Wednesday, April 6, 2016

Bernie Sanders' Knee Jerk Reaction Against Free Trade is the Wrong Response


Bernie Sanders is anti-free trade. He opposed the North American Free Trade Agreement (NAFTA) in 1993; he opposed Permanent Normal Trade Relations with China (PNTRC) in 2000; and he opposed the Trans Pacific Partnership (TPP) which was negotiated by the Obama administration and is currently under review. "The top priority of any trade deal should be to help American workers...; American trade policy over the past 30 years has done just the opposite," says his website. In this he echoes Donald Trump, who says: "We need smart negotiators who will serve the interests of American workers – not Wall Street insiders that want to move U.S. manufacturing and investment offshore." Earning his socialist stripes, Sanders dubiously adds that all the benefits of free trade agreements go to the owners of the means of production and the owners of capital, and none of the benefits go to workers. 

Having the interests of workers at heart is a good thing. But what Sanders says about free trade raises questions whether his ideological bias would get in the way of good governance? There are good reasons for government to do more for workers displaced by globalization and free trade, but a knee jerk retreat to isolationism is the wrong response.

The Trade Deficit: What is it and is it Necessarily Bad?

To the extent that free trade allows us to export to other countries things we make here, that is of course good for workers. It creates jobs. To the extent we purchase the same things from other countries, it creates jobs in those countries and reduces jobs here.

In the wake of World War 2, when the U.S. was the strongest economy left standing, we exported a lot of manufactured goods we made here to the world. But since the 1970's we have run consistent and sizable trade deficits with other countries.


Free trade agreements have contributed to this growing trade deficit. Trade deficits, however, are not necessarily a bad deal for America, and they don't necessarily mean fewer jobs.

Here is Neil Irwin at the Upshot:
Trade deficits are not inherently good or bad; ... The trade deficit is not a scorecard. ... [I]n isolation, the fact that the United States has a trade deficit does not prove that trade agreements are bad for Americans, a staple of Bernie Sanders’s campaign .... In fact, trying to eliminate the trade deficit could mean giving up some of the key levers of power that allow the United States to get its way in international politics. 
Getting rid of the trade deficit could very well make America less great. .... 
What is the trade deficit? 
Imagine a world where there are only two countries, and only two products. One country makes cars; the other grows bananas. People in CarNation want bananas, so they buy $1 million worth from people in BananaLand. Residents of BananaLand want cars, so they buy $2 million of them from CarNation. That difference is the trade deficit: BananaLand has a $1 million trade deficit; CarNation has a $1 million trade surplus.

But this does not mean that BananaLand is “losing” to CarNation. Cars are really useful, and BananaLandites got a lot of them in exchange for their money.

Similarly, it’s true that the United States has a $58 billion trade deficit with Mexico, for example. But it’s not as if Americans were just flinging money across the Rio Grande out of charity. Americans get a lot of good stuff for that: avocados, for example, and CancĂșn vacations.....

But don’t trade deficits mean fewer jobs?

Maybe.

It is true that ... when a country is selling less stuff abroad than it buys from abroad, the country is making less stuff, and as a result there are fewer jobs. ... But when a country runs a trade deficit, as the United States does, there is a countervailing force. Think back to our pretend countries. BananaLand has a $1 million trade deficit with CarNation. But that means that car producers in CarNation are sitting on an extra $1 million a year in income. Something has to happen with that $1 million, and both of the two options have consequences.

One option is to keep that money at home. But keeping that money inside CarNation will push the value of its currency upward. And as its currency goes up, cars will become more expensive in BananaLand — causing people there to buy fewer of them until eventually the trade deficit is eliminated. 
If CarNation doesn’t want its currency to rise, it has to take that $1 million trade surplus and plow it back into BananaLand. There are different ways it could do that. People in CarNation could buy stocks or bonds in BananaLand, or companies in CarNation could invest in factories in BananaLand, or the government of CarNation could buy assets directly.

The choice is stark: A country running a trade surplus must either let its currency rise or let money flow back to its trading partners.

This isn’t just an abstraction. It’s what has happened between the United States and China for the last couple of decades. China has had consistent trade surpluses, but it did not want its currency to rise in a way that would undermine its exporters. So money has flowed from China into the United States — both from the Chinese government’s purchases of United States Treasury bonds and more recently in the form of direct investment from Chinese companies into the United States....
Whether a trade deficit means fewer jobs, in other words, depends not only on the number of jobs eliminated from importing stuff instead of making it here, and on the number of jobs created by exporting more, but also on the jobs created from investment dollars flowing into the country from our trading partners.

