Be careful what you wish for

In his column in the New York Times, Harvard economist Gregory Mankiw points out that China's accused currency manipulation is more complicated than our new Treasury Secretary has made it seem:

"Just before his confirmation as Treasury secretary, Timothy F. Geithner turned up the heat on the Chinese regarding the dollar-yuan exchange rate. President Obama, he said, 'believes that China is manipulating its currency. Countries like China cannot continue to get a free pass for undermining fair-trade principles'...

Critics of China say it is keeping the yuan undervalued to gain an advantage in the international marketplace. A cheaper yuan makes Chinese goods less expensive in the United States and American goods more expensive in China. As a result, American producers find it harder to compete with Chinese imports in the United States and to sell their own exports in China.

There is, however, another side to the story. The loss to American producers comes with a gain to the many millions of American consumers who prefer to pay less for the goods they buy...

Mr. Geithner and other China critics might also want to ponder how the Chinese keep the yuan undervalued. The essence of the policy is supplying yuan and demanding dollars on foreign-exchange markets. The dollars that China accumulates in these transactions are then invested in United States Treasury securities.

So when the Treasury secretary complains about the undervalued yuan, his message to the Chinese boils down to this: Stop lending us money."

The stimulus package just passed by the Senate will cost a lot of money; money that will be raised through the sale of Treasury bills to, among others, the Chinese government. A sudden change of heart by our foreign creditors could cause a currency crisis larger than any we've seen in the past. Antagonizing the Chinese is good politics, but bad economics.

If we're really interested in raising the value of the Chinese currency relative to ours, we might want to consider cutting our debt so we don't need so many countries buying our dollars. Until we do that, we might want to get off our high horse.

The case for protectionism (sort of)

Paul Krugman adds some nuance to our recent discussion on protectionism and the stimulus:

"...one part of the problem facing the world is that there are major policy externalities. My fiscal stimulus helps your economy, by increasing your exports — but you don’t share in my addition to government debt. As I explained a while back, this means that the bang per buck on stimulus for any one country is less than it is for the world as a whole.

And this in turn means that if macro policy isn’t coordinated internationally — and it isn’t — we’ll tend to end up with too little fiscal stimulus, everywhere.

Now ask, how would this change if each country adopted protectionist measures that “contained” the effects of fiscal expansion within its domestic economy? Then everyone would adopt a more expansionary policy — and the world would get closer to full employment than it would have otherwise. Yes, trade would be more distorted, which is a cost; but the distortion caused by a severely underemployed world economy would be reduced. And as the late James Tobin liked to say, it takes a lot of Harberger triangles to fill an Okun gap."

Krugman is quick to point out that this is not an argument in favor of long-term protectionism or even that protectionism is the best possible policy. The crux of his argument is the last sentence of the quote: the negative effect of a tax (like an import quota) is smaller than the negative effect of unemployment due to reduced total output.

Do some countries free ride on the fiscal stimulus of their partners? Probably. So in that sense, anything that encourages coordinated stimulus is a good thing. The clear downside is the risk of a trade war. Hopefully, we now have the global regulatory structure in place (such as the WTO) to prevent things from devolving into a situation like we saw in the 1930s.

I'm more pessimistic than Krugman about the potential for a trade war; but then again, he just won a Nobel Prize for his work on trade theory.

Getting more bang for the buck

Following up on the "Buy American" provisions in the stimulus package, Douglas Irwin points out of the pitfalls of lacing stimulus with protectionism:

"In rebuilding the San Francisco-Oakland Bay Bridge in the 1990s, the California transit authority complied with state rules mandating the use of domestic steel unless it was at least 25 percent more expensive than imported steel. A domestic bid came in at 23 percent above the foreign bid, and so the more expensive American steel had to be used. Because of the large amount of steel used in the project, California taxpayers had to pay a whopping $400 million more for the bridge. While this is a windfall for a lucky steel company, steel production is capital intensive, and the rule makes less money available for other construction projects that can employ many more workers."

