There Is No Such Thing As a Free Market

Matt Yglesias starts with a cute little point about trade politics -- the Marvel corporation has defined the X-Men as mutants rather than humans so as to exploit the difference in tariffs between human dolls and non-human "toys" -- but then, I think, misses an opportunity to explain something more significant about how the world works:

It's remarkable, incidentally, the extent to which the politics of "trade deals" have gotten away from the fundamental issues of free trade as seen in an economics textbook. What we have here is a federal 12% sales tax on dolls, but only if the dolls are made in foreign countries, and a different -- arbitrarily lower -- 6.8% federal sales tax on toys, but again only if the toys are made in foreign countries. There's no good reason to have special higher sales taxes on toys made in foreign countries, and there's certainly no good reason to tax dolls and non-doll toys at different rates. It's nuts and it could and should be addressed by a unilateral acts of congress. The amount of revenue that would be lost to the federal government by repealing these taxes would be tiny, and it's trivial to think of better ways to raise the money. And yet this core -- and quite simple -- trade policy issue is a world away from the incredible complexity of the trade deals of the past decade.

This goes back to what I was driving at in my old post arguing that "The Problem with Economics Is the Economists". The standard welfare case for trade assumes that through specialization in comparative advantage each country can consume more via trade than they can via autarky. That's where economics stops, unless they go on to mutter about something about "distributional consequences blah blah politics blah". In other words, economics books don't spend much time noticing that those employed in the sector/factor that does not have a comparative advantage all get put out of business.

In reality the distributional consequences drive everything. The length and specificity of trade agreements is mind-boggling. The "schedules" of tariffs from the last completed WTO negotiating round (the Uruguay round) is over 30,000 pages, and it's full of thousands of cases like the dolls/toys distinction Yglesias is describing. Each one has a highly-motivated domestic interest group behind it, who will fight to keep in each and every provision that benefits them even tangentially. As there is generally no countervailing force, Congress will listen to whoever is talking to them.

The reason why Congress does not, and will not, step in to change these rules is because there is no political reason why they should. Maybe it's "nuts" and maybe it isn't, but there is some group in this country for whom each of the rules represents the difference between profit and loss. For example, if Marvel can sell X-Men as "toys" rather than "dolls", then they get an immediate competitive advantage over DC Comics, who has to factor in the higher tariff rate when it produces Batman dolls. So Marvel will lobby Congress not to change the tariff schedule. Because, as Yglesias notes, the issue is really pretty trivial for almost everyone in the country (except for Marvel) the likelihood of it being changed is pretty low.

Issues which are generally of very high salience to a small group and low salience to a larger group are high susceptible to capture by the small group. There's a ton of political economy research developing this point (Mancur Olson made a prominent career out of it), but it doesn't seem to have captured the public's mind. Or the mind of many economists.

Here is what it means: there is no such thing as a free market, anywhere or in anything. The reason why is because of politics. To the extent that economics ignores this, economics is irrelevant.