Tag: international finance and trade

At Dissent: Industrial Policy without Nationalism

(This piece was published in the Fall 2024 issue of Dissent.)

In the first two years after Biden’s election, there was considerable enthusiasm on the left for the administration’s embrace of a larger, more active economic role for the federal government. I was among those who saw both the ambitions of the Build Back Better bill and the self-conscious embrace of industrial policy as an unexpectedly sharp break with the economic policy consensus of the past thirty years.

Biden squandered that early promise with his embrace of Israel’s campaign of mass murder in Gaza. His legacy will be the piles of shattered buildings and children’s corpses that he, with aides like Antony Blinken, did so much to create.

The administration has also struck a Trumpian note on immigration, promising to shut down the border to desperate asylum seekers. And internationally, it is committed to a Manichean view of the world where the United States is locked into a perpetual struggle for dominance with rivals like Russia and China.

Can industrial policy be salvaged from this wreckage? I am not sure.

There are really two questions here. First, is there an inherent connection between industrial policy and economic nationalism, because support for one country’s industries must comes at the cost of its trade partners? And second, is it possible in practice to pursue industrial policy without militarism? Or does it require the support of the national security establishment as the only sufficiently powerful constituency in favor of a bigger and more active government?

Much of the conversation around industrial policy assumes that one country’s gain must be another’s loss. U.S. officials insist on the need to outcompete China in key markets and constantly complain about how “unfair” Chinese support for its manufacturers disadvantages U.S. producers. European officials make similar complaints about the United States.

This zero-sum view of trade policy is shared by an influential strand of thought on the left, most notably Robert Brenner and his followers. In their view, the world economy faces a permanent condition of overcapacity, in which industrial investment in one country simply depresses production and profits elsewhere. In the uncompromising words of Dylan Riley, “the present period does not hold out even the hope of growth,” allowing only for “a politics of zero-sum redistribution.” Development, in this context, simply means the displacement of manufacturing in the rich countries by lower-cost competitors.

I don’t know if anyone in the Biden administration has read Brenner or been influenced by him. But there is certainly a similarity in language. The same complaints that Chinese investment is exacerbating global overcapacity in manufacturing could come almost verbatim from the State Department or from the pages of New Left Review. More broadly, there is a shared sense that China’s desire to industrialize is fundamentally illegitimate. The problem, Brenner complains, is that China and other developing countries have sought to “export goods that were already being produced” instead of respecting the current “world division of labor along Smithian lines” and focusing on exports complementary to existing industries in the North.

Fortunately, we can be fairly confident that this understanding of world trade is wrong.

The zero-sum vision sees trade flows as driven by relative prices, with lower-cost producers beating out higher-cost ones for a fixed pool of demand. But as Keynesian economists have long understood, the most important factor in trade flows is changes in incomes, not prices. Far from being fixed, demand is the most dynamic element in the system.

A country experiencing an economic boom – perhaps from a upsurge in investment – will see a rapid rise in both production and demand. Some of the additional spending will falls on imports; countries that grow faster therefore tend to develop trade deficits while countries that grow slowly tend to develop trade surpluses. (It is true that some countries manage to combine rapid growth with trade surpluses, while others must throttle back demand to avoid deficits. But as the great Keynesian economist A.P. Thirlwall argued, this is mainly a function of what kinds of goods they produce, rather than lower prices.)

We can see this dynamic clearly in the United States, where the trade deficit consistently falls in recessions and widens when growth resumes. It was even more important, though less immediately obvious, in Europe in the 2000s. During the first decade of the euro, Germany developed large surpluses with other European countries, which were widely attributed to superior competitiveness thanks to wage restraint and faster productivity growth. But this was wrong. While German surpluses with the rest of the European Union rose from 2 percent to 3 percent of German GDP during the 2000s, there was no change in the fraction of income being spent in the rest of the bloc on German exports. Meanwhile, the share of German income spent on EU imports actually rose.

If Germans were buying more from the rest of the European Union, and non-German Europeans were buying the same amount from Germany, how could it be that the German trade surplus with Europe increased? The answer is that total expenditure was rising much faster in the rest of Europe. Rising German surpluses were the result of austerity and stagnation within the country, not greater competitiveness. If Germany had adopted a program to boost green investment during the 2000s, its trade surpluses would have been smaller, not larger. The same thing happened in reverse after the crisis: the countries of Southern Europe rapidly closed their large trade deficits without any improvement in export performance, as deep falls in income and expenditure squeezed their imports. 

Europe’s trade imbalances of a decade ago might seem far afield from current debates over industrial policy. But they illustrate a critical point. When a country adopts policies to boost investment spending, that creates new demand in its economy. And the additional imports drawn in by this demand are likely to outweigh whatever advantages it gains in the particular sector where investment is subsidized. Measures like the Inflation Reduction Act (IRA) or CHIPS and Science Act may eventually boost U.S. net exports in the specific sectors they target. But they also raise demand for everything else. This is why a zero-sum view of industrial policy is wrong. If the US successfully boosts investment in wind turbine production, say, it will probably boost net exports of turbines. But it will also raise imports of other things – not just inputs for turbines, but all the goods purchased by everyone whose income is raised by the new spending. For most US trade partners, the rise in overall demand will matter much more than greater US competitiveness in a few targeted sectors.

China might look like an exception to this pattern. It has combined an investment boom with persistent trade surpluses, thanks to the very rapid qualitative upgrading of its manufacturing base. For most lower- and middle-income countries, rapid income growth leads to a disproportionate rise in demand for more advanced manufactures they can’t make themselves. This has been much less true of China. As economists like Dani Rodrik have shown, what is exceptional about China is the range and sophistication of the goods it produces relative to its income level. This is why it’s been able to maintain trade surpluses while growing rapidly.

While Biden administration officials and their allies like to attribute China’s success to wage repression, the reality is close to the opposite. As scholars of inequality like Branko Milanovic and Thomas Piketty have documented, what stands out about China’s growth is how widely the gains have been shared. Twenty-first-century China, unlike the United States or Western Europe, has seen substantial income growth even for those at the bottom of the income distribution.

More important for the present argument, China has not just added an enormous amount of manufacturing capacity; it has also been an enormous source of demand. This is the critical point missed by those who see a zero-sum competition for markets. Consider automobiles. Already by 2010 China was the world’s largest manufacturer, producing nearly twice as many vehicles as the United States, a position it has held ever since. Yet this surge in auto production was accompanied by an even larger surge in auto consumption, so that China remained a net importer of automobiles until 2022. The tremendous growth of China’s auto industry did not come at the expense of production elsewhere; there were simply more cars being made and sold.

All this applies even more for the green industries that are the focus of today’s industrial policy debate. There has been a huge rise in production—especially but not only in China—but there has been an equally huge growth in expenditure. Globally, solar power generation increased by a factor of 100 over the past fifteen years, wind power by a factor of ten. And there is no sign of this growth slowing. To speak of excess capacity in this sector is bizarre. In a recent speech, Treasury Under Secretary Jay Shambaugh complained that China plans to produce more lithium-ion batteries and solar modules than are required to hit net-zero emissions targets. But if the necessary technologies come online fast enough, there’s no reason we can’t beat those targets. Is Shambaugh worried that the world will decarbonize too fast?

Even in narrow economic terms, there are positive spillovers from China’s big push into green technology. China may gain a larger share of the market for batteries or solar panels — though again, it’s important to stress that this market is anything but fixed in size — but the investment spending in that sector will create demand elsewhere, to the benefit of countries that export to China. Technological improvements are also likely to spread rapidly. One recent study of industrial policy in semiconductors found that when governments adopt policies to support their own industry, they are able to significantly raise productivity – but thanks to international character of chip production, productivity gains are almost as large for the countries they trade with. Ironically, as Tim Sahay and Kate Mackenzie observe, the United States stands to lose out on exactly these benefits thanks to the Biden administration’s hostility to investment by Chinese firms.

