Politics overrides economics – and it doesn’t seem to matter

It’s a dangerous world which doesn’t seem to be letting up. For obvious reasons, like supply chain disruptions, and for senseless ones, like the war in Ukraine, the whole idea of a global economy is running up against harsh realities.

People who see world trade in economic terms want to see a bigger, more integrated world economy because that tends to be the more efficient way to deliver goods and services at lower prices everywhere! People who see this in political terms, though, want to produce more in their own country, in the expectation of creating more jobs and retaining more national autonomy.

Both economics and politics are created by flawed human beings, so neither side has a monopoly on truth nor on short-sightedness. And no matter which of these constructs comes to dominate the post-Covid, post-Mariupol world, the relationship between politics and economics will cause prices to keep going up. Here’s why.

Economically speaking

While we could write at some length on what turns out not to be true in your freshman economics textbook, let’s focus on one theory that’s had a pretty good run but seems to be failing now: comparative advantage.

It goes like this: Let’s say you live in a country that makes widgets better than any other country in the world.

It makes sense for your country to structure its economy to maximize widget production and become the widget purveyor to everybody, everywhere. You crank up widget factories. You spend tax dollars on widget research. You erect trade barriers to widget imports and provide financial support to widget exporters. You integrate supply chains so that you provide just-in-time inventory of widgets to manufacturers in other countries who use them as parts in value-added products. With your widget profits, you can then buy anything else you need from other countries, including those value-added products. Your trading partners are happy because they get widgets of a higher quality and at a lower price than they could produce themselves.

Now let’s say that another country should challenge your primacy in the widget trade. It hires away your top industry experts. It’s willing to take smaller profits and undercut you on price. It flat-out steals your technology. One day, this other country’s share of the world market for widgets eclipses yours. Should you get out of the widget game?

Probably not.  Based on the relationship between politics and economics, you might no longer have an absolute advantage, but you still have a comparative advantage. This means that you still make widgets better than you make anything else. The math suggests that chugging along with a widget-based economy is a better decision – at least in the short and intermediate runs – than making an enormous investment to retool for a product that would require a steep learning curve. However, maybe it makes sense to consider diversifying resources and not having all your eggs in one basket, or even in just a few big ones.

Politically speaking

Whether Covid-19 was a “plandemic” or not, it originated with our chief economic rival, China. Because of the relationship between politics and economics, and since our facilities are so tightly integrated, disruptions to Chinese production are felt here and vice versa. When Beijing’s zero-Covid policy went into effect, factories in China shut down. This stopped the flow of not only finished goods but also of electronic and automotive components, idling American factories. This in turn left aisles of empty shelves at retail shops and tire tracks on showroom floors where new cars should’ve been.

Then, when Russia invaded Ukraine, we found out how important Russia is to world oil and natural gas supplies. As our fuel bills skyrocketed, we were also presented with how important both these countries are to the annual wheat harvest. Here we are, watching prices for agricultural staples go up as capacity in southeastern Europe goes offline.

All this could have been avoided, some say, if we did more to protect such industries as electronics, autos, energy and agriculture.

 Policy prescriptions

According to the Corporate Finance Institute, there are four different tools associated with protectionism:

  1. Tariffs, or import taxes,
  2. Quotas, or restrictions on the number of units allowed to be imported in a year or other specific period of time,
  3. Subsidies, or tax credits to domestic manufacturers (the U.S. and component states actually do a lot of this), and
  4. Standardization, or stringent requirements that importers must make additional investments to comply with, but domestic manufacturers have always met as a matter of custom.

And there are certainly sound reasons to implement one or more of these measures. The most crucial is national defense. Does anyone really care how much cheaper it would be to build ICBMs in Indonesia?

Another good reason is the “infant industry” argument. A nascent business – electric vehicles, industrial-strength batteries, the metaverse, etc. – might require incubation. If we give them five years of protection from overseas challengers, they might become the comparative-advantage widgets of the future.

But there are downsides. The closeness of the relationship between politics and economics means that without competition from abroad, technological advancement could stagnate, and consumer choices would be limited.

But one thing protectionism might never cure is inflation. Sure, today with our exposure to the economies of the more than 200 countries we share the world with, we’re looking at 8% annualized inflation. Even if a disaster or war has little to do with us, it ends up costing us.

Let’s remember, though, that these supply chains work well almost all the time, and that inflation so far this century has been in the healthy 2%-per-year range. What would happen to prices if we suddenly decided we were going to drill all our own oil, make all our own cars and smartphones and grow all our own food? We’d have to divert resources from other parts of our economy. We’d find that other countries would stop buying American-made goods if we stopped buying stuff from them. Sure, we’d create lots of jobs, but we’ll be replacing cheap foreign labor with expensive domestic labor, so production costs would rise a lot.

So, whether we adopt a protectionist stance or a free-market stance, prices will almost certainly go up due to the relationship between politics and economics.

But how high? How fast? In what industrial sectors? And how can someone use this analysis to rebalance a retirement portfolio? These are things that our experienced wealth advisors discuss with their clients every day. If you would like to find out how we can help you plan your finances and make the most out of your accumulated wealth in this uncertain time, give us a call.

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