The more money we pay for inputs, the less money we have for infrastructure projects that will hopefully create jobs, and lay the foundation for future growth, to steal a phrase from the President. We can't do that if the steel industry (or any other industry for that matter) uses the stimulus bill to buffer their profits to the detriment of American welfare. 

A lot of Americans are employed using steel. But if the price of steel goes up, fewer of these people will keep their jobs. It's that simple.

And so it begins...

Most economists, even on the left, are not going to be happy about the "Buy America" provisions within the new stimulus package.  

Proponents naturally argue that the only way to create American jobs is to ensure that the money gets spent on American goods and services. Simple enough, right?

Opponents of the provision counter with two main arguments. The first is the threat of a trade war. In the 1930s, the Hoover administration, mired in the beginning of the Great Depression, signed into law the Smoot-Hawley Act, significantly raising American tariffs. Europe, similarly dealing with the economic downturn, enacted their own tariffs. In the end, everyone got poorer. 

The second argument is that it simply won't work, for a variety of reasons having to do with the dynamics of international trade and capital mobility. As Nick Rowe explains:

"A 'buy domestic' policy will not shift demand towards domestic goods. If it did, so that imports fell and net exports increased, the current account surplus would merely cause the exchange rate to appreciate so that net exports fell to their original level. The current account must stay the same, because the capital account stays the same, because the interest rate differential stays the same, because interest rates stay the same."

Brad DeLong adds:

"If there's little excess capacity in the U.S. steel industry--so that the price of steel is high enough to induce people to look outside for suppliers--then a stimulus won't be much needed. If there's a lot of excess capacity so that a stimulus is needed, then steel customers should be able to bargain prices down to marginal cost--in which case foreign producers will have an extremely difficult time competing on price given that steel is heavy and distances are great. "Buy American" seems mostly designed to allow the steel producers to collude and push their profits up--at the expense of American taxpayers." (emphasis added)

Much has been made about the Obama administration's attempts to keep the stimulus package pork-free. But trade restrictions benefit well connected constituencies and are politically popular (usually); it's hard to think we were going to get a an $800 billion stimulus package without pork. As Russ Roberts says, you're better off hoping for a ham sandwich without pork.

Question?

This week's New York Times magazine section has an interesting article about Cuba, titled "The End of the End of the Revolution". It quotes an official with the Cuban Ministry of Economics discussing Cuba's economic successes and failures:

"Álvarez reeled off some numbers. There were 6,000 doctors in Cuba at the time of the revolution; there are now close to 80,000 for a population of 11.3 million, one of the highest per-capita rates in the world. The U.S. embargo has cost Cuba about $200 billion in real terms. When the Berlin Wall crumbled, 80 percent of Cuba’s international trade was with Soviet-bloc countries. About 98 percent of oil came from them. Back to the Communist bloc states, at inflated prices, went Cuba’s sugar and rum.

'We’ve had to reinsert ourselves in the global economy twice in 30 years, once in 1960 and again in 1990,' Álvarez said."

If capitalism and globalization lead to the exploitation of the developing world, then the US embargo should be viewed as a positive for Cuba, right?.

If trade impoverishes developing countries then how could lack of trade also impoverish developing countries?

Think local, buy global

I work next door to a Whole Foods, so the issue of "food miles" comes up a lot.

However, a recent study from Pierre Desrochers and Hiroko Shimizu called "Yes, We Have no Bananas" synthesizes a good deal of research showing that the food miles concept is severly lacking:

"The most problematic aspect of the food-miles perspective is that it ignores productivity differentials between geographical locations. In other words, activists assume that producing a given food item requires the same amount of inputs independently of where and how it is produced. In this context, the distance traveled between producers and consumers, along with the mode of transportation used, become the only determinants of a food’s environmental impact. But any realistic assessment must reflect both transport to final consumers and the total energy consumption and greenhouse gas emissions associated with production."

The data on this issue are striking. The authors cite several studies showing that 83% of CO2 emissions came from the production of food, while only 4% came from the transportation from the producers to the retailer (the piece on which activists tend to focus).

