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Spoken like a good neoliberal. But it's plainly false. Imports do weaken an economy, pro tanto, because they crowd out domestic supply. The neoliberal theory is that if those imports contribute to a restructuring of global production along the lines of comparative advantages (and/or technological progress, or theoretically an increase in social or human capital, I guess, though that part's not mentioned much), the global production increase will outweigh the local reversal.
However, in the case of Spain, the neoliberal reasoning does not apply, for several reasons:
a) transport costs were relatively high, meaning that even an allocation of labour more in line with comparative advantage could still be unproductive - and countries could not simply maximise their profits by pursuing comparative advantage, because they could remain at an absolute disadvantage (the higher the transport costs, the less Ricardo's theories apply). So neither the global gain from restructuring nor the ability of the country to restructure its own industry apply in the way that your theory demands;
b) the neoliberal theory assumes that trade deficits are inherently short-term, because they cannot be sustained long-term because the country would run out of money; in the case of Spain, however, the supply of money was for all meaningful purposes infinite in extent (if not in volume produced per year);
c) the neoliberal theory assumes that trade deficits are self-limiting, because a large imbalance will lead to an adjustment in the exchange rate; however, Spain was on the silver standard, which is to say that the exchange rate was fixed and could not be changed. As a result, imports did not lower the value of the currency, lowering imports, as Friedman points out that they should with floating exchange rates;
d) Spain was not, technologically or socially, modern. This is important because it meant it could not substitute in the way a modern country can. When America imports, and its domestic industries suffer, that's OK, because American labour can instead be invested in, say, service industries, or in high-tech industries. Spain had no high-tech industries, and very limited service industries. Therefore, its excess labour force remained trapped in agriculture - a sector with very low productivity gains to be made. As a result, there was little domestic investment, and as a result the economy did not grow.
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Let's summarise that by comparing America with Spain. America shows us what should happen:
- America imports. Americans have more stuff more cheaply, and thus have more excess money.
- Americans spend that money not only on buying more stuff from abroad, but also on buying stuff that cannot be got from abroad: haircuts, complicated financial products, massages, supercomputers, and so on.
- Americans lose jobs in manufacturing, but gain jobs in massage parlours, banks, and computer labs.
- American investors see that these sectors can grow, and so invest in them. This encourages a healthy level of financial trade, that oils the machinery of production.
- Because America is now doing what America does best, and Outland is doing what Outland does best, global production increases, or prices decrease, so more people can get more stuff for the same price, including Americans.
- If America now does what it does best, it will actually make more money for itself thanks to comparative advantage.
- If deficits look like getting too big (ie if the above isn't enough to make up for the loss of manufacturing jobs), that's OK - that'll just force down the value of the dollar, which'll make it more expensive to import into the US (or less expensive to export from the US), so the deficit will remain at a manageable level.
Look, imports don't hurt the economy!
But then let's look at Spain:
- Spain imports. Spaniards can get more stuff more cheaply and thus have more money.
- Spaniards spend that extra money on... well, they don't, they just turn their silver into silverware and keep it locked up. Why? Because they'd love to spend their money on supercomputers, but they don't exist yet. And there isn't all that much call for masseurs, because, for a start, only a tiny, tiny fraction of the population lives within ten miles of a viable massage parlour site. With very small cities (towns, by modern standards), most service industries are not viable (even if they are technologically and educationally possible in the first place).
- Spaniards lose jobs in manufacturing. In fact, a lot of them lose jobs in agriculture. Or they don't, because they're mostly de facto serfs with limited mobility but strong family ties, so they remain on the family farm, but they can no longer sell their crops at a price that enables them all to survive (because foreign grain is so much cheaper).
- Spanish entrepeneurs do not invest in the new industries because there aren't any. They may perhaps invest abroad. More likely these 'entrepeneurs' (ie local gentry) just hoard their silver as silverware, because there's nothing else that offers a comparable rate of return.
- Because the trade imbalance is not created by underlying production costs but simply the accidental location of a massive silver mine, Spain is not necessarily doing what it does best, and nor is the rest of the world, so global production is not necessarily increasing (indeed, if more money is being lost to the 'friction' of transport costs, production may actually be decreasing), so the world isn't getting richer.
- Because high transport costs get in the way of comparative advantage, Spain can't just do what it does best (even if it had an economy that was fast enough to respond, despite lack of modern communication speeds and a highly decentralised economic system).
- Deficits can keep getting bigger and bigger, as foreign industry (and agriculture) get invested in more and more, driving down foreign production costs, while domestic inflation pushes domestic production costs up. This should produce currency revaluation, but since Spain's currency is pegged to silver, and so is everyone else's, Spain is essentially using the same currency as everybody else, and cannot revalue, so the problem cannot go away.
- Finally, if devaluation is impossible, deflation should occur, which would make the Spanish economy more competitive. However, deflation cannot occur, because more and more money is being created.
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At least, that's what I remember being taught.
Can you explain why "imports do not weaken an economy" is true in a way that does not rely on free exchange rates, low transport costs, finite money supplies, and a workforce that can be easily reconfigured into industries that did not exist in the time-frame in question?
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[Basically, Spain was an anti-Iceland. You know how you can't get inflation and deflation together? Well Iceland got them both. That was because the financial system collapsed (ie no investment, ie deflation), but at the same time the exchange rate forced the cost of imports up (inflation). With floating exchange rates, a sufficiently large shock to domestic demand, causing a lack of domestic investment, co-existed with inflation driven by the high cost of imports. Well, Spain had the opposite: with fixed exchange rates, a sufficiently large inflationary surge in domestic demand caused a lack of domestic investment driven by the low cost of imports. A lot of what we generally assume about economics is based on operating within certain parameters - Iceland violated those paremeters by having an unexpectedly large systemic financial failure, while Spain violated them by having an unprecedently large financial windfall coupled with fixed exchange rates and a rigid economy]
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