Re: CJE 2001 critical review of trade theory and policy

["Leigh Harkness" <Leigh@xxxxxxxxxxxxxxxxxxxx>]

> You do seem to be excessively reluctant to actually look at
> the proposal.

You are right.  My web brouser is not functioning.  I am dependant on you to
explain your approach in a few words.

> QUOTE
> First create an arbitrary normal demand curve. Then create a
> normal cost of production curve with fixed and variable
> costs of production with falling costs to the point of
> diminishing returns and a rising cost beyond that point.
> Then find the most profitable production point on the demand
> curve.
>
> With me so far?
>
> Then when you've done this simple task find the variable
> costs of production at the most profitable production point
> and change a substantial portion of this cost to fixed cost
> of production and find the new point of maximum profit that
> falls on the same demand curve. That is, change only the
> distribution of costs between variable costs and fixed costs
> just as would occur if nominal wages collected by employers
> as taxes and never seen by employees as actual wages were
> collected as property taxes from the employer as I described
> in the original post.
>
> If you can manage to do that and honestly report the result
> as an increase in the level of production you may even
> accept the conclusion that such a change would increase
> employment to produce the greater amount of product that is
> sold more profitably at the lower price needed to obtain the
> increased demand.
> UNQUOTE


John

If we were to apply this analysis to a macro economy and if a shift from
variable to fixed taxes where to lead to a reduction in the relative price
of domestic products, that is to a real devaluation of the exchange rate, I
can see that there would be an increase in employment.  But that requires
the exchange rate to be fixed.

If this same policy were to occur within the confines of a floating exchange
rate system, I cannot understand how you could attain the change in relative
prices necessary to raise domestic production. While the exchange rate
mechanism is designed to ensure that international receipts and payments are
equal, no amount of playing around with domestic prices will fix the
problem.  You appear to neglect the exchange rate system from your analysis.


John

When I write about exchange rates, I am writing about relative prices
between domestic products and imports.  Thus when you propose to change the
tax system to make domestic products cheaper than imports, I see that as a
devaluation of the the currency.  It is a technical term meaning that
foreign goods have become more expensive relative to domestic products.

You write:

> The effect of price changes on the value of money would be
> zero IF THE MONETARY POLICY WERE ESTABLISHED TO MAINTAIN THE
> VALUE OF THE CURRENCY.

Money is only a measuring system like a number.  It has no intrinsic value
of its own.  The only way that it has value is because it can be exchanged
for something.  If I hold one million units of money and the price of bread
is one unit, then the value of my money is one million loaves of bread.  If
the price of a loaf of bread is one million units, then my money is worth
one loaf of bread.  Prices have everything to do with the value of money or
currency.

You appear to suggest that prices of domestic products can be reduced while
maintinaining the nominal value (exchange rate) of the dollar.  As I have
explained, that is not a valid understanding of exchange rates.  Even if it
were, you are in effect assuming fixed exchange rates.  I am prepared to
accept that you could raise incomes and employment by reducing prices under
a system of fixed exchange rates.  The problem is that we have floating
exchange rates and they do not behave like fixed exchange rates.

You continue:

If the facade of attempting to affect
> AS or AD by monetary policy continues the effect of monetary
> policy on employment, production, prices, etc. will be as
> uncertain as is demonstrated by the uncertain outcome
> whenever the policy is implemented. Remember the black swan
> -- it would only takes one to demonstrate that not all swans
> are white. Likewise, it only takes one failure of the
> assumption that monetary policy can cause economic
> improvement to demonstrate that it is NOT a causal factor.
> How much money creation [i.e. -- lowering of the interbank
> interest rate] must Japan implement to accomplish an
> increase in employment?

There is more to the monetary policy than interest rates.  You have already
presented one, namely:

IF THE MONETARY POLICY WERE ESTABLISHED TO MAINTAIN THE
> VALUE OF THE CURRENCY.

The exchange rate system is one part of monetary policy, as are interest
rates, policies on bank lending etc.  As I explained earlier, money is the
software that drives the hardware.  Take it out of the economy and you have
no demand, as we know it.  You may have exchange of products and informal
systems for recording entitlements and obligations, but no aggregated
demand.   How we operate the monetary system has a bearing on how the
economy functions.  If there is a bug in the software, we cannot expect the
hardware to perform at optimum levels.



> EXAMINE THE PROPOSITION AND YOU TELL ME HOW IT DOESN'T
> HAPPEN!

You have neglected the exchange rate system.



> Aside from punishing domestic purchasers border taxes simply
> displace unemployment of the favored producers with
> unemployment of those not so favored.

Getting the exchange rate right (whether throught the exchange rate system
or the tax system or some other system) does not "displace unemployment of
the favored producers with unemployment of those not so favored."  It does
increase employment in the domestic (favoured) economy.  Initially, at the
lower exchange rate the country increases exports, reduces imports and
domestic incomes rise.  As the domestic income rises, imports rise.  A new
equilibrium is reached when imports are equal to exports.  As exports have
increased, imports must also have increased, thereby raising employment in
the unfavoured nation.  It is a win-win solution for all parties.


John writes:

> You're stuck in the nonsense of conventional economic
> beliefs of your "school of thought" and not examining the
> proposal. You may believe that monetary policy can be
> manipulated to cause employment but that is just belief, not
> fact. Look at the black swan and forget the erroneous
> nonsense written in your bible.

I have tried to examine your proposal from what you have written. There are
many things I agree with.  But you are simply trying to use taxes to change
the exchange rate in an environment of floating exchange rates. That type of
policy is conventional wisdom.  The IMF and World Bank are out there daily
telling countries to implement policies designed to reduce the prices of
their products to be more competitive yet at the same time pedalling the
floating exchange rate system.  I am sure your policies would at least be as
effective as theirs.


> Do the simple task described above and then say where it
> errs and maybe you'll stop giving bad advise, but I suspect
> it will be too much for someone so inculcated with the
> economic biblical beliefs to face reality.

I know my abilities are limited and I am constrained by the limit of my
experience in the profession.   If I misunderstand your enlightened
proposal, please correct me. I do try to be open to reality. I am often
reminded of Norman Dixon's comments (On the Psychology to Military
Incompetence) that information that contradicts what we already know is the
most valuable information but it very difficult to accept and assimilate.

Best wishes

Leigh