Following Up: The CCP Virus is Making the Case for Free Trade Look Ever Sicker

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CBO, CCP Virus, China, Commerce Department, Congressional Budget Office, coronavirus, COVID 19, Financial Times, Following Up, free trade, GDP, Goldman Sachs, gross domestic product, Guggenheim, IMF, inflation-adjusted growth, International Monetary Fund, Morningstar, output gap, real GDP, Trade, Wuhan virus

A month ago, I put up a post claiming that the gargantuan economic losses stemming from the CCP Virus outbreak were shredding the standard economics case for free trade. Essentially, most economists have long insisted that the gains from trade always exceeded the losses that might be suffered by individual parts of the economy and their workers. (I purposely excluded the debate over whether more trade has exacted excessive non-economic costs, like eroded national security or more pollution.) Even better, the freest possible international trade flows would create enough additional wealth to permit generous compensation for these losers.

But I then documented that the virus-related hit to American economic output – which will clearly had stemmed from decades of freeing up trade and broader commerce with China – had already dwarfed the trade gains claimed even by cheerleaders for doing ever more business with the People’s Republic.

One month later, the China trade bonanza estimates haven’t gotten any better. But the projections of damage to the U.S. economy have greatly worsened.

My April 6 post cited two leading private sector forecasts of U.S. output losses for this year, measured in terms of gross domestic product (GDP) adjusted for inflation – Morningstar’s figure of $954 billion, and Goldman Sachs’ judgment of nearly $725 billion.

Since then, some official figures have been released, and most are bigger. For example, on April 29, the U.S. Commerce Department came out with its first read on real GDP for the first quarter of this year. Even though most of that January through March period preceded the onset of various shutdown orders across the nation, the Commerce statisticians still found that the economy shrank by 4.87 percent at an annual rate in price-adjusted terms. This means that if output kept falling at that rate for all of 2020, by year-end the economy would be $928.86 billion smaller than on New Year’s Day.

That’s still a smaller production plunge than estimated by Morningstar, but Commerce (as usual) never actually predicted that the drop-off would remain constant. Its annualized figures are simply notional.

A few days before, the Congressional Budget Office did engage in some prediction. Its expectation of constant-dollar GDP decline in 2020 was $1.27789 trillion. The International Monetary Fund’s (IMF) expectation for the U.S. economy was pretty similar – a $1.1253 trillion slump in inflation-adjusted U.S. GDP.   

As also noted in last month’s post, though, virtually everyone agrees that CCP Virus-induced damage will continue beyond 2020, and the way most economists try to quantify such losses is by calculating what they call an output gap. It’s an effort to specify how much lower output will be over a period of time as a result of a shock like the virus compared with how an economy would have performed had the shock never taken place.

The last time a major output gap-estimating exercise took place was in the aftermath of the Great Recession – caused by a shock resulting from the bursting of closely related credit and housing bubbles. As shown by the chart below (originally published in the Financial Times), a team at Guggenheim investments at least consider the gap to have started in 2010 (the first year after the recovery is generally thought to have started) at about $750 billion (according to my eyeballs). Thankfully, it proceeded to shrunk steadily thereafter. But the bad news is that it shrunk so slowly that the lost growth wasn’t made up for until 2018 – eight years later.

Nevertheless, if the Guggenheim economists are right, that output gap literally was nothing compared with the one that CCP Virus’ outbreak will open up. It starts this year at about $2.7 trillion (again, as my eyeballs see it) after factoring in price changes, and it closes at a rate no faster than that seen during the last economic recovery – which was historically sluggish. In other words, the decision to free up trade with China could cost the United States economy trillions of dollars of lost growth year after year for the foreseeable future.   

Maybe during this period, someone or some organization will come up with a study of the gains to America from freer trade with China that will claim purely economic benefits orders of magnitude greater than previously judged. In order to preserve a serious case that such trade expansion has turned out satisfactorily for the United States, they’ll have to.

