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Making Free Trade Work for Everyone -- Rich and Poor, Surplus and Deficit Countries-- New Rules for World Trade

11/30/2016

A Rational Trade Policy – Alter the WTO Rules Requiring Countries in Chronic Deficit to Impose Non-discriminatory Tariffs and Countries in Chronic Surplus to Impose Export Taxes
By
David L. Blond, President, QuERI-International[1]

There is much of President-elect Trump’s agenda that I will never agree with, but on one point I do agree – we need a more American-centric trade policy. I’ve written about this for much of my life including years and more than twenty essays published during the 2002-2004 period in the business magazine The Manufacturer. From my time as Senior Economist in the Office of the Secretary of Defense to my years forecasting global trade flows for commercial customers and governments, I’ve taken public positions on why growing imbalances in global trade are bad for the countries running surpluses and those in deficits. In the case of the US, this has meant a loss in the capacity to bend metal and provide gainful employment to millions of hard working men and women without the means or interests to go to College. For someone who makes a living from advising and forecasting the global economy with a special emphasis on forecasting international trade this emphasis on rebalancing the heavily one sided or unbalanced global trade accounts makes little sense.
In my debut novel, an economic thriller, The Phoenix Year, one of the characters on the eve of the greatest financial melt down since the Great Depression that this character, a Swiss mult-billionaire, has engineered in part by collapsing a real estate empire of a Trump-like character, explains the problem to the more conventional economic advisor to the current President, as follows:
“I’m not that radical. There is a role for government, but also a role for well-meaning capitalists with the skills and finances to make things happen. Government alone can’t keep an economy growing, or ensure that everyone who wants to work can work.”
“Describe this new man; this well-meaning capitalist,” Michael demanded, showing his own cynicism about businessmen in general. Too often he’d seen them act in the interests of themselves, rather than society, company employees or even the shareholders. Cutting jobs often profited them more than growth, and those profits relied on government assistance and subsidies. These captains of industry would then yell and scream that the government had to bring its accounts into balance.
“Only men who own companies outright are true capitalists. I own my companies, which means that I can take chances and forgo short-term profits, in order to get growth and stability for the workers who make my firms successful. The same can’t be said for someone hired by a team of outsiders, who may be only there for a year or two before they are gone, but who, in that period, may do damage to the company’s reputation and its workforce. Its simple arithmetic: the circular flow of money has to be maintained; and productivity gains have to be shared with the ultimate consumers. Henry Ford saw that. He paid workers enough so they could buy Ford automobiles. I would say that your current version of capitalism is broken, Michael. For the past thirty years, ever since economists got into their head that globalization was the answer to all problems, rich and advanced countries’ workers have been in a race to the bottom. Wages have barely increased, and in many cases, have fallen. Don’t you see? It is time for something different; something noble and good; for both the owners and the workers.”
Ten years ago I wrote this essay for the now defunct magazine The Manufacturer that I think summarizes the trade question. In my essay titled “How I Learned to Love Chinese Workers and Not Worry About the Red Ink” I wrote the following:
Two and a half years ago, I started writing about the trade deficit in this magazine. I have spent a good ten-thousand words trying to get Executives of manufacturing companies excited about the risk to their businesses and the economy from the growing, persistent, structural, trade deficit.   Given the poor response to these essays (I can count on one hand the number of e-mails I’ve received), I have come to the conclusion that I was wrong -- I would like to recant, like an old Communist. It is smart business, not dumb policy, to let the Chinese and other, underpaid workers, do our work.    Giving-up high paying, secure manufacturing jobs, and the ability to make anything of importance here, is an act of charity that should be lauded, not decried. American workers who have lost their livelihoods, and the companies that have shipped their jobs overseas, should be praised for their courage in accepting the inevitable.   Executives of these companies should be rewarded with six figure salaries and bonuses for their intelligence and financial savvy in junking the messy, metal bending, for the highly profitable import-resale trade.

American policy makers should be applauded for their sagacity in making the US dollar the key currency for international trade and finance, as well as American capital markets the largest and most efficient in the world. Our current account deficit has grown each year – in good years and bad – for over 25 years. The amount of outstanding Treasury Bills issued by the US government to foreigners is so large that it is no longer an issue. Foreign governments can’t change it into any other currency without causing inflation.    Kudos should go to American economic brilliance in hooking the world on holding onto dollars and not spending them.

