Cheaters, Saving, and Investment

It is easy and perhaps even fun to describe the US balance of trade as born of cheaters and clearly unfair to US workers. The logic seems simple and intuitive. We are a great nation, and yet we import more goods from other countries than we can export to other countries. If trade was perfectly fair, then, of course, Americans could not lose. After all, we are smart, educated, attractive, competitive, and whatever else you want to add. How could we possibly be so uncompetitive? Surely those other guys are cheating. End of story. Where is my celebratory JD?

Not so fast. Economists have another explanation, and it has to do with how much a country saves and invests. Whammo, the intuition vanishes and the reader is pretty sure that economists are from another planet. In defense, I will point out that intuition has an advantage when people decried the Earth flat. From anyone’s vantage point, the world did not look round. This “saving and investment thing” lacks intuition but that doesn’t make it wrong.

One more point. Some friends have told me that maybe saving and investment do matter to the trade balance – but there is no way to get Americans to consume less and save more. While it might seem like an uphill climb, the data in the table below suggest that the USA is an outlier. When compared to other countries and other regions of the world, we are second-class citizens of saving. Maybe if people understood that this imbalance is truly a problem we might begin to do something about it. If the choice was between a devastating trade war and inducing Americans to save more, might one not entertain policies to raise saving?

To review: If a nation spends more (and saves less) than its ability to produce then it will import the difference. Or put another way, the paucity of saving means that firms and government will have to draw in or borrow foreign money to meet its spending needs. This capital inflow raises the value of the dollar, increases imports of goods, and reduces exports of goods. Viola. A lack of saving leads to trade deficits in goods.

What do the numbers in the table show you?

First, I have 15 countries and regions listed in the table (data taken from an International Monetary Fund report). The highest saving rate among those 15 in 2017 was the 40.5% of GDP for emerging Asia. Just below are Japan and Germany with respective saving rates of 27% and 28%. The lowest in the list is the United Kingdom at 13.4%. At 17.5%, the US was in the third place from the bottom. We clearly do not save very much. I knew that Japan saves more than us by a long shot. But so do 12 of the 15 in the table. The average for all developing countries was 31.7%, and for all advanced countries, 22%.

We do better at investment. The almost 20% investment ratio for the US is bigger than our desire to save.  But in looking down the list, our investment ratio is bigger than only Germany, Italy, UK, and Sub-Saharan Africa. The average for developing countries was 32%; for advanced 21.1%. So we are a laggard when it comes to both saving and investment. Does the low saving retard investment?

What really matters for the trade deficit is how short our saving is relative to investment since that gap is the key to capital inflows as explained above. Half of the regions included have negative saving ratios – meaning that saving is less than investment and those countries will have capital inflows and trade deficits. Our saving deficit of 2.3% of GDP puts us in the middle of those countries with the (negative) deficit sign. So it looks like we are in the bottom third of the whole group when it comes to saving insufficiency as a percent of GDP.

If so many of these countries can have adequate savings, then why can’t we in America? Do we really need all that crap we buy? Are there no policies that might improve incentives for saving? 

Table. Saving and Investment as a Share of GDP, 2017

USA and Selected other Countries and Regions

	Saving	Investment	S-I
United Kingdom	13.4	17	-3.6
Sub-Saharan Africa	15.3	18.7	-3.4
USA	17.5	19.8	-2.3
Italy	19.6	16.9	2.7
Canada	19.9	23.3	-3.4
Advanced nations	22	21.1	0.9
France	22.1	23.1	-1
Spain	22.5	20.6	1.9
Emerging Europe	22.5	24.8	-2.3
Middle East, Africa, etc	25.2	26.8	-1.6
CIS	25.6	24.3	1.3
Japan	27	23.4	3.6
Germany	27.6	19.4	8.2
Emerging and developing nations	31.7	32	-0.3
Emerging Asia	40.5	39.6	0.9

10,000 Tariffs

In working on my last post about import villains, I stumbled across an incredible realization. Steel and aluminum are just the tip of the iceberg. Most of us mere mortals have not tried to explore the labyrinth of information called the Harmonized Tariff Schedule (HTS) where we list all the tariffs levied against our trading partners. My reaction to perusing that schedule is a lot like the feeling one gets when they first try to understand all the notes on the neck of a guitar. Yikes, I didn’t realize all those notes were in so many places! Luckily, on a six-string guitar in one octave, there are only 72 places for notes.

The HTS contains 22 sections of goods categories broken into 99 chapters covered on 3,710 pages including over 12,000 import tariffs. Are you kidding me? I didn’t even know there were 12,000 goods.

What’s my point? My point is that a trade novice evaluates or judges the change in the tariff on steel imports without any real understanding of the whole tuna. Imagine such a novice who thinks that we don’t have many tariffs and that a 25% tariff is weirdly high or unusual. In that case you might come to one kind of conclusion about steel and aluminum. I am tired of typing steel and aluminum so let’s just say S&A.

But now, after a fascinating morning with my friend Google, I know there are more than 12,000 goods tariffs. One of them is the 127% levied on Chinese paper clips. Paper clips! I found examples of very high tariffs including those on canvas sneakers, leather and foot ware, synthetic yarns, canned tuna, and a large variety of lovely foods from the EU including cured ham, truffles, oats, and mineral water.