None of this is to say that other countries face no disruptions or challenges from China’s growth, or from policies to support particular industries in the United States or elsewhere. The point is that these disruptions can be managed. Lost demand in one sector can be offset by increased demand somewhere else. Subsidies in one country can be matched by subsidies in another. Indeed, in the absence of any global authority to coordinate green investment, a subsidy race may be the best way to hasten decarbonization.

As a matter of economics, then, there is no reason that industrial policy has to involve us-against-them economic nationalism or heightened conflict between the United States and China. As a matter of politics, unfortunately, the link may be tighter.

They are certainly linked in the rhetoric of the Biden administration. Virtually every initiative, it now seems, is justified by the need to meet the threat of foreign rivals. A central goal of the CHIPS Act is to not only reduce U.S. reliance on Chinese imports but to cut China off from technologies where the United States still has the lead. Meanwhile arms deliveries to Ukraine are sold as a form of stimulus. This bellicose posture is deeply written in the DNA of Bidenomics: before becoming Biden’s national security advisor, Jake Sullivan ran a think tank whose vision of “foreign policy for the middle class” was “Russia, Russia, Russia and China, China, China.”

Thea Riofrancos calls this mindset the “security-sustainability nexus.” Is its current dominance in U.S. politics a contingent outcome—the result, perhaps, of the particular people who ended up in top positions in the Biden administration? And if so, can we imagine a U.S. industrial policy where the China hawks are not in the driver’s seat? Or is the political economy of the United States one in which only a Cold War enemy can motivate a public project to reorient the economy?

In a recent paper, Benjamin Braun and Daniela Gabor argue for the second alternative. It is only “the salience of geopolitical competition” with China that has allowed the United States to go as far with industrial policy as it has. In the absence of much more popular pressure and a broader political realignment, they suggest, the only way that “green planners” can overcome the deep-seated resistance to bigger government is through an alliance with the “geopolitical hawks.”

Many of us have pointed to the economic mobilization of the Second World War as a model for a quick decarbonization of the U.S. economy through public investment. Wartime mobilization — the “greatest thing that man has ever done,” in the words of a contemporary Woody Guthrie song — offers an appealing model for decarbonization. It combines both the most rapid expansion and redirection of economic activity in U.S. history, and the closest the country has ever come to a planned economy. But given the already dangerous entanglement of industrial policy with war and empire, it’s a model we may not want to invoke.

On the other hand, the climate crisis is urgent. And the arguments that it calls for a more direct public role in steering investment are as strong as ever. It’s safe to say that neither the historic boom in new factory construction nor the rapid growth in solar energy (which accounts for the majority of new electrical generating capacity added in 2024) would have happened without the IRA. It’s easy to see how climate advocates could be tempted to strike a Faustian bargain with the national security state, if that’s the only way to get these measures passed.

Personally, I would prefer to avoid this particular deal with the devil. I believe we should oppose any policy aimed at strengthening the United States vis-à-vis China and flatly reject the idea that U.S. military supremacy is in the interest of humanity. An all-out war between the United States and China (or Russia) would be perhaps the one outcome worse for humanity than uncontrolled climate change. Even if the new Cold War can be kept to a simmer—and that’s not something to take for granted—the green side of industrial policy is likely to lose ground whenever it conflicts with national security goals, as we’ve recently seen with Biden’s tariffs on Chinese solar cells, batteries, and electric vehicles. The Democratic pollster David Shor recently tweeted that he “would much rather live in a world where we see a 4 degree rise in temperature than live in a world where China is a global hegemon.” Administration officials would not, presumably, spell it out so baldly, but it’s a safe bet that many of them feel the same way.

Adam Tooze observes somewhere that historically socialists often favored strictly balanced budgets — because they expected, not without reason, that the main beneficiary of lax fiscal rules would be the military. The big question about industrial policy today is whether that logic still applies, or whether an expansion of the state’s role in the economic realm can be combined with a diminution of its capacity for war.

China’s Economic Growth Is Good, Actually

(I write a monthlyish opinion piece for Barron’s. This one was published there in June. My previous pieces are here.)

Once upon a time, the promise of globalization seemed clear. In an economically integrated world, poor countries could follow the same path of development that the rich countries had in the past, leading to an equalization of global living standards. For mid-20th century liberals, restoring trade meant bringing the New Deal’s egalitarian model of economic development to a global stage. As Nebraska Senator Kenneth Wherry memorably put it, “With God’s help, we will lift Shanghai up and up, ever up, until it is just like Kansas City.”1  

For better and for worse, globalization has failed in its promise to deliver a planet of Kansas Cities. But Shanghai specifically is one place that it’s come through, and then some. As we debate the Biden administration’s new tariffs, let’s not lose sight of the fact that China’s industrialization is a very good thing for humanity. Indeed, it is the outstanding case of globalization’s promises being fulfilled.

For most of modern history, the gap between the global rich and global poor has only gotten wider. Though there are many tricky issues of measurement, most economic historians would agree with  Branko Milanovic — perhaps the world’s foremost authority on the global distribution of income — that global inequality rose steadily for perhaps 200 years until 1980 or so. Since then, and particularly since 2000, there has been a sharp reversal of this trend; according to Milanovic, global income is probably more equally distributed today than at any time since the 19th century. 

The reason for this remarkable turn toward equality? China. 

 According to Milanovic, the rise of China was almost singlehandedly responsible for the reduction in global inequality over the past 30 years. Thanks to its meteoric growth, the gap between the world’s rich and poor has closed substantially for the first time since the beginning of the Industrial Revolution. 

Almost all the fall in global inequality in recent decades is attributable to China. Source.

Convergence to rich-country living standards is extremely rare historically. Prior to China,  the only major examples in modern times were Taiwan and South Korea. Much more typical are countries like the Philippines or Brazil. Sixty years ago, according to the World Bank, their per-capita incomes were 6 and 14 percent that of the USA, respectively. Today, they are … 6 and 14 percent of the USA. There were ups and downs along the way, but overall no convergence at all. Other poor countries have actually lost ground.

Or as Paul Johnson summarizes the empirical growth literature: “Poor countries, unless something changes, are destined to remain poor.” 

China is not just an outlier for how rapidly it has grown, but for how widely the benefits of growth have been shared. One recent study of Chinese income distribution over 1988-2018 found that while growth was fastest for the top, even the bottom 5 percent of wage earners saw real income grow by almost 5 percent annually. This is faster than any group in the US over that period. Milanovic comes to an even stronger conclusion: The bottom half of the Chinese income distribution saw faster growth than those at the top. 

Even studies that find rising inequality in China, find that even the lowest income groups there had faster income growth than any group in the US.

Thomas Piketty finds a similar pattern. “The key difference between China and the United States,” he writes, “is that in China the bottom 50 percent also benefited enormously from growth: the average income of the bottom 50 percent [increased] by more than five times in real terms between 1978 and 2015… In contrast, bottom 50 percent income growth in the US has been negative.”2

It’s clear, too, that Chinese growth has translated into rising living standards in more tangible ways. In 1970, Chinese life expectancy was lower than Brazil or the Philippines; today it is almost ten years longer. As the sociologist Wang Feng observes in his new book China’s Age of Abundance, Chinese children entering school in 2002 were 5-6 centimeters taller than they had been just a decade earlier – testimony to vast improvements in diet and living conditions. These improvements were greatest in poor rural areas. 

How has China delivered on the promises of globalization, where so many other countries have failed? One possible answer is that it has simply followed the path blazed by earlier industrializers, starting with the United States. Alexander Hamilton’s Report on Manufacturers laid out the playbook: protection for infant industries, public investment in infrastructure, adoption of foreign technology, cheap but strategically directed credit. The Hamiltonian formula was largely forgotten in the United States once it had done its work, but it was picked up in turn by Germany, Japan, Korea and now by China. As the Korean development economist Ha-Joon Chang puts it, insistence that developing countries immediately embrace free trade and financial openness amounts to “kicking away the ladder” that the rich countries previously climbed.

Today, of course, the US is rediscovering these old ideas about industrial policy. There’s nothing wrong with that. But there is something odd and unseemly about describing the same policies as devious manipulation when China uses them. 

