(What’s Left of) Our Economy: What John Oliver Didn’t Tell You About Trade – or About RealityChek

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"Last Week Tonight, BMW, bubble decade, China, consumer prices, domestic content, Financial Crisis, Global Imbalances, Jobs, John Oliver, manufacturing, Peter Navarro, productivity, tariffs, Trade, Trade Deficits, Trump, wages, {What's Left of) Our Economy

In his segment last night on President Trump’s trade policy, HBO Will Rogers wannabe John Oliver had some good fun at my expense due to a technical glitch here on RealityChek, and I deserved it. In the course of making the case why Mr. Trump’s tariff-centered approach is dangerous economic Know-nothing-ism, the (profanity-philic) comedian argued that the President’s main trade adviser, Peter Navarro, once cited me as one of only two economists that agree with his views on the harm of trade deficits – and then correctly pointed out that I told an inquiring journalist soon after that I don’t hold an economics degree. (I recounted these events in this post.)

Oliver proceeded to go on to suggest that I don’t hold a degree in website design, either (and maybe nothing else?), spotlighting the RealityChek bio section where my portrait hasn’t been rotated correctly. And to that I plead “guilty.” I’m a stubborn techno-phobe and have never managed to figure out how to present the photo rightside up. But first impressions are important, and I should have somehow taken care of it. So my bad.

Oliver deserves credit on two other counts as well. First, he acknowledges that trade policy is complicated, and that unfettered trade can have major downsides. Indeed, he even specifies that for trade’s overall net gains to be realized, it needs to be “done right,” and that valid grounds exist for complaints about China’s trade policies in particular. Second, he asked one of his producers to check whether or not I still lack an economics degree.

But what’s also noteworthy (and not so commendable) about that instance of meticulousness is that, although this producer and I wound up having a fairly lengthy conversation about trade policy, my only “contribution” to the show was strengthening Oliver’s attack on Navarro. And that’s really too bad for anyone seeking genuinely to understand the pros and cons, and ins and outs of trade policy. Because had Oliver and his staff gone beyond my bio page, here’s some of what they would have found:

>Despite Oliver’s claim that tariffs are to be avoided in large part because they make goods for consumers and producers who use the tariff-ed products more expensive, there’s little evidence that, in today’s U.S. economy, many producers have the pricing power to pull this feat off. For that, you can thank a combination of the lingering impact of the last financial crisis and ensuing Great Recession (which resulted in part from American leaders ignoring the huge, trade-centered global imbalances that were building up during the bubble decade). And let’s not forget the longer-lasting wage stagnation that’s afflicted so much of the American labor force (which can also be blamed in part on trade policies that have exposed this workforce to penny-wage foreign competition and/or predatory practices by low- and high-wage foreign competitors alike).

>Although Oliver contends that Trump-like concerns about trade policy’s impact on U.S. domestic manufacturing overlook how much larger American industry is today than in 1984, during the current economic recovery, after-inflation manufacturing output has yet to regain its pre-recession production levels. And perhaps not so coincidentally, all the while, the manufacturing trade deficit has surged to the point where it’s likely to hit $1 trillion this year (in pre-inflation dollars). In other words, that’s a lot of American demand for manufactured products that was supplied from foreign economies rather than from the U.S. economy. 

>Oliver accepts as gospel the view that manufacturing’s recent employment losses are due mainly to the sector’s productivity gains, not to failed U.S. trade policies. But industry’s productivity performance has been so poor for so long that it’s lost its historic role as the country’s labor productivity growth leader. Further, it’s anything but difficult to find highly credentialed economists who finger inadequately dealt-with foreign competition instead.

>Oliver makes much of how Mr. Trump’s tariffs on steel and aluminum will cost many more jobs than they save or create by observing that they will harm metals-using industries – which employ many more Americans than the metals producers. Yet since the metals tariffs began to be imposed, these sectors have experienced growth and employment gains at least as strong as those of the rest of manufacturing.

>Like so many journalists, Oliver describes BMW as an American manufacturing gem because it builds so many of its vehicles in South Carolina – and an example of how the Trump trade approach simplistically assumes that domestic and foreign companies can be easily distinguished. Like many journalists, however, Oliver ignores readily available U.S. government data making clear that BMW in the United States mainly snaps together foreign-produced parts and components, and therefore adds relatively little value to the American economy.

>According to Oliver, Trump’s metals tariffs are also boneheaded because they are “pissing off the leaders of every other country on earth” and therefore sandbagging any hope of prevailing in trade diplomacy against the world’s main metals trade bad guy, China. Too bad he never mentioned that, as China’s metals glut ballooned, the United States emerged as far and away the world’s metals dumping ground of last resort because other metals-producing countries responded to Chinese pressure on their own industries either by transshipping Chinese metals, or stepping up their own exports to the United States to compensate. I.e., a global problem required a global response. P.S.: The world’s leading economies have been vowing to work on multilateral responses to China’s overcapacity for nearly two years, and have produced exactly nothing in the way of concrete results.

>Most disappointing, I asked Oliver’s fact-checker why her boss puts so much stock in economists’ views when nearly all of them (including those so confident in orthodox trade theories and their policy implications) clearly flunked the biggest test they’d faced in decades: warning that the economy of the previous decade was an immense bubble whose bursting would bring disaster. Or figuring out that anything was fundamentally wrong with the American economy in those years. Her response: Many of them did – which will come as a major surprise to anyone in the mid-2000s who owned a home or a share of stock.