Inasmuch, a less naïve person would interpret the newly increased S&A tariffs in a different light. A 10% or even a 25% tariff is neither startling or unusual. That does not mean I am supporting or advocating these new tariffs – it simply means we need a more realistic approach to evaluating them. From the reactions in the press, you would have thought that CNBC had purchased Fox Business News. Not so.

These new tariffs are really like a blip in the ocean. Given all the tariffs we already have on imports, I doubt these new tariffs are going to drastically change those 3,710 pages. But it is interesting that among all those 12,000 goods that somehow S&A avoided a tariff and that past attempts to levy them had been so unsuccessful.

Why do we have so many import tariffs? Is the world so unfair to the US that we had to slap on tariffs to be competitive and save US jobs? Or is this more of the same game of government spoils that is applied so routinely by companies within our borders? The government has a lot of elected officials with lovely salaries and benefits. Perhaps we have so many protections because it pays well?

I am asking more questions than I am answering. But this thing with S&A really opens a much bigger set of questions once we view it in a wider context:

Why have we not had tariffs protecting S&A when we protect so many other industries?

What does any of this have to do with US national security?

How many of these 12,000 existing tariffs improve national security?

How many other goods should have tariffs because of national security?

Do we really need any tariffs to protect national security?

How can we preach the values of competition when we seem so far from the ideal?

While the WTO made initial progress in removing barriers to trade, why is the Doha Round dead after so many years of negotiation?

Have we given up on the idea that reduced trade barriers are good for the global economy?

Where is my JD?

Import Trade Villains

The President correctly pointed out that the US has large and persistent trade deficits. Those deficits have mostly to do with goods traded since we have a surplus in services. He then decided to put some import tariffs on steel and aluminum. Apparently, after his trade gurus spent a lot of time poring over the data, some of them recommended that iron, steel, and aluminum deserved our attention -- and therefore some protection. It does not take a genius or a phone call to your local steel mill to learn that employment in those industries has been hurt. If I was a steelworker, I would be happy that the President was willing to help me.

But the connection between US persistent large goods trade deficits and these new tariffs is lacking and I am wondering what those gurus were smoking when they advised our President on how to solve this pressing trade imbalance using tariffs. They must have known that the US has already set in motion more than 100 cases within the World Trade Organization to overturn unfair and illegal trade practices in China and other countries. But I guess that wasn't getting enough attention, and they thought that starting a trade war would be a better approach.

Today I want to show you some data that I obtained from my secret contract in Moscow. Just kidding. I got this data from a perfectly legitimate organization called Facebook. Just kidding again. I got it from the US Census Bureau at https://www.census.gov/foreign-trade/Press-Release/current_press_release/index.html.

The Census breaks down US goods imports and exports into five major categories which you will find in the below table. The negative signs in the third and fourth columns show you that the US has a goods trade deficit in EVERY one of these main categories. So when it comes to laggards in trade -- blame all of them. Steel and aluminum -- the two main categories for the new tariffs -- are found as very small parts of Industrial Supplies. While imports are larger than exports for Industrial Supplies, notice the difference is tiny compared to the trade deficits in Consumer Goods and Vehicles.

How one could have looked at that table and decided to single out steel and aluminum, I can't fathom. If trade deficits are bad and hurt US workers -- I think I might have started with Japan and Korea -- those terrible places that sell us things like Hondas and Hyundais. By the way, if you look more closely at Industrial Supplies the key import villain is not steel or aluminum. It is crude oil.

If you want to know the full set of villains the following list shows you the worst offenders in January 2018 for each of the five categories. I chose the worst villains because they contributed more than 10% to the imports of each of the main categories. Notice that you can't find steel or aluminum in this list of villains:

1. Fish, shellfish, fruits frozen juices
2. Crude oil
3. Telecom equipment, computers, computer accessories
4. Passenger cars and parts
5. Cell Phones, pharmaceutical preparations

If we went after all the countries that sell us all that stuff, that would be a real trade war. But what's the point? What if we won a trade war? Where would they get us?

There is an answer to all this and some economists spout this information regularly even though it puts more people to sleep than Benadryl. I am not shouting but I will put this next sentence in all caps. WE HAVE PERSISTENT TRADE DEFICITS IN THE USA BECAUSE WE MAKE MISS PIGGY LOOK LIKE A VEGAN. WE SPEND TOO MUCH AND SAVE TOO LITTLE. Are you asleep yet?

Those awake might protest. You might ask: What does spending and saving have to do with persistent trade deficits?

Answer 1: When a country consumes more than it produces, it must buy goods from outside the country.
Answer 2:  When a country saves too little, domestic investors have to find savers elsewhere. When foreigners buy US assets they first have to buy dollars, driving the value of the dollar higher, imports higher, and exports lower.

If we are really serious about reducing trade deficits in this country, the way forward is simple. Stop all this stupid trade war stuff and implement policies to do two things:

1. Raise output relative to spending.
2. Raise saving relative to investment.

QED.