(What’s Left of) Our Economy: New Reminders of Why Growth’s Quality Mustn’t be Ignored

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an economy built to last, business investment, capex, CBO, Congressional Budget Office, debt, Financial Crisis, GDP, growth, manufacturing, NABE, National Association of Business Economics, tariffs, Tax Cuts and Job Act, Trade, {What's Left of) Our Economy

For years I’ve been beating the drum about the need for American to pay as much attention to the quality of growth generated by the economy as they pay to the rate of growth itself. And in just the last 24 hours, two great examples have emerged of how ignoring the former can produce worrisomely off-base policy conclusions.

To repeat, the quality of growth matters because even growth that seems satisfactory, or even better, on a quantitative basis can be downright dangerous if its composition is wrong. Go back no further into the nation’s economic history than the last financial crisis to see why. Excessive reliance on intertwined housing, personal consumption, and credit booms nearly led to national and global meltdowns because, in former President Obama’s apt words, America became a “house of cards” overly dependent for growth on borrowing and spending. And he rightly emphasized the need to recreate an economy “built to last” – i.e., one based more on investing and producing.

In numerous posts, I’ve documented how little progress the nation has made in achieving this vital goal. And new reports by the Congressional Budget Office (CBO) and the National Association for Business Economics (NABE) valuably remind of one big reason why: This crucial challenge remains largely off the screen in government, business, and economics circles.

The new CBO study is its annual projection of U.S. federal budget deficits and federal debts, and the agency helpfully describes in detail the economic assumptions behind these forecasts. One key finding concerned the impact on American growth of the Trump administration’s various tariffs on certain products and U.S. trade partners.

Largely echoing the conventional wisdom, CBO predicted that if the levies remained unchanged, the tariffs would “reduce U.S. economic activity primarily by reducing the purchasing power of U.S. consumers’ income as a result of higher prices and by making capital goods more expensive. In the meantime, retaliatory tariffs by U.S. trading partners reduce U.S. exports.”

Specifically, according to CBO, “new trade barriers will reduce the level of U.S. real GDP by roughly 0.1 percent, on average, through 2029” – although its economists acknowledged that the estimate “is subject to considerable uncertainty.”

So that sounds pretty like a pretty counter-productive outcome for the President’s trade policies. But check out what else CBO said about the short-term impact of new U.S. tariffs. “Partly offsetting” the negative effects of those rising prices, along with the damage done by retaliatory foreign tariffs, the levies will also

“encourage businesses to relocate some of their production activities from foreign countries to the United States….In response to those tariffs, U.S. production rises as some businesses choose to relocate their production to the United States. In the meantime, tariffs on intermediate goods encourage some domestic companies to relocate their production abroad where those intermediate goods are less expensive. On net, CBO estimates that U.S. output will rise slightly as a result of relocation.”

In other words, the Trump tariffs will lower overall growth a bit, but more of that growth will be generated by domestic production, rather than by consumers and businesses purchasing more imports – primarily financed of course with more borrowing, and boosting debts. For anyone even slightly concerned with the quality of growth, that could be an acceptable price to pay for a healthier American economy over the long run.

Over the longer run, CBO speculates that the tariffs will reduce private domestic investment and productivity (and in turn overall growth), though it admits that this outlook is even more uncertain than that for the short run. Moreover, it’s easy to imagine public policies that could negate considerable tariff-related damage. For example, if the trade curbs do indeed undermine productivity in part by reducing the competition faced by domestic businesses – and therefore reducing their incentives to continue to improve – more overall competition could be restored through more vigorous anti-trust policies. So the tariffs could still result in growth that’s somewhat slower, but more durable.

The NABE’s January survey of members’ companies painted a pretty dreary picture of another Trump initiative – the latest round of tax cuts. As reported by the organization’s president, “A large majority of respondents—84%—indicate that one year after its passage, the 2017 Tax Cuts and Jobs Act has not caused their firms to change hiring or investment plans.”

As a result, even though the sample size was pretty small (only 106 companies responded to the organization’s questions), these answers significantly undercut tax cut supporters’ claims that the business-heavy reductions would lead to a capital spending boom.