There’s more, but let’s close with this irony: Even though Oliver made much of China’s decision to impose some retaliatory tariff on U.S. goods, in contrast to a Navarro prediction, a team of high level Chinese negotiators will arrive in Washington, D.C. in a few days to try and end a trade confrontation that has hammered their country’s stock markets and currency, and that, according to numerous reports, has President Xi Jinping worried that he’s overplayed China’s economic hand. Any chance that any of this upcoming highlight of this week’s news will be reported on the next edition of “Last Week Tonight”?

(What’s Left of) Our Economy: The China Trade Cheerleaders Make their Failures Painfully Clear

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Bill Clinton, Bob Davis, Charlene Barshefsky, China, Financial Crisis, Global Imbalances, Great Recession, The Wall Street Journal, Trade, Trump, World Trade Organization, WTO, {What's Left of) Our Economy

This is how abysmal America’s pre-Trump China policies were: Wall Street Journal reporter Bob Davis recently gave supporters of China’s 2001 accession to the World Trade Organization (WTO) ample opportunity to defend their positions on this landmark decision. And what were the most convincing rejoinders they could muster to claims that the benefits of WTO membership (chiefly, legally sheltering China from unilateral U.S. responses to its wide array of predatory trade practices) enabled China’s rise as a dangerous economic and military power – and that American trade policy needs to respond vigorously? Observations that the biggest gains have indeed flowed to China.

According to Davis, WTO admission advocates “can point to real gains from integrating China into the global economy. According to the World Bank, some 400 million Chinese have been lifted from extreme poverty—that is, from living on less than $1.90 a day—since 1999.”

In addition, “After the deal, foreign investment in Beijing mushroomed from $47 billion in 2001 to $124 billion a decade later. The lower investment and import restrictions required of China as part of its WTO entry also encouraged multinationals to rush in, as did the prospect of serving the vast Chinese market. China became the world’s manufacturing floor, and Chinese imports [sic] to the U.S. soared.”

Evidently, the WTO admission supporters tried to identify benefits for the United States, too. For example, “Today, technology companies tap the Chinese market to boost profits and defray research costs.” And “The low inflation associated with cheap imports, together with Chinese purchases of U.S. government bonds, has also helped to hold down interest rates, making it cheaper for Americans to buy not only clothes and electronics but also homes and cars.”

But apparently none could point to evidence of U.S. companies’ China earnings trickling down to the American domestic economy and its workers. Indeed, the reference to “defraying research costs” looks like a euphemistic way of describing how these businesses often moved white collar and professional as well as blue-collar manufacturing jobs to China.

Similarly, the low inflation and interest rate points amount to gushing that China’s WTO membership helped enable Americans to live way beyond their means. On that score, the only sane U.S. response should be “thanks but no thanks” – since the result was a decade of bubbles whose inevitable bursting triggered the terrifying global financial crisis and ensuing Great Recession.

The unprecedented bubble decade global trade imbalances fostered by the WTO’s enabling of China’s mercantilism, and their nearly cataclysmic results, also provide vital context to claims (chiefly by former U.S. Trade Representative Charlene Barshefsky) that China “became the world’s second-largest importer, giving a boost to rich and poor nations alike.” For these imports and their growth were clearly dwarfed by China’s export surge. And although China’s post-2009 spending spree did help “the global economy from tumbling even more deeply into recession,” it’s unquestionable that the “kitchen sink” stimulus from the Federal Reserve and other major central banks played a far more important role.

But perhaps the most compelling evidence offered in Davis’ article for the abject failure of the China WTO decision came from former President Bill Clinton – who led the campaign to support Chinese membership by promising both an economic boom for U.S. exporters and irresistible pressure for a democratization of China that would bring more global peace and freedom. As Davis reports, the normally loquacious Clinton “declined to comment for this article.”

(What’s Left of) Our Economy: The IMF (Unwittingly) Explains Why Trade Deficits Really Do Matter

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China, current account, current account surplus, current deficit, Germany, Global Imbalances, globalization, IMF, International Monetary Fund, Japan, tariffs, The Netherlands, Trade, Trade Deficits, Trump, {What's Left of) Our Economy

One of my greatest professional disappointments has been my failure to help make many converts to the idea that one of the biggest – and possibly the biggest – reason that trade deficits matter a lot (contrary to the insistence of most economists) is that they can lead to global financial crises like the one that struck in 2007 and 2008. The idea is that these deficits lay at the heart of the broader economic imbalances run up during the previous decade – which flooded borrowing- and spending-happy economies (especially America’s) with oceans of cheap credit, and inevitably produced the reckless use of such credit and the inevitable – and terrifying – bursting of the resulting bubbles.

You see? It’s a thesis that’s tough to summarize briefly – even though it’s widely accepted by some of the world’s leading economists, who nonetheless remain reluctant to acknowledge any connection to trade flows.

So I’m gratified that the International Monetary Fund has just lent additional support to this thesis, but I’m under no illusions that the determinedly oblivious conventional wisdom is going to budge – especially since the Fund goes out of its way absolve lopsided trade flows of any blame.

