal Reserve Bank of Dallas.