I understand that some of this cannot be so easy to measure.

Here's what I gather from this so far: If everything were equal between the U.S. and its trading partners we could evaluate the overall benefit of free trade agreements in terms of (1) jobs created due to increased exports; (2) jobs lost to imported goods that otherwise would have been built here;  (3) jobs created as a result of investments that flow into the country; and (4) the overall benefits of purchasing imports at lower prices than those things could be made for at home.

But everything is not equal, suggests Irwin. There's also the fact that the U.S. dollar serves as the world's reserve currency and the fact that we are the world's economic leader and, as a result, get to make many of the rules.

The Cost of Being the World's Reserve Currency  

Both Sanders and Trump imply the problem is that we have negotiated poor trade agreements that do not adequately protect American workers. This contention fails to acknowledge, suggests Irwin, that any free trade agreement will (a) necessarily have a disrupting effect on the economy and the labor markets, and (b) that the overall merit of a free trade agreement may turn on more than just the employment picture. 

In addition, says Irwin, there is a price to be paid for the U.S. Dollar being the world's reserve currency. 
The dollar is a global reserve currency, meaning that it is used around the world in transactions that have nothing to do with the United States. When a Malaysian company does business with a German company, in many cases it will do business in dollars; when wealthy people in Dubai or Singapore’s government investment fund want to sock away money, they do so in large part in dollar assets. 
That creates upward pressure on the dollar for reasons unrelated to trade flows between the United States and its partners. That, in turn, makes the dollar stronger, and American exporters less competitive, than they would be in a world where nobody used the dollar for anything except commerce involving the United States. 
The roughly $500 billion trade deficit that the United States runs each year isn’t just about poorly negotiated trade deals and currency manipulation by this or that country. It’s also, to some degree, a byproduct of the central role the United States plays in the global financial system. 
In the 1960's Belgian American economist Robert Treffin noted that any provider of the global reserve currency must run a perpetual trade deficit to keep the world financial system from freezing--even if such long term trade deficits can lead to domestic booms and busts.

The key point, says Irwin, is that if Sanders or Trump really want to reduce our trade deficits... this would entail a reworking of the entire world financial system.

We don't really want to rework the entire world financial system, suggests Irwin, because we gain a lot of power and advantage from being the world's reserve currency, largest importer, and largest economy. It gives us clout; it means we get to call many of the shots; it means our government has access to unlimited easy financing to counteract recessions and fight panics; it provides us with a strong stock market, which workers too benefit from through their pension funds.

Irwin concludes:
The centrality of the dollar to global finance gives the United States power on the global stage that no other country can match. It has enforced sanctions on Iran, Russia, North Korea and terrorist groups with the implicit threat of cutting off access to the dollar payments system for any bank in the world that does not cooperate with American foreign policy. 
Part of what makes the United States powerful is the great importance of the dollar to global finance. And part of the price the United States pays for that status is a stronger currency and higher trade deficits than would be the case otherwise.

Digesting Trade Shocks

On the other hand, Sanders seems correct that free trade agreements undoubtedly hurt some workers and some regions of the country more than others, and may even mean a net loss of jobs over the short term. 

Here is the abstract of a just published working paper posted at Equitablog, The China Shock: learning from labor market adjustment to large changes in trade: 

China’s emergence as a great economic power has induced an epochal shift in patterns of world trade. .... Alongside the heralded consumer benefits of expanded trade are substantial adjustment costs and distributional consequences. These impacts are most visible in the local labor markets in which the industries exposed to foreign competition are concentrated. 
Adjustment in local labor markets is remarkably slow, with wages and labor-force participation rates remaining depressed and unemployment rates remaining elevated for at least a full decade after the China trade shock commences. Exposed workers experience greater job churning and reduced lifetime income. At the national level, employment has fallen in U.S. industries more exposed to import competition, as expected, but offsetting employment gains in other industries have yet to materialize. Better understanding when and where trade is costly, and how and why it may be beneficial, are key items on the research agenda for trade and labor economists.
The question is what is the correct response to trade shocks? Is it to turn towards protectionism and isolation, as Sanders seems to suggest? Or to take punitive measures against trade partners, as Trump seems to suggest? Or is it to "look for opportunities for effective investments in education, job training, (seek) to speed along the recovery of workers displaced, and to make investments in the engines of growth," as Hillary Clinton is proposing? 

Clinton looks pretty good on this score.  

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