Table 2017 Goods Trade Data  (Census Bureau)
In Billions of Dollars				Net Exports
			Net	as %
	Exports	Imports	Exports	of Exports
1. Foods, Feeds, Bev,	132.9	137.8	-4.9	-3.7
2. Industrial Supplies*	462.9	507.6	-44.7	-9.7
3. Capital Goods	532.8	640.7	-107.9	-20.3
4. Auto. Vehicles, etc	157.6	359	-201.4	-127.8
5. Consumer Goods	197.8	602.2	-404.4	-204.4
6. Other Goods	62.8	95.6	-32.8	-52.2
Total	1,546.8	2,342.9	(796.1)	(51.5)

* Industrial Supplies includes iron and steel products and aluminum

Tariffs and Courage, Guest Post by Charles Trzcinka, Professor of Finance, Kelley School of Business, Indiana University

My brother is losing his job this month because of foreign competition. At his age and with his roots in the community where he lives, it will be a struggle to replace the income. He is exactly the person whose life experiences should drive him to support the protectionism that is flowing out of the White House. He does not. He makes all arguments that economists make about tariffs costing far more than the benefit and weakening the industries that are protected. He certainly is on solid ground. Arguing against free trade is like arguing against evolution. The scientists have accumulated so much evidence that the arguments for protectionism are taken as a demand for welfare or a demonstration of a psychological problem. Moreover, in the case of trade, there is 200- year history of building our economy with free trade— that is having lower tariffs than anyone we trade with. Tariffs are also very anti American who compete in markets around the world. I was in Hungary just after the fall of the communist regime when a British CEO told me that “everywhere in the world where there is money to be made, you will find an American”. Even our universities have benefited from global competition. Unlike, profit-making firms, universities have long had virtually unlimited H1B visas which means there are much fewer restrictions on immigrants. In principle, the result has been lower wages and in practice it has resulted in more competition. The free trade in ideas and people has given Americans far better universities which by any metric are the best in the world. This story repeats in many industries.

We now have an administration that uses rhetoric to encourage the worst protectionist views. President Trump thinks that all trade agreements are “unfair”, that the World Trade Organization is a waste of time, and that trade deficits show that other countries are “taking advantage of us”. In imposing steel and aluminum tariffs, the White House has politicized trade policy and opened itself to furious lobbying efforts. The policy has become more “carve outs galore” than a coherent trade effort.

Ronald Reagan and George Bush used tariffs as a threat to open markets and reduce trade barriers. If the Trump administration moves in this direction it will be strong positive factor for the economy. However, the simplistic statements from the White House have united economists who know that the facts and logic are strongly against these views. While economists differ on how much China cheats and what should be done about it, virtually nobody thinks deficits show anything other than low savings and all agree that trade has built the wealth of this country. Economists who make these arguments often do not have much “skin in the game” and some argue this makes them wrong. Not having a stake in the argument tells us nothing about the truth of the argument and it is too easy and cheap to dismiss the argument for free trade based on who is saying it. Still, it is courageous for someone who is losing his job to agree. My brother is an example of an American who takes personal responsibility seriously and doesn’t look to broad trade protection to save his job. He doesn’t let his personal experience distort his views. Neither should anyone who thinks and votes on the question of tariffs. There are winners and losers for every policy decision and the protectionists need stop imaging a fantasy world where there are no trade-offs. We have built this country with free trade and there is no case for ending it with broad tariffs. Just ask my brother.

Nero Fiddles as Rome Burns

As I was writing last week’s post about Macroeconomic Fuzziness, it occurred to me that there are some things that are not so fuzzy. It not only made me think of Nero but also reminded me of a book written by Herman Hesse titled Journey to the East. A traveler boards a train taking him to a very clear destination. During his travels, however, the traveler gets off and on the train. Somehow the destination got obscured each time, and he found himself lost or moving in the wrong direction. Luckily, he found his way back to the train and moved again towards his destination.

Hesse was writing about spiritual things, but this story says much about macroeconomic policy. There is nothing so fundamental to survival and standard of living as economic growth. Whether the location is Catalonia or California, the truth is that economic growth makes everything easier. This should not be interpreted to say that economic growth is everything. It isn’t. But it is to say that without economic growth, everything else struggles. When the economic pie is growing, we might fight over our share of the increase, but when the economic pizza stays the same, the only way for Jim to get more is for Toni to take less. Like Hesse's traveler, we often get lost and forget that growth is so critical. 

Inasmuch, it is important to keep economic growth on the front burner. It does not have to grow at a lightning pace, but it does have to grow enough to keep us out of each other’s hair. Nowadays, we keep referring to populism. I looked at a couple of definitions of populism and they contained the words “ordinary people”. Populist policy is aimed at improving the lives of ordinary people. It follows that economic growth is a perfect part of populism because there is no way to improve the economic situation of ordinary people without it.

Yet, we hem and haw. Sometimes Republicans appear to be helping rich people at the expense of ordinary people. Sometimes Democrats appear to be assisting minorities at the expense of ordinary people. And these Republicans and Democrats often have good reasons to be doing these things. But if they go too far and ordinary people are injured, then they make their complaints known. And so, we get back on the train and head in the right direction.

That brings us to our present government. I am told repeatedly that this government is populist. But I don’t see it. I do see some smatterings of policy supporting economic growth. I applaud those. But then I see just the opposite. Most recently, the proposals relating to protectionism seem to fly in the face of economic growth. I can’t find a single rational explanation for why one would want to save a few thousand jobs (steel and aluminum) in America while at the same time destroying tens of thousands of jobs (drink and auto manufacturing and other users of steel and aluminum) in America. 

