Yale Faculty v. Administrators
Yale has approximately one administrator for every undergraduate student (see also here and here). Years of simmering tension about the growth of administration relative to faculty has now been brought forward. President Trump has threatened to cut funding to Yale, the Yale administration has threatened to stop hiring faculty and raises, some faculty are now threatening to revolt.
Over 100 Yale professors are calling for the University administration to freeze new administrative hires and commission an independent faculty-led audit to ensure that the University prioritizes academics.
In a letter written to University President Maurie McInnis and Provost Scott Strobel, signatories addressed the “collision of two opposing forces: extraordinary financial strength and runaway bureaucratic expansion.”
…Professor Juan de la Mora, a letter’s signee, said that a significant number of Yale professors believe that the institution is using funding for “improper” purposes and neglecting the school’s founding principles of emphasizing faculty and students.
…Professor of Philosophy Daniel Greco mirrored these sentiments, recognizing the increase in administrative spending in Yale’s budget.
Greco said these spending habits have faculty “puzzled,” as they hear of the money being spent but do not see a change in their day-to-day work.
Professor of Law Sarath Sanga, author of the letter, wrote to the News that over the last two decades, “faculty hiring has stagnated while administrative ranks have by some estimates more than doubled–outpacing peer institutions.”
University are supposed to be faculty-led but over the last several decades most have been taken over by administrators–perhaps we shall see some change.
AI Goes to College…for the Free Money
Last year, the state [CA] chancellor’s office estimated 25 percent of community college applicants were bots.
Everyone understands that students are using AI; sometimes to help them learn, sometimes to avoid learning. What I didn’t appreciate is that community colleges offering online courses are being flooded with AI bots who are taking the courses:
The bots’ goal is to bilk state and federal financial aid money by enrolling in classes, and remaining enrolled in them, long enough for aid disbursements to go out. They often accomplish this by submitting AI-generated work. And because community colleges accept all applicants, they’ve been almost exclusively impacted by the fraud.
The state has launched a Bladerunner-eque “Inauthentic Enrollment Mitigation Taskforce” to try to combat the problem. This strikes me, however, as more of a problem on the back-end of government sending out money without much verification. It’s odd to make the community colleges responsible for determining who is human. Stop sending the money to the bots and the bots will stop going to college.
Sam Altman, as usual, is ahead of the game.
The Library Burned Slowly
A powerful but grim essay by John McGinnis, Professor of Constitutional Law at Northwestern. For decades, the federal government—driven by the left—expanded its control over universities. The right, most notably Ronald Reagan, tried to resist, shielding civil society from state overreach. They failed. Now, a new right has turned to the left’s playbook and is imposing its own vision of the good society. Chris Rufo mocks classical liberals like myself and their naive ideas of neutrality, fairness and open institutions. Principles are for losers. Seize power! Crush your enemies. Rufo does know how to crush his enemies. But what happens when the devil turns? Bludgeoning your enemies is fun while it lasts but you can’t bludgeon your way to a civilization. Hayek’s civil society dies in the rubble.
It seems remarkable that seemingly antisemitic protests by undergraduates, such as those at my own university of Northwestern, could threaten the biomedical research funding of its medical school. But the structure of civil rights laws as applied to universities has long allowed the federal government to cut off funding to the entire university based on the wrongful actions of particular units or departments.
Ironically, the left, now alarmed by the federal government’s intrusive reach, bears direct responsibility for crafting the very legal weapons wielded against the universities it dominates. Almost four decades ago, progressive legislators demanded sweeping amendments to civil rights law, expanding federal oversight over higher education. The sequence of events reveals a cautionary tale of political hubris: progressive confidence that state power would reliably serve their ends overlooked the reality that governmental authority, once unleashed, recognizes no ideological master. Today’s circumstances starkly illustrate how expansive federal control over civil society, originally celebrated by progressives, returns to haunt its architects. The left’s outrage ought to focus not on this particular administration but on its own reckless empowerment of the state.