According to the Fund’s new External Sector Report (click here for a link to the PDF), these imbalances (measured in their broadest form, the current account) stayed at about the same share of the world economy last year as they did in 2016 (some 3.25 percent). Yet in the IMF’s view, between 40 and 50 percent of these imbalances were “excessive (that is, not explained by countries’ fundamentals and desirable polices).”

Why should anyone care? Because, as the Fund explains, “Large and sustained excess external imbalances in the world’s key economies—amid policy actions detrimental to external balances—pose risks to global stability.” Specifically, “Over the medium term, sustained deficits, leading to widening debtor positions in key economies, could constrain global growth and possibly result in sharp and disruptive currency and asset price adjustments.”

That last reference to “sharp and disruptive currency and asset price adjustments” is a fancy, and deliberately understated, way of saying “financial crisis.”

The danger is underscored by Figure 1 from the Report (on page five) – which shows how the world’s current account situation has changed over time. Optimists might take comfort from the fact that the overall global imbalance today (showed by the thick, solid line), is considerably smaller as a share of global output than it was at the peak of the last decade’s bubble. Also of interest: China’s current account surplus has shrunk in relative terms, while those of Japan, Germany, and the Netherlands have remained about the same. (For evidence that the better Chinese numbers are largely smoke and mirrors, see this analysis from the Council on Foreign Relations – not exactly a hotbed of protectionist thought.)

But here’s what the pessimists would note – and what should worry everyone: Although the total worldwide current account imbalances is down, so is global growth. During the peak bubble years, it was about 4.30 percent annually after inflation. During the current recovery, it’s been much lower, and last year, it was 3.15 percent. Worse, a new slowdown may well be in the cards.

That is, the world economy seems to be facing all the dangers of a new financial crisis without having received many of the (dubious) benefits of a preceding bubble.

The IMF has a solution: The persistent surplus countries should spend more (which will presumably pull in more imports from the deficit countries) and the deficit countries should take “actions to strengthen public and private sector balance sheets” (that is, in large measure, spend less).

And it sends a warning: “[P]rotectionist policies should be avoided as they are likely to have significant deleterious effects on domestic and global growth, while limited impact on external imbalances.”

These are pretty standard prescriptions. The trouble is, as usual, neither the surplus nor the deficit countries are showing any interest in following them. Moreover, the IMF’s views on the relationship between trade flows on the one hand, and national borrowing and spending and savings rates on the other, seems to repeat the canard that net savings levels determine trade flows. Nowhere do its economists acknowledge that the fundamental mathematical relationship is that of an identity – which says nothing about causation at all. As a result, they also ignore all the ways in which trade flows can determine savings rates.

It’s anything but realistic to expect the Fund to endorse President Trump’s tariffs or any of the rest of his trade policies. But it also seems to remain anything but realistic to expect the Fund to identify any plausible alternative ways to prevent today’s global imbalances from turning into Financial Crisis 2.0.

(What’s Left of) Our Economy: More Evidence of Germany’s Stealth Protectionism

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Angela Merkel, consumers, consumption, developing countries, Financial Times, Germany, Global Imbalances, globalization, imports, Matthew C. Klein, protectionism, savings, taxes, Trade, Trump, value-added taxes, VATs, wage suppression, wages, {What's Left of) Our Economy

President Trump’s charges that the United States has signed terrible trade deals in recent decades, and that foreign economies have been the main beneficiaries, inevitably have triggered a potentially useful debate over which major countries are most open to trade and which are tightly closed. Unfortunately, such arguments won’t actually be useful until “open” and “closed” are properly defined, and a new Financial Times column on Germany’s economic policies nicely illustrates how remote that goal remains.

I’ve previously made the case that accurately measuring protectionism – and thus accurately gauging which countries are contributing adequately to global prosperity and which are free-riding – entails much more than adding up individual trade barriers. Such simple counts also mislead on the equally important question of which countries the United States can reasonably hope to trade with for mutual benefit, and which countries can’t possibly qualify.

And because Germany’s government has both taken trade fire from Mr. Trump and vigorously replied, I’ve used it to illustrate the above points. In a short op-ed for USA Today and a much more detailed RealityChek post, I’ve noted that, as with many other leading foreign economies, the main problem with Germany as a promising trade partner stems at least as much from its overall national economic strategy as from its specific trade practices. That is, countries like Germany, which heavily emphasize growing by saving, producing, and exporting, can’t possibly be good trade matches for countries like the United States, whose priorities have been the diametric opposites.

Of course, those national economic strategies manifest themselves in specific practices and policies. (How else could their focus be established?) But the links to trade flows aren’t always clear. For example, there’s widespread reluctance to acknowledge the trade impact of value-added taxes (VATs), which promote exports and penalize imports. The role played by other German policies, like suppressing wages or skimping on infrastructure spending, has been even less apparent.

What the new Financial Times post adds to the mix is a generally neglected form of wage suppression: Germany’s taxes on low-wage workers – which author Matthew C. Klein describes as “among the highest in the world” since at least the turn of the century.