When John Podesta announced the formation of the administration’s White House Climate and Trade Task Force last month, he tried to draw a sharp line between industrial policy in the United States and industrial policy in China. We use “transparent, well-structured, targeted incentives,” he said, while they have “non-market policies … that have distorted the market.” Unlike us, they are trying to “dominate the global market,” and “creating an oversupply of green energy products.” Yet at the same time, the administration boasts that the incentives in the Inflation Reduction Act will double the growth of clean energy investment so that “US manufacturers can lead the global market in clean energy.”

No doubt if you squint hard enough, you can make out a distinction between changing market outcomes and distorting them, or between leading the global market and dominating it. But it certainly seems like the difference is when we do it versus when they do.

The claim that China is creating a global “overcapacity” in green energy markets — often trotted out by tariff supporters — is particularly puzzling. Obviously, to the extent that there is global overcapacity in these markets, US investment contributes exactly as much as Chinese does — that is what the word “global” means. 

More importantly, as many critics have pointed out, the world needs vastly more investment in all kinds of green technologies. It’s hard to imagine any context outside of the US-China trade war where Biden supporters would argue that the world is building too many solar panels and wind turbines, or converting too quickly to electric vehicles.

Not so long ago, the dominant view on the economics of climate change was that the problem was the  “free rider” dynamic  — the whole world benefits from reduced emissions, while the costs are borne only by the countries that reduce them. In the absence of a global government that can impose decarbonization on the whole world, the pursuit of national advantage through green investment may be the only way the free rider problem gets solved.

As development economist Dani Rodrik puts it: “Green industrial policies are doubly beneficial – both to stimulate the necessary technological learning and to substitute for carbon pricing. Western commentators who trot out scare words like ‘excess capacity,’ ‘subsidy wars,’ and ‘China trade shock 2.0’ have gotten things exactly backwards. A glut in renewables and green products is precisely what the climate doctor ordered.”3

The Biden administration is not wrong to want to support US manufacturers. The best answer to subsidies for green industries in China is subsidies for green industries in the US (and in Europe and elsewhere). In a world that is desperately struggling to head off catastrophic climate change, a subsidy race could harness  international rivalry as a part of the solution. But that requires that competition be channeled in a positive-sum way.

Unfortunately, the Biden Administration seems to be choosing the path of confrontation instead. In the 1980s, the Reagan administration dealt with the wave of imported cars that threatened US automakers through a voluntary agreement with Japan to moderately reduce auto exports to the US, while encouraging investment here by Japanese automakers. Unlike the pragmatists around Reagan, the Biden team seems more inclined to belligerence. There’s no sign they even tried to negotiate an agreement, instead choosing unilateral action and framing China as an enemy rather than a potential partner. 

Tellingly, National Security Advisor Jake Sullivan is described (in Alexander Ward’s new book The Internationalists) as arguing that the US can make serious climate deals with other countries while “boxing China out,” a view that seems to have won out over the more conciliatory position of advisors like John Kerry. If Sullivan’s position is being described accurately, it’s hard to exaggerate how unrealistic and irresponsible it is. The US and China are by far the world’s two largest economies, not to mention its preeminent military powers. If their governments cannot find a way to cooperate, there is no hope of a serious solution to climate change, or to other urgent global problems.

To be clear, there’s nothing wrong with an American administration putting the needs of the United States first. And if it’s a mistake to treat China as an enemy, it would also be wrong to set them up as an ideal. One could make a long list of ways in  which the current government of China falls short of liberal and democratic ideals. Still, it’s clear that China is being punished for its economic success rather than its political failures. Tellingly, the same month that the tariffs on China were announced, the Biden administration indicated that it would resume sales of offensive weapons to Saudi Arabia, whose government has nothing to learn from China about political repression or violence against dissidents. 

The policy issues around tariffs are complicated. But let’s not lose sight of the big picture. The fundamental premises of globalization remain compelling today, even if attempts to realize them have often failed. First, no country is an island – today, especially, our most urgent problems can only be solved with cooperation across borders. Second, economic growth is not a zero sum game – there is not some fixed quantity of resources, or markets, available, so that one country’s gain must be another’s loss. And third, democracy spreads best via example and the free movement of ideas and people, not through conquest or coercion. We don’t have to endorse the whole classical case for free trade to agree that its proponents were right in some important ways. 

China’s growth has been the clearest case yet of globalization’s promise that international trade can speed the convergence of poor countries with rich ones. The opportunity is still there for its broader promises to be fulfilled as well. But for that to happen, we in the United States must first accept that if the rest of the world catches up with us, that is something to be welcomed rather than feared.

Thoughts on International Finance, with Application to the US and China

(I wrote this back in 2020, and never posted it. The context is different now, but the substance still seems valid.)

Here is my mental model, for whatever it’s worth:

(1) The US-China trade balance is determined in the short to medium run by relative income growth in the two countries. In the medium to long run relative prices do play a role. But at least past the early stages of industrialization, the impact of exchange rates is thru producer entry/exit than thru expenditure switching. The impact of the overvalued dollar of the early 80s came mainly through e.g. the bankruptcy of US steel producers selling at world prices, rather than a loss of market share from selling at US prices.

(2) Chinese capital controls limit cross-border financial flows. This especially limits the acquisition of foreign assets (including real estate, consequentially for New York) by Chinese firms and households. This implies greater net inward financial  flows than there would be in absence of controls. This is probably the most important Chinese policy with respect to cross-border flows — a broad liberalization would be more likely to push the renminbi down than up.

(3) The Chinese central bank passively accumulates/decumulates whatever level of reserves are implied by the combination of 1 and 2.

(4) The exchange rate is either chosen by one or both governments or determined in speculative markets. (In practice this means the Chinese government, but there’s no in-principle reason why this has to be so.) There is no meaningful link from the trade balance to the exchange rate, and at most a weak link from the exchange rate to the trade balance. Exchange rate interventions are not an independent factor in reserve changes. 

(5) The interest rate on US Treasury debt is determined by some mix of Fed policy and self-confirming market expectations (convention). Chinese reserve purchases play zero role. 

(6) US deficit spending is not constrained, required, or influenced in any way by foreign reserve accumulation. When desired foreign reserve accumulation departs from new Treasury issues, the gap is accommodated by net sales between foreign central banks and the private sector.

(7) If a mismatch between the supply of Treasury issues and the demand for reserve accumulation creates pressure anywhere, it will be on private assets that are close substitutes for Treasuries. In particular, it is plausible that insufficient federal borrowing in 1990s-2000s helped create the mortgage securitization market. 

(8) Returning to exchange rates. The fact that import price elasticities are low, and that most trade is priced in dollars, means that exchange rates affect trade mainly via exporters’ profit margins. An appreciation can undermine exports, but this is a slow process of failure/exit by exporters, and thus strongly depends on financial capacity of exporters to operate with diminished margins. So for instance the large, roughly symmetrical movements in the dollar-yen exchange rate in the first and second halves of the 1980s affected the US tradable sector more than the Japanese, because Japan’s bank-based financial system plus the lack of shareholder pressure made it easier to sustain losses for extended period there than in the US.

In the textbooks, we get a picture of a tightly articulated system where a change in behavior in one place must lead to an exactly offsetting change somewhere else, mediated by price changes. Given a set of fundamental parameters, there is only one possible equilibrium. The considerations above suggest a different vision.

In the orthodox vision, international trade and financial flows are like a pool of water. If you drop a rock in, the whole surface of the pool rises by the same amount. Of course there are passing ripples. But knowing what level this part of the pool was at a while go doesn’t tell you anything about what level it is at now. One could, though, just as easily imagine a pile of rocks. When you move one rock, it normally affects only the rocks in the immediate vicinity. And the same rocks can be piled up in many different ways; where they are now depends on where they were before.

From where I’m sitting, there are three major sources of flexibility in the international system, all of which undermine any claim that shift in one flow must lead to equivalent shift in some other flow.

First is the existence of passive, accommodating positions that act as buffers. Central bank reserves can function this way; this is accepted in mainstream theory. But so can bank loans and deposits, and positions taken by fx specialists. In the short run, bank deposits are always accommodating buffers for any other flow.