…Clumsy governmental dictates on contentious matters such as transgender rights do not merely settle disputes; they inflame societal divisions by transforming moral disagreements into winner-takes-all political battles. Civil society, by contrast, thrives precisely because it embraces diversity and facilitates compromise, allowing pluralistic communities to coexist peacefully without being conscripted into ideological warfare. The left, fixated upon uniform outcomes, consistently undervalues the power of voluntary cooperation and cultural persuasion. Their shortsightedness has delivered into the hands of their opponents the very instruments of coercion they forged, vividly confirming an enduring truth: the power you grant government today will inevitably be wielded tomorrow by your adversaries.
Read the whole thing.
The Prophet’s Paradox
The political problem of disaster preparedness is especially acute for the most useful form, disaster avoidance. The problem with avoiding a disaster is that success often renders itself invisible. The captain of the Titanic is blamed for hitting the iceberg, but how much credit would he have received for avoiding it?
Consider a pandemic. When early actions—such as testing and quarantine, ring vaccination, and local lockdowns—prevent a pandemic, those inconvenienced may question whether the threat was ever real. Indeed, one critic of this paper pointed to warnings about ozone depletion and skin cancer in the 1980s as an example of exaggeration and a predicted disaster that did not happen. Of course, one of the reasons the disaster didn’t happen was the creation of the Montreal Protocol to reduce ozone-depleting substances (Jovanović et al. 2019; Tabarrok and Canal 2023). The Montreal Protocol is often called the world’s most successful international agreement, but it is not surprising that we don’t credit it for skin cancers that didn’t happen. I call this the prophet’s paradox: the more the prophet is believed beforehand, the less they are credited afterward.
The prophet’s paradox can undermine public support for proactive measures. The very effectiveness of these interventions creates a perception that they were unnecessary, as the dire outcomes they prevented are never realized. Consequently, policymakers face a challenging dilemma: the better they manage a potential crisis, the more likely it is that the public will perceive their actions as overreactions. Success can paradoxically erode trust and make it more difficult to implement necessary measures in future emergencies. Hence, politicians are paid to deal with emergencies not to avoid them (Healy and Malhotra 2009).
Since politicians are incentivized to deal with rather than avoid emergencies it is perhaps not surprising to find that this attitude was built into the planning process. Thus, the UK COVID Inquiry (2024, 3.17) found that:
Planning was focused on dealing with the impact of the disease rather than preventing its spread.
Even more pointedly Matt Hancock testified (UK COVID Inquiry 2024, 4.18):
Instead of a strategy for preventing a pandemic having a disastrous effect, it [was] a strategy for dealing with the disastrous effect of a pandemic.
From my paper, Pandemic preparation without romance.
Smith Reviews Stiglitz
Vernon Smith reviews Joe Stiglitz’s book The Road to Freedom:
Stiglitz did work in the abstract intellectual theoretical tradition of neoclassical economics showing how the standard results were changed by asymmetric or imperfect information. He is oblivious, however, to the experimental lab and field empirical research showing that agent knowledge of all such information is neither necessary nor sufficient for a market to converge to competitive supply-and-demand equilibrium outcomes.
Consequently, both the standard and the modified theories are irrelevant because buyers and sellers in possession only of dispersed, private, decentralized, value information easily converge to competitive price-quantity allocations in experimental markets over time via learning in repeat transactions.
…The first experiments, showing that complete WTP/WTA information was not necessary, were reported in Smith (1962), and none of us could any longer accept the standard and Stiglitz-modified theories. Further experiments, showing that such information was not sufficient, and that equilibrium prices need not require that markets clear, were reported in Smith (1965). (For propositions summarizing and evaluating observed empirical regularities in these experimental markets, see Vernon L. Smith, Arlington Williams, W. K. Bratt, and M. G. Vannoni, 1982, “Competitive Market Institutions: Double Auctions vs. Sealed Bid-Offer Auctions,” American Economic Review 72, no. 1, 58–77; and Vernon L. Smith, 1991, Papers in Experimental Economics, Cambridge: Cambridge University Press.) It was natural, in the first market experiments, to investigate those questions, such as the information state of traders, that were central to the abstract economic theory of the time.
So, the Akerlof-Stiglitz modifications of theory were founded on a false conditional and thus were not germane to practical market performance. They were born falsified.
