Last week I blogged about Sen. Dianne Feinstein’s (D-CA) proposal to devote $20 billion of the Export-Import Bank’s funds to promoting manufacturing exports, and why that was a bad idea.

But I realize that my recent call to “X Out the Ex-Im Bank” will be facing some very entrenched interests in Washington, and some well-funded lobby groups. The Bank has historically attracted bipartisan support, and a renewal of its charter sailed through the House Committee on Financial Services earlier this year. The Washington establishment loves this program.

My friend and long-time Ex-Im Bank supporter Gary Hufbauer of the Peterson Institute for International Economics published a critique a few weeks ago of my analysis, and calls for a doubling of Ex-Im’s authorization cap (from $100 billion to $200 billion). His piece is a fair characterization of my arguments, and at least Gary tries to counter them with actual facts and analysis (not always a given in an increasingly poisonous trade policy environment).  But it seems to me that Gary focuses his critique on my assessment of the effectiveness of the Bank. That’s fair enough, of course, but I tried in my paper to make the point that the efficiency or efficacy of the Ex-Im Bank’s activities is kind of irrelevant. The important point, which Gary did not address, is that it is simply not the proper role of the federal government to be in this business at all, even if they can operate “efficiently” (which I do not concede in any case). Where in the Constitution is the federal government authorized to be involved in the export credit business (a business, by the way, that benefits mainly large, profitable companies)?

My opposition to the Bank, in other words, is at a more fundamental level.  On an empirical level—and this is where Gary’s critique is focused—can markets work well enough in trade finance, and if not, can government intervention work better? Gary points to the Bank’s low default rate as evidence that private markets are missing good opportunities:

These figures suggest that the Ex-Im Bank plays a large role in facilitating exports to countries that encounter reluctance from private banks but nonetheless are not ‘bad risks.” Judging by its low default rate, the Ex-Im Bank’s risk assessment seems more correct than the private market.

But I would argue that its low default rate suggests the Ex-Im Bank’s backing is unnecessary. We don’t know that private credit wasn’t available to finance those exports. And even if it wasn’t, private credit not always being available on terms that the trading partners would like does not necessarily signify market failure. So a finance company missed an opportunity that may have paid out. So what? Maybe they had even better opportunities available to them that we (and bureaucratic Washington) don’t know about, or they simply wanted to hold on to their capital for future investment or to meet new reserve standards. The would-be exporter might miss out, but government intervention to direct that private capital (either through mandates, or siphoning it through the Ex-Im Bank) would come at another producer’s or bank shareholders’ expense.

Gary argues that:

Ex-Im’s capability should be strengthened so that the United States can respond when official finance offered by other countries violates the principles of fair competition…Successful multilateral negotiations…are certainly a superior option to tit-for-tat retaliation…[but]…without sufficient leverage…it is difficult to see what will bring China and India to the negotiating table.

But will China and India (and others) see higher Ex-Im funding as “leverage” to bring them to the table, or will it be seen as just the next step in the escalating arms race of subsidized export credit? I suspect, and fear, the latter.

Gary rejects my call to dismantle the Ex-Im Bank, and in fact suggests the government increase the scope of Ex-Im financing to cover 5 percent (rather than the current 2 percent) of total U.S.exports. That seems pretty arbitrary to me. Why stop at 5 percent? Heck, with the Ex-Im Bank being “self-financing” and all, why not go for 100 percent?

Lastly, Gary repudiates my “orthodox free-market reasoning” and the suggestion, attributed to me, that “… the dollar exchange rate alone determines the volume of U.S. exports or the size of the U.S. trade deficit.”  Exchange rates do not equilibrate to keep trade balances at zero, but to keep them in line with the savings and investment balance. The United States has been running persistent deficits because savings has fallen short of investment for many years.

Similarly, Gary takes issue with my analysis on the net effect of Ex-Im financing on jobs:

 …nor do we agree that free markets are sufficiently self- regulating to ensure a constant and low rate of unemployment…If [that proposition] described the American economy, the United States [unemployment would not be stuck at 9 percent-plus.

Here Gary seems to ignore the many interventions in labor markets that can keep unemployment high, no matter what the exchange rate. I’m certainly not under any illusions that the U.S. economy would be totally free market were it not for the existence of the Ex-Im Bank, and I don’t think my paper implied that, either.