Second is speculative price dynamics that make asset demand endogenous to current price. Concretely: If an asset is held largely in hope of capital gains, as opposed to yield or use in production, and if there are anchored expectations of normal or long-run price x, then any position that produces a price move away x implies capital gains for anyone who takes the other side of the position. In markets where these kinds of speculative dynamics operate – and I think they operate very widely – then even large changes in flows don’t have to lead to significant price adjustments. (Conversely, shifting expectations can lead to large price changes without any shift in flows.)

Third is the fact that trade adjustment happens mainly thru entry/exit rather than expenditure switching in product markets. This means in effect that the balance sheets of exporting firms act as shock absorbers. Let’s say that a country’s financial assets become more desirable to global wealth owners, causing a financial inflow and (plausibly though not necessarily) an appreciation of its currency. In the textbook story, this leads to an equal and immediate fall in net exports. But in reality, with exports priced in global markets, the immediate effect is a fall in the profitability of exporters. Only over time, as those firms go bankrupt or give up on export markets, will trade volumes change.

 

At Barron’s: What We Don’t Talk About When We Talk About Inflation

(I am now writing a monthly opinion piece for Barron’s. This one was published there in July.)

To listen to economic policy debates today, you would think the U.S. economy has just one problem: inflation. When Federal Reserve Chairman Jerome Powell was asked at his last press conference if there was a danger in going too far in the fight against inflation, his answer was unequivocal: “The worst mistake we could make is to fail—it’s not an option. We have to restore price stability…because [it’s] everything, it’s the bedrock of the economy. If you don’t have price stability, the economy’s really not going to work.”

Few would dispute that rising prices are a serious problem. But are they everything?

The exclusive focus on inflation acts like a lens on our view of the economy—sharpening our attention on some parts of the picture, but blurring, distorting, and hiding from view many others.

In the wake of the Great Recession, there was a broadening of macroeconomic debates. Economists and policy makers shifted away from textbook truisms toward a more nuanced and realistic view of the economy. Today, this wide-ranging conversation has given way to panic over rising prices. But the realities that prompted those debates have not gone away.

In the clamor over inflation, we’re losing sight of at least four big macroeconomic questions.

First, does the familiar distinction between supply and demand really make sense at the level of the economy as a whole? In the textbooks, supply means the maximum level of production in the economy, labeled “full employment” or “potential output,” while demand means total spending. The two are supposed to be independent—changes in spending don’t affect how much the economy can produce, and vice versa. This is why we are used to thinking of business cycles and growth as two separate problems.

But in the real world, supply often responds to demand—more spending calls forth more investment and draws people into the labor force. This phenomenon, known by the unlovely name “hysteresis,” was clearly visible in the slowdown of labor force and productivity growth after the Great Recession, and their recovery when demand picked up in the years before the pandemic. The key lesson of this experience—in danger of being forgotten in today’s inflation panic—was that downturns are even more costly than we thought, since they not only imply lost output today but reduced capacity in the future.

Hysteresis is usually discussed at the level of the economy as a whole, but it also exists in individual markets and industries. For example, one reason airfares are high today is that airlines, anticipating a more sustained fall in demand for air travel, offered early retirement to thousands of senior pilots in the early stages of the pandemic. Recruiting and training new pilots is a slow process, one airlines will avoid unless it’s clear that strong demand is here to stay. So while conventional wisdom says that rising prices mean that we have too much spending and have to reduce it, in a world with hysteresis a better solution may be to maintain strong demand, so that supply can rise to meet it. In the textbook, we can restore price stability via lower demand with no long-run costs to growth. But are we sure things work so nicely in the real world?

The second big question is about the labor market. Here the textbook view is that there is a unique level of unemployment that allows wages to grow in line with productivity. When unemployment is lower than this “natural rate,” faster wage growth will be passed on to rising prices, until policy makers take action to force unemployment back up. But in the years before the pandemic, it was becoming clear that this picture is too simplistic. Rising wages don’t have to be passed on to higher prices—they may also come at the expense of profits, or spur faster productivity growth. And not all wages are equally responsive to unemployment. Younger, less-educated, and lower-wage workers are more dependent on tight labor markets to find work and get raises, while the incomes of workers with experience and credentials rise more steadily regardless of macroeconomic conditions. This means that—as Powell has acknowledged—macroeconomic policy has unavoidable distributional consequences.

In his classic essay “Political Aspects of Full Employment,” the great Polish economist Michal Kalecki argued that even if it were economically feasible to eliminate unemployment, this would be unsustainable, since employers’ authority in the workplace depends on “the threat of the sack.” Similar arguments have been made by central bank chiefs such as Alan Greenspan, who suggested that low unemployment was sustainable in the 1990s only because workers had been traumatized by the deep recession of the decade before.

Some would argue that it’s unnecessarily wasteful and cruel to maintain labor discipline and price stability by denying millions of people the chance to do useful work—especially given that, prior to the pandemic, unemployment had fallen well below earlier estimates of the “natural rate” with no sign of accelerating inflation. But if we wish to have a permanent full-employment economy, we need to answer a difficult question: How should we manage distributional conflicts between workers and owners (and among workers), and motivate people to work when they have little to fear from losing their job?

A third set of questions concerns globalization. There are widespread fears that renewed Covid lockdowns in China may limit exports to the U.S. and elsewhere. Seen through the inflation lens, this looks like a source of rising prices and a further argument for monetary tightening. But if we take a step back, we might ask whether it is wise to organize the global economy in such a way that lockdowns in China, a war in Ukraine, or even a factory fire in Japan leave people all over the world unable to meet their basic needs. The deepening of trade and financial links across borders is sometimes presented as a fact of nature. But in reality it reflects policy choices that allowed global production of all kinds of goods—from semiconductors to Christmas decorations and latex gloves—to be concentrated in a handful of locations. In some cases, this concentration is motivated by genuine technical advantages of larger-scale production, in others by the pursuit of low wages. But either way, it reflects a prioritization of cost minimization over flexibility and resiliency. Whatever happens with inflation, this is a trade-off that will have to be revisited in coming years, as climate change makes further disruptions in global supply chains all but inevitable.

Then there is climate change. Here, the inflation lens doesn’t just recolor the picture but practically reverses it. Until recently, the conventional wisdom was that a carbon tax was the key policy tool for addressing climate. An Obama-era economist once quipped that the big question on climate was whether a carbon tax was 80% of the solution, or 100%. A carbon tax would increase the prices of energy, which still mainly comes from fossil fuels, and of travel by private car. As it happens, this is exactly what we have seen: Autos and energy have increased much faster than other prices, to the point that these two categories account for a majority of the excess inflation over the past year. In effect, we’ve seen something like a global carbon tax. But far from welcoming the disproportionate rise in the prices of carbon-intensive goods as a silver lining of inflation, both policy makers and the public see it as an urgent problem to be solved.

To be clear, people are not wrong to be unhappy at the rising cost of cars and energy. In the absence of practical alternatives, these high prices inflict real hardship without necessarily doing much to speed the transition from carbon. One reasonable lesson, then, is that a carbon tax high enough to substantially reduce emissions will be politically intolerable. And indeed, before the pandemic, many economists were already shifting away from a carbon-price-focused approach to climate policy toward an investment-centered approach.

Whether via carbon prices or investment, the only way to reduce carbon emissions is to leave fossil fuels in the ground. Yet an increasing swath of the policy conversation is focused on how to encourage more drilling by oil-and-gas companies, not just today but into the indefinite future. As a response to today’s rising energy prices, this is understandable, given the genuine limitations of renewable energy. But how can measures to boost the supply of fossil fuels be consistent with a longer-term program of decarbonization?

None of these questions have easy answers. But the danger of focusing too single-mindedly on inflation is that we may not even try to answer them.

