Today we are fortunate to have a guest contribution written by Jeffrey Frankel, Harpel Professor of Capital Formation and Growth at Harvard University, and former Member of the Council of Economic Advisers, 1997-99. This post is an extended version of an earlier column at Project Syndicate.
Trade is now high on the agenda in Washington. President Obama is pushing hard for Congress to give him Trade Promotion Authority (TPA), once known as fast-track, which he intends to use to complete negotiations with 11 trading partners under the Trans Pacific Partnership. Without TPA, trading partners hold back from offering their best concessions to the president’s trade representative, fearing correctly that Congress would seek to take “another bite of the apple” when the White House brought the agreement to them for ratification. Other countries wised up to this trick 40 years ago. That is why the Congress has given every president since Richard Nixon fast-track authority, which allows only up-or-down approval of the final agreement.
Foreign Affairs magazine last month surveyed 24 experts (“experts”?), asking “Should Congress Pass Trade Promotion Authority?” In short, 21 of us said yes, 3 said no. It gives our names and short explanations.
In marketing the Trans Pacific Partnership (TPP), the President emphasizes some of the features that distinguish it from earlier free trade agreements such as NAFTA. They include commitments by Pacific countries on the environment and expansion of enforceable labor rights. They also include the geopolitical argument for the much-discussed “pivot to Asia.” (Detractors, for their part, focus on some new features as well, such as investor protection, which is said to benefit only big corporations.)
The White House political strategy is understandable. As with commercial products, the slogan “New and Improved!” sells. Previous trade agreements are not very popular. This is especially true of NAFTA. Furthermore, longstanding concerns about trade are probably now exacerbated by a deterioration of the trade balance this year.
President Obama’s argument is apparently, “Yes, the earlier agreements fell short in many ways. But we have learned from the mistakes and this one will fix them.” The truth, however, is that the previous agreements did benefit the US, as well as partners. The most straightforward argument for TPP is that similar economic benefits are likely to follow.
The economic arguments for the gains from trade of course go back to David Ricardo’s classic theory of comparative advantage. Each country benefits from producing and exporting what it is relatively best at, and importing what other countries are relatively better at making. Modern theories are more realistic, in allowing for imperfect competition, returns to scale, changing technology, and heterogeneity across firms; but they don’t change the bottom line that trade contributes to economic prosperity.
These standard theories are bolstered by lots of recent statistical studies.
- Trade boosts productivity, by specialization in production, access to larger markets, learning about new products and new techniques through trade, and importing inputs to the manufacturing process.
- Exporters on average pay higher wages than other companies, an estimated 18% higher in the case of US manufacturing.
- The purchasing power of income is enhanced by the opportunity to consume imported goods that are available at lower prices and in greater variety than if households could only buy domestic goods. The cost savings are especially large in food, clothing, consumer electronics [and other manufactured goods], purchases that make up a higher proportion of middle class households’ income than of wealthy households. (Trade boosts the purchasing power of the median income American household by an estimated 29%.)
Trade debates in Washington have long been framed as arguments over whether a policy will raise or lower the number of jobs. This is unfortunate.
The jobs debate is first cousin to the old mercantilist language focusing on whether a policy will improve or worsen the trade balance. A “mercantilist” could be defined as one who believes that gains go only to the country that enjoys a higher trade surplus, mirrored by losses in the trading partner that runs a correspondingly higher trade deficit.
Even by the mercantilist sort of reasoning, one could make an American case for the ongoing trade negotiations. The US market is already rather open; such TPP participants as Vietnam, Malaysia, and Japan have higher tariff and non-tariff barriers against imports of some products that the US would like to be able to sell them than the US does against their goods. Liberalization would thus mean more of a reduction in barriers to US exports to Asia than Asian exports to the US. The same was true of NAFTA, as Mexican barriers to imports from the US had traditionally been much higher than American barriers to trade in the other direction.
But economic theory says that trade balances and employment levels are not determined by trade measures. They are, rather, determined by macroeconomic factors (national saving, investment, labor force participation, etc.). The gains from trade show up in the quality of jobs, as reflected in real wages, more than in the quantity of jobs.
Have these ivory-tower-sounding propositions held in practice? The late-1990s are a good illustration of the theory. The volume of trade increased rapidly, in part due to trade negotiations that put NAFTA into force in 1994 and the World Trade Organization (WTO) into force in 1995. For the United States, imports grew (even) more rapidly than exports: the trade deficit widened. Did this have a negative effect on output and employment? No. Real growth averaged 4.3% during 1996-2000; productivity increased at 2½ % per year and workers received their share of those gains: real compensation per hour rose 2.2% per year. The unemployment rate fell below 4.0% by the end of 2000, as low as it goes.
A stronger trade balance in the late 1990s would not have added to output growth or job creation, which were running at full throttle. Further increases in net export demand would only have been met by pulling workers away from the production of something else. That is precisely why the gains from trade took the form of bidding up real wages, rather than further increasing the number of jobs.
Admittedly it is harder to make the case for trade (particularly for unilateral trade liberalization) when unemployment is high and output is below potential, as it was in the aftermath of the big financial crisis and recession of 2007-09. Under such circumstances, there is a kernel of truth to mercantilist logic: trade surpluses contribute to GDP and employment, coming at the expense of the trade deficit countries. Of course if one country puts up import barriers, its trading partners are likely to retaliate with “beggar-thy-neighbor” policies of their own, which leaves everyone worse off. The Smoot-Hawley tariff of 1930, and retaliation and emulation by other countries, helped put the “great” in the Great Depression. Thus the case in favor of multilaterally agreed renunciation of protectionism is as strong in recessionary conditions as ever. In response to the 2008-09 global recession, for example, G20 leaders agreed to refrain from any new trade barriers. Contrary to many cynical predictions, President Obama and his counterparts successfully fulfilled this commitment, avoiding a repeat of the 1930s debacle. The record compares favorably even with the milder recessions of 1981 and 2001.
In any case, mercantilist logic is once again no longer relevant as of 2015. The American unemployment rate has fallen to 5.4 %, the same as it was 20 years ago, not quite full employment, but getting close. If output and employment were rising this year as rapidly as they did in 2014, the Federal Reserve would probably have felt the need to start raising interest rates as early as this June, to begin restoring normal monetary/financial conditions and to forestall overheating of the economy in coming years. As it is, the Fed will almost certainly delay raising interest rates as a result of the drag on the economy created by a slowdown in net exports. (There are two reasons to expect deterioration in the non-oil trade balance this year: slowed growth among our trading partners and the stronger dollar.) The Fed does not have to put a brake on the economy because the loss in net exports is doing it already.
If the US can negotiate the facilitation of auto exports to Malaysia, agricultural exports to Japan and service exports to Vietnam, it will show up by the bidding up of real wages more than by the creation of additional jobs. Thus the best reason to pass TPA and TPP is pretty much the same as it ever was: to help put real median incomes back on a rising trend.
This post written by Jeffrey Frankel.