MMT’s ignorance of economic thought
Bill Mitchell has a new post "A surplus of trade discussions" responding to some of the criticisms of the MMT position on trade deficits (though he didn't link to any of them, including my post "Some Preliminary Questions for MMT"). He opens with the proposition that "exports are a cost and imports are a benefit", and reaches the following conclusion:
When it comes to trade, MMT focuses, initially on the real layer of the analysis.
Thus it is undeniable (and I am surprised to read all those who are torturing themselves trying to deny it) – exports are a cost and imports are a benefit.
Giving some real thing away is a cost. Getting some real thing is a benefit.
That doesn't equate, as I have been reading the last few weeks, in a conclusion that MMT's preference is for a nation to have a current account deficit.
It just states the obvious fact that exports, by definition, involve sacrificing real resources and depriving a nation of their use.
Imports on the other hand clearly involve receiving final goods and services where the real resource sacrifice has been made by the exporting nation.
In a world where we produce to consume – not for its own sake – then receiving goods and services is better (real terms) than sending them elsewhere.

Since I was one of the ones denying Mitchell's opening gambit—though there must have been other people "torturing themselves", since all I noted in my post was that I disputed it as a premise—I had better reply now on this issue.

I do not deny the proposition that "Giving some real thing away is a cost. Getting some real thing is a benefit": that's obvious in a materialist world. What I do deny is that this proposition has any relevance to either macroeconomics or trade theory. And I am not the first one to deny this: that honour goes to Karl Marx.

This raises one of my major issues with MMT: advocates know their own economic logic very well, but they seem to have little knowledge of compatible precursors to their views (or even compatible contemporaries, like complexity theory). Consequently, whether they realise it or not, they often end up making arguments that would be right at home in a conventional Neoclassical textbook. These arguments are just as wrong in MMT hands as they are in Neoclassical ones.

This "exports=cost, imports=benefit" MMT analysis of international trade is a classic case in point. There are at least three ways in which this MMT perspective is a backward step in relation to preceding enlightened work in economics:

  • Standard Neoclassical work on the irrelevance of opportunity cost below full employment
  • Marx's arguments on the irrelevance of the seller's utility in trade
  • The extensive Post Keynesian research on declining marginal costs of production and economies of scale.

Inapplicability of opportunity cost except at full employment

Mitchell used the argument of opportunity costs several times in his recent posts. This is from "Trade and external finance mysteries – Part 1"

Exports mean that we have to give something real to foreigners that we could use ourselves – that is obviously an opportunity cost.
Imports represent foreigners giving us something real that they could use themselves but which we benefit from having. The opportunity cost is all theirs!

Opportunity cost is a mainstream economics attempt to sound scientific about production while caricaturing it at the same time. In their jargon, the "opportunity cost" of producing more of one good is the amount of another good(s) that has to be foregone as a result.

They illustrate it with a diagram like the one below from Wikipedia's "Production–possibility frontier" entry, where the maximum quantity of one good that an economy can produced is shown on the horizontal axis (Butter), and the maximum quantity of another (Guns) on the vertical. A curved line is then drawn illustrating the maximum combinations of the two goods that can be produced, if the economy produces both of them rather than just one. Along this curve, to have more of one, you must have less of the other.

The "opportunity cost" of "more butter" is therefore "less guns": in the second (C,D) comparison shown below, the opportunity cost of 10 more units of butter is 50 less units of guns. It's the Neoclassical songbook version of the Rolling Stones's "You can't always get what you want": you can't get more of one thing without getting less of another.

Except that you can. I've laboured the point about the "Production Possibility Frontier" (PPF) showing the maximum output combinations for what I hope is now an obvious reason: by placing its toy economy on its "PPF", this model assumes full employment.

Even an introductory treatment of this model will point out that, if you are not at full employment, then there is no opportunity cost: you can have more of both guns and butter at the same time if you increase the level of employment. In the next diagram, this toy economy can have more of both food and clothing if it is at point B, and can (somehow) move to point A.

So is it valid to assume full employment when discussing international trade—full employment, therefore, in every country at the same time? Of course not! That's what most mainstream economics models do of course, but that is the sort of unrealistic nonsense that MMT should be helping us to escape. Instead, it somehow makes this the starting point of its analysis of international trade when MMT itself, unlike mainstream economics, acknowledges that economies can be at well below full employment (otherwise there would be no point in advocating government spending in excess of taxation to boost employment).