These taxes inflict an outsized blow on Germany’s imports – and on the the world economy as a whole – in at least two important respects. First, economists tend to agree that the lower an individual’s or household’s income, the higher the share of that income will be spent (as opposed to saved). If they’re right, then these taxes ave been hitting Germany’s overall consumption and import levels especially hard. Therefore, these levies look like notable contributors to the bloated German trade and current account surpluses that are not only detrimental to America, but that could threaten the entire world’s financial stability.

Second, as supporters of pre-Trump U.S. trade policies constantly point out, much of what low-income consumers buy is produced and exported by low-income countries (e.g., apparel or school supplies or furniture). So since high taxes on low-wage workers in Germany prevent them from importing as much from the developing world as they could, third world countries need to focus more on customers in more promising markets – like America’s.

Germany and its leader Angela Merkel lately have been basking in the glow of praise from the political classes in the United States and abroad, which have anointed them as among the new, post-Trump champions of free trade and all its purported benefits. (China’s another alleged globalization champion, but that’s another story.) Its lofty taxes on low-wage workers add to the evidence that these titles are wildly premature.

Making News: New Articles Appear on Marketwatch and Lifezette

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alliances, allies, Financial Crisis, Global Imbalances, Lifezette.com, Making News, Marketwatch.com, North Korea, nuclear weapons, South Korea, tariffs, Trade, trade wars, Trump

I’m pleased to report the publication of two new op-ed pieces over the last week.

Today, Marketwatch.com published my column explaining why President Trump should portray any new hard line trade moves as doses of tough love needed to ensure sustainable worldwide growth, rather than narrow-minded America First-type measures.  Here’s the link.

And last Thursday, Lifezette.com ran my call for a thoroughgoing overhaul of the U.S. security alliance with South Korea – before North Korea becomes unmistakably able to strike the American homeland with nuclear weapons.  Read the piece at this link.

And keep checking in with RealityChek for ongoing news of media appearances and other developments.

 

(What’s Left of) Our Economy: Where Trump Deserves High, Low, and “Incomplete” Marks on Germany Trade

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advanced manufacturing, automotive, commodities, comparative advantage, Financial Crisis, Germany, Global Imbalances, Great Recession, innovation, manufacturing, productivity, Trade, Trade Deficits, trade surpluses, Trump, {What's Left of) Our Economy

As I’ve suggested, President Trump has big, valid points to make about Germany’s auto trade with the United States. Not only does America run an enormous deficit with Germany in vehicles and parts, but claims that Germany deserves great praise from Washington because it makes so many vehicles in the United States are completely unjustified. For they overlook its companies’ very low levels of U.S. content and only very modest improvement on this score. That is, German vehicles are overwhelmingly screwed together in the United States, and therefore add much much less value to the American economy than autos made with domestic parts.

The trouble is that America’s troubles with German trade policies greatly transcend the automotive industry and, to a great extent, Germany. I’ve previously written that there’s a fundamental problem that both the administration and it’s critics are missing:  Germany’s economy, like China’s and many others around the world, is simply not structured in such a way as to make mutually beneficial trade with the United States possible.

But there’s another big U.S.-Germany trade issue that needs highlighting, along with a major danger that Bonn’s approach to trade is creating for the entire world – at least in the medium or long-term.

That other U.S. Germany trade problem has to do with the makeup of bilateral commerce. If you look at the nature of what the United States trades most successfully with Germany and vice versa, you find that the former category contains a mix of high value manufactures and commodities, while the latter is dominated by advanced industrial goods. Here are lists of the sectors in which America last year ran its biggest trade surpluses and deficits with Germany. (To the surplus list should be added – prominently – aircraft, which are not counted accurately in the U.S. International Trade Commission database I’m relying on.)

Top ten U.S. trade surpluses with Germany: 

glass products 

tree nuts 

soybeans 

computers 

non-costume jewelry 

non-anthracite coal & petroleum gases 

fin-fish products

computer parts 

surgical appliances and supplies 

pulp mill products 

 

Top ten US deficits with Germany

autos and light trucks 

pharmaceuticals

goods returned from Canada 

motor vehicle transmissions and transmission parts

aircraft engines and engine parts

construction machinery

miscellaneous general purpose machinery 

miscellaneous basic org chemicals 

miscellaneous engine equipment 

motor vehicle parts

These results are disturbing because, contrary to the superficial conventional wisdom, if you take seriously standard trade theory and its core concept of comparative advantage, sectoral trade balances matter tremendously. For the main idea behind the freest possible international trade is structuring the world economy so as to enable those countries most proficient at producing various goods and services to dominate their output. So surpluses and deficits in different industries show which countries are passing and failing this test – and thus which countries look likely eventually to control worldwide supplies of the sophisticated goods that create so many high wage jobs and foster so much innovation and productivity growth.

Since the U.S.-Germany data aren’t U.S.-global data, in theory they could be anomalies. In other words, Americans could be doing better with the world as a whole, and therefore, the nation’s prospects in high value industries could be a lot brighter. Unfortunately, that’s not the case at all. The makeup of U.S.-Germany trade isn’t terribly different from the makeup of U.S. global trade, in that America’s trade winners are, again, a mix of commodities and high value goods (again, including aircraft), and its losers are nearly all advanced sectors.

