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.
Lucy , Professor of Top-1% Capital Formation and Concentration , presents FTA/TPP to Charlie , a working stiff :
http://www.limitstogrowth.org/WEB-Graphics/LucyFootballNotAgain.jpg
Jeffery Frankel wrote:
“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.
These are exactly the kinds of provisions that are empowering the Chinese in the bid for trade and monetary agreements. Where the US always imposes conditions on their so called “free trade agreements” the Chinese are actually engaging in free trade agreements. Where countries in Africa cannot afford the conditions imposed by the US they are welcoming the Chinese with open arms.
I favor the TPP but I do it holding my nose. The problem with the TPP is that it gives the president (any president from Nixon to Obama) too much power. Then extortion of the Clintons clearly demonstrates the huge problem with giving any politician this power to intimidate and extort donations and speaking fees. But under our current economic conditions the TPP is necessary or the trade wars will simply intensify.
Our Asian trading partners, particularly China, not taking account of their social costs (e.g. environmental and labor) is our gain and their losses.
U.S. gains from trade have been much greater than China, Japan, and other Asian countries gains from trade.
And, international trade, since around 1980, facilitated the U.S. Information and Biotech economic revolutions, where the U.S. not only leads the world (in both revenue and profit), it leads the rest of the world combined.
Peak,
You might find this interesting.
Merkel’s Green Shift Forces Germany to Burn More Coal
“Social costs” have their own unintended consequences and seen in Merkel’s shift actually creating more greenhouse gasses.
Yes, free trade is generally good.
But how can anyone claim to think TPP is a good idea? The deal is being negotiated in secret, and hardly anyone knows what is in it. Even members of Congress must sign NDAs, agree to not take notes, and go to a special room to read the current draft. Is that the kind of country you want to live in?
Tom,
The agreements have to be revealed and voted on by congress. Granted congress cannot amend them but if they are bad agreements we should all see them.
I agree with the assertion that the “mercantilist” belief that gains go only to the country that enjoys a higher trade surplus is flawed, but the author totally ignores the fact that when imbalances build-up over time they lead to dire consequences for all parties involved: the recycling of US dollars into the bond market during 2000-2007 which supressed interest rates and paved the way for the U.S. housing crisis.
Trade imbalances can distort asset prices just as much as Central Bank QE can, and in fact they did prior to 2008. Now we have distorted asset prices for a different reason entirely, but unfettered free trade wherein asian exporters were pegging a curency and recycling dollar reserves back into the U.S. paved the way for the crisis in 2008.
Matt, you’re shifting blame assuming Asian exporters caused the U.S. housing crisis.
Low lending standards, not low interest rates, caused the U.S. housing crisis.
It was U.S. policy, not foreign policies, that caused the U.S. housing crisis.
PeakTrader,
I believe that it is incorrect to blame the housing crisis on low lending standards – exclusively – Europe, especially Spain and the UK, had the same housing crisis as the US. This can’t be blamed on US regulations (or lack thereof).
It is more likely that surplus cash led to banks desperate search for customers willing to borrow, which lead to lower lending standards.
Think about this in a different way: if the banks weren’t desperate to lend, they could easily have kept the standards as high as they wanted (provided that they applied them to all customers, avoiding red-lining certain neighborhoods).
Bellanson, why would banks be “desperate” to lend money to people with no income, no down-payment, marginal credit, etc.? They would lend only if they couldn’t lose money, i.e. with the federal government backing them up, which became pro-cyclical, in an increasingly globalized world.
Citigroup, for example, knew the housing boom would end badly. Nevertheless, it had to join in, although late, because it had to compete with other money center banks. Consequently, since Citigroup was late, it lost the most.
What originates in Washington and New York can spread far and wide. If you don’t believe me, you may believe Michael Bloomberg, former Mayor of New York City:
“It was not the banks that created the mortgage crisis. It was, plain and simple, Congress who forced everybody to go and give mortgages to people who were on the cusp.
Now, I’m not saying I’m sure that was terrible policy, because a lot of those people who got homes still have them and they wouldn’t have gotten them without that.
But they were the ones who pushed Fannie and Freddie to make a bunch of loans that were imprudent, if you will. They were the ones that pushed the banks to loan to everybody. And now we want to go vilify the banks because it’s one target, it’s easy to blame them and Congress certainly isn’t going to blame themselves.”
Keynes Had a Different View
In The General Theory, Chap. 23, Notes on Mercantilism, p. 368, Keynes approvingly quotes J.A. Hobson:
“Finally he notices the bearing of his theory on the validity of the orthodox Free Trade arguments:
We also note that the charge of commercial imbecility, so freely launched by orthodox economists against our American cousins and other Protectionist Communities, can no longer be maintained by any of the Free Trade arguments hitherto adduced, since all these are based on the assumption that over-supply is impossible.”