This alone is grounds to reject the MMT argument "cost/benefit" attitude towards exports and imports. If a country is at less than full employment, then exporting more of one (or both!) goods might increase total employment. Equally, importing what you could produce locally might reduce employment. Given that achieving full employment is a core objective of MMT, there is no sound basis for claiming that "exports are a cost and imports are a benefit".

The irrelevance of seller's utility in trade

Mitchell's riposte also abounds with arguments that the seller of something is giving up something that has potential utility to it: "Exports mean that we have to give something real to foreigners that we could use ourselves" and so on. This, again, is a very Neoclassical way of thinking about exchange in general (not just international trade): the seller of an object foregoes the possible utility of consuming it in order to gain revenue instead.

Marx quite rightly ridiculed this approach to modelling exchange in an advanced capitalist economy. In such a society, goods are produced with a view, not to either consuming them or selling them if "the price is right", but with a view to selling them, period. The precursors of Neoclassical economics in Marx's day were, in his opinion, modelling the sort of exchanges that might occur in early contacts between two different communities without a pre-existing history of trade. But once trade is established, part of what is produced by each society is produced specifically for the purpose of exchange. The utility of the product to the actual producer is close to zero: its true utility to the producer is its capacity to be sold for a profit. These are Marx's quite readable words on this subject in Volume I of Capital:

The first step made by an object of utility towards acquiring exchange-value is when it forms a non-use-value for its owner, and that happens when it forms a superfluous portion of some article required for his immediate wants.
Objects in themselves are external to man, and consequently alienable by him. In order that this alienation may be reciprocal, it is only necessary for men, by a tacit understanding, to treat each other as private owners of those alienable objects, and by implication as independent individuals.
But such a state of reciprocal independence has no existence in a primitive society based on property in common, whether such a society takes the form of a patriarchal family, an ancient Indian community, or a Peruvian Inca State. The exchange of commodities, therefore, first begins on the boundaries of such communities, at their points of contact with other similar communities, or with members of the latter.
So soon, however, as products once become commodities in the external relations of a community, they also, by reaction, become so in its internal intercourse. The proportions in which they are exchangeable are at first quite a matter of chance. What makes them exchangeable is the mutual desire of their owners to alienate them. Meantime the need for foreign objects of utility gradually establishes itself. The constant repetition of exchange makes it a normal social act.
In the course of time, therefore, some portion at least of the products of labour must be produced with a special view to exchange. From that moment the distinction becomes firmly established between the utility of an object for the purposes of consumption, and its utility for the purposes of exchange. Its use-value becomes distinguished from its exchange-value.

This, of course, is not how Neoclassical economics models trade, at either the individual or national level. It still maintains the fantasy that the products tendered by the seller are things which the seller could use if they weren't sold—that the seller sacrifices some subjective utility in the process of making a sale.

Mitchell preserves this manner of thinking when he discusses both exports and imports: "Exports mean that we have to give something real to foreigners that we could use ourselves". No: if the export sale wasn't there, the product—let's say a Mercedes Benz—wouldn't be made in the first place; or it would sit in the car yard a bit longer until a local buyer came along, and the level of capacity utilization of the Mercedes Benz factory would be lower. And the utility of that Mercedes Benz to its owner at the time—the Mercedes Benz corporation—is if anything, negative.

This raises the next issue: the reason that firms individually pursue export markets is that it provides a means to use the substantial excess capacity almost all of them have, especially when they start as suppliers to a national market only.

Economies of scale and declining marginal costs

The Neoclassical theory of production assumes that, for the vast majority of firms, each additional unit of output costs more to produce than the ones before it. In their lingo, the "marginal cost" of production is rising. This in turn occurs because of "diminishing marginal productivity": to produce an extra unit of output requires adding more of a variable factor of production (labour) to a fixed factor of production (machinery, a.k.a. "capital"). In this model, price rises, not because the inputs get more expensive, but because inputs of uniform cost (workers) produce less per additional worker since the amount they can produce declines. The firm is assumed to be operating past its point of optimum capacity utilization, where the output per worker is maximized.