Ronald Bailey, writing in Reason Magazine, explains the implications:

"Food miles advocates fail to grasp the simple idea that food should be grown where it is most economically advantageous to do so. Relevant advantages consist of various combinations of soil, climate, labor, capital, and other factors. It is possible to grow bananas in Iceland, but Costa Rica really has the better climate for that activity. Transporting food is just one relatively small cost of providing modern consumers with their daily bread, meat, cheese, and veggies. Desrochers and Shimizu argue that concentrating agricultural production in the most favorable regions is the best way to minimize human impacts on the environment."

One of the best ways to do this is to lift the huge subsidies that the US and Europe dole out to their agricultural lobbies. This would lead to more food being grown in advantageous climates, and has the added benefit of being an economic boon to the developing world. Lifting the subsidies would be good for the environment, good for the worlds poor, and would free up $300 billion in US government budget. What's not to like?

Blood, gore and trade barriers

For those who like horror films, there are two new ones coming out. One is about a group of people quarantined in an apartment building where a virus is spreading, causing the infected to turn into vicious cannibals. The other is about a group of people fighting against an evil force that has descended upon their city, seeking to dominate the globe.

The second film, which opens tomorrow, is called Battle in Seattle. It chronicles the experience of different groups (protesters, riot police, city officials) caught up in the 1999 protests of the World Trade Organization meeting in Seattle. Initial reviews are generally positive, and the cast includes Ray Liotta, Charlize Theron, Andre Benjamin and Woody Harrelson.

Having not yet seen the film, I can't make specific criticisms or comments. I do, however, question the use of person narratives from a large-scale protest to provide insight into complex and abstract issues. The film's director, Stuart Townsend, is personally sympathetic to the protesters' cause. He spells out the conflict in stark terms:

"It's the faceless bureaucrats — they're the problem... It's the lobbyists and the corporations that rape the environment."

San Francisco-based NGO Global Exchange provides a good list of the most commonly cited critiques of the WTO. The WTO provides rebuttals to many of these arguments on its own website.

I think there's a lot of confusion about the WTO, it's history and purpose. The WTO is generally portrayed as an autonomous, unelected bureaucracy, when it's really a member-state organization like the UN. WTO representatives are not, themselves, elected (neither are UN ambassadors), but they are appointed by government leaders. Their policy-positions reflect the positions of their respective governments.

The WTO is also often accused of amplifying the power of large countries over global commerce. In actuality, WTO amplifies the power of small countries. This is because by joining the WTO, all countries, large and small, are committing themselves to a set of rules and responsibilities (again, not unlike the UN). Large countries have much more power to break their trade agreements with small countries (for example, put an illegal tariff on goods from the smaller country). The WTO provides an institutional mechanism so that small countries can seek damages from large countries when they break the rules.

Additionally, the claim that the WTO gives more power to corporations is a bit misleading. As I've said before, corporations only support "free-market competition" when it's in their interest. In reality, politically-connected corporations are the ones that benefit most from trade restrictions. They are the ones who get to avoid facing foreign competitors, yielding higher prices and lower quality goods for consumers.

The world faces many challenges too large for any one nation to solve. That is why we have global institutions, which allow for member states to agree on a set of rules and guidelines. But these institutions are really just the sum of their parts. If you want to change their priorities, you need to change the priorities of the member states.

My purpose in writing this is not to denigrate the concerns of the global justice movement - equitable labor standards, environmental protection, and human rights. I do, however, think that too many people have been seduced by a caricature of international trade that vastly overstates the costs and vastly understates the benefits. Trade is not zero-sum; we can all benefit at the same time.

Not done yet

Recently I wrote about globalization's critics cheering on high oil prices in hopes that they will reduce trade levels. According to recent research, however, it seems like oil prices wont have that large an effect. Writing in Vox, the authors argue:

"Our evidence suggests that the determinants that matter most for explaining trade costs are standard factors like geographic distance (which is a rough proxy for information and transportation costs), trade policy and tariffs, adherence to fixed exchange rate regimes, and membership in the British Empire or Commonwealth... Anderson and van Wincoop (2004) find that the tariff equivalent of international trade costs is about 74%. Transport costs only make up a third of these trade costs. The rest consists of border-related costs such as informational barriers, tariffs and red tape. Even if oil prices directly feed through to transport costs, the impact on overall trade costs is limited."