…The needed policy implications are quite clear, and they have nothing to do with Stiglitz’s market failure and everything to do with how markets function. Indeed, the appropriate policy recommendation is to fully support the market-system maximization of prosperity, as did Friedman and Hayek, then use incentive mechanisms to improve the relative positions of those who are disadvantaged in that system. Never kill the goose that lays eggs of gold.
Deregulation suggestions
If you have ideas for cutting regulations, the US government wants to hear from you! This could be important. Provide details on the exact regulation in the CFR.
Pandemic Preparation Without Romance
My latest paper, Pandemic Preparation Without Romance, has just appeared at Public Choice.
Abstract: The COVID-19 pandemic, despite its unprecedented scale, mirrored previous disasters in its predictable missteps in preparedness and response. Rather than blaming individual actors or assuming better leadership would have prevented disaster, I examine how standard political incentives—myopic voters, bureaucratic gridlock, and fear of blame—predictably produced an inadequate pandemic response. The analysis rejects romantic calls for institutional reform and instead proposes pragmatic solutions that work within existing political constraints: wastewater surveillance, prediction markets, pre-developed vaccine libraries, human challenge trials, a dedicated Pandemic Trust Fund, and temporary public–private partnerships. These mechanisms respect political realities while creating systems that can ameliorate future pandemics, potentially saving millions of lives and trillions in economic damage.
Here’s one bit:
…in the aftermath of an inadequate government response to an emergency, we often hear calls to reorganize and streamline processes and to establish a single authority with clear responsibility and decision-making power to overcome bureaucratic gridlock. By centralizing authority, it is argued that the government can respond more swiftly and effectively, reducing the inefficiencies caused by a fragmented system.
Yet, the tragedy of the anti-commons was also cited to explain the failure of the government after 9/11. Indeed, the Department of Homeland Security was created to centralize a fragmented system and allow it to act with alacrity. Isn’t a pandemic a threat to homeland security? And what about the Swine Flu pandemic of 2009? While not nearly as deadly as the COVID pandemic, 60 million Americans were sickened, some 274 thousand hospitalized with over 12 thousand deaths (Shresha et al. 2011). Wasn’t this enough practice to act swiftly?
Rather than advocating for a reorganization of bureaucracies, I propose accepting the tragedy of the anti-commons as an inevitable reality. The tragedy of the commons is an equilibrium outcome of modern-day bureaucracy. Bureaucracy has its reasons and some of those reasons may even be reasonable (Wittman 1995). It is too much to expect the same institution to respond to the ordinary demands of day-to-day politics and to the very different demands of emergencies. Indeed, when an institution evolves to meet the demands of day-to-day politics it inevitably develops culture, procedures and processes that are not optimized for emergencies.
Instead of rearranging organization charts we should focus on what has proven effective: the creation of ad-hoc, temporary, public–private organizations. Two notable examples are Operation Warp Speed in the United States and the British Vaccine Taskforce. These entities were established quickly and operated outside regular government channels, free from the typical procurement, hiring, or oversight rules that hinder standard bureaucracies.
…Operation Warp Speed exemplified the “American Model” of emergency response. Rather than relying on command-and-control or government production, the American Model leverages the tremendous purchasing power of the US government with the agility and innovation of the private sector.
The only problem with the “American Model” was its inconsistent application.
I am especially fond of this paper because it is the first, to my knowledge, to cite separate papers from Alex, Maxwell and Connor Tabarrok.
Addendum: This paper isn’t about lockdowns. It’s about avoiding lockdowns!
My Blind Spots
“Based on everything I’ve ever asked you, what do you think my biggest blind spots are?” ChatGPT replies:
Here’s a speculative, analytical take based on your past questions and style of interaction:
1. Underestimating Non-Market Frictions in Implementation
You’re extremely sharp on incentives, regulation, and institutional design, especially in economic theory and historical analysis. But sometimes there’s a relative underemphasis on execution risk — how slow-moving bureaucracies, agency coordination failures, or political coalitions can thwart otherwise well-aligned incentive structures. You assume policy failure is mostly about incentives or ideology, but sometimes it’s about sheer implementation entropy.Example: In questions about permitting reform or ARPA-H, you tend to focus on structural misalignments or regulatory burden. That’s a big part of it, but sometimes it’s also just institutional incompetence or “slack” that defies modeling.