Maybe the political optics of helping some manufacturing workers seems attractive to some politicians but surely this cannot help economic growth. If other countries retaliate against the US, then the gloom spreads to many other US firms that export to those countries.

Or better said, how does protectionism fit the description of populism relating to ordinary people? Or worse, how does protectionism fit in with anything good for the USA?

This story is not hard to understand. Local manufacturers of steel and aluminum want less competition. They want to be freer to charge higher prices. To whom do they charge these higher prices? They charge these higher prices to all those companies in the US that use steel and aluminum to produce Miller Lite beer and Ram Macho Power Wagons. Then these companies pass along these cost increases to ordinary people. But let’s not stop there. Our tariffs on foreign products make countries like Canada and Mexico wonder what it means to have a free trade agreement. Any country wounded by these tariffs will ponder assessing similar taxes against products from the USA. So guess what happens to ordinary people who work to produce goods going to those countries?

The world is a tough place. Companies and countries cheat and skirt the rules of international trade. It is always easy for a politician in any country to promote protectionist policies. But do they really work? We have had subsidies against imported steel in the past. Yet steel is still not viable and needs yet more protection.

I looked at employment data from the Bureau of Labor Statistics for the primary metals industry. These numbers include employees in the production of iron, steel, and aluminum. Clearly, this is an industry with declining employment. From 1990 to 2017, the number of jobs decreased by 317,000, or 46%. During that same time, all US manufacturing jobs declined by 5.2 million, or 30%. All private sector jobs in the US, in contrast, increased by 33 million, or 36%. It makes one wonder what can be done in the way of tariffs and protectionism to an industry in job decline for more than a quarter of a century. If protectionism is our game, then how do we best help ordinary people?

That brings me to my final point. There are ways we can create growth. There are ways we can augment and develop a skilled labor force that is the envy of the world. But guess what? The more we get diverted into arguing about the pros and cons of protectionism, the more time we are wasting with respect to moving this parade forward. Is anyone seriously putting forth proposals to permanently expand employment opportunities in the USA today?

            Year               Primary Metals

                                    Employment

                                    In thousands

            1990              689

            1995              642

            2000              622

            2005              466

            2010              362

            2015              392

            2017              372

https://data.bls.gov/pdq/SurveyOutputServlet

The Marx Brothers International Trade Policy

If you didn’t notice, two weeks ago we had some name-calling and hair-pulling in this quiet little blog. What fun! Chuck T posted a guest blog that argued against protectionism, and this energized the Tuna to take the other side. The battle was on, and I was among a few others who jumped into the fray. Along the way I was accused of being a two-handed economist, and after I figured out what that meant, I decided I needed to keep pursuing this topic. Two-handed economist indeed! 😊

The last time I looked, I had two hands. The issues of hands and economists apparently started when President Harry Truman got fed up with economists who couldn’t make up their minds and he demanded a one-handed economist who would not say on the one hand this and on the other hand that. He wanted someone who would take a firm position one way or the other. He realized that all national policy topics were multifaceted and wanted an economist who would weigh all the important elements. But he wanted someone who would then take a stand. Be on one side or the other!

So I am going to do that today. International trade and the benefits of trade are definitely complicated and multifaceted. No question. But this one-handed economist has little use for recently posed ideas about trade and trade policy.

But let’s start with the apparent problem with trade. Widely quoted data show that manufacturing employment in the USA has declined. They also show a deficit in our trade account and many stories corroborate that companies have moved their production abroad attracted by apparent favorable business conditions. These conditions might be lower wages or tax rates, but they also include closer locations to key parts of their supply chains, including materials or proximity to rapidly growing customer markets.

Some argue that policies that would thwart either imports of goods or the relocation of US firms will solve employment problems in America. A novel recent policy proposal would essentially make trade part of corporate taxes – wherein any export of goods from America would not be taxed while all imports would be. This pretty much reverses what used to be and would greatly favor firms that export from the USA. A second but complementary policy would somehow prevent other countries from depreciating their currencies so as to favor their exports in world markets while damaging US exports. A third policy would aim America-first principles at past and future trade agreements. Let’s call this set of three policies the Marx Brothers (Harpo, Chico, and Groucho).

There is much intuition to these polices. On the surface they seem to directly improve the situation. If other countries can’t cheat, this will help US export sales and jobs. If America matches subsidies given to exporters in foreign countries with similar subsidies at home, then those companies will have higher sales and employ more workers. If America penalizes companies for moving abroad, then even more jobs would be preserved at home. If past US trade negotiators “gave away the factory,” a new group of negotiators can get the factories back.

But just as a sticking one’s finger in the hole in a leaky dike sounds good in a moment of panic or frustration, such an act endangers the dam and all that live below it. What we need is a policy that works – not one that sounds like it might. So let’s think about what’s wrong with the three Marx Brothers.

First, economists who have studied the new tax proposal believe it will cause the value of the dollar to rise enough to offset the impacts of the tax incentives on the trade deficit. Thus, the desired remediation would be at best temporary. In addition, a permanent increase in the value of the dollar could make potential producers wary of locating in America, because it makes investment in the US more expensive. If they project a continued rise in the dollar that makes America a great place to import and makes it more expensive for foreigners to locate in America. 