Gary and I, not to mention others who study the Ex-Im Bank, will no doubt continue to debate these issues as the Ex-Im Bank’s charter expiry date comes closer.

More on the Ex-Im Bank is a post from Cato @ Liberty - Cato Institute Blog

University of Michigan economist and American Enterprise Institute scholar Mark Perry has an excellent oped in today’s Wall Street Journal [$] about how U.S. manufacturing is thriving.  It can’t be emphasized enough how important it is to present such illuminating, factual, compelling analyses to a public that is starved for the truth and routinely subject to lies, half-baked assertions, and irresponsibly outlandish claims about the state of American manufacturing.

The truth matters because U.S. trade and economic policies—your pocketbook—hang in the balance.

For more data, facts, and background about the true state of U.S. manufacturing, please see this Cato policy analysis and these opeds (one, two, three).

American Manufacturing Continues to Thrive in a Global Economy is a post from Cato @ Liberty - Cato Institute Blog

The U.S. trade deficit rose in 2010, and the bilateral deficit with China reached a record high last year, according to the monthly trade report released this morning by the U.S. Commerce Department. The usual critics (such as Peter Morici of the University of Maryland) are already spinning it into yet another indictment of trade, but the report contains a lot of good news for the U.S. economy.

Last year, Americans bought $2,330 billion worth of goods and services from other countries, while selling $1,832 billion, for a trade deficit of $498 billion. Our bilateral deficit with China grew to a record $273 billion.

Politicians and commentators love to focus on the trade deficit, as though it were a scorecard of who is winning in global trade. But the real measure is the total volume of trade. As economies expand, so does trade, both imports and exports. Exports help us reach new markets and expand economies of scale, while imports bless consumers with lower prices and more choices, while stoking competition, innovation, and efficiency gains among producers.

By this measure the trade report was good news all around, and one more sign that the U.S. and global economies continue to recover from the Great Recession. Last year, U.S. exports of goods were up 21 percent from 2009, while imports were up 23 percent. In contrast, in the recession year of 2009, exports of goods dropped 18 percent from the year before while imports plunged 26 percent. (Unemployment soared in 2009, but, hey, at least the trade deficit was “improving”!)

Our trade with China last year tells the same story. The value of goods imported from China rose 23 percent in 2010 (the same rate as imports from the rest of the world), while the value of the goods we exported to China jumped by 32 percent. That’s a rate of export growth that is 50 percent higher than export growth to the rest of the world. Members of Congress who complain that China’s managed currency is somehow a major barrier to U.S. exports should take note.

Rising Exports — and Imports — Are Good News for U.S. Economy is a post from Cato @ Liberty - Cato Institute Blog

As a primer for the new Congress, my friend John Murphy of the U.S. Chamber of Commerce posted the “top ten reasons why pro-growth trade and investment policies and agreements are good for America.” As usual, I agree with John’s points. And I concur that the time is particularly ripe for educating policymakers about the virtues of trade.

But with all due respect to John, his list is not so much about trade and investment. It’s really about exports (one of 10 points is about imports). Informing new members and reminding old of the benefits of exports to U.S. businesses and workers is clearly a worthwhile objective of the Chamber, the business community, and really anybody interested in economic growth. But in some respect there’s a preaching-to-the-choir element in that approach. You’re not going to find too many policymakers opposed to exports, and the administration has constructed a whole new bureaucracy devoted to the proposition that exports should double in five years.

Where the trade agenda has stalled (and where it always has problems) is on the rough terrain that–for lack of a better catchphrase–might be called “rationalizing” imports. That’s been the hard part of trade adovcacy over the years: “We had to cede some access to our markets, but look what we got in exchange!”

In pitching the very same bilateral trade agreements two and three years ago that the business community is pitching today, then-USTR Susan Schwab liked to remind Congress that the United States had an aggregate trade surplus with the countries with whom the Bush administration had concluded free trade agreements, as though that were the appropriate success metric. “We export more to them than we import from them; let’s call this a triumph!” But anyone inclined to accept that statistic as conclusive could simply visit the Commerce Department’s website and see that, at the time, our overall trade account was in deficit by about $800 billion. Thus, if “exports minus imports” is the measure by which we judge the benefits of trade, then America should shun trade entirely. That sales approach doesn’t seem to be in short- or long-run equilibrium. Mercantilist arguments only ensure that every step forward on trade requires a full-fledged battle. We need better–that is, more comprehensive–salesmanship of trade for the new Congress.

