Incentives drive trade and economic decisions

David MoonBlog

Business schools teach our future leaders of industry that countries should engage in trade with partners that have lower opportunity costs to produce specific goods and services. That is, standards of living will increase in both countries when the U.S. imports sneakers from Indonesia and exports soybeans to the country.

I believed this economic theory for years, mostly blindly accepting one important assumption: decision-makers in each country seek to maximize overall wealth and living standards in each country. That’s the theory, anyway. And it’s mostly true most of the time. But it is definitely not always true all of the time.

Incentives are among the most powerful forces in the universe, and without understanding what motivates the other guy – especially if we wrongly assume the other guy is motivated similarly to us – it is easy to naively stumble into serious mistakes.

My guess is that most politicians in Washington are not motivated to expand the overall wealth and living standards in the U.S. They don’t oppose these objectives, of course, but their true incentive is no different than that of China’s Xi Jinping: to retain and expand power and influence. Because of the difference in the political systems in the U.S. and China, officials in each country pursue their objectives in different ways. Because we elect our politicians, candidates must pursue policies that at least half of the electorate find appealing. Increasing living standards are by-products of political goals, not the actual motive.

In China, Xi only needs to concern himself with general living standards enough to dissuade a massive general uprising – something he can also dissuade by pointing tanks at his own people. Xi’s only electorate concern is to occasionally be re-elected by the 205 members of the CCP Central Committee – all of whom are selected with his approval.

Because Xi doesn’t have to worry about pesky elections, he can redirect resources from citizens to generously subsidize a number of businesses and industries. China’s support for its technology and pharmaceutical industries lowers prices in the U.S., at the expense of general living standards in China. This would make no sense if China’s leaders’ incentives were the same as in the U.S. But they aren’t. GDP per capita in the U.S. is $70,250, compared to only $12,500 in China.

Based solely on the comparative advantage economic theory, we should have no concern that Chinese firms supply more than 90% of U.S. antibiotics. Expect that pharmaceutical trend to continue. Earlier this year, the Food and Drug Administration approved the temporary import of Chinese chemotherapy drugs.

But the comparative advantage theory assumes the only thing decision-makers consider is maximizing living standards in their country – and I personally don’t accept that assumption.

David Moon is president of Moon Capital Management. A version of this piece originally appeared in the USA TODAY NETWORK.