Second is retaliation. A quick review of figures shows that US exports of goods and services is a mere 13% of US GDP. While we think this is large, exports are much more important to key trading partners. World Bank data for 2015 includes these ratios. Japan exports 19% of its GDP, China 22%, Canada 31%, Mexico 35%, Germany 47%, Vietnam 124%. Some might say Aha!  But that Aha! misses the point. These are countries whose medium-term survival is predicated on export success. They will not quietly nod as the US employs a new policy that threatens to harm their exports. They will retaliate quickly and with gusto. They will make it very difficult for their citizens to purchase US goods.

Third, it is possible that a new team of negotiators will do better with respect to past and future trade pacts. But keep in mind that the new team will be faced with increasingly motivated adversaries and a single unbending truth. The truth is that all sides to an agreement want the best for their own country. In doing so they have to make tough decisions because they know that every negotiation requires one to “give a little” to “get a little.” As in the above discussion about taxes and trade, the US is not going to be the only player in the room.  If the US wants to open services markets, protect intellectual property on foreign shores, or ask countries to reduce non-tariff barriers against US goods,  the US is going to have to give something up. If the US wants lower foreign tariffs on some of our manufactured exports, we may have to lower the tariffs on some of their manufactured exports. Whatever they choose, these negotiators will not be coming home with only trade benefits.

Finally we might need to come to grips with the idea that we are in a difficult transition, and whatever policies we impose to restore things to ways they used to be might work in surprising ways. Be careful what you wish for. 

We can close our borders to wonderful products produced abroad. Recall the cell phone took off when a Finnish company named Nokia made our lives incredibly better. We can make it unprofitable for US companies to locate abroad – when they are already not producing good results in the USA. Or by preventing our companies from locating abroad, we can deny them opportunities of innovation-sharing. If we are not careful, we will get what we ask for:  things like they used to in 1954. Aside from the TV show Father Knows Best, I think I like 2017 better. 

The Marx Brothers  and other America-first trade policies are most definitely not a slam dunk. Working to root out cheating. Trying to update relationships to current realities. These and other approaches are necessary, but even modest changes can backfire if not approached correctly. In today’s hypersensitive world with leaders who speak in riddles – even the smallest of changes can evoke recollections of Attila the Hun and reactions that go beyond the pale. Walking on egg shells is a better way to go. Meanwhile, we in the USA must figure out how a very rich country can grow and prosper as we fit into the world economy of the next 100 years. 

Trade

You don’t grow bananas or manufacture your own shirts, and Bill Gates doesn’t do his own typing. That’s called the benefits of trade. There was a day when people were mostly self-sufficient. Families grew their own crops, chopped wood, made their own clothing, and so on. But we don’t do that anymore. True, we are all getting fatter as a result. But we are also getting richer too.

The change from self-sufficiency to trade came gradually, and now we don’t think about it. Today is an age of specialization and trade. Most of us are plumbers or accountants or bartenders. We earn incomes at our specializations and use our incomes to buy whatever we need or want. In Tuna’s case, that would mean luxurious vacations for Pat. We don’t think of it this way but what we are doing is benefiting from the activity called trade.

We benefit from trade mostly because of what some whacked out economists call comparative advantage. Bill Gates is really good at what he does for a living. Suppose he is worth $1 million dollars a day in the marketplace. Should he do his own typing? I think not. If he spends a day typing, he loses $1 million and gains the average wage of an administrative assistant. It wouldn’t make sense. And of course, trade doesn’t just help Gates. Some people cannot make business decisions and are not valued at $1 million a day. Some people are really good at being an administrative assistant. Those people are delighted that Mr. Gates needs their services. They happily trade with Bill Gates.

It is true that the administrative assistant might earn $30,000 per year. But that person cannot pawn himself off to a company for more. That person is probably quite happy to find employment for what he is good at. In trade, people willingly enter into agreements, and both parties are advantaged by it. This goes on every day. 

We live at a wonderful time when all we have to do is want something and someone else is there to make it or sell it to us. Of course, we have to uphold our end of the bargain and make sure people value what we do, so we can earn the money to buy all those other things.

That’s pretty simple. But it all goes haywire when we go from talking about Nathan and Christina to similar trade between the US and Mexico. You see, trade is trade, whether it goes across a national boundary or not. The same principles apply. Nations have always traded. Even dinosaurs traded. Trade works because a nation can produce and sell things in which it has an advantage and buy things in which it has no advantage. In doing so, all countries benefit.

Back to benefit. Recall Bill Gates and his administrative assistant. Both of them enter into an agreement willingly and gain from it despite the fact that one is a lot richer than the other. Some people believe that some countries are always harmed by trade. These countries are poor and get taken advantage of. That may sometimes be true but what is also true is a country’s poorness often gives it great advantages in trade. Think of why we richer nations buy things from places like Vietnam. We buy because they have learned production techniques and combined that mastery with employees who are used to living on very low incomes and wages. It might not seem fair to some of us, but if you are from such a country and a new trade deal makes you MORE valuable, you are less inclined to envy the rich and more inclined to take advantage of a higher income and standard of living and perhaps better job security.