In 2002, then-USTR Robert Zoellick said of his new Doha Round proposal for zero tariffs on industrial goods by 2015 that it would “turn every corner store into a duty-free shop.” That was the right message—although apparently not for the timid White House at the time, which adhered to the sweep-imports-under-the-rug model.  In 2011, we should remember, embrace, and revive Ambassador Zoellick’s words in our advocacy of trade liberalization. In that spirit, I return to John Murphy’s top ten list and introduce a few tweaks (in bold).

1. The United States is the number one manufacturing nation in the world, and that success depends on exports.  And since over half of the total value of U.S. imports consists of “intermediate goods” (products that are used as inputs for further value-added activity), manufacturing success also depends on imports.
2. The United States is the world’s number one services exporter and has been since services trade data have been tracked.  And one of the reasons that foreigners are able to purchase American services is because they have been able to earn dollars by selling goods to American businesses and consumers.
3. U.S. agricultural exports support nearly a million jobs in the United States.  And, agricultural and manufactured imports have made life’s necessities and conveniences more affordable to hundreds of millions of Americans.
4. 95 percent of the world’s consumers lives outside the United States…as do 95 percent of the world’s workers, who produce many of the goods Americans consume as imports less expensively than Americans can, freeing up U.S. resources for investment, innovation, and consumption of the higher value products and services that Americans produce.
5. FTA countries purchased more than 40 percent of U.S. exports in 2009. And imports from those countries have helped extend families’ budgets and reduced the costs of production for U.S. business relying on inputs from those countries.
6. Since the creation of the WTO in 1994, U.S. exports of goods and services have doubled to more than $1.5 trillion. And real U.S. GDP has increased by 50 percent.
7. Imports support millions of U.S. jobs in retail, research, design, sourcing, transportation, warehousing, marketing and sales…and in manufacturing. 
8. U.S. exports to China have quadrupled over the past 15 years, and China is now the 3rd largest market for U.S. exports.  And U.S. imports from China, too often wrongly portrayed as evidence of U.S. profligacy or decline, have enabled U.S. industries that require access to lower-cost labor for economic viability to be born, to blossom, and to spark the advent of new products and industries.
9. U.S. companies with overseas investments account for 45 percent of all U.S. exports.  And foreign companies operating in the United States employ 5.6 million Americans, support a payroll of $408.5 billion, provide compensation that is 33% higher than the U.S. average, account for 18% of U.S. exports,   pay U.S. taxes, support local charities, and act as investment magnets in communities across the country.
10. Trade supports 38 million jobs in the United States–more than one in five American jobs.  And most Americans enjoy the fruits of international trade and globalization every day: driving to work in vehicles containing at least some foreign content; talking on foreign-made mobile telephones; having extra disposable income because retailers like Wal-Mart, Best Buy, and Home Depot are able to pass on cost savings made possible by their own access to thousands of foreign producers; eating healthier because they now can enjoy fresh imported produce that was once unavailable out-of-season, etc.

Of course, all of these selling points are economic in nature.  There is an even stronger moral argument for free trade, which is what all Americans — indeed all earthlings — should embrace.

Embracing More of Trade’s Selling Points is a post from Cato @ Liberty - Cato Institute Blog

This morning’s report from the U.S. Department of Commerce that the pesky trade deficit shrank unexpectedly in October is being hailed in the media as “good news” for the economy, while the real news behind the numbers remains buried.

According to the latest monthly trade report, exports of U.S. goods rose in October compared to September, while imports declined slightly. Rising exports are good news in anybody’s book, but according to the conventional Keynesian and mercantilist logic, falling imports must also be good for the economy because that means consumers are spending more on domestically produced goods, right? Wrong.

In the real world, that assumption is almost always false, as I did my best to document a few weeks back in an op-ed titled, “Are rising imports a boon or bane to the economy?”

The real news in the report is the spectacular rise of U.S. exports to China. Year to date, U.S. exports to China are up 34 percent compared to the same period in 2009. That compares to a 21 percent increase in U.S. exports to the rest of the world excluding China. China is now the no. 3 market for U.S. exports, behind only our NAFTA partners Canada and Mexico, and by far the fastest growing major market.

The politically inflammatory bilateral trade deficit with China is also up 20 percent so far this year, but our trade deficit with the rest of the world excluding China is up 38 percent.