An over-supply of goods/insufficiency of demand is exactly the condition of the U.S. economy today. The TPP advocates want to compound the problem by flooding the American market with more goods without any corresponding increase of consumption. Likewise, they want to flood Asian markets with subsidized American agricultural products for which there is no obvious demand. The net effect will be massive disruption of employment throughout the Pacific Rim that lowers workers’ living standards while benefiting corporate suppliers. Over-supply of goods and services is not impossible. What we really need is agreement by all countries to increase demand by orders of magnitude.
Paul, see the law of supply and demand.
And, production is needed for consumption.
So You Are Saying Keynes is Wrong?
Yeah, that just makes so much sense. Keynes forgot about the law of supply and demand.
No, I’m saying you’re wrong.
For example, raising production raises consumption.
Oh right, because supply creates demand. IOW, Keynes got it backwards.
You got it only one way,
There can’t be one without the other.
Income is an important component.
Sen. Warren does not like it.
http://www.npr.org/blogs/itsallpolitics/2015/05/12/405950630/sen-warren-on-the-tilted-process-of-asia-trade-bill
The problem here is that Pres. Obama lacks credibility, even within his own party.
Frankel: ” A “mercantilist” could be defined as one who believes that gains go only to the country that enjoys a higher trade surplus.”
Frankel is attacking a nice straw man there. The objection to the TPP is not that gains go only to the country that enjoys a higher trade surplus. The objection is that the deals are structured so that the gains primarily go to the top 1%. (For example intellectual property laws that don’t free up trade, but instead restrict it.)
We always hear from proponents that there will be winners and losers and we will use redistribution to compensate the losers. Of course, that never happens. So for now on, how about we do the redistribution first and then we’ll talk about the trade deal? Otherwise it is the same false promises all over again.
Joseph, everyone benefits from lower prices and interest rates.
Of course, in a dynamic economy, some will win and some will lose.
True! The 1% win and the workers lose, just as Sen Warren says.
Workers win when better jobs are created and poor jobs are destroyed.
You can thank capitalists, including in the 1%, later.
Yes, trickle down economics has worked so well over the years. That’s why Pres. Hoover was elected 4 times.
Paul, I guess, you miss the textile mill, or living in Detroit.
But theory does not tell us whether the numbers of winners will be as great as the number of losers.
Experience since 1980, but particularly since 2000 suggests the number of winners is far smaller than the number of losers.
I think the problem with this argument is that it seems shockingly unaware of how past trade pacts have failed to bring about broad based prosperity. They have failed to deliver and unfortunately you don’t seem to even know this. Don’t rely on lectures about the wonder o f cheap goods when the middle class is crumbling. You don’t shop at Walmart and it sounds not only peculiar but patronizing when you trumpet cheap goods in a context of stagnant wages and job market. Begin at the beginning. You have lost credibility for your position due to policy failure. Address that FIRST or you will be preaching to an empty room.
Soon we will all be shopping at Walmart.
The U.S. has benefited enormously offshoring older industries, importing those goods at lower prices and higher profits, and shifting limited resources into high-end manufacturing and emerging industries.
Of course, when you import tens of millions of dirt poor people, with low skills, from Third World countries, and include their children, along with spending trillions of dollars to pay people not to work, it’s not surprising the result would be greater wealth and income inequality.
There starting place for any discussion of the economy has to be with the disconnect between wages and productivity growth. The intuition is this is a result of a shift in the balance of power between labor and capital. One explanation for this shift is the ability of capital to threaten to move work overseas.
The author of this article simply ignores this, and fall back to citing data from the late 90’s, as if the last 15 years did not happen.
Mr Frankel wants to pretend that the disconnect did not happen.
He then rather outrageously argues that we are close to full employment, an argument which broader measures of unemployment refutes.
Mr. Frankel needs to address the data since 2000 to make his case.
He does not do so here, and as a result he is not very persuasive.
If you compare the U.S. economy when it peaked in 2007, after the 1982-07 long boom, to the 1970s, it has improved dramatically. And, the explosion in international trade was an important part of the improvement.
Since 2007, we needed more pro-growth and fewer anti-growth economic policies, e.g. reducing and removing the $2 trillion a year of federal regulations, creating more incentives to work, for lower and middle class workers, tax reform, that promotes work and investment, raising the minimum wage to $15 an hour, to correct a market failure, etc..
The U.S. economy has the capacity for much stronger growth than the past six years. We need to unleash that growth, until we close the output gap. Then, we can afford more regulations and higher taxes, which will slow the economy to a sustainable rate.
This trade agreement may be great for the poorer countries. But for our country it looks like it’s just standard politics: more power for the corporations, less power for the rest of us.
How can any agreement that has secret courts, be good?
So, you wouldn’t trade a worth less piece of paper for a valuable good, because you didn’t work to produce a valuable good to exchange for another valuable good.
If you just want to work, you can dig holes and fill them up again, or if you want to produce valuable goods foreigners don’t want, you can store them in a warehouse.
PeakTrader,
I don’t see how you’ve answered my question.
So let me ask it again:
How can any agreement that has secret courts, be good?
anon2, I can’t answer that question, unless I know why?
Do you know why?