Super Models

May 21st, 2015 at 6:20 pm

Sorry, nothing prurient. Just a quick observation and reading/listening assignments for serious OTE’ers on some material that I will return to shortly with the necessary time and attention.

Over the past few days, in three separate (though intimately connected) debates in which I take part, I’ve come across writers emphasizing the critical importance of getting the economic models right. I too cannot over-emphasize the importance of this.

I know: “all models are wrong.” They’re distillations of reality that we cast in order simplify complex phenomena. But that’s the point–the second half of the quote is “…but some models are useful.” When they’re useful, it’s because the filter out the noise such that we can glean an important truth–or, given that this is econ, not physics, an important tendency–that should inform our diagnostic and prescriptive work.

On trade, Harold Meyerson points us away from Ricardian comparative advantage and towards more nuanced models of international competition associated with Samuelson and Ohlin, both of whom consider distributional outcomes of trade driven by differences in factor endowments (e.g., how trade with lower-wage countries can affect workers in higher wage countries).

On the minimum wage, Till von Wachter and Jeff Wenger explain why neo-classical models of the labor market fail to explain the empirical evidence around minimum wage increases, specifically the inaccuracy of the simple prediction that large numbers of workers affected by the mandated increase will lose their jobs. They cite “efficiency wage” models, where increased productivity generated by the wage increase becomes its own absorption mechanism, and “search” models, wherein the higher wage reduces “frictions,” such as turnover and vacancies.

Finally, I’m deeply ensconced in the absolutely masterful new book by British scholar Anthony Atkinson, Inequality: What Can be Done? I don’t have it in front of me, but early on in the book, as well as in this excellent lecture, Atkinson stresses, and I’m paraphrasing, “you know, there’s more than one economic model…” Much like my own models, his include the critical components of bargaining power, political power, as well as their roles in shaping not merely inequality, but more fundamentally, the way other dominant economic forces, like globalization and technological change, play out in the real world.

If you’re not up to reading the above, please at least give the Atkinson lecture a listen. I did so while jogging–learn while you burn!

Bottom line, like it or not, the models through which we interpret the economy matter a great deal, and more often than not, powerful people employ the wrong one.

 

What we’re arguing about when we’re arguing about trade deals.

May 18th, 2015 at 10:20 am

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One problem in this whole debate over the Trans-Pacific Partnership is that we lose the forest for the trees. We end up arguing about trade deals—and worse, a deal almost no one has read (because it’s negotiated in secret)—as opposed to the broader underlying issues of the economic impact of trade from the perspective of what matters most: growth, jobs, wages, incomes, and inequality.

I draw that distinction because what follows is not about politics. Many players in this debate form their views based on perceived labor or corporate interests, or the fact that their constituents are convinced, often legitimately, that prior trade deals have hurt them. That’s not what I’m thinking about here. What follows is instead is my brief take on the economic questions invoked by the debate. For a deeper dive into much of what’s here, see Chapter 5 in the Reconnection Agenda (I’m not saying it’s any good, but I will say that I spent a lot of time trying to make some of the less intuitive parts of this as clear as possible.)

There’s trade and then there’s trade deficits: Economists and the punditry typically pull for more trade because its benefits are well known: greater supplies of goods (and thus lower prices), the opportunities for trading partners to produce and sell more of the goods and services in which they specialize, greater interdependence between countries, the opportunity for developing countries to spur their development.

Of course there are costs to those displaced by trade, but in the textbook model, the benefits are more widely felt than the costs.

That’s not, however, the full story in the US by a longshot. The key distinction is, as the figure above shows, that we’ve run large—in terms of their impact on the generally benign scenario just described—trade deficits since the mid-1970s.

So why is that a problem?

Trade and full employment: First, since the trade deficit is a drag on GDP growth, it means that unless we make up that drag through some other component of growth, demand will be too weak to get to full employment. Note that as the figure shows, even while the trade deficit as a share of GDP has improved in recent years, it has still averaged -4 percent since 2000. That’s a steep barrier to full employment.

Notably, both Ben Bernanke and Larry Summers have made this point, adding these negative trade balances as a factor in their “secular stagnation” (persistently weak demand) discussions.

And yet, while the trade deficit/GDP was -4 percent in 2000, so was the unemployment rate 4 percent that year, because the other components of GDP—consumption, investment, government spending—more than made up the difference. The problem is, these global imbalances have contributed to the bubbles that have doomed the last few business cycles. In other words, the question is not whether we can get to full employment with large trade deficits—we know that we can. But can we do so without damaging bubbles? Perhaps so, but that’s not occurred in recent decades.

Second, as Josh Bivens points out, it’s not the case, as is often said, that the winners from trade are many and the losers are few. He estimates that that our persistent trade deficits have cost the 70 percent of the workforce that’s non-college educated about $1,800 per year in lost earnings. To be clear, that’s not just the impact of the directly displaced. It’s also the impact on those with whom they compete, post-displacement, in lower-wage service sectors.

The point is that large, persistent trade deficits make it harder to get to full employment without lastingly damaging bubbles. Moreover, even at full employment, these deficits affect the composition of jobs in ways that hurt the majority of the workforce.