Top ten US surpluses globally

petroleum refinery prods

soybeans

special classification goods

plastics materials andcresins

waste and scrap

corn

liquid natural gas

semicaonductor manufacturing equipment

non-poultry meat products

turbines and turbine generator sets

 

Top ten US deficits globally

autos and light trucks

crude oil and natural gas

goods returned from Canada

broadcast and wireless communications equipment

computers

pharmaceutical products

telecommunications equipment

audio and video equipment

aircraft engines and engine parts

games, toys, and children’s vehicles

Yet Germany also is contributing significantly to a major trade-related threat that threatens the entire world, not just the United States. I’ve repeatedly spotlighted blue chip academic research concluding that unprecedented global imbalances centered on American trade shortfalls were instrumental in setting the stage for the last global financial crisis and the painful recession that followed. Worse, evidence keeps accumulating that international commerce is becoming worrisomely lopsided again, and that Germany’s overall international surpluses – currently the world’s largest – have generated much of the problem.

Indeed, a valuable reminder came in this morning’s Washington Post:

“[G]ermany is one of a number of countries, including China, Japan, and South Korea that are now saving far more than they are either consuming or investing….At some point, the world will be unable to absorb the capital surpluses of Germany, China and others, leading to another painful correction that might undermine the liberal order.”

Interestingly, Germany itself has indirectly acknowledged these risks, and hinted that it recognizes some responsibility to get the surpluses down. Unfortunately, Berlin has demonstrated few signs of following through. So although some of President Trump’s focus on the German trade issue seems off target, it’s also clear that the sense of urgency he’s brought to the issue, from both an American and global standpoint, is not only appropriate, but necessary.

(What’s Left of) Our Economy: New Peterson Pro-Globalization Study Only Deserves a “Nice Try”

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China, Financial Crisis, Gary C. Hufbauer, Global Imbalances, globalization, Great Recession, Larry Summers, manufacturing, Peterson Institute for International Economics, productivity, secular stagnation, technology, Trade, trade agreements, trade liberalization, trade policy, World Trade Organization, {What's Left of) Our Economy

The Peterson Institute’s new study of the benefits to Americans of globalization apparently leaves no doubt that the nation should promptly forget about any retreat from conventional trade liberalization policies and resume its aggressive pursuit of new trade agreements like the Trans-Pacific Partnership (TPP). Or does it? A close reading of the report reveals gaping holes in these claims.

According to authors Gary C. Hufbauer and Zhiyao Lu, between 1950 and 2016, “trade expansion” has enriched the overall U.S. economy by $2.1 trillion, and boosted America’s output per head and per household by just over $7,000 and $18,000, respectively. Even better, lower-income households probably gained the most (since the greatest trade liberalization progress has been made in the goods that comprise so much of their consumption).

Yet the phrase quoted in that previous paragraph points to the first big hole in the Peterson findings. “Trade expansion’s” benefits, the authors specify, entails much more than either signing new trade deals or otherwise reducing trade barriers. It also includes “technological advances in transportation and communications [that] have drastically slashed the economic distance between countries.”

Of course, there’s been a lot of the latter over the last 66 years. What share of expanded trade’s benefits has come from trade liberalization policy decisions and what share from that technological progress? Darned if the authors know.

The long time frame, in turn, reveals a second major problem with the central argument. Obviously over that last two-thirds of a century, the world economy, and America’s position in it, have changed in numerous and fundamental ways. One prominent example: For the first roughly three post-World War II decades, the United States was the only fully intact developed country. How could trade liberalization not have been a major net benefit? America produced countless products that the rest of the world desperately needed. And none of its important industries faced significant import competition until the 1970s. That doesn’t sound much like current circumstances.

And in fact, Hufbauer and Lu acknowledge this problem, noting, for example, that “compared to previous decades, increased trade since 2003 has not delivered substantial gains.” At this point, however, their analysis gets dicey. For example, they speculate that that low recent payoff resulted partly from “the lack of fresh policy liberalization on a large scale (the failure of the Doha Round)….” But that period actually saw a hugely important liberalization initiative completed – China’s accession to the World Trade Organization. And don’t forget the numerous free trade deals signed by the George W. Bush and Obama administrations, including with South Korea’s very large economy.

Moreover, although Hufbauer and Lu rightly note that the financial crisis and Great Recession also have marked the post-2003 period, they claim that “The decade that experienced the greatest gains from increased trade was 1970 to 1980.” That decade witnessed no less than two recessions (three if you count the 1980 downturn).

Undaunted, the authors contend that returning to the trade liberalization policy course will result in even more American wealth creation. But here’s where their discussion of the post-2003 period fails badly – and unmistakably. They never mention that, thanks largely to that aforementioned boost to incredibly lopsided U.S.-China the first decade of this century produced the greatest U.S. trade deficits and associated global economic imbalances in world history. They ended in the financial crisis and the nation’s worst economic downturn since the Great Recession.

Since America’s main trade partners – including China – seem either just as export-dependent, and/or just as import-and consumption-phobic as ever, it’s difficult to understand why a return to conventional trade diplomacy, combined with the cumulative and often lagged impact of past deals (as noted by Hufbauer and Zu) wouldn’t end in near-catastrophe again.