However, the authors also note that higher fuel costs may affect large supply chains. As a result, there may be a decline in the "back and forth" trade of bulky items that are assembled partially in one country and partially in another. For example, IKEA just opened their first factory in the US.

What's good for the goose...

Dean Baker is a well respected economist who has pushed the issue of liberalizing trade in high-wage services like law, medicine and accounting. He notes, for example, that:

"If we could bring in enough fully qualified doctors from the developing world to bring the wages of our physicians down to West European levels it would save patients in the United States close to $80 billion a year on their health care. This swamps the gains from NAFTA, CAFTA, and the other trade deals"

Today, he provides some context to a recent New York Times article about the outsourcing of some financial research jobs to India. According to Baker, this trend:

"will lead to gains to the economy as a whole, as the cost of financial services drops. It should also help to reduce inequality as one, two, or even three digits get removed from some of the compensation packages of the Wall Street crew.

This is not just sour grapes over Wall Street salaries taking a hit. Rather, we should look at this trend through the same lens with which we view all trade. If we can gain from buying our tee-shirts and calculators from China, so too can we gain from buying of our financial services from India.

Baker is fond of pointing out the hypocrisy implicit in forcing low-skill workers to compete with foreign competition but protecting high-skill workers through licenses and restrictions on immigration for the highly educated. Certainly the fear here is that low-six figure salary jobs under threat from cheaper competition will spell doom for the American standard of living. This fear is understandable, but unwarranted for two reasons (among others):

• According to Daniel Drezner (writing in Foreign Affairs), close to 90 percent of jobs in the United States require geographic proximity and thus cannot be outsourced
• Lowering the price of financial services raises the standard of living of everyone that consumes financial services, increasing investment returns on 401(k) and pension plans. This is substantial, as roughly half of American households are invested in the stock market

Gains from trade are gains from trade, whether it comes in the form of cheaper shoes or cheaper financial research. So why not make trade more egalitarian?

More on trade (sorry, no witty Kubrick reference this time)

Following on the trade theme, consider the following facts about US trade:

• imports account for only 16.7% of US Gross Domestic Product (GDP) and imports from China account for 2.2%
• between 60% and 70% of the US economy faces virtually no international competition (including low-wage jobs like auto mechanics, high-wage jobs like doctors and the 18.5 million government employees)
• Chinese exports only overlap with between 5% and 10% of the US economy

For all the concern about trade in this election cycle, trade is a relatively unimportant part of the US economy (particularly compared with the rest of the industrialized world). The average US tariff on foreign goods, currently 2%, is already very low (note that many goods face 0% tariffs, while some goods, particularly agricultural products, face close to 100% rates). According to the World Bank, removing these remaining tariffs would boost the US economy by $16 billion per year; a large number, but certainly a drop in the bucket in the $10 trillion US economy.

One of the biggest trade issues discussed in the campaigns has been NAFTA. In my last post I cited a quote from Barack Obama in which he said, "Well, I don't think NAFTA has been good for America -- and I never have". But the empirical evidence doesn't implicate NAFTA in the downfall of American manufacturing. David Leonhardt, writing in the New York Times states:

When Nafta took effect on Jan. 1, 1994, Ohio had 990,000 manufacturing jobs. Two years later, it had 1.03 million. The number remained above one million for the rest of the 1990s, before plummeting in this decade to just 775,000 today. It's hard to look at this history and conclude Nafta is the villain. In fact, Nafta did little to reduce tariffs on Mexican manufacturers, notes Matthew Slaughter, a Dartmouth economist. Those tariffs were already low before the agreement was signed.

And yet candidates on both sides of the aisle have cited trade as a major concern for the American economy. Some even promised to bring manufacturing jobs back to Michigan. However, this stance misinterprets the structural changes the American economy has experienced over the past twenty years.