Obstfeld, Globalist

This Maurice Obstfeld op-ed in the FT is a perfect distillation of the orthodox position on trade. Obstfeld is the guardian of free-trade orthodoxy ex officio as head of research at the IMF; he’s also done the circuit of top US departments and is co-author of one of the most widely used undergraduate textbooks. [1]

The op-ed is, of course, against tariffs. This isn’t news. I was at a session on trade policy at the American Economic Association last year, where the chair introduced the panel by saying, “Obviously, if you are in this room then you are for free trade, as much as we can get,” which is a pretty fair description of the range of opinion among credentialed economists. But it’s still striking how many of the tenets of faith Obstfeld manages to hit in 250 words.

Start with the explanation for why trade deficits are not necessarily bad:

“For example, they can help countries finance productive long-term investments that ultimately raise national income and wealth.”

This is the classic argument for international integration. Poor countries, by accepting capital inflows (the ambiguity between capital as money and capital as means of production is essential to the argument) can finance more investment and thereby achieve faster income growth than they would be able to on the basis of domestic savings alone. Obstsfeld’s “for example” is misleading here — as I’ve pointed out before, the option of running trade deficits is the entire benefit of free flows of portfolio investment in the orthodox theory.

Analytically, the op-ed’s key passage is:

A country’s overall trade balance is a macroeconomic phenomenon that mirrors whether it spends less than its income or more. In contrast, the structure of bilateral trade reflects the international division of labor – based on each country’s comparative advantage.

Here we have three key planks of orthodox trade economics. First, the airtight seal between “macro” and “micro” analysis, which protects us from discovering that these are two incompatible approaches based on mutually contradictory assumptions. Second, the anti-Keynesian macro component, with income fixed and savings as a constraint. Third, the bland invocation of the “international division of labor,” as if this were an anodyne technical fact and not a hierarchical, unequal relationship between the rich and poor worlds.

The macroeconomic part of Obstfeld’s argument is that trade restrictions “would not alter the fact that the US spends more than it earns — the source of the overall US deficit.” It is, of course, true as a matter of accounting that the current account deficit is equal to the government deficit plus the difference between private investment and private saving. Writing “the source” implies that this is a causal relationship and not just an accounting one — that how much the US “earns” is independent of the trade position. But there’s a problem — additional US exports constitute additional income for US businesses and households. An increase in US exports (or fall in imports) would, all else equal, increase savings by an exactly equal amount. So it’s not obvious how savings can be a constraint on the trade balance.

The argument that trade policy cannot change the overall deficit because national saving is fixed, is simply a transposition of the “Treasury view” of the 1930s that public investment could not increase output or employment since it would draw on the fixed supply of national saving and would crowd out an equal amount of private investment. It’s wrong for the same reason: Exports, like investment, create their own saving. It’s straightforward to show how interventions like tariffs or devaluations can generate some mix of higher output and a move toward trade surplus, while all the accounting identities are satisfied. This was a standard feature of older textbooks, and of many more recent ones in the form of the IS-LM-BP model, even if it’s not there in the more recent Obstfeld-Krugman books.

Obstfeld himself seems to have some misgivings about this argument, since he adds the caveat “for a country at full employment, like the US.” He also warns that trade restrictions “could derail the world economy’s current expansion,” which is obviously inconsistent with the idea that saving and investment are determined prior to trade balances.

It’s also striking that while Obstfeld acknowledges that “trade balances can of course be excessive” (the “of course” here functioning as a dismissal) there is no hint anywhere else in the op-ed about what the dangers of excessive deficits might be or how they could arise.

On the micro side, Obstfeld simply repeats variations on the same formula several times: trade restrictions “can badly distort the international division of labor.”

This sounds fine: division of labor is good, distorting is bad. (Distort is one of the many keywords that allows economic theory to appear to make contact with observable reality by confusing a technical meaning with an everyday one.) But what this formula actually means is: The countries that are rich, should remain rich. The countries that are poor, should remain poor. The countries that specialize in higher education and software and pharmaceuticals should retain their monopolies, the countries that specialize in plantation agriculture and sweatshop clothing should keep on doing that. “Comparative advantage” means that the hewers of wood and drawers of water are destined to remain such. Everybody should stay in their lane.

The “international division of labor” is a gesture at models that start from the premise that countries’ productive potential is fixed, given by nature or god. It is directly opposed to the idea of economic development, which starts from the premise that productive potentials are contingent and path-dependent, and that the whole goal of policy is to change — “distort”, if you will — the international division of labor.

These phrases might not have leaped out at me so much if I hadn’t just been reading Quinn Slobodian’s Globalists. (It’s a great book — look for my review in the Boston Review of Books sometime soon.) As Slobodian lucidly recounts, the real content of Obstfeld’s pieties was expressed more clearly by Mont Pelerin luminaries like Wilhelm Ropke, who

believed that an economically equal world might simply be impossible, and that developing countries might have to remain underdeveloped as a way of preventing possible ‘over-industrialization and underagriculturalization of the world.’ … the conditions for industrialization in the Third World did not exist. .. ‘The rich countries of today are rich because, along with the necessary prerequisites of modern technology, they have a particular form of economic organization that responds to their spirit.’ … Ropke believed that the ‘lack of punctuality, reliability, inclination to save and create’ … meant that industrialization schemes in the Global South were ‘doomed to fail.’

The position these early neoliberals were arguing against was the “global New Deal” which aimed not to reinforce the global division of labor, but to erase it through a convergence between the poor and rich worlds — in the memorable words of Senator Kenneth Wherry, to “lift Shanghai up and up, ever up, until it is just like Kansas City.” It’s worth emphasizing how diametrically opposed Obstfeld’s 2018 vision of trade is to Wherry’s 1940 one. Comparative advantage and the international division of labor are, for Obstfeld, fixed and god-given. You’d think the fact that Shanghai has in fact risen up well above Kansas City — and more broadly, that China, the greatest economic growth story of our times, has violated every one of his precepts — would give him pause. But it doesn’t seem to.

The neoliberals of the 1940s and 50s took exactly Obstfeld’s line. In Slobodian’s summary, their “critique of mainstream development theories began with the conviction that the industrialization of formerly agricultural areas … distorted the international division of labor and led nations to specialize in branches of production for which their natural endowments were unsuited.” Since so many people in the newly independent South were unhappy with their current position in the division of labor, this led naturally to calls for restrictions on political rights in the former colonies, and of non-whites in South Africa and elsewhere.

Obstfeld would, I’m sure, be appalled at the frank racism of Ropke. But Ropke at least had an explanation for why the benefits of industry and technology should be concentrated in a small part of the globe — the genetic-slash-cultural superiority of white Europeans. What’s Obstfeld’s explanation for why the “undistorted” international division of labor happens to so favor Europe and North America? Is it the climate?

 

[1] I’ve assigned Obstfeld’s textbook. It’s pretty good, as mainstream texts go.

V for Varoufakis

I have a long review up at Boston Review of three books by Yanis Varoufakis: The Global Minotaur, And the Weak Suffer What They Must?, and Adults in the Room. Here’s the start:

In the spring of 2015, a series of debt negotiations briefly claimed a share of the world’s attention that normally goes only to events where celebrities give each other prizes. Syriza, a scrappy left-wing party, had stormed into office in Greece on a promise to challenge the consortium of international creditors that had effectively ruled the country since its debt crisis broke out in 2010. For years, austerity, deregulation, the rolling back of labor rights and public services, the rule of money over society, had been facts of life. Now suddenly they were live political questions. It was riveting.

Syriza was represented in these negotiations by its finance minister, Yanis Varoufakis. With his shaved head, leather jacket, and motorcycle, he was not just a visual contrast to the gray-suited Eurocrats across the table. His radical but rigorous proposals for a different kind of Europe—one based on meeting human needs rather than rigid financial criteria—offered a daily rebuke to the old refrain “there is no alternative.”

The drama was clear, but the stakes were a little obscure. Why did it matter if Greece stayed in the euro? Orthodox economic theory, after all, gives little role for money or finance. What matters are real wants and real resources, for which money is just a convenient yardstick. University of Chicago economist John Cochrane probably spoke for much of the profession when he asked why it made any more sense to talk about Greece leaving the euro than about Greece leaving the metric system.