There’s trade and then there’s trade deals: What does all of this have to do with the TPP, NAFTA, etc.? As you’ve hopefully gleaned from the above, the main question is whether and how such deals affect trade flows. The answer, as far as I can tell, is not in the ways you’d think from listening to the rhetoric.

Boosters of US trade deals say we’re running trade surpluses with the countries with whom we’ve got trade deals; Public Citizen says that’s wrong (one good point they make is that you have to exclude “re-exports”—foreign-made goods that pass through US ports on their way to other countries—from the tally of US exports). It’s certainly true that our trade deficits with Mexico and South Korea increased post those bi-lateral trade deals, but there are so many different factors that determine these net balances that it’s beyond my understanding to make the call either way.

So, with the critical exception of the currency point below, I wouldn’t base support or opposition for a trade deal on the belief that it’s going to raise or lower the trade deficit. I’d recognize that these agreements include both “free-trade” measures, like tariff reductions, and “protectionist” measures, like patent extensions. Though I’ll have to see it to believe it, I trust our trade reps and the President when they say labor protections are stronger in the TPP than in the NAFTA. But the deal also includes dispute settlement mechanisms that can supersede sovereign courts.

You will find none of that stuff in the textbooks on the benefits of trade and globalization. So do not conflate trade deals with the simple “trade good…more trade better” argument that dominates.

Currency matters: Finally, I’ve written extensively about the importance of currency rules in or around these trade deals. “In” is better, as it’s more effective to have a neutral tribunal making the call and imposing corrective measures than an individual country acting unilaterally. But if, as the administration plausibly maintains, they can’t get a currency deal in the bill, then there’s got to be something outside the bill.

Remember, the key factor in all of this is the trade deficit, and the punchline of the currency/exchange rate piece of it is that a country that lowers its tariffs in a trade deal can almost instantaneously reverse that impact by devaluing their currency by the same amount.

Interestingly, the Senate has two options in play to fight back: the Bennet amendment and the Schumer amendment. The Schumer bill’s been around for a while but I’m still learning about the Bennet one, and I’ll post on them once I’ve done more homework. My initial take is that Bennet is better in terms of diagnosing currency-induced export subsidies, but has weak teeth relative to Schumer’s approach of countervailing duties on subsidized exports.

 

End of the day, as I say in Chapter 5, I’m all for more trade and globalization, and not just for us but for developing economies as well. And it wouldn’t matter if I wasn’t. That toothpaste ain’t goin’ back in the tube. But a useful debate must be informed by the real benefits and costs I’ve tried to summarize above.

There are those who disagree, strongly, with many of these assertions. The President’s economic council, for example, has quite different views on trade deficits (see box 7-3 here)—and while I disagree, I’ve got great respect for those guys/gals. The admin and the US trade rep also believe currency management is no longer much of a threat and not something we could block without implicating our Fed, views I also think are wrong.

But those are good debates to have, and I welcome them.

It’s sunny today. Destroy your umbrellas!

May 15th, 2015 at 11:14 am

Just a brief note of confusion and befuddlement regarding a position on currency in the TPP that’s been uncritically picked up by news sources lately, including the WaPo today.

The position touted by the piece is that since China’s currency has floated down relative to the dollar in recent years (see figure), and their trade surplus is also significantly diminished, we don’t need to worry about them or other trading partners managing their currencies to get an export edge over us in the future.

This is wrong for at least three reasons.

First, as the title of this post suggests, just because something isn’t happening now doesn’t mean it won’t happen again later. The figure shows numerous periods of the yuan floating for awhile before a dollar peg again took hold.

If anything, I’m concerned that by announcing to the world that we can’t do anything about currency management without implicating our central bank, pro-TPP (and anti-currency-rule) forces are giving competitors the green light to revert to their old ways in this space with impunity.

Second, everyone, including the Post, is focusing only on flows while ignoring stocks. China still holds large dollar reserves (~$4 trillion), as does Japan, and this too affects exchange rates. As Bergsten and Gagnon put it: “China’s heavy past intervention has lingering effects on the level of the exchange rate, keeping it considerably lower than it would otherwise be.” Dean Baker makes a compelling connection on this point as well:

It is widely believed by economists that the Fed’s holding of $3 trillion of assets is holding interest rates down in the United States. The idea is that by holding this stock of government bonds and mortgage backed securities, it is keeping their prices higher than they would be if investors had to hold this stock of assets. (Higher bond prices mean lower interest rates.) If we accept the view that holding a large stock of bonds affects their price, then it must follow that the decision of China’s bank to hold a large stock of foreign reserves raises their price relative to a situation where investors held them. This would mean that China’s central bank is continuing to prop up the value of the dollar against its currency, even if it is not actively buying dollars.

Finally, a touch of game theory. If currency management is passe’–yesterday’s problem, as the Post implies–then why would it allegedly crash the TPP deal to include measures against it? If countries are so game to join the treaty, why would rules against doing something they don’t do anymore drive them from the negotiating table?

Here’s a DC truism for you: in their zeal for the deal, these trade deals make people say all kinds of unfortunate things.

 

yuan_dol