There are some significant industries where this model makes sense—notably extractive industries (mining) where energy is the primary input, and it takes more energy input to increase the rate of extraction (so that the "Energy Return On Energy Invested", or EROEI, falls with increasing output).

But for the vast majority of industrial firms, this model is simply a fallacy: these firms operate with substantial excess capacity, and if anything the cost of each additional unit produced falls as output rises.

Why? Because engineers purposely design factories to avoid the problems that economists believe force production costs to rise. Factories are built with significant excess capacity, and are also designed to work at high efficiency right from low to full capacity. Only products that can't be produced in factories (like oil) are likely to have costs of production that behave the way economists expect.

This is an empirical finding: there have been something like fifty surveys, over the last century, of firms to find out what their cost functions look like, and every one of them has found that, for at least 89% of firms surveyed, the average cost of production falls as output rises. These surveys are superbly covered in Fred Lee's masterful book Post Keynesian price theory (Cambridge University Press, 1998), but my favorite example of its discovery is the book Asking About Prices by the distinctly Neoclassical Alan Blinder (a previous vice chairman of Federal Reserve, and a member of the Bill Clinton's Council of Economic Advisors).

Blinder was attempting to explain why prices are "sticky", and undertook a survey of US firms that collectively produced 15% of the USA's GDP, using Economics PhD students to conduct face-to-face surveys to minimize the danger that the very economic-theory-oriented survey questions might be poorly posed misinterpreted. He went expecting the standard Neoclassical world of rising marginal cost to be revealed, along with some behavioural reasons why prices might not be as flexible as that theory expects. Instead, he found a world that flatly contradicted the textbook:

The overwhelmingly bad news here (for economic theory) is that, apparently, only 11 percent of GDP is produced under conditions of rising marginal cost…
Firms report having very high fixed costs-roughly 40 percent of total costs on average. And many more companies state that they have falling, rather than rising, marginal cost curves. While there are reasons to wonder whether respondents interpreted these questions about costs correctly, their answers paint an image of the cost structure of the typical firm that is very different from the one immortalized in textbooks." (105) (Blinder 1998, pp. 102, 105; emphases added)

This empirical—and, when you think about it deeply, logical (Sraffa 1926, "The law of returns under competitive conditions")—finding is part of the explanation for the aggregate empirical regularity that at least 10% of industrial capacity is idle even when the economy is going gangbusters, like it was in the 1960s. Today, aggregate capacity utilization is a lot lower, with over 20% of factory capacity idle, and with a nadir of 33% of capacity idle during the Great Recession.

The relevance of this for international trade is twofold:

  • Exports are a way of increasing capacity utilization over and above the limits imposed by aggregate demand in the home economy; and
  • Since the extra units exported will drive the firm closer to full capacity utilization, the costs will be lower and the potential profit margin higher.

Exports are therefore not a cost to the exporting firm, or its host country: they are a profitable way of increasing domestic aggregate demand.

This brings me to my final point, which I am not able to fully develop here yet, but I will: MMT isn't MMT enough.

MMT isn't MMT enough

When I got into the debate with Warren Mosler, I expected a discussion of the cash flows involved in international trade, in double-entry terms. Though I haven't yet done the modelling, my intuitive sense was, and remains, that exports increase domestic money supply, thus financing higher aggregate demand, and imports reduce it.

That's not what I got. Instead, Warren put the "exports=cost, imports=benefit" argument that Mitchell has since elaborated, plus much discussion of the financial transactions in ForEx markets that would result, which somehow obviated any impact of international trade on domestic or foreign money supplies.

I don't buy that argument, but I can't rebut it either until I've had time to develop a basic system dynamics model of trade in Minsky (in the meantime, I recommend this excellent video "Flow of Money - Foreign Exchange" by Wayne Vernon).

 My critique is also in the spirit of a tweet posted by another MMT advocate, Brian Stobie:

To my way of thinking, the MMT position on trade is not MMT enough. I don't want to see, and obviously won't tolerate, further arguments about exports as costs and imports as benefits. I want to see a detailed double-entry bookkeeping exploration of the monetary (and capacity-utilization/real GDP/physical) implications of trade surpluses and deficits. As noted, I might not have time to develop that in Minsky for a while, but Wayne Vernon's spreadsheet exploration of the topic is well worth watching in the meantime.

Become a patron to

Unlock 421 exclusive posts
Listen anywhere
Connect via private message