But money does indeed matter—especially in economic relations between countries, as Varoufakis himself has convincingly shown. In his three books—The Global Minotaur (2011), And the Weak Suffer What They Must (2016), and Adults in the Room (2017)—Varoufakis offers a fascinating lens on the euro system and its masters. While the first two books chart the history of the international monetary system from World War II up to the debt crisis, his last and most recent book is a reflection on his five months as Greek finance minister. Taken together, they read as if Varoufakis is the protagonist in some postmodern fable, in which he is transformed from a critic of the play to one of the main characters in it. …

Read the rest there, and then comment here if you are so inclined.

Links for May 5, 2017

Some economics content, for this rainy Friday afternoon:

 

Turbulence. Over at INET, Arjun Jayadev has posted the next in our series of “rebel masters” interviews with dissenting economists. This one is with Anwar Shaikh, who is, I’m sure, familiar to readers of this blog. Shaikh’s work resists summary, but the

broad thesis revolves around the idea that there is an alternative tradition-embedded in the classical approach of Smith, Ricardo and Marx which insists on understanding the world on its own terms rather than from an idealized economy from which the real world deviates. This approach focuses on what is termed “real competition” wherein competition between firms, each seeking to get the highest price they can, leads to a “turbulent gravitation” of prices around values. As such, there is never an equilibrium, but a dancing around some key deeper parameters.

As with all these interviews, there’s also some discussion of his own political and intellectual development, as well as of the content of his work.

I haven’t made a serious effort to read Shaikh’s big new book Capitalism. Given its heft, I suspect it will function more as a reference work, with people going to specific sections rather than reading it from front to back. (I know one person who is using it as an undergraduate textbook, which seems ambitious.) But if you want an admiring but not uncritical overview of the book as a whole, this review in New Left Review by John Grahl could be a good place to start. It’s written for people interested in the broad political economy tradition; it’s focused on the broad sweep of the argument, not on Shaikh’s position within current debates in heterodox economics.

 

The rich are different from you and me. [1] At Washington Center for Economic Growth, Nick Bunker calls attention to some new research on income inequality over the past 15 years. The key finding is that since the end of the 1990s, the rise in income inequality is almost all due to income from S-corporations (pass-through companies, partnerships, etc.) at the very top of the distribution. As a result, rising inequality shows up in tax data, but not in Social Security data, which captures only labor income. What do we take from this? First, the point I’ve made periodically on this blog: Incomes at the top are mainly capital income, not labor income. But there’s also a methodological point — the importance of constantly walking back and forth between your theoretical construct, the concrete social reality it hopes to explain, and the data (collected by somebody, according to some particular procedures) that stands between them.

 

What are foreign investors for? At FT Alphaville, Matthew Klein has a very interesting post on capital controls. As he notes, during the first decade of the euro, Spain was the recipient of one of “the greatest capital flows of all time,” with owners of financial assets all over Europe rushing to trade them for claims on Spanish banks. This created immense pressure on Spanish banks to increase lending, which in the event financed a runup in real estate prices and an immense quantity of never-to-be-occupied houses and hotels. (It’s worth noting in passing that this real estate bubble developed without any of the securitization that so mesmerized observers of the American bubble.) Surely, Klein says,

if you accept the arguments for regulating cross-border financial movements in any situation, you have to do the same for Spain. The country raised bank capital requirements and ran large fiscal surpluses, but none of that was enough. Plus, it didn’t have the luxury of a floating currency. Both the boom and bust would clearly have been smaller if foreigners had been prevented from buying so many Spanish financial assets, or even just persuaded to buy fewer bonds and more stocks and direct equity.

This seems right. But we could go a step farther. What’s the point of capital mobility?  If you don’t in fact want bank balance sheets expanding and shrinking based on the choices of foreign investors, what benefit are those investors providing to your economy? They provide foreign exchange (allowing you to run current account deficit), they provide financing (allowing credit to expand more), they substitute their judgement of future for domestic actors’. These are exactly the problems in the Spanish case. What is the benefit, even in principle, that Spain got from allowing these inflows?

 

There’s always a first time. Also from Matthew Klein, here is a paper from the Peterson Institute looking at historical fiscal balances and making the rather obvious point that there is little historical precedent for the surpluses the Greek government is expected in order to  pay its conquerors creditors. It is not quite true that no country has ever sustained a primary surplus of 3.5 percent for a decade a more, as Greece is expected to do; but such episodes are exceedingly rare.

My one criticism of Klein’s piece is that it is a little too uncritical of the idea that “market rates” are just a fact about the world. The Peterson paper also seems to regard interest rates as set by markets in response to more or less objective macroeconomic variables. Klein notes in passing that the interest rate Greece pays on its borrowing will depend on official choices like whether Greek debt is included in the ECB’s bond-buying programs. But I think it’s broader than this — I think the interest rate on Greek bonds is entirely a policy choice of the ECB. Suppose the ECB announced that they were fixing the interest rate on Greek bonds at 1 percent, and that they’d buy them as long as the yield was above this. Then private lenders would be happy to hold them at 1 percent and the ECB would not have to make any substantial purchases. This is how open market operations work – when a central bank announces a policy rate, they can move market rates while buying or selling only trivial amounts. If the ECB wished to, it could put Greece on a stable debt path and open up space for a less sociocidal budget, without the need for any commitment of public funds. But of course it doesn’t wish to.

 

Capital with Chinese characteristics. This new paper on wealth and inequality in China from Piketty, Zucman and Li Yang is an event; it’s a safe bet it’s going to be widely cited in the coming years. The biggest contribution is the construction of long-run series on aggregate wealth and the distribution of wealth and  income for China. Much of the paper is devoted, appropriately, to explaining how these series were produced. But they also draw several broad conclusions about the evolution of the Chinese economy over the apst generation.

First, while the publicly-owned share of national wealth has declined, it is still very high relative to other industrialized countries:

China has ceased to be communist, but is not entirely capitalist; it should rather be viewed as a “mixed economy” with a strong public ownership component. … the share of public property in China today is somewhat larger than – though not incomparable to – what it was in the West during the “mixed economy” regime of the post-World War 2 decades (30% in China today vs. 15-25% in the West in the 1950s-1970s). … Private wealth was relatively small in 1978 (about 100% of national income), and now represents over 450% of national income. Public wealth [has been] roughly stable around 250% of national income.

It’s worth noting that the largest component of this increase in private wealth is housing, which largely passed from public to private hands, The public sector, by Piketty and coauthors’ measures, continues to own about half of China’s non-housing wealth, including the majority of corporate equity, and this fraction seems to have increased somewhat over the past decade.

Second, income distribution has become much more unequal in China over the past generation, but seems to still be more equal than in the United States:

In the late 1970s China’s inequality… [was] close to the levels observed in the most egalitarian Nordic countries — while it is now approaching U.S. levels. It should be noted, however, that … inequality levels in China are still significantly lower than in the United States…. The bottom 50% earns about 15% of total income in China (19% in rural China, 23% in urban China), vs. 12% in the U.S. and 22% in France. For the time being, China’s development model appears to be more egalitarian than that of the United States, and less than Europe’s. Chinese inequality levels seem to have stabilized in recent years (the biggest increase in inequality took place between the mid-1980s and the mid-2000s)

The third story — much less prominent in the article, and of less important, but of particular interest to me — is what explains the observed rise in the ratio of wealth to national income. Piketty et al. suggest that 50-70 percent of the rise can be explained, in accounting terms, by the observed rates of saving and investment and their estimate of depreciation, while the remaining 30-50 percent is due to valuation changes. But in a footnote they add that this includes a large negative valuation change for China’s net foreign wealth, presumably attributable to the appreciation of the renminbi relative to the dollar. So a larger share of the rise in domestic wealth relative to income must be accounted for by valuation changes. (The data to put an exact number on this should be available in their online appendices, which are comprehensive as always, but I haven’t done it yet.)

This means that a story that conflates wealth with physical capital, and sees its growth basically in terms of net investment, will not do a good job explaining the actual growth of Chinese capital. (The same goes for the growth in capital relative to income in the advanced countries.) The paper explains the valuation increase in terms of a runup in the value of private housing plus

changes in the legal system reinforcing private property rights for asset owners (e.g., lifting of rent control, changes in the relative power of landlords and tenants, changes in the relative power of shareholder and workers).