2. Belief in the Power of Market Discovery—But Underplaying Political Constraints on Entry
You have a strong pro-innovation, pro-market stance (which I think is generally well-supported), but perhaps slightly underweight how entrenched interests and legal choke points often stifle the ability of new entrants or ideas to surface, regardless of technical merit.Example: In urban planning discussions, you’re excellent on NEPA, zoning, etc.—but some of the constraints (e.g., unions, fire codes, or insurance regulation) are less about “bad planning ideology” and more about deliberately created veto points to preserve incumbent interests. These can be harder to dislodge than your strategic framing sometimes suggests.
3. Technological Optimism Without Full Political Economy Accounting
You’re rightly excited by machine learning, drug discovery, synthetic data, airships, etc., and you press for empirical backing. However, you may be underestimating the political economy of deployment — i.e., how many powerful actors are actually threatened by cost-reducing innovation (e.g., in health, energy, or defense) and have the ability to delay, distort, or co-opt those technologies.Example: In the machine learning for antibiotics discussion, you emphasize technical pathways (which are exciting), but less the entrenched FDA-pharma interplay or hospital group purchasing organizations that can prevent adoption even when evidence is strong.
4. Preference for Models That Cleanly Allocate Causality
You often seek elegant theoretical clarity — e.g., all-pay auctions, comparative advantage under automation, misallocation models. But the real world often features multiple overlapping distortions (e.g., taxes, zoning, union rules, insurance, etc.) that interact nonlinearly. Sometimes there’s a search for “the” distortion when it’s really a system of entangled local optima.5. Policy-First Lens vs. Demand-Side Social Shifts
You focus a lot on supply-side issues (permitting, misallocation, productivity). This is correct and important. But occasionally the demand-side cultural or preference shifts get underweighted — e.g., the declining taste for urban density, aversion to risk, or increasing parental control over children’s autonomy. These may not be fixable through supply-side tweaks alone.
Hat tip: Aashna Doshi.
The Decline of Manufacturing
Look at the incredible decline of manufacturing across a wide variety of industries in the figure below. Nearly 7.5 million jobs lost, just since 2011. Devastated communities. Factories shuttered. Millions of older, lower-skilled workers out of work. A rise in inequality. Jobs going overseas.
“The future is bleak and hopeless if we continue like this,” said one worker.
…“This eventually leads to serious social problems, such as higher rates of unemployment and increased crime and social unrest. Nations with socially polarised work forces also suffer from political instability.”
And now for the rest of the story (non-paywalled or go to the comments.)
America’s Tourism Deficit: How the French Are Winning the Currency War One Croissant at a Time
Every year, American tourists pour billions of dollars into France, wandering the Louvre, sipping overpriced espresso in Montmartre, and snapping selfies along the Seine—while far fewer French tourists bother making the reverse pilgrimage to admire, say, Disney World. The result? A massive tourism deficit.
On paper, this reflects wealth differentials and revealed preferences – Americans, being richer and more numerous than the French, express a high demand for old world Parisian experiences. But behind this innocent wanderlust is something more sinister. When Americans vacation in France, that’s counted as a US import of tourism. When French people vacation here—fewer, more begrudgingly—that’s a US export. So voilà, the tourism deficit creates a trade deficit, an excess of imports over exports!
The tourism deficit means there is a steady leak of the world’s reserve currency into the hands of a nation famous for its cheese, wine, and suspicion of American capitalism. France, using little more than museums and moodiness, is accumulating dollars from innocent American travelers. And they’re not just hoarding them for kicks. Those dollars are claims on real assets. First it’s a Napa vineyard. Then a Brooklyn fintech startup. Eventually, who knows? The Port of Long Beach? The Federal Reserve’s snack bar?
Make no mistake: France’s true comparative advantage isn’t wine or luxury goods—it’s the ruthless extraction of tourism dollars, performed with flawless precision, a disdainful shrug, and a little help from Emily in Paris. We’re being out-traded, one overpriced pastry at a time, by a nation whose strategic horizon spans centuries—and whose Netflix marketing is impeccable.