The focus on trade shifts our attention away from the real factors that determine wage inequality and job creation, particularly technology and skills. Austan Goolsbee, Obama's economic adviser, estimates that roughly 80% of income inequality in the US can be explained by changes in technology. Highly educated workers have benefited disproportionately from technological change. In 1980, college graduates earned on average 30 percent more than those with only high school diplomas. Today, that difference has widened to 70 percent. Over the same period, the average earnings of people with advanced degrees went from 50% more than workers without degrees to 100% more.

Unfortunately, stoking trade fears is a cheap and effective means for politicians to seem like they're "doing something" about the economy. Congress can easily derail CAFTA or some other trade agreement if voters are concerned. The impact any one such deal would be slight to the American economy. But if voters are really concerned about jobs, they shouldn't look to protectionism as a solution. The only way to change trends in job creation and income inequality is to improve the skill level of the American workforce; and this can only be achieved by reducing educational inequalities. But that's a big task. It's much easier to blame people who talk funny.

Rise of the machines, or how I learned to stop worrying and love trade

It's been a tough election cycle for proponents of trade. In particular, Hilary Clinton and Barack Obama turned the Democratic nomination race into a contest to see who hates trade the most. While campaigning in Ohio a few months ago, Obama declared:

"One million jobs have been lost because of NAFTA, including nearly 50,000 jobs here in Ohio. And yet, 10 years after NAFTA passed, Sen. Clinton said it was good for America. Well, I don't think NAFTA has been good for America -- and I never have"

Now Obama, the Democrat's presumptive nominee, has proposed a tax credit that is aimed at keeping jobs from moving overseas.

Why all the focus on trade? The concerns center on the decline of manufacturing employment and stagnant wages for blue collar workers.

Are these concerns warranted? Economic theory indicates that trade with developing countries could put downward pressure on wages for poorer Americans. However, empirical investigation of this issue has suggested that this effect is not that large. A recent book by Harvard economist Robert Lawrence shows that the gap between white- and blue-collar workers has not risen that much since the late 1990s when China's global integration accelerated and that the wages of the least skilled have improved relative to those in the middle. (see here for a larger discussion of these issues).

A large part of the problem here is disentangling the separate effects of trade and technology. Wages are closely tied to productivity. The main reason that American workers earn more money than their Chinese counterparts is that they produce more stuff in the same amount of time. Of course, one of the main factors that increase productivity is technology.

However, technology is a double edged sword. While technology raises productivity (and thus wages) it also eliminates many jobs. Consider this: despite losing 4 million manufacturing jobs between 1998 and 2007, US manufacturing output increased by 22%. Thanks to machines, we can make more stuff with less people.

What's interesting is despite the fact that technology has much more effect on manufacturing jobs than trade, politicians are not warning us against the impending robot threat. None except Arnold Schwarzenegger that is. And yet trade and technology have essentially the same impact: greater economic efficiency, which leads to lower prices and higher standards of living.

Politicians railing against technology would be laughed at as kooks. Certainly John McCain, who is already dealing with concerns about his age, wouldn't want to seem anti-progress. No one would support a tax credit for business that avoid using computers or other machinery.

However, unlike technology, foreigners represent salient fear for the public. Bryan Caplan has written extensively on the issue. There is a tendency to talk about trade with other countries in terms of it being a "race" or a "war", when in reality trade is mutually beneficial. Further, trade is a policy that politicians can change; technology is something they have less control over. So even if they have the same impact, it is more effective for politicians to rail against cheap labor in southeast Asia than to hate those adorable robots.

The good news is that we really don't need to fear either. Trade creates new economic opportunities and lower prices, which raise living standards. And recent research has shown that trade actually increases the purchasing power of the poor more than the rich, helping to stem inequality. Technology has largely the same effect. Despite the loss of 4 million manufacturing jobs over the last 10 years, unemployment has remained fairly constant. Technology may eliminate some jobs, but it creates many others.

So don't hate trade. And don't hate the machines either. Both improve your life in countless ways you don't even see.