This seems plausible to me. But I wish Piketty and his coauthors — and even more, his admirers — would take this side of the story more seriously. If we want to talk about the “capital” we actually see in public and private accounts, a theory that sees it growing through net investment is not even roughly correct. We really do have to think of capital as a social relation, not a physical substance.

 

On other blogs, other wonders.

Here’s a video of me chatting with James Parrott about robots.

Who’d have thought that Breitbart is the place to find federal government employment practices held up as an ideal?

At PERI, Anders Fremstad and Mark Paul have a nice paper on the distributional impact of different forms of carbon taxes.

Also at PERI, another whack at the Reinhart-Rogoff piñata.

I’ll be speaking at this Dissent thing on May 22.

 

 

[1] This phrase has an interesting backstory. The received version has it that it’s F. Scott Fitzgerald’s line, to which Ernest Hemingway replied: “Yes. They have more money.” But in fact, Hemingway was the one who said the rich were different, at a lunch with Maxwell Perkins and the critic Mary Colum, and it was Colum who delivered the putdown. (The story is in that biography of Perkins.) In “Hills like White Elephants,” Hemingway, for reasons that are easy to imagine, put the “rich are different” line in the mouth of his frenemy Fitzgerald, and there it’s stayed.

At Dissent: A Cautious Case for Economic Nationalism

I have an article in the new issue of Dissent, arguing that “As long as democratic politics operates through nation-states, any left program will require some degree of delinking from the global economy.”

My piece is part of a special section on “Capitalism Today.” There will be an accompanying event at the New School on May 22, with Jamie Galbraith, Julia Ott, Mark Levinson and me.

I’ve made similar arguments to this article’s in a number of posts on this blog:

Capital Mobility as Trojan Horse
Only the Debt Is National
How to Think about the Balance of Payments
What Is Foreign Investment For?
Lessons from the Greek Crisis
Prices and the European Crisis, Continued

One thing that’s probably not as clear as it should be in the Dissent piece, is that the case for delinking is much stronger for most other countries than for the United States. For most countries, free trade and, even more, free capital mobility, drastically reduce the choices available to national governments. (This “disciplining” of the state by foreign investment is sometimes acknowledged as its real function.) For the US, I don’t think this is true – I don’t think the threat of capital flight meaningfully constrains policy here. And in particular I don’t think it makes sense to see a more positive trade balance as necessary or even particularly desirable to boost demand, for reasons laid out here and here.

 

Links and Thoughts for Feb. 17

Minimum wages are good for poor people. Here is an important paper from Arin Dube on the impact of minimum wage increases on family income. Using a variety of approaches, he asks what the record of minimum wage changes tells us about how the effects of the minimum at different points in the income distribution. The core finding is that, in his preferred specification, the elasticity of income at the 10th percentile with respect to the minimum wage is around 0.4 – that is, a one percent increase in the minimum wage will raise income for poor families by close to half a percent. This is, to my mind, a really big number – it suggests that pay at most low-wage jobs is tightly linked to the minimum wage, and that criticism of minimum wages as being badly targeted at low income households is off the mark. Tho to be fair, he also finds that minimum wage increases don’t do much for the very bottom of the distribution, where there is not much wage income to begin with. But beyond whatever this ammo this gives for minimum wage supporters, this is a great example of how you should approach this kind of question as a social scientist. The paper gets out of the box of qualitative debates about job loss that have dominated this debate and makes a positive, quantitative claim about what minimum wages actually do.

This is the effect of a doubling of the state minimum wage on family income, per Dube.

 

Why prefund? I’m still trying to finish this interminable paper on state and local government balance sheets. But one of the big things I’ve learned is that the biggest constraint these governments face is not the terms on which they can borrow, but the extent to which they are required to prefund future expenses. The idea that pensions should be fully funded has a solid basis for private employers but it’s not at all clear that the same arguments apply for governments. It’s good to see that some professionals in state and local finance have come to the same conclusion. Here is a new paper from the Haas Institute on exactly this question. It makes a strong case that the requirement to fully fund public employee pensions is costly and unnecessary, and is an important factor in local government budget crises.

 

Privilege: still exorbitant. Here’s a nice analysis of the international role of the dollar. This is the same argument I tried to make in my Roosevelt Institute piece on trade policy last summer. The Economist says it better:

Unlike other aspects of American hegemony, the dollar has grown more important as the world has globalised, not less. … As economies opened their capital markets in the 1980s and 1990s, global capital flows surged. Yet most governments sought exchange-rate stability amid the sloshing tides of money. They managed their exchange rates using massive piles of foreign-exchange reserves … Global reserves have grown from under $1trn in the 1980s to more than $10trn today.

Dollar-denominated assets account for much of those reserves. Governments worry more about big swings in the dollar than in other currencies; trade is often conducted in dollar terms; and firms and governments owe roughly $10trn in dollar-denominated debt. … the dollar is, on some measures, more central to the global system now than it was immediately after the second world war. …

America wields enormous financial power as a result. It can wreak havoc by withholding supplies of dollars in a crisis. When the Federal Reserve tweaks monetary policy, the effects ripple across the global economy. Hélène Rey of the London Business School argues that, despite their reserve holdings, many economies have lost full control over their domestic monetary policy, because of the effect of Fed policy on global appetite for risk.

… During the heyday of Bretton Woods, Valéry Giscard d’Estaing, a French finance minister (later president), complained about the “exorbitant privilege” enjoyed by the issuer of the world’s reserve currency. America’s return on its foreign assets is markedly higher than the return foreign investors earn on their American assets…  That flow of investment income allows America to run persistent current-account deficits—to buy more than it produces year after year, decade after decade.

Exactly right. You can have free capital mobility, or you can have a balanced trade for the US. But you can’t have both, as long as the world depends on dollar reserves.

 

Greece: still a catastrophe. Over at Alphaville, Matthew Klein makes a strong case that Greece’s experience in the euro has been uniquely catastrophic – no modern balance of payments crisis elsewhere has led to anything like as large and as sustained a fall in output and employment. Martin Sandbu objects, arguing that the Greek catastrophe is the result of austerity, not of the single currency per se. Which is true, but also, it seems to me, misses the point. The problem with the euro — as Klein more or less says — isn’t mainly that it precludes devaluation, but that it surrenders authority over the basic tools of macroeconomic policy to a foreign authority — an authority, as it turns out, that has been happy to see Greece burn pour encourager les autres.

 

The myth of capital strike. I was more on Team Streeck than Team Tooze in their great LRB showdown. But this followup post by Tooze is very smart. Mostly he’s just trying to bring some much-needed order to a complicated set of debates about the role of private finance, credit markets, central banks and the state. But he also scores, I think, a stronger point against Streeck than in the LRB review: Streeck exaggerates the threat of capital strike in modern “managed-money” economies. As Tooze says:

Greece, Spain, Portugal, Ireland even Italy and France all experienced bond market attacks. But this is because they were left by the ECB in a situation which was as though they had borrowed their entire sovereign debt in a foreign currency with no central bank support. … That peculiarity is the result of deliberate political construction. To generalize and reify it into a general theory of capitalist democracy in crisis is highly misleading.

I think Tooze is right: behind the apparent power of the bondholders there’s always either a hostile central bank, or else other, stronger countries.

 

Things are speeding up here at the end. From Credit Suisse, here is an interesting discussion of longevity of firms in the S&P 500.

There is a general sense that the rate of change is accelerating and that corporate longevity is shrinking. This assertion appears frequently in the business press. Our research shows a more nuanced picture. Indeed, a common measure of corporate longevity, turnover of the companies in the S&P 500, shows that longevity has lengthened in recent years.

 

A hell of a way to run a railroad. For New Yorkers who are bored of the things they are mad about and want something new to be mad about: The Port Authority capital plan approved this week includes $1.5 billion for Cuomo’s pointless LaGuardia AirTrain. Of course it would be too much to ask that we extend the existing transit system, we have to create a special new system for airport travelers only. But Cuomo’s plan is useless even for them.