The political implications are, shall we say, obvious.
From now on, we demand a tourism balance. No more visa waivers, no more jet-setting to Provence until they send an equal number of French tourists to Branson, Missouri. It’s high time the French get over their Napoleon complex and start to appreciate American corn dogs and Dolly Parton. France needs to treat us with the same respect as the friendly countries that enthusiastically dispatch high-spending tourists to our shores.
It’s one-for-one, or the deal is off. Tourism parity or rien! Point final.
AI on Tariffs
There is some evidence that the White House used AI to come up with a quick and dirty (and incorrect) formula to correlate tariff rates with trade deficits. I have no problem with using AI, I think they just didn’t go far enough. The White House should have asked the AI a question like this:
Suppose the US imposed tariffs on other countries in an effort to reduce bilateral trade deficits to zero using the formula for the tariff of (exports-imports)/imports. What do you estimate would be the consequences of such a policy?
Answer (O1 Pro):
A tariff schedule keyed to bilateral deficits—imposing a rate equal to (US exports − US imports) / US imports—would be extremely disruptive and unlikely to achieve its goal. Key points:
Immediate Impact on Prices and Supply Chains
If the US imports more than it exports from a given country, (exports − imports) is negative, making the tariff percentage negative unless the formula is modified (e.g., by absolute value). In practice, one would presumably set a positive tariff aimed at closing the bilateral gap.
Such high tariffs would sharply raise import prices for both consumers and firms reliant on foreign inputs. It would encourage attempts to switch suppliers but at the cost of disrupting supply chains and increasing production expenses.
Retaliation and Trade War Dynamics
Targeted countries would almost certainly retaliate with their own tariffs. Retaliation would damage US export sectors—especially agriculture and high-value manufacturing—and risk a broader trade war.
Countries with a US trade surplus would apply punitive measures that shift US business to alternative suppliers, undermining the very exports the policy is meant to foster.
Misalignment with Macroeconomic Fundamentals
Bilateral imbalances reflect global production patterns, comparative advantage, and macro factors like savings–investment imbalances and currency flows. A country that persistently imports more overall does so because it’s running a capital account surplus. Tariffs don’t fundamentally alter that global saving–investment arithmetic.
If the US still runs an overall current account deficit, restricting imports from some countries will simply shift deficits to others. Global supply chains will rearrange, but the total US deficit will be largely unchanged.
Violation of Trade Agreements
Such a policy almost certainly violates WTO rules, since it imposes discriminatory tariffs based on bilateral imbalances. The resulting litigation and sanctions would add more uncertainty.
Net Effect: Reduced Efficiency, Higher Costs
Economically, the net effect is negative. Costs rise for US consumers and US manufacturers reliant on imported inputs. Retaliatory measures reduce export opportunities. Overall trade volume shrinks. Growth slows, and no fundamental improvement in the US external balance occurs.
In summary, a bilateral “deficit-equalizing” tariff policy would create severe distortions, invite retaliation, and do little to fix the structural causes of US trade deficits. Empirical evidence and standard trade theory both suggest it would reduce economic efficiency and likely harm US producers and consumers alike.
Good answer.
Hat tip: SB.
A Blueprint for FDA Reform
The new FDA report from Joe Lonsdale and team is impressive. It has a lot of new material, is rich in specifics and bold in vision. Here are just a few of the recommendation which caught my eye:
From the prosaic: GMP is not necessary if you are not manufacturing:
In the U.S., anyone running a clinical trial must manufacture their product under full Good Manufacturing Practices (GMP) regardless of stage. This adds enormous cost (often $10M+) and more importantly, as much as a year’s delay to early-stage research. Beyond the cost and time, these requirements are outright irrational: for example, the FDA often requires three months of stability testing for a drug patients will receive after two weeks. Why do we care if it’s stable after we’ve already administered it? Or take AAV manufacturing—the FDA requires both a potency assay and an infectivity assay, even though potency necessarily reflects infectivity.