Another big problem: Former Treasury Secretary and chief Obama economic adviser Larry Summers, along with many others, worry that the United States has fallen into an economic trap they call “secular stagnation.” They speculate that the nation has become so incapable of generating healthy growth that it’s grown dependent on blowing up credit and consumption bubbles to at least produce (misleading) signs of economic life – and that these bubble’s inevitable bursting keeps creating financial crises and serious slumps. Do Hufbauer and Zu believe that the sandbagging of domestic manufacturing (which hasn’t grown in real terms since 2006) due to import competition and offshoring isn’t partly to blame? 

Finally, and similarly, American leaders have finally recognized that the economy is experiencing a major productivity growth slowdown. Can trade liberalization’s real economic impact be measured without considering the effect on productivity of allowing all that trade damage to manufacturing, which historically has led the nation in productivity growth?  

It’s definitely encouraging that a major think tank like the Peterson Institute is looking in detail at globalization’s impact on America’s economy.  Let’s hope that its next effort reflects some actual thinking.  

(What’s Left of) Our Economy: Latest Trade Deficit Scuffles Still Missing Lessons of 2008

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bubbles, finance, Financial Crisis, free trade agreements, G20, Germany, Global Imbalances, investment, Japan, manufacturing, offshoring, tax reform, Trade, Trade Deficits, trade policy, trade surpluses, Trump, Wall Street, {What's Left of) Our Economy

Roughly ten years after it broke out, it’s still incredibly rare to see economists or pundits link U.S. and resulting global trade imbalances with the financial crisis. So I’m always thrilled – as I tweeted this past week – to see it ever happen. All the same, even this insightful column by Reuters’ Edward Hadas simply dances around the crucial link between these imbalances and American trade policies, and in particular, their offshoring-friendly nature.

In a March 15 essay, Hadas commented on the German (and other countries’) trade surpluses that have attracted such attention this past week for two main reasons: German Chancellor Angela Merkel’s first-ever meeting with President Trump, and a conclave taking place at the same time of the finance chiefs of the world’s 20 leading economies (the so-called G20). The author’s main contention is indisputable as far as it goes. According to Hadas, the real problem with these imbalances is financial:

“The euros, pounds and dollars which Germany, Korea et al accumulate inevitably land in the global financial system. There would be no problem – only gains all round – if these monies funded valuable infrastructure, productive factories and other assets which can generate a reasonable economic return.

“Too often, though, though, the extra currency winds up supporting counterproductive finance. It backs ultimately ruinous property speculation, lends support to chronically weak governments, encourages unsustainable consumer spending and destabilises developing economies, not to mention enriching banks and bankers and stimulating corruption. A typical example: the recycled dollars from the U.S. trade deficit helped fund the American housing bubble whose pop created the 2008 crisis.”

But what Hadas – and so many others – fail to do is explain adequately why deficit countries (like the United States) make such dangerously shortsighted choices with their windfalls. Three main (and not mutually exclusive) reasons have been served up. First, financial systems in the deficit countries (especially the United States, which runs the biggest deficits) have over-rewarded uses of capital that produce the fastest possible payoffs, and under-reward longer-term projects. The result is too much investment that encourages speculation, financial monkey business, and simple consumption, and too little investment that builds factories and laboratories and funds other activities that create wealth more slowly, but on a more sustainable basis.

Second, such irresponsible uses of capital have become practically inevitable if only because the deficits have been so enormous, and so much money has become available. When anything is in such abundance, and therefore costs so little, most economists would agree that there’s little reason to use it carefully. After all, it looks like a sure bet that more of that thing at very attractive prices will be readily available.

A somewhat different version of this argument has to do with what economists call “moral hazard.” It argues that the American financial system used over-abundant money so recklessly at least partly because investors felt certain that they’d get bailed out of most or all of their mistakes by government. So why not take maximum advantage of what seems to be a “heads, we win; tails, we lose” proposition?

The third explanation for the irresponsible use of resources focuses on the consumption-heavy nature of the economies of the deficit countries. (This argument also tends to note that the surplus countries frequently try to limit and even depress consumption.) The more capital they take in, in other words, the more such spending (as opposed to productive investment) is likeliest to result either because such behavior is encouraged by government, because a “live for today” has been produced by that country’s culture, or because of some combination of the two.

Whenever something as a big as a global financial crisis strikes, many culprits are responsible. And all of the above explanations should be taken very seriously (along with others, like lax financial regulation). But what Hadas and all the rest continue to miss is how the world trade system, national trade policies, and the trade flows they have fostered have actively fostered in deficit countries like the United States a neglect of productive activities like manufacturing (which is so heavily traded).

Specifically, as Washington in the 1990s and 2000s signed more and more trade agreements structured to encourage multinational companies from all over the world to supply U.S. consumers from locations in super low-cost and virtually unregulated developing countries like China and Mexico, American leaders and other elites (e.g., in the media) naturally sought to rationalize their decisions by spreading the message that sectors of the economy like manufacturing (and the income loss produced by the accelerated offshoring that rippled throughout so much of the Main Street economy) could be neglected with impunity. And the administration of George W. Bush (along with Congress of course) and the Federal Reserve chaired by Alan Greenspan underwrote America’s spendthrift ways with big budget deficits and ultra-low interest rates, respectively.