We have reached economic nirvana in which work no longer is of any importance. We can have others do that work for us. All we need do is have the government print money and give it to us in the form of tax rebates or, when we are all unemployed, simply handouts. Our job is to consume and by our consumption, the whole world benefits.

So my record on why trade deficits are dangerous is long. It began even in graduate school when I argued with my Professor and thesis advisor, Fritz Machlup, who saw losses of jobs as a form of society gratification that trade was working, freeing up labor for other more profitable pursuits (the standard Ricardian argument for efficiency gains).   I almost wrote my graduate thesis not on how exchange rates impact trade between countries, but on the idea that there is a real labor production function that maximizes employment across all educational brackets as its measure of success. There is need for brains and brawn. I built some early models for the CIA to measure Japanese and Chinese trade protectionism using an objective cross-country model. And when the US Japanese trade deficit was just $ 18 billion dollars, I was called an “evil force” in a back channel communications by the Ambassador when I questioned the decision to sell plans, not planes for the F-15 that could have helped rebalance the deficit.

I have been forecasting global trade at a detailed commodity and industry level since the early 1980’s and I have watched the size of global trade imbalances grow larger each year making the benefits of free trade less obvious to me and to billions of people damaged by industries ability to take jobs from one location to another in search of the lowest wages or the least environmental rules. So I will agree with President-elect Trump, something has to give. It is time for a more balanced, rational approach, but given the web of relationships, it has been done carefully.

The Train Has Left the Station…the Genie can’t be put back in the bottle

We live in an interconnected world where companies depend upon long distance supply chains. To slow global trade in one part of the world can have adverse impacts on the ability to make goods for sale in other parts of the world. The table below illustrates this for the United States showing how in many critical manufacturing sectors the degree to which the factors of production, the inputs to make the finished products, are themselves largely sourced from foreign suppliers. To slow this trade is bi production, factors of production – a mix of domestic and foreign content goods – are positive. The likely impact then of disruptive tariffs will be to reduce production in the short-run, but the possibility of once disrupted for these companies unable to manufacture the products to survive is minimal. Moreover much of what is sold in the retail sector now comes from abroad. To understand the global interdependence look at the four table that follow. Table 1 shows the share of foreign content in factor inputs for the United States needed in the production of both goods and services in the United States. The foreign content share of factor inputs reflects the purchases by retailers, like Walmart, of necessary inputs to keep stores open, not the foreign content share of products sold. The four columns to the right show the share of domestic consumption supplied by foreign manufacturers. Tables 2,3, and 4 provide similar information for China, Germany, and the World.

What is clear from this is that any efforts to suddenly change trade patterns will have unintended consequences at least in the short-run, not just in the US but worldwide. As I’ve warned now for more than 30 years (since my last year’s at the Pentagon in 1985) the growing deficit of the United States on our foreign accounts is dangerous and damaging to the ability of countries to grow and benefit from global integration. After many years of thinking about this problem, I think there is a simple, easy to see, solution that if carried out with tact and skill can change the dynamics not just in the United States, but worldwide, allowing the benefits offered by globalized commerce to be shared.

Approach to Global Trade Rebalancing
The chart below illustrates the problem which is on a global basis less about China and more about Germany’s unwillingness to balance its trade. In the case of China the slowing of world trade growth to around 4% real growth and the continued growth in the Chinese middle class will lead to a deficit in the Chinese trade in constant dollars and a slight deficit before expanding towards the end of the period as world market prices increase for raw materials and the Chinese economy slows to only around 4% real growth in the later period. For the US, however, the problem remains that we are continuing to buy more than $ 700 billion dollars more than we sell to the world. Over the long period when this structural deficit has existed, millions of good jobs have disappeared. But we can’t blame that problem entirely on China, rather the problem should be blamed on US manufacturers who have taken advantage of the growth in Chinese manufacturing capacity to source from China. Chinese trade has tended to remain relatively in balance as much of what is exported is made up of imports of intermediate goods and raw materials.
Figure 1: US, China and German Trade Balance

Three Approaches to Controlling the US Trade Deficit
Over the years I’ve suggested three possible approaches to controlling our trade deficit. One approach uses the corporate tax code to penalize companies that sell more products in the US than they buy here while lowering the tax bill of companies that sell more outside the country and buy more here. The second approach is based on an import warrant that must be purchased on the open market from either exporters (who earn a dollar’s warrant for every dollar exported) or from government. By managing the total number of warrants outstanding in a period the government can gradually reduce the deficit while offering incentives to exporters. This would likely be seen as a subsidy for exports so the alternative is for the government to sell these using the money to invest in US industry and infrastructure. These approaches are complicated and require changes in US legislation.