This change would not be unprecedented either. By contrast, countries like Australia and China permit Phase 1 trials with non-GMP drug with no evidence of increased patient harm.
The FDA carved out a limited exemption to this requirement in 2008, but its hands are tied by statute from taking further steps. Congress must act to fully exempt Phase 1 trials from statutory GMP. GMP has its place in commercial-scale production. But patients with six months to live shouldn’t be denied access to a potentially lifesaving therapy because it wasn’t made in a facility that meets commercial packaging standards.
Design data flows for AIs:
With modern AI and digital infrastructure, trials should be designed for machine-readable outputs that flow directly to FDA systems, allowing regulators to review data as it accumulates without breaking blinding. No more waiting nine months for report writing or twelve months for post-trial review. The FDA should create standard data formats (akin to GAAP in finance) and waive documentation requirements for data it already ingests. In parallel, the agency should partner with a top AI company to train an LLM on historical submissions, triaging reviewer workload so human attention is focused only where the model flags concern. The goal is simple: get to “yes” or “no” within weeks, not years.
Publish all results:
Clinical trials for drugs that are negative are frequently left unpublished. This is a problem because it slows progress and wastes resources. When negative results aren’t published, companies duplicate failed efforts, investors misallocate capital, and scientists miss opportunities to refine hypotheses. Publishing all trial outcomes — positive or negative—creates a shared base of knowledge that makes drug development faster, cheaper, and more rational. Silence benefits no one except underperforming sponsors; transparency accelerates innovation.
The FDA already has the authority to do so under section 801 of the FDAAA, but failed to adopt a more expansive rule in the past when it created clinicaltrials.gov. Every trial on clincaltrials.gov should have a publication associated with it that is accessible to the public, to benefit from the sacrifices inherent in a patient participating in a clinical trial.
To the visionary:
We need multiple competing approval frameworks within HHS and/or FDA. Agencies like the VA, Medicare, Medicaid, or the Indian Health Service should be empowered to greenlight therapies for their unique populations. Just as the DoD uses elite Special Operations teams to pioneer new capabilities, HHS should create high-agency “SWAT teams” that experiment with novel approval models, monitor outcomes in real time using consumer tech like wearables and remote diagnostics, and publish findings transparently. Let the best frameworks rise through internal competition—not by decree, but by results.
…Clinical trials like the RECOVERY trial and manufacturing efforts like Operation Warp Speed were what actually moved the needle during COVID. That’s what must be institutionalized. Similarly, we need to pay manufacturers to compete in rapidly scaling new facilities for drugs already in shortage today. This capacity can then be flexibly retooled during a crisis.
Right now, there’s zero incentive to rapidly build new drug or device manufacturing plants because FDA reviews move far too slowly. Yet, when crisis strikes, America must pivot instantly—scaling production to hundreds of millions of doses or thousands of devices within weeks, not months or years. To build this capability at home, the Administration and FDA should launch competitive programs that reward manufacturers for rapidly scaling flexible factories—similar to the competitive, market-driven strategies pioneered in defense by the DIU. Speed, flexibility, and scale should be the benchmarks for success, not bureaucratic checklists. While the drugs selected for these competitive efforts shouldn’t be hypothetical—focus on medicines facing shortages right now. This ensures every dollar invested delivers immediate value, eliminating waste and strengthening our readiness for future crises.
To prepare for the next emergency, we need to practice now. That means running fast, focused clinical trials on today’s pressing questions—like the use of GLP-1s in non-obese patients—not just to generate insight, but to build the infrastructure and muscle memory for speed.
Read the whole thing.
Hat tip: Carl Close.
Manufacturing and Trade
It has become popular in some circles to argue that trade—or, in the more “sophisticated” version, that the dollar’s reserve-currency status—undermines U.S. manufacturing. In reality, there is little support for this claim.
Let’s begin with some simple but often overlooked points.
- The US is a manufacturing powerhouse. We produce $2.5 trillion of value-added in manufacturing output, more than ever before in history.
- As a share of total employment, employment in manufacturing is on a long-term, slow, secular trend down. This is true not just in the United States but in most of the world and is primarily a reflection of automation allowing us to produce more with less. Even China has topped out on manufacturing employment.