Yet a closer look at the results offers greater reasons for (quality-of-growth-related) optimism. And they represent some evidence that the tariffs are achieving intended benefits as well. In the words of NABE’s president, “The goods-producing sector…has borne the greatest impact, with most respondents in that sector noting accelerated investments at their firms, and some reporting redirected hiring and investments to the U.S.”

This goods-producing sector includes manufacturing, and its outsized reaction to the tax cuts makes sense upon considering how capital-intensive industry has always been. In addition, manufacturing dominates U.S. trade flows, so it makes perfect sense that the tariffs’ jobs and production reshoring impact has been concentrated in this segment of the economy.

And once again, the bottom line seems to be more growth spurred by more domestic production – which can only improve the quality of the nation’s growth, and the sustainability of its prosperity.

Of course, the best results of new American economic policies would be the promotion of more and sounder growth. But as widely noted, big debt hangovers resulting from financial crises make even pre-crisis growth rates difficult to achieve even when quality is ignored – as the specialists quoted in this recent New York Times article appear to admit. So in order to achieve the best long run results, Americans may need to lower their short-term goals and expectations somewhat. That greater realism – and sharper focus – will surely come a great deal faster if important institutions like the CBO and the NABE start paying them at least some attention.

(What’s Left of) Our Economy: Will the CBO Ever Forecast U.S. Growth Accurately?

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CBO, Congressional Budget Office, forecasting, GDP, growth, {What's Left of) Our Economy

The Congressional Budget Office’s annual economic outlook came out today, and for the life of me, I can’t figure out why anyone cares.

Yes, I know – the CBO’s forecasts on the size and direction of America’s federal budget deficits strongly influence the biggest domestic economic policy debates conducted in the nation. And the Office seems truly nonpartisan, and therefore presumably more reliable than more self-interested studies put out by Democrats and Republicans.

The problem is, the CBO doesn’t seem to be very good at forecasting the growth of the economy. And if it’s considerably off-base on the gross domestic product (GDP), it’s hard to imagine it’s going to be a lot more accurate for budget deficits and surpluses. After all, because the levels of employment and taxable income in the United States greatly affect the deficit’s magnitude (along with many other important factors, including policy measures, which the CBO can’t reasonably be expected to foresee), getting growth wrong would appear to be a big problem.

How bad has CBO been? To its credit, the agency itself acknowledges its failings. For starters, check out Figure 15 in this report, which compares its crystal ball with the economy’s actual performance through 2007. As you can see, the errors are considerable, and most are overestimates.

But has CBO gotten better since then? Not even close. In its January, 2008 Outlook, the agency predicted inflation-adjusted growth of 1.7 percent. The actual figure? -0.3 percent. Part of the problem was CBO’s view that the economic slowdown whose signs it detected “would not be large enough to register as a recession.”

A year later, it was apparent that a recession had taken place – the worst since the Great Depression. But CBO still erred on the side of optimism, predicting that the economy would shrink by 2.2 percent versus the actual 2.8 percent contraction that was suffered.

For 2010, CBO evidently fell victim to the “once (twice?) burned, twice shy” syndrome. Its forecast of 2.1 percent growth lagged the 2.5 percent gain that was logged. Unfortunately, in 2011, the Office fell back into polyannism. Its 3.1 percent real growth forecast was nearly twice the 1.6 percent improvement.

The following year, though, CBO undershot again, predicting less growth (2.0 percent) than the economy actually achieved (2.3 percent.). And its 2013 underestimate was even worse (with its forecast 1.4 percent after inflation GDP rise dwarfed by the final 2.2 percent advance.

We don’t have the final 2014 U.S. growth figure, but for the record, CBO anticipated a 3.1 percent performance, as well as a 2.8 percent gain for 2015. It’s true that CBO has revised all such projections in the middle of all the years mentioned above. But even improvisations that wound up sharpening the agency’s vision (I haven’t examined those forecasts), would only reinforce my original point: From an economic standpoint, the CBO’s annual economic outlooks are nothing-burgers.