Change WTO Rules
Each of the other techniques for slowing or reversing the impact of the US trade will be outside of the WTO rules.   If we are to rebalance trade then we need an approach that meets the needs of more than a single country. The best approach is to change the underlying WTO Charter to require countries in chronic deficit to impose across the board tariffs on a non-discriminatory basis starting with 10% until the deficit falls below 1% or 2% of GDP. Countries in chronic surplus would be required to impose a 10% export tax until the surplus falls below 1% or 2% of GDP. If a country in chronic surplus as determined by the WTO fails to impose the tax, then chronic deficit countries will be allowed to add a 5% tariff additionally on imports from the surplus country failing to impose an export tax.

Our Integrated Global Economy
The QuERI Integrated Global Model unlike those of other companies includes the relationship between countries impacts the domestic production with exports generally positive to production and imports negative. Thus reducing imports should logically make domestic output grow. But there is a countervailing effect that comes from the share of factor inputs – iron for building buildings, chemicals for making plastics, etc. – that are sourced outside the country. Tables 1 through 4 below show the degree to which dependencies gave been built that make undoing the web of global trade complex and likely fraught with danger. The shares we used were at a broad level of industry detail, but the actual business to business trade is detailed and based on unique requirements. Thus shifting to generic local supplier may be impossible. For many key inputs the existing share of imports to apparent consumption is well over 20% and for clothing and apparel nearly 70%. Replacing these with domestic supplies will be difficult even if absolute prohibitions are imposed. As much of these type producs from computers to clothing come from China, draconian tariffs on Chinese imports will simply lead to less being sold to American consumers. Companies will not bother to import something that has to be priced at 45% higher because of tariffs.
The bottom line is that when foreign inputs are included in industry production functions the positive effect on demand is negated by the decidedly stronger negative impact on production of finished or semi-finished goods. If we try to reduce the deficit too quickly or using methods that make imports too expensive to companies and consumers we will set in motion a disaster with unemployment increasing rapidly as substitutes for many imported products sold hard to come by or non-existent.
Why Changing WTO Rules Creating Friction in the Free Flow of Goods is the Right Approach
The 10% solution applied across the board, without differentiation on individual trade flows – be they from China or Mexico – offers a single source internationally agreed solution to the problem that was created initially when the WTO (and its predecessor organization, The GATT) put the emphasis only on reducing or eliminating trade barriers. President-elect Trump is correct in pointing out that the United States has historically allowed weaker foreign countries to get somewhat better deals than the US on the assumption that the US is the leader and needs to set the correct example. There are examples, however, when the US has asserted that it needs to protect some key industries. President Reagan initiated a number of these in automobiles, electronics and steel that slowed the demise of US industry. In the case of automobiles it led to the development of a large scale foreign owned automobile industrial complex (parts and finished assembly) in the US. The 10% tariffs imposed across the board would force US companies importing foreign products to assess the risks especially if higher tariffs might be applied if the problem (the size of the deficit on the trade account) is not resolved. This is a gradual rebalancing of the world not just in the US but worldwide. The size of the deficit is a problem not just here, but in many other countries. If the deficit become a critical element in determining trade restrictions as a result international agreement then this will not spark a trade war. Changing the WTO rules should be the approach taken by the Trump administration using the leverage of unilateral action and enlisting the help of other countries running serious trade imbalances.

For a spread sheet with the tables showing the degree of trade dependency by country and ISIC categories manu please contact me at davidblond2000@gmail.com. Say trade dependency tables.