Trade is good and makes both parties better off even if it doesn’t make them equal. The problems come when one or more of the parties to trade receive actual benefits that are less than expected. Unintended effects of trade can occur for many reasons. Some reasons are real and can be addressed. Other problems are made up or simply contrived for political purposes.

For example, Bill Gates might suffer business losses because of a new competitor. He might blame his administrative assistant despite the fact that the assistant was not the real problem. So he reduces the wage of his assistant or fires him. Clearly, if the real problem is a new business competitor, firing the assistant accomplishes nothing and sooner or later we find out the truth of the matter.

In the US today, we are rethinking trade. We have trade deficits with the world and with specific countries. We are about to say “You are fired!” to these trading partners. How much of these trade deficits are in fact the direct results of freer or unfair trade? How much are caused by ourselves, or at least things out of control of our biggest trading partners?

I don’t have all the answers but I can offer a few. One answer comes from macroeconomics. We in the US love to spend. We love to buy goods and services. Apparently we can’t make enough to satisfy our love of buying, so we have to import. Maybe if we saved more that would help. Furthermore, we find ourselves in a time when the US economy, despite a lumbering pace, looks stronger than many of our trading partners. We have more ability to buy from them than they from us. None of this has to do with cheating, and none of this argument can be solved by US protectionism.

Another answer has to do with a realistic assessment of economic transformation in developing countries. When we made trade agreements with these countries, we made them with the full knowledge that they were transforming. Transformation is neither easy nor quick. When the Soviet Union collapsed, I recall economists saying that it would take 30-40 years for countries like Poland (not in the Soviet Union) and Latvia to approach rich country status.

What’s the hang-up? The problem is that subjecting a country that was centrally planned for decades to the rigors of competition is rough. You can’t wave a magic wand and privatize very inefficient companies that have little experience with competitive markets. Likewise you can’t overnight liberalize prices of all goods and services when many prices were kept at a very non-economic low.

Rapid privatization of companies can lead to large-scale unemployment and liberalization of prices can cause drastic increases in prices. Any country engaged in these and many other transition policies understands the social/economic upheavals associated with change. Nevertheless, they do it because of the eventual benefits transformation promises.

Richer countries know this, and trade agreements were made with the understanding that many of our important trading partners have government-owned companies and government control over prices, wages, and many other things. To say today that country X unfairly subsidizes its industry Y makes no sense. The word subsidize makes no sense in the context of a transforming nation.

Are we all wrong and are they all right? No. Maybe we do need to reopen some trade agreements. After all, some of them are old, and times have changed. But in doing this we need to remember a few things. First, some of these problems we bring on ourselves because we probably won’t ever produce enough to satisfy our appetite for goods and services. Second, some of the problems will go away when economic growth in other countries returns to something more normal. Third, developing countries are still developing. They have very low incomes. They are in transition. 

Putting unrealistic pressures on them only weakens them. We don’t gain by weakening the people who we want to buy our goods.

Trade is good. Trade agreements can be reopened. But there are clear limits to what can be accomplished without changes in our own domestic policies. 

Manufacturing Employment by the Numbers

The populist shift in the world these days seems to be driven in large part by employment. In the USA, the lament seems focused on manufacturing employment (ME). So I decided to take a little trip down memory lane to see what has happened to US ME, especially within the context of a little history, globalization,  and NAFTA. As you might guess my conclusion is that the data does not support the idea that trade, unfair or fair, is mostly responsible for robbing the US of its manufacturing prowess and employment.

Has US manufacturing employment declined? Yes. See the table below. In 1948 ME was about 14.3 million workers and represented almost 25% of the US workforce. But that was a long time ago and I hadn't even heard of JD then. ME grew after that and peaked in 1979 at 19.4 million workers. But already – before globalization – ME had fallen to less than 20% of the US employment in 1979. Point – a downward trend had begun without globalization or Nafta. Between 1948 and 1979 ME fell from one-quarter to one-fifth of US total civilian employment.

Even 1979 was a long time ago. At that point I was mixing JD with Coke and grooving to disco music. Between 1979 and 1994 the number of MEs fell from 19.4 million workers to 17 million. By 1994 ME was down to 13.8% of total employment. So before Nafta or before the fall of the Soviet Union (1991) could impact trade very much, ME was down to less than 14% of all US jobs. Note the fall from 25% to 20% to 14% from 1948 to 1979 to 1994.

It took another 12 years to push ME down even farther. By 2006 and just before the world economic crisis, US ME has fallen to 14.2 million workers and accounted for just under 10% of all employment. So in those 12 years ME fell by another 2.8 million workers and by another 4% of the total employment.  This was the time period in which NAFTA, the opening of China (in the 1990s), and other major global forces were in full bloom.

But it would be exaggerating the truth to say that globalization was responsible for all of the ME declines between 1994 and 2006. For example, whatever was causing firms to replace workers with machines before 1994 was surely still operating after 1994. And another important cause of falling ME was recessions. After the recession in the early 2000s, ME fell from more than 16 million to about 14 million workers. After the 2008 recession ME fell from about 14 million to about about 11.5 million. We expect many of those jobs to come back if and when the economy regains its former strength. But for now recession aftermath continues to impede ME.

