We’ve just gotten another example of international trade’s unique ability to turn even a Nobel Prize-winning economist ignorant or deceitful (take your pick) on a fundamental maxim of economics.
The latest know-nothing (or con man)? Nobelist and New York Times columnist Paul Krugman. In a post yesterday, Krugman repeated a claim about the chronic U.S. trade deficit that is as widely made as it is flat wrong: “[T]he trade balance is a macroeconomic phenomenon, determined by the excess of savings over investment.” http://krugman.blogs.nytimes.com/2014/06/20/america-as-a-lousy-exporter/
This may sound incredibly boring and technical, but the savings canard explains much of (a) Washington’s decades-long habit of letting its trade deals and broader trade policies off the hook as engines of the trade deficit’s growth, and (b) its determination to keep staying the trade policy course and thus worsening the damage these measures inflict on the economy.
Instead, the savings claim enables the bipartisan economic policy establishment to insist that all of the nation’s trade-related problems stem from America’s deeply ingrained spend-aholic ways. As a result, all would be well on the trade front if consumers and government alike would simply put away their credit cards and begin some nest-egg building. But since both keep living beyond their means, the gap between what they buy on the one hand, and what they produce and sell on the other, inevitably is filled by products from abroad.
This story is perfectly plausible. But it’s not the story told by the macroeconomic/mathematical relationship between excess saving and the trade balance referred to by Krugman and so many others. The reason? That relationship is a mathematical identity. It simply says that, mathematically speaking, the trade deficit will equal the savings shortfall. It does not say that the savings shortfall “determines” (i.e., causes) the deficit, or that the trade deficit causes the shortfall. It says nothing about causality at all.
In fact, it’s easy to explain how the trade deficit could cause the savings shortfall, especially in a democracy like America’s. Since it’s overwhelmingly concentrated in manufacturing – a high-wage sector of the economy – the deficit depresses the income-earning opportunities of all Americans not lucky enough to be born with a silver spoon or otherwise to be living off their investments. As the persistent trade gap destroys jobs and lowers wages in manufacturing, the effects ripple throughout the entire economy. Displaced manufacturing workers are forced to compete for jobs elsewhere in the economy, add to the labor supply outside manufacturing, and force down these wages.
Because these ever-poorer workers can all vote, they eventually communicate their unhappiness to elected politicians, and confront them with a difficult choice. Presidents and members of Congress can either change U.S. trade policies – and risk angering the multinational businesses that benefit from these policies. Or they can keep the trade policies and mollify voters by enabling them to replace their lost incomes with more credit. But since the easier money for consumers does nothing to boost the nation’s production, the purchases it makes possible need to come from overseas in the form of imports. So the trade deficit increases.
The main point is not that my interpretation is indisputably right and that of Krugman et al is equally wrong (although mine corresponds terrifically well with the U.S. economy’s steady march last decade toward an historic financial crisis fueled by unheard-of levels of debt). The main point is that both these interpretations are simply interpretations that are entirely separate from the mathematical relationship between the national savings rate and the trade deficit. Whenever you read an economist, politician, or pundit failing to acknowledge this uncertainty, and peddling what’s actually fakeonomics, feel free to ignore them. But make sure to hold onto your wallet, too.