 

Strikes: still declining. Various people have been sharing a graph of strikes “involving 1000 or more workers” on Facebook. I expressed some doubts about this – it’s obviously true that the US has seen a drastic decline in strikes and in worker militance in general, but how well is this captured by a series that only includes the largest strikes? Andrew Bossie replies, showing that for the earlier period where we have more comprehensive strike data, it matches the 1000+ series pretty well. Fair enough.

 

Welfare is not only for whites. Here is a useful corrective from Matt Bruenig to claims that the welfare state disproportionately serves white Americans.  I assume the idea behind these arguments is to disarm claim that welfare is just for “them.” But the politics could cut other way – it’s equally easy to see “welfare goes to whites” as a move to advance the idea that racial justice and economic justice are unrelated, even conflicting, goals. Anyway, whatever it rhetorical uses, we still need a clear and honest assessment of how things work. Which Matt as usual provides.

 

TPP is dead … or is it? My collaborator Arjun Jayadev has a nice piece in The Hindu (circulation 1.4 million, not far off the New York Times) on the legacy of the late, unlamented Trans-Pacific Partnership. It can be hard to rememebr, amid the shrieks and shudders and foul smells coming from the Oval Office, how destructive and, in its own way, insane, was the pre-Trump liberal consensus for free trade and endless war.

 

Just give people nice things is a sound basis for policy. “When we decided peoples’ houses shouldn’t burn down, we didn’t provide savings accounts for private fire insurance, we hired firefighters and built fire stations. If the broad left takes power again, enough with too-clever-by-half social engineering. Help people and take credit.”

What Exactly Does Mexico Export to the US?

One of the many ways conventional economic theory hinders our discussions of trade is it gets us thinking about goods “produced” in one country and “consumed” in another. Mexicans grow tomatoes, drill oil, sew shirts, and assemble cars; Americans eat, burn, wear and drive them.

Most trade in the real world does not look like this. What you have, rather, are commodity chains, where different parts of the production process take place in different countries. In most cross-border transactions, the buyers are not consumers, or even distributors, but producers who use the imported goods as inputs. And in many cases, the relevant transactions are not arm’s-length market exchanges, but transfers within a single corporate structure. Even the final purchasers may not be consumers: In general, investment goods and exports have higher imported content than consumption goods do.

Case in point: US-Mexico trade. What with the latest eruption from DC, I was curious what US imports from Mexico actually look like. [1] Here’s what the Census says:

$ millions % of total
Consumer goods 84,572 26.6
   food 22,432 7.0
   autos 23,434 7.4
   clothing 5,257 1.7
   others 33,448 10.5
Industrial inputs 89,583 28.1
   oil 13,689 4.3
   other raw materials 7,568 2.4
   auto parts 53,175 16.7
   other intermediate goods 15,152 4.8
Investment goods 113,312 35.6
   computers 41,778 13.1
   vehicles 31,943 10.0
   other machinery/equipment 39,590 12.4
Services and other 30,872 9.7
Total 318,338 100

As you can see, consumer goods account for only about a quarter of US imports from Mexico. Given that a large fraction of the service imports are tourism, the total share of consumption in US imports from Mexico will be a bit higher, between 30 and 35 percent. [2] (But presumably tourism would not be affected by a tariff.) The remainder is divided about evenly between industrial inputs (raw materials plus intermediate goods like cloth, steel, auto parts, etc.) and investment goods. Machinery and equipment, including computers, account for an impressive 25 percent of Mexican exports to the US. Petroleum products, despite the widespread perception of Mexico as an oil exporter, account for less than 5 percent.

OK, so why does this matter?

Well, it’s enough, to begin with, that most of us have a distorted idea of what “trade” involves. It’s always dangerous to talk about something at a high level of abstraction without a clear sense of the concrete reality involved — even if, in a given case, the abstract description works fine.

But in this case I don’t think it works fine. I think our model of one country and producing and the other consuming, misleads us in some important ways about the likely impact of something like Trump’s tariff.

First of all, the fact that trade is normally part of a longer commodity chain helps explain why trade flows are often insensitive to changes in relative prices. Notice, for instance, the $50 billion auto parts imported from Mexico — about one-seventh of total Mexican exports to the US. Some of these parts may be generic but most presumably represent investment by the parent company in a specialized supply chain. There’s little or no short-run possibility of substituting components from elsewhere in response to changes in relative prices. In any case, insofar as the importer and exporter are part of the same corporate structure, the relevant price is an administered one that presumably has more to do with internal accounting practices than with exchange rates, tariffs or other macro phenomena. This kind of trade is the excluded category in orthodox trade theory — it doesn’t responds rapidly to changes in prices, but neither does it reflect any fundamental differences in natural resources or other “endowments” between countries.

The second reason the composition of trade matters is when we look at the distributional impact. If Mexican exports were just corn tortillas, as some people seem to imagine, it would be relatively easy to answer “who pays” for a tariff. You just estimate the price elasticities of supply and demand and do the math. (OK, maybe not that easy.) But with a high proportion of intermediate and investment goods it’s much trickier. Especially since there are profits collected at a number of points along the commodity chain, so an increase in the price of Mexican imports at the border is not necessarily passed on to ultimate consumers. Some fraction will presumably come out of the various rents along the way. Even the broad claim that it must ultimately be Americans who pay doesn’t hold, since a large fraction of imports are inputs for export industries.

The third reason follows directly. Insofar as the final users of imports are exporters, tariffs and other relative-price changes will have less of an effect on the trade balance. In the old days of import-substitution industrialization people took this problem seriously — they recognized that the effective rate of protection  for a given industry might be quite different from the statutory rate, depending on how dependent the industry was on imported inputs. In this case, if a large fraction of Mexican imports are destined for US export industries — and they are — then a tariff on Mexican goods will improve US competitiveness less than the textbook analysis would predict.

Finally,  the disproportionately large share of intermediate and investment goods in international  trade should factor into how we think about trade in general. The more I study this stuff, the more I get the sense of international trade and finance as a world unto itself — sitting on top of, dependent on, the rest of the economy, but irrelevant to most of the routine activity of extracting human labor to meet human needs. Imports are purchased to make exports, which will be purchased to make more exports to somewhere else.

An exaggeration? Yes, but maybe not an extreme one. Somewhere in Civilization and Capitalism, Fernand Braudel describes the early modern world as an archipelago of towns scattered around the margins of an interior world — whether in France or India — that remained focused on immediate, local needs. The boundary regions were more connected to each other than to their own hinterlands perhaps only a few miles away. Mutatis mutandis (and there’s a lot of mutatis!) I think something like this applies today. Traders and producers for trade are mostly much more integrated with each other than with the rest of us. Your t-shirt is a valid counterexample, but not necessarily a representative one.

In summary: Most US imports from Mexico are intermediate and investment goods, not consumer goods. A tariff on Mexican goods is more likely to raise costs for US businesses — including for US exporters — than to lead people to substitute American-made goods for Mexican ones.

 

[1] This is my own categorization of the more detailed breakdown given by the census. I’ve included computers with investment goods because most computer expenditure in the US is by businesses, not households. Yes, some computers are purchased by households, but on the other hand some autos are purchased by businesses, so it probably balances out.

[2] Under the conventions of the national accounts, when someone from country A visits country B as a tourist, their spending there counts as a service export from country B to A.

 

 

UPDATE: I feel obliged to point out that I anticipated the latest iteration of “Mexico will pay for the wall’ towards the end of this post from last summer.

UPDATE 2: As Peter K. points out in comments, my line about trade within corporate supply chains not responding to relative costs doesn’t really make sense as written. As he reasonably asks, in that case why would they relocate production to lower-cost areas in the first place? What I should have said is that intra-corporate trade (1) isn’t responsive to *short-run* changes in relative prices and (2) is responsive to long-run changes, but on the supply side, not the demand side. I.e. if there were a large persistent rise in prices in Mexico relative to the US, that might well eventually reduce Mexican exports, but the main way this would happen would be firms disinvesting in production capacity there. Not expenditure switching by consumers in response to higher prices.