In 2015 ME was down to a humble 8.3% of total US employment. That’s a steep fall from the 25% it garnered in 1948. During those years many factors were impacting ME in the USA.  Equipment, robots, and other capital improvements have displaced labor continuously. Globalization has caused some US producers to move offshore and has allowed other countries to compete for US consumers, thus displacing workers. Recessions always caused temporary declines and they continue to do so.

ME employment fell from its peak of 19.4 million workers in 1979 to about 12 million recently.  It is not easy to decompose that decline and to know exactly how much of it was caused by globalization.  Conversely it is not easy to say by how much globalization increased ME in the USA. Surely as foreign firms have geared up to compete internationally US business productivity has benefited by importing new capital, parts, and assemblies—making US firms more competitive and allowing them to expand output and employment in the USA.

Don’t be easily persuaded to think that globalization and free trade agreements have decimated US ME. Note that ME in 1948 was not the major US employer. Even back then ME accounted for only 25% of jobs. It is true that ME declined to 12 million jobs today. But the numbers say that globalization is only one of  many things causing US ME to decline. It is foolish to think that extreme nationalistic and protectionist policies will do anything to stop or restore these changes in US economic structure.

Table. Manufacturing Employment (ME)
Selected Years since 1948

Year    Millions  % of Total Employment
1948      14.3               24.5
1979      19.4               19.7
1994      17.0               13.8
2006      14.2                 9.8
2015      12.3                 8.3

The Gravity of Globalization

Much is being written lately about globalization. Free traders love to see more cross border activity. Non-Free traders wish international trade would be less prevalent. Belgian Walloons tried to stop a free trade agreement between Europe and Canada. I was once in Seoul when a monk set himself on fire and died to protest the coming FTA between S. Korea and the USA. Free trade and globalization have become a central focus in the current US presidential campaign.

Much of the debate has to do with politics and ideological warfare applied to trade. But it helps to know that there are basic economic forces to explain both the rise and the fall of globalization. These basic economic forces have been described by using something called a gravity model. Gravity is the force that attracts a body toward the center of the earth or toward any other physical body having mass. As Charlie would say – gravity is the thing that keeps us from falling off the earth. It is also the thing that causes bird poop to come down on unsuspecting heads. The pull of gravity between two bodies is proportional to the masses of the bodies and inversely proportional to the distance between them. Two large bodies close by have a lot of gravitational pull. Two distant small bodies would have little pull.

Economists have applied gravity models to economic issues. St. Paul and Minneapolis are two cities in Minnesota. Bloomington Indiana and Palo Alto California are also two cities. A gravity model predicts that there would be more trade between the larger close cities St. Paul and Minneapolis than between the smaller distant cities Bloomington and Palo Alto. To apply this basic theory to globalization we need to better define the terms mass and distance as they relate to trade.

Mass refers to economic size but it should be the relevant economic size. For example, if two distant small cities were very specialized art centers – then you might expect a lot of trade in art objects between those two cities. Or if two large close cities had a mountain in between them, then that object might impede trade between the two. Dig a tunnel or build a road through the mountains and the situation changes. Much more trade would be expected.

These ideas are easily applied to globalization. While the physical distance between countries and cities did not change in the 1990s, the distance measured in economic terms did. For one thing technology great reduced the costs of communication and transportation in the last 25 years. For another, the fall of the Soviet Union and the demise of many dictatorships in Latin America allowed people in dozens of countries the legal right to trade. Technology and political change were tantamount to pulling nations much "closer" together or removing a mountain. As they came closer they discovered the benefits of trade.

Harvesting low hanging fruit is easy. But once the easy to reach apples are gone, you need a ladder to get the higher ones. The picking process gets more challenging and more costly the farther up you go. The same happened with globalization. It was easy to get rid of thousands of tariffs. Those tariffs hindered growth in most countries so the politics of tariff removal were easier. When world economic growth picked up and countries dropped many trade restrictions, it seemed like most people in most countries benefited. Today it is harder to see how technology or politics would change again so dramatically so as to make international trade even more seductive. It was hard to see the things that might change in the future that would make serious dents in the costs of distance.

And then it got harder to agree on liberalization. The tariffs that were left (on the higher branches) were the ones that offered protection to a country’s farmers or steel makers. But tariff protection was not enough to satisfy some free traders. If barriers to goods could be beneficial, then why not remove obstacles to trade in services (like airlines, banking, healthcare, and so on)? If restrictions on cross-border investing and mergers and acquisitions seemed unfair, why not remove those barriers too?  If laws did not protect ones ownership of intellectual or other property then why not make it harder for foreigners to easily pirate your patents and copyrights?

Once the low hanging fruit was gone, the remaining trade barriers were much harder to remove. With no earth-shaking transportation/communications inventions expected it is harder to convince voters of the needs for freer trade. This is why the so-called Doha Round of the World Trade Organization remains unsigned though negotiations started in November 2001. The average person says something like – yes, we want the benefits of trade but we do not want to be exactly like other countries. We don’t want a one world government. We don't want our our national champions weakened. 

Inasmuch the advancement of free trade and free trade agreements has become even more political and ideological. As we move to closer economic integration, the benefits of the potential trade are fuzzier and the costs of trade in terms of reduced national independence and stability seem scarier.

