Michael Pettis Continues to Blunder
Here’s a letter to a long-time “unsympathetic but friendly” Café patron.
Ms. C__:
Thanks for sending Michael Pettis’s recent X-thread on trade. I’m afraid, however, that I don’t share your high opinion of his string of tweets. It’s a march of missteps. I haven’t the time to detail them all, so I’ll address just one of his foundational fallacies.
He’s wrong to write that in a world in which governments use neither subsidies nor protectionist interventions “countries [would] export goods in which they have a comparative production advantage in order to pay for the import of goods in which they don’t. Trade, in that world, is broadly balanced, and international capital mostly funds trade finance and direct investment in developing countries with high investment needs.”
Nonsense.
There’s absolutely no reason to believe that in a world with no subsidies or protectionism no country would run persistent trade (or current-account) deficits, and that little or no capital would be invested (and re-invested) abroad in long-term projects in advanced economies. Insofar as markets are free, capital grows in size and flows to where its expected returns are highest – which generally is in advanced economies. As long as economies differ in the expected returns they offer to investors, economies that offer the highest returns will consistently receive disproportionately large amounts of both short-term and long-term investment.
Investors do not allocate their funds according to countries’ “investment needs”; investors allocate their funds according expected returns.
Because human ingenuity in free markets is practically unlimited, investment returns in advanced economies are not, contrary to Pettis’s sophomoric assumption, destined to be lower than in “developing” countries. The very reason an economy such as that of the U.S. is advanced is that it treats capital with respect and welcomes entrepreneurship and creative destruction. Investors love such countries. The very reason “developing” countries are not developed is that they do not treat capital with sufficient respect, and they resist entrepreneurship and creative destruction. Investors hate such countries.
The persistent annual trade deficits that America has run ever since the collapse of Bretton Woods and its policy of capital controls reflect – also contrary to Pettis’s assumptions – neither excessive American consumption nor ‘excessive’ foreign savings being forced (as he put it in his 2020 book with Matthew Klein) on us allegedly unfortunate Americans. Instead, they reflect the enormous attractiveness of the American economy to global investors. As long as, and insofar as, we keep our markets reasonably free and continue to embrace market-tested creative destruction, we will continue to attract lots of foreign capital. This state of affairs is perfect natural, sustainable, and – best of all – wonderful.
Sincerely,
Donald J. Boudreaux
Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030
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