Can soybeans be turned into washing machines? The alchemist of times past might try to convince us that it can be done. But we know better. Alchemy is an early, unscientific form of chemistry that tried, among other things, to change base metals into gold. Alchemy fell out of favor as it encountered failure after failure.
Notwithstanding the unsuccessful efforts of alchemists, economists can explain how soybeans can be turned into washing machines. Not just washing machines either. Thousands upon thousands of other product transformations can occur. More importantly, when the transformations are completed, overall living standards are higher! All without bunnies, wands, and chants. Patience, an open mind, and a willingness to think things through are the only requirements.
Setting the Stage
Let’s begin by assuming the United States is self-sufficient in washing machines. That is, the only washing machines Americans buy are those produced by fellow Americans. For purposes of the example, suppose these washing machines sell for $500 and that Americans buy 5 million each year.
Let the plot thicken by assuming comparable Chinese washing machines sell for $400. What would happen if the US law restricting Americans’ access to Chinese washing machines were abolished?
For starters, competition from sellers of Chinese washing machines would drive the US price to $400. Americans’ purchases of washing machines would rise, as purchases deemed uneconomic at $500 but worth more than $400 would occur. At the same time, some American washing machine producers would find it uneconomic to continue producing washing machines. Which Americans? It would be those whose alternative earning capabilities are worth more than matching the Chinese price.
What would happen to the dollars the Chinese “earn” by selling washing machines to Americans? They would do what dollars do best—buy American goods (soybeans, for example) along with American stocks and bonds.
American purchases of Chinese washing machines would rise for two reasons. Not only would Americans buy more washing machines, but they would also simultaneously substitute Chinese machines for previously produced, but now uneconomic, American machines. The increased purchases and reduced domestic production would equal US machine imports.
What would happen to the dollars the Chinese “earn” by selling washing machines to Americans? They would do what dollars do best—buy American goods (soybeans, for example) along with American stocks and bonds. This means American soybeans would, in effect, turn into Chinese washing machines. That’s why Americans could rightly say they saw Chinese washing machines hovering in, around, and over US soybean fields every summer.
Higher Living Standards
The above story doesn’t stop here. American living standards are higher as a result of this transformation.
Consider first the effect of the additional machines. Suppose Americans washing machine purchases increased from 5 million to 5.5 million as a result of the price decline from $500 to $400. The consumption value of these additional 500,000 machines would range between $400 and $499.99. Assume it averaged $450. Paying $400 for these additional machines would mean Americans gained on average $50 per machine for a gain of $25 million (500,000 x $50).
Am I describing a free lunch? No, not at all—just larger helpings that result from availing access to lower-cost consumption alternatives.
What about the decline in US production of washing machines? If I told you that this fall in washing machine production would also be a gain for overall American living standards, you’d be likely to say “You’re crazy, Van Cott!” But, read on. Overall living standards would rise on this account.
Assume the alternatives of the Americans leaving production equaled, on average, $450 per washing machine. That would mean Americans would give up $450 per machine if the 3 million machines were produced domestically. Americans would give up $400 per machine buying Chinese washing machines. Substituting lower-cost Chinese washing machines for higher cost American machines would mean Americans would give up less to obtain the 3 million machines. Giving up less to obtain something means having more of other things.
The gain from this switch to Chinese machines would be $150 million (3,000,000 x $50). When added to the aforementioned consumption gain, the total increase in living standards from abolishing the self-sufficiency law would be $175 million.
Am I describing a free lunch? No, not at all—just larger helpings that result from availing access to lower-cost consumption alternatives. The principle holds for households as well as nations. Adam Smith put it best in his 1776 classic, Wealth of Nations: “What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom.”