Even worse, these destructive trends fed on themselves. The more offshoring seemed to pay off, and the more domestic manufacturing operations looked like losing — or at least anachronistic — propositions, the less interested financiers became in investing in them. So the amount of productive activity on which to use incoming capital to start with began shriveling. And the less productive activity available to sustain Main Street living standards responsibly (i.e., mainly through earnings), the greater the political establishment needed to prop up those living standards by providing more easy money — at least if it wanted to stay in power while maintaining the offshoring status quo.

Ironically, even though Hadas emphasizes regulation as the answer to global imbalances, his particular focus has big trade implications:

“Regulation can do more than strengthen bank capital ratios. It can reform the system, so trade surplus funds are not directed to economically counterproductive uses. That will be tough, both politically and practically. But it should be easier – and will be far more helpful – to solidify finance than to try to change the national characters of Germany or Korea.”

I’m all in favor of channeling the use of trade surplus funds by deficit countries into productive activity. In fact, I strongly support requiring such uses by U.S. multinational companies if much-discussed tax reform finally succeeds in persuading them to bring home the vast amounts of earnings they’re currently stashing abroad to avoid paying higher U.S. corporate rates. 

But this requirement needs to be accompanied by (at the very least) strong measures to keep out foreign-made goods that benefit from predatory trade practices like dumping, subsidization, and intellectual property theft. Otherwise, foreign competitors will be able to keep undercutting their domestic American competition in the U.S. market, and these new productive investments will fail. It’s also entirely likely, however, that more sweeping trade curbs will be needed – to offset the scale economy disadvantages created by U.S.-based firms’ inability to sell into so many important markets and their rivals’ ability to sell freely in their home countries and the United States.

And this is in fact where recognition is needed that the trade problem created by American policy concerns not simply inducements to offshore, but the coddling of protectionism in high income countries like Japan and Germany.

The bottom line: As indicated in a post last week, the United States may have to accept that even reasonably balanced foreign trade is not achievable with competitors holding radically different economic priorities (as I argued last week was precisely the case with Germany), and that reducing trade flows is a more than acceptable price to pay for preventing financial crises caused by imbalanced trade. When you add in America’s great capacity for much more self-sufficiency in a wide range of manufactured good, that seems like a more than acceptable trade-off to me. More important, it’s where the Trump administration, admittedly in fits and starts, could be leading us.

(What’s Left of) Our Economy: Why Trade’s Best Champions Really Need to Raise Their Game

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Brad Setser, China, Council on Foreign Relations, Financial Times, George W. Bush, Global Imbalances, manufacturing, Martin Wolf, non-tariff barriers, offshoring, offshoring lobby, tariffs, Trade, Trump, World Trade Organization, WTO, {What's Left of) Our Economy

When you’ve been in the trade policy trenches as long as I have, it’s important these days to look up from time to time and pinch or otherwise remind yourself how dramatically Donald Trump’s election a president has changed the policy landscape. And I’m of course someone who broadly supports his stated objectives in this field.

Weirdly, however, folks who oppose Mr. Trump’s views keep showing that their need to wake up is even greater, and this goes double for backers of the general trade status quo intellectually honest enough to acknowledge many of its serious problems. The biggest adjustment they need to make? Demonstrating that they can develop approaches to solving these problems that are realistic alternatives to the tariff-centered measures that the president is apparently contemplating. Recent offerings from the Financial Times‘ Martin Wolf and the Council on Foreign Relations’ Brad Setser reveal how much more progress is needed.

In Wolf’s latest column, he heaps scorn on the Trump-ian claim that expanding trade with China (or with any country) has played a “significant” role in causing any of U.S. manufacturing’s problems. And he declares that “Nothing [President Trump] does will reinstate manufacturing to its lost role as the dominant provider of “good jobs”.

But Wolf continues to see a different – and arguably more important – danger stemming from preserving the global trade status quo:

“[H]uge current account surpluses in some countries forced deficit countries into financial excesses as an (ultimately unsustainable) way to maintain demand in line with potential output. The [2007-08 financial] crisis vindicated the concern of John Maynard Keynes about the potentially malign role of surplus countries in the global economy.”

So logically, Wolf is telling readers that if better balance doesn’t come to global trade, Financial Crisis 2.0 could easily result – echoing a warning made both by me and by many eminent economists.

What does he recommend to stave off such a catastrophe? A “proactive, not defensive” approach that includes a drive to “open global markets” (as if this hasn’t been tried before?) and – most interesting in light of his opposition to U.S. trade barriers – “forcing” chronic trade surplus countries like China “to rely more on domestic and less on external demand.” It’s somewhat encouraging that Wolf recognizes that the surplus countries (read “protectionists”) won’t take these steps voluntarily. But what could he possibly mean by “forcing” if no “defensive,” or even punitive, measures like tariffs are permissable? Maybe he’ll tell us in his next column?

The gap between diagnosis and prognosis is at least as wide in Setser’s January 18 post on “China’s WTO Entry, 15 Years On.” The essay is worth reading in its entirety, for it decimates the arguments made by the entire bipartisan U.S. globalization cheerleading policy establishment (not to mention the corporate Offshoring Lobby) about the unprecedented benefits that would flow from admitting China into the global trade rule-making and enforcement body – and thereby shielding it legally from most American unilateral economic power and leverage. Here, though, are a few key examples:

>”It now seems clear that the magnitude of the post-WTO China shock to manufacturing was significantly larger than was expected at the time of China’s entry into the WTO. China already had ‘most-favored-nation” (MFN)/“normal trade’ access to the U.S. Market….But China’s pre-WTO access to the U.S. came with an annual Congressional review, and the resulting uncertainty seems to have deterred some firms from moving production to China.”