- A substantial majority of US imports are for intermediate goods like capital goods, industrial supplies and raw materials that are used to produce other goods including manufacturing exports! Tariffs, therefore, often make it more costly to manufacture domestically.
- The US is a big country and we consume a lot of our own manufacturing output. We do export and import substantial amounts, but trade is not first order when it comes to manufacturing. Regardless of your tariff theories, to increase manufacturing output we need to increase US manufacturing productivity by improving infrastructure, reducing the cost of energy, improving education, reducing regulation and speeding permitting. You can’t build in America if you can’t build power plants, roads and seaports.
- The US is the highest income large country in the world. It’s hard to see how we have been ripped off by trade. China is much poorer than the United States.
- China produces more manufacturing output than the United States, most of which it consumes domestically. China has more than 4 times the population of the United States. Of course, they produce more! India will produce more than the United States in the future as well. Get used to it. You know what they say about people with big shoes? They have big feet. Countries with big populations. They produce a lot. More Americans would solve this “problem.”
- Most economists agree that there are some special cases for subsidizing and protecting a domestic industry, e.g. military production, vaccines.
The seven points cover most of the ground but more recently there has been an argument that the US dollar’s status as a reserve currency, which we used to call the “exorbitant privilege,” is now somehow a nefarious burden. This strikes me as largely an ex-post rationalization for misguided policies, but let’s examine the core claim: the US’s status as a reserve currency forces the US dollar to appreciate which makes our exports less competitive on world markets. Tariffs are supposed to (somehow?) depreciate the currency solving this problem. Every step is questionable. Note, for example, that tariffs tend to appreciate the dollar since the supply of dollars declines. Note also that if even if tariffs depreciated the currency, depreciating the currency doesn’t help to increase exports if you have cut imports (see Three Simple Principles of Trade Policy). I want to focus, however, on the first point does the US status as world reserve currency appreciate the dollar and hurt exports? This is mostly standard economics so its not entirely wrong but I think it misses key points even for most economists.
Countries hold dollars to facilitate world trade, and this benefits the United States. By “selling” dollars—which we can produce at minimal cost (albeit it does help that we spend on the military to keep the sea lanes open)—we acquire real goods and services in exchange, realizing an “exorbitant privilege.” Does that privilege impose a hidden cost on our manufacturing sector? Not really.
In the short run, increased global demand for dollars can push up the exchange rate, making exports more expensive. Yet this effect arises whatever the cause of the increased demand for dollars. If foreigners want to buy more US tractors this appreciates the dollar and makes it more expensive for foreigners to buy US computers. Is our tractor industry a nefarious burden on our computer industry? I don’t think so but more importantly, this is a short-run effect. Exchange rates adjust first, but other prices follow, with purchasing power parity (PPP) tendencies limiting any long-term overvaluation.
To see why, imagine a global single-currency world (e.g., a gold standard or a stablecoin pegged to the US dollar). In this scenario, increased demand for US assets would primarily lead to lower US interest rates or higher US asset prices, equilibrating the market without altering the relative price of US goods through the exchange rate mechanism. With freely floating exchange rates, the exchange rate moves first and the effect of the increased demand is moderated and spread widely but as other prices adjust the long-run equilibrium is the same as in a world with one currency. There’s no permanent “extra” appreciation that would systematically erode manufacturing competitiveness. Notice also that the moderating effect of floating exchange rates works in both directions so when there is deprecation the initial effect is spread more widely giving industries time to adjust as we move to the final equilibrium.
None of this to deny that some industries may feel short-run pressure from currency swings but these pressures are not different from all of the ordinary ups and down of market demand and supply, some of which, as I hove noted, floating exchange rates tend to moderate.
Ensuring a robust manufacturing sector depends on sound domestic policies, innovation, and workforce development, rather than trying to devalue the currency or curtail trade. Far from being a nefarious cost, the U.S. role as issuer of the world’s reserve currency confers significant financial and economic advantages that, in the long run, do not meaningfully erode the nation’s manufacturing base.
Why Do Domestic Prices Rise With Tarriffs?