[1] QuERI-International is a private consulting firm that carries out quantitative research into global economics using a series of dynamic models of the world economy pulling together data from international sources with synthetic data developed internally using Input-Output model. For more information see www.queriinternational.com, davidblond2000@gmaill.com, 301-704-8942.

Fixing the Trade Deficit Will Be Easier Said than Done

11/29/2016

I wrote this essay around the time of the 2004 election. I attended a NABE meeting in Washington and sat in the back of the room. The keynote address was by Greg Mankiw and I asked a question about the US deficit on our trade account that had reached $500 billion dollars. I'd been writing about why this was dangerous for several years without much influence. His response didn't surprise me. At the time John Edwards was the only "populist" in the race to replace George Bush. Donald Trump's complaint is a familiar one, but since that ill fated year the trade deficit increased reaching an apex of over $800 billion. It should remain in the $ 700 billion range for the foreseeable fucture, but without some dramatic and very dangerous interventions, we will have to remain the global engine of growth.

Corporate Free Riders – Why John Edwards May Win in November

Chairman of the Council of Economic Advisors, Greg Mankiw, is the President’s key advisor on the economy. A clueless academic and victim of Washington speak, Mankiw will be vilified in the coming months as a “poster child” for sending high paying American jobs overseas.   If employment growth sputters, as more companies rush to send more jobs outside the country before this practice is outlawed or too costly, then Greg Mankiew will be on his way back to Boston. Of course, Larry Summers, President of Harvard, may find it more advantageous to shift Professor Mankiew’s own job to Bangalore in order to save money and take advantage of the low cost of telecommunications.

Six months ago, I asked Professor Mankiw if he was at all worried about the $ 500 billion in IOUs we hand out each year.     He wasn’t worried. In fact, he told me that the problem would take care of itself. I think he believes in the tooth fairy, along with other well-known economists including Robert Reich and Jagdish Bhagwati. Barring divine intervention the trade deficit will likely increase for years to come.

Many economists are sticking with the conventional wisdom that free trade and outsourcing is beneficial even though they are unable to make this theory work when it comes down to dollars and cents or jobs.     There is a disconnect between outsourcing jobs, the high rate of growth in American productivity, and the fact that despite this, American companies continue to buy more than they sell to foreign buyers.   If efficiency is the goal, then how much more efficient will we have to be to re-balance world trade and create more jobs at home.    To close the gap on our foreign trade account, American exports must capture 40% of the total growth in non-US trade within ten years.

Economists believe markets magically make the best choices.    This same thinking led to the Great Depression, as the “classically trained economists” waited for the self-correction to come. It was Keynes who showed that markets do not always fully use their resources.   An efficient economy – where many of the jobs are outsourced – can be in equilibrium well below the point where all resources are fully used.

Supporters of outsourcing usually cite studies, such as the one carried out by the McKinsey Institute, that suggest that gains from lower costs allow faster economic growth. Faster growth has equated to profits and not to jobs or higher wages. According to Business Week the benefits are spread to a new “investor class”.   While this is helpful in the short-run, it will not support a rising standard of living for all Americans.   Another study by Catherine Mann suggests that outsourcing software to India leads to greater use of lower priced software and to more employment here. Have they heard the joke about the economist stranded on a desert island with a can of beans?   He assumes he has a can-opener to open that can of beans. Both studies assume that all the freed up labor resources find other jobs that are higher paying.

Let me state the obvious – if we did not have a $ 500 billion trade deficit with the world – then outsourcing and sending offshore low value production would yield a higher American standard of living. Citing Ricardo’s theory of comparative advantage as a rational for a $ 500 billion deficit is flat wrong.   In Ricardo’s theory, labor is traded at a rate of exchange that allows both parties to benefit.      Reich and Bhagwati are tenured Professors who have recently weighed in support of the Greg Mankiw. If they believe that Ricardo meant that we can hand out IOUs to the world rather than trade American employment for foreign employment, then perhaps they should take a refresher course in International Trade theory.

Most supporters of outsourcing believe we have a comparative advantage in the production of high technology products. If this is the case, then why did we have a surplus of $ 19 billion in this trade in 1999 and a deficit of $ 27 billion in 2003?      If we can not run a surplus in high technology products, then what is the benefit offered by free trade? It does not matter how much more efficient we get, if we hollow out shell of the American economy.