>”Moving final assembly of electronic goods to Asia created pressures for the full supply chain [i.e., the much more valuable and innovative production of parts and components, as well as the research and development and engineering work] to move to Asia….Even if the currency issue is taken off the table, I suspect that the trade gains—or really the export gains— from integrating China into the WTO’s “rules” were overestimated.”

>“It is now clear that WTO accession was not enough to make China into an easy market for foreign firms to supply from outside China.

“Here is a point that I think should get a bit more emphasis. China’s imports of manufactures, net of its imports of imported components, peaked as a share of Chinese GDP in 2003—and have fallen steadily since then. There is no ‘WTO’ effect on China’s imports of manufactures, properly measured (i.e. leaving out imports for re-export).”

>”Some firms have succeeded in China, but generally by producing in China for the Chinese market, not by selling to China. Successful challenges to some specific Chinese practices in the WTO have yet to alter this pattern….The WTO rules aren’t all that constraining in a country like China—thanks to state control of commanding heights enterprises and banks, and institutions, such as the National Development and Reform Commission (NRDC), that assure party control of major state firms and large investment projects.”

>Many WTO-legal remedies that might have worked were not used “because U.S. and European firms benefited from making use of Chinese production to meet global demand” – and because George W. Bush’s administration danced to their tune.

But Setser’s policy recommendations seem no more realistic than Wolf’s, especially if significant, unilateral tariffs are ruled out:

“The correct fight right now is against the domestic policies that keep China’s savings so high, against a surge in capital outflows that leads to a yuan depreciation that then becomes entrenched (if China’s currency goes down, I worry it won’t go back up), and against Chinese import-substituting industrial policies that aim to displace major exports to China.”

In the pre-Trump period, the diagnosis-prognosis gap unaddressed by intellectually honest supporters of the trade status quo didn’t matter much, since American presidents were so determined to preserve that status quo. But this time, it seems to be different.  And if these trade advocates hope to prevent what they tend to describe as a counterproductive – and maybe worse – shift in American policy, they’ll need to do a much better job of showing that no major course change is needed at all.

Following Up: Why Economists & Establishment Media Should be a Little More Humble on Trade

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Adam Davidson, Donald Trump, economics, economists, Federal Reserve, Financial Crisis, Following Up, Global Imbalances, Great Recession, Janet Yellen, Korea, Peter Navarro, The New Yorker, TPP, Trade, Trans-Pacific Partnership

A fascinating and revealing coda has just been provided to my brief brush with fame last week, when The New Yorker deemed my views on trade issues not worthy of consideration.  And the source was, of all people, Fed Chair Janet Yellen.

As I wrote on October 13, in a profile of Donald Trump economic adviser Peter Navarro, New Yorker writer Adam Davidson made clear that he considered one glaring weakness of the Republican candidate’s views on trade and other economic policies to be their lack of support among professional economists. As a result, Davidson was completely unimpressed when Navarro noted that I have endorsed them in general – since I lack an economics degree. Nor was his interest piqued when I reminded him by email that my predictions about the outcomes of major trade policy initiatives, like admitting China into the World Trade Organization, were much more accurate than those of most Ph.Ds .

Enter Chair Yellen. In a speech in Boston the very next day, she focused on “some ways in which the events of the past few years [since the outbreak of the financial crisis and Great Recession] have revealed limits in economists’ understanding of the economy….” And despite her understatement, these limits look awfully important. The subjects to which they apply include how demand influences supply, the makeup of the groups of actors economists study (which these scholars’ models assume are completely homogeneous), how finance affects the real economy, and “what determines inflation.”

Indeed, Yellen’s list raises the question of where economists’ knowledge really is solid – at least in terms of ideas that affect economies’ performance in the real world. And so does the economy’s abysmal performance on net since the outbreak of a near-financial cataclysm that virtually none of its members foresaw.

Yellen did add an international question that she believes deserves much more research: how changes in American monetary policy affect the rest of the world and then feed back to the United States. But even though other aspects of the nation’s relationship with the global economy strictly speaking don’t fall under the Fed’s purview, she still might have noted that major gaps still exist in her profession’s understanding of international trade.

Even more disturbing: Although the trade-fueled global imbalances that built up during the bubble decade have been identified as bearing great responsibility for the crisis’ outbreak, as Davidson’s attitude suggests, international commerce is the one area of economics where no significant thinking has been called for at all since the disaster. Indeed, judging from the reactions to Trump’s trade proposals, the conventional wisdom is more entrenched than ever.

Of course, none of this is to say that economists know nothing useful, whether on trade or elsewhere. But with evidence that those global imbalances are once again nearing pre-crisis peaks (albeit with a somewhat different composition), and with President Obama seemingly more determined than ever to win passage of a trade agreement (the Trans-Pacific Partnership) modeled on a Korea deal that has supercharged the U.S. merchandise deficit, you’d think that both economists and journalists would react to proposals for fundamentally new approaches with at least minimal humility.