Many people think they understand why domestic prices rise with tariffs–domestic producers take advantage of reduced competition to jack up prices and increase their profits. The explanation seems cynical and sophisticated and its not entirely wrong but it misses deeper truths. Moreover, this “explanation” makes people think that an appropriate response to domestic firms raising prices is price controls and threats, which would make things worse. In fact, tariffs will increase domestic prices even in perfectly competitive industries. Let’s see why.
Suppose we tax imports of French and Italian wine. As a result, demand for California wine rises, and producers in Napa and Sonoma expand production to meet it. Here’s the key point: Expanding production without increasing costs is difficult, especially so for any big expansion in normal times.
To produce more, wine producers in Napa and Sonoma need more land. But the most productive, cost-effective land is already in use. Expansion forces producers onto less suitable land—land that’s either less productive for wine or more valuable for other purposes. Wine production competes with the production of olive oil, dairy and artisanal cheeses, heirloom vegetables, livestock, housing, tourism, and even geothermal energy (in Sonoma). Thus, as wine production expands, costs increases because opportunity costs increase. As wine production expands the price we pay is less production of other goods and services.
Thus, the fundamental reason domestic prices rise with tariffs is that expanding production must displace other high-value uses. The higher money cost reflects the opportunity cost—the value of the goods society forgoes, like olive oil and cheese, to produce more wine.
And the fundamental reason why trade is beneficial is that foreign producers are willing to send us wine in exchange for fewer resources than we would need to produce the wine ourselves. Put differently, we have two options: produce more wine domestically by diverting resources from olive oil and cheese, or produce more olive oil and cheese and trade some of it for foreign wine. The latter makes us wealthier when foreign producers have lower costs.
Tariffs reverse this logic. By pushing wine production back home, they force us to use more costly resources—to sacrifice more olive oil and cheese than necessary—to get the same wine. The result is a net loss of wealth.
Note that tariffs do not increase domestic production, they shift domestic production from one industry to another.
Here’s the diagram, taken from Modern Principles, using sugar as the example. Without the tariff, we could buy sugar at the world price of 9 cents per pound. The tariff pushes domestic production up to 20 billion pounds.
As the domestic sugar industry expands it pulls in resources from other industries. The value of those resources exceeds what we would have paid foreign producers. That excess cost is represented by the yellow area labeled wasted resources—the value of goods and services we gave up by redirecting resources to domestic sugar production instead of using them to produce other goods and services where we have a comparative advantage.
All of this, of course, is explained in Modern Principles, the best textbook for principles of economics. Needed now more than ever.
In Defense of Econ 101
People sometimes dismiss basic economic reasoning, “that’s just Econ 101!” yet most policymakers couldn’t pass the exam. Here’s an apropos bit from our excellent textbook, Modern Principles of Economics.
Do you shop at Giant, Safeway, or the Piggly Wiggly? If you do, you run a trade deficit with those stores. That is, you buy more goods from them than they buy from you (unless, of course, you work at one of these stores or sell them goods from your farm). The authors of this book also run a trade deficit with supermarkets. In fact, we have been running a trade deficit with Whole Foods for many years. Is our Whole Foods deficit a problem?
Our deficit with Whole Foods isn’t a problem because it’s balanced with a trade surplus with someone else. Who? You, the students, whether we teach you or whether you have bought our book. You buy more goods from us than we buy from you. We export education to you, but we do not import your goods and services. In short, we run a trade deficit with Whole Foods but a trade surplus with our students. In fact, it is only because we run a trade surplus with you that we can run a trade deficit with Whole Foods. Thanks!
The lesson is simple. Trade deficits and surpluses are to be found everywhere. Taken alone, the fact that the United States has a trade deficit with one country is not special cause for worry. Trade across countries is very much like trade across individuals. Not every person or every country can run a trade surplus all the time. Suddenly, a trade deficit does not seem so troublesome, even though the word “deficit” makes it sound like a problem or an economic shortcoming.
We continue on to discuss ” What if the United States runs a trade deficit not just with China or Japan or Mexico but with the world as a whole, as indeed it does? Is that a bad thing?”
Here’s a good Noah Smith piece if you want the details.