Further global trade integration is not impossible. It is just tougher. It is made even more difficult in an epoch of slow world growth. In a slow growth world economic mass is not increasing and it is harder to believe that trade will raise all boats. But it is easy to see the risks to any nation that lowers its barriers. In a world where growth is strong, there is less to lose. Growth means people are doing better, worry less, and are more willing to try something that makes them even better. Without much stronger economic growth I find it very hard to envision a world in which globalization advances. 

Globalization and the Trumpaline

A trampoline is a thing you jump on. If you get really good at it you can do flips and all sorts of amazing gymnastic maneuvers. Right now everyone is jumping on Donald Trump so I thought I would jump on him too. Let’s call this a Larry Cannonball on the Trumpaline.

I will leave all the exciting stuff to other people and focus on the one thing that I think I know a little about – industrialization and globalization. Okay smarty pants – those are two things but in some ways they amount to the same thing because they are known to chew up jobs. Industrialization is a force that has been going on for centuries but it got a very hot reputation when it resulted in tractors replacing horses and plows. 

Ever since then we acknowledge that new technologies and innovations destroy jobs. Of course, we have also learned that while each significant industrialization phase creates its own destabilizing impacts the net result takes time and usually leads to not only more national employment but also higher wages and incomes.

Lauren’s great grandpa used to be the guy who blew out the candles in all the street lamps in Bloomington. Electricity knocked him out of work but that whole electricity thing also led to cool inventions like vacuum cleaners and blenders and pretty soon all sorts of people had great jobs as electrical engineers and bar tenders. If you take a big swig of JD, close your eyes, and think about your life you can easily think of all the labor-displacing inventions that caused similar disruptions but eventually came to be ho hum. I make light but these are no small things. When the textile industry abandoned the NE part of the US – it wasn’t very funny to those displaced by the invention of air conditioners that made work in the South more tolerable. Now we all say "yawl" and I "guarandamnteeit".

Most of us don’t fight industrialization very hard. We know it works. We like the fact that all those street lamps can be turned off with the push of one button and we like the fact that we can afford vacuum cleaners and bartenders. One of the reasons we have social programs is to try to make the transitions a little gentler. Helping those persons who become unemployed or otherwise disadvantaged by change is both good for the head and the heart. So we usually embrace change. Some of us love change but that is not necessary so long as society allows these transitions. The truth is in the pudding since not many of us are demanding a return to the horse and plow.

That brings us to globalization. Globalization is pretty much the same thing as industrialization except it allows us one more angle – the good guys (us) versus the bad guys (foreigners). Globalization is the same as industrialization because it does the same things – it creates havoc for some people while opening up avenues for growth and change for the rest of us. If a company closed operations in Indianapolis and reopened in Guadalajara Mexico you could hear the labor union and Donald Trump screaming all the way to the South Pole. How dare those blankety blanks leave Indianapolis to go to Mexico? They must be national traitors and they should be hung in the public square or in the Hoosier Dome.  Trump has made it very clear that he will make America great again by pulling all those companies back to Indianapolis and Detroit. Hillary Clinton is saying similar things. 

It sounds great. Let’s save American jobs. How can one argue with that? For one thing, it amounts to asking us to return to horses and wooden plows. Industrial transitions do not just occur in America. Now that dozens of countries are freer to compete in global markets the marketplace for change is everywhere. New ideas and innovations that improve our lives are developed and sold everywhere. To think that all that stuff would always be made in America does not make any sense. China will be the best place to make some items but even China is outsourcing output to Vietnam. Mexico will be a place of manufacturing for other things and they will outsource some of their supply chain to Chile. To think that Donald Trump or anyone else can or should fight globalization is silly.

For another thing fighting globalization means voting against change and the transitions that actually make American workers worth what they want to earn – close to $50,000 per year. We talk about greedy US companies who want to go to Mexico to take advantage of lower labor costs in Mexico. Now they are greedy. Yesterday and for how many years were those same companies employing American workers? Unions might complain about this or that but the truth is that many people raised families for decades because of the jobs offered by these companies. Were they greedy then? I don’t know whether they are more or less greedy today. What they are doing is fighting to succeed and in some cases to survive.  Competition across the globe is intense. To not change is to die.

So long as the average income of educated and/or trained workers in many emerging markets is less than $10,000 per year it is pure folly to think that US workers hired at $50,000 will offer the best place to do business.  To save the company and American jobs, a US multinational will move some operations out of the US. Of course to save the remaining jobs they will continually have to improve productivity of the domestic workforce or even the higher skilled jobs will be threatened. Think of wave after wave of enemy combatants coming after your defensive position. Building a bigger wall might work for a while. But what you really need is an advantage.

Trump vilifies other countries for trying to come into the global economy and for daring to compete with the USA. The only real solution to this challenge is not to regulate US companies but to unleash them. Making America great means American companies winning in the global marketplace. It means change and growth. Don’t tell me that centuries of US growth are over. Tell me we have a plan to empower US companies so they can do what is necessary to continue producing good jobs and incomes in America.  The world is not always a fair place. Making it even less fair isn’t the solution. We have so many advantages over emerging market competitors they are impossible to list. We should use them and quit bellyaching!