Yet Sens. Chuck Schumer, D-N.Y., and Lindsey Graham, R-S.C., are still talking about pushing a bill during the lame-duck session that would authorized the same Commerce Department to assess duties on imports from China because of its undervalued currency. A cheaper Chinese currency relative to the U.S. dollar supposedly inhibits U.S. exports to China while tempting American consumers to buy even more of those useful consumer goods assembled in China. [For the record, U.S. imports from China so far this year have grown, too, but at a rate slightly below imports from the rest of the world.]

To anyone taking an objective look at the numbers, this morning’s trade report shows that whatever the wisdom of China’s currency policy, it has not been a real obstacle to robust U.S. export growth, nor has it fueled an extraordinary growth in our bilateral trade balance with China. Members of Congress should drop their obsession with China trade and move on to more urgent matters.

Media Miss Real News in Latest Trade Report is a post from Cato @ Liberty - Cato Institute Blog

The Chinese currency issue is in full bloom this week, as the House of Representatives passed the Currency Reform for Fair Trade Act of 2010 by a vote of 348-79 on Wednesday.  Though there is so much to criticize about the bill and about the layers upon layers of misinformation, myth, and subterfuge that brought us to this point, this post concerns the dubiousness of the bill’s central premise: that Yuan appreciation will significantly reduce the bilateral trade deficit.

That is the position of the Peterson Institute’s Fred Bergsten and Bill Cline.

The premise seems plausible enough.  At least, the economics textbooks tell us that as a nation’s currency appreciates, its people will consume more imports and foreigners will reduce consumption of that nation’s exports.  Hence, a stronger Yuan vis-à-vis the dollar would mean that the Chinese buy more from the United States and sell less to the United States, reducing the bilateral deficit.

But in March Cato published a short paper of mine titled “Appreciate This: Chinese Currency Rise Will Have a Negligible Effect on the Trade Deficit.”  The central argument of that paper was that our national obsession with the value of the Chinese currency is misplaced—a red herring, in fact.  I presented recent historical data showing that despite a 21 percent increase in the value of the Yuan between July 2005 and July 2008, the U.S. deficit with China increased from $202 billion to $268 billion, or by 33 percent.  U.S. exports to China increased (as would be expected) by $28 billion, but U.S. imports from China increased, as well (contrary to expectations based on the old textbooks), and by $94 billion, or 38.7 percent. 

In other words, in the face of a 21 percent increase in the Yuan’s value, the U.S. bilateral trade deficit with China increased by 33 percent—a fact that raises serious questions about the integrity of the testimony, discussion, and “debate” that preceded the House vote on Wednesday. 

How can the premise that Yuan appreciation will reduce the bilateral deficit still hold?  Why is so much credence given to economists with fancy models who project with certainty that an X% increase in the value of the Yuan will generate a Y% increase in economic growth, which will produce Z number of new jobs in the economy, when recent evidence plainly refutes those claims?  What is the value in holding hearings when conjecture matters more than fact?

Bergsten and Cline (in testimony and podcast, respectively) dismiss the counterintuitive relationship between currency and the trade deficit during 2005-2008 by suggesting that there is a long lag period to consider—two to three years, according to Bergsten; two years, according to Cline.  In other words, the impact on the trade deficit of Yuan appreciation in the period 2005-2008 would not be fully manifest until the period 2007-2010.  While lags are expected (economists speak of a J-curve effect that accounts for the process of adjustment to the new prices in both countries), a two- or three-year lag in an era of instant communications, cyberspace transactions, transnational production, and airtight supply chains is simply not credible.  It took only a matter of months for the financial meltdown in 2008 to spread to the real economy, which prompted an overnight crash in international trade volumes, as production orders were terminated, shutting down operations throughout supply chains across the globe.

The two- to three-year lag theory is convenient merely because it puts in play the data for 2009, when international trade tanked worldwide, and the Chinese global trade surplus and the U.S. deficit with China were cut in half.  If the two- to three-year lag theory were plausible, the U.S. trade deficit with China would be falling in 2010, not rising, as the steepest appreciation in the Yuan occurred in 2008.

There’s a more plausible theory than that.

In my paper, I went on to examine whether the increase in imports was attributable to American demand for Chinese goods being price inelastic.  In other words, if the price of Chinese goods to American consumers increased by 21 percent (on average) and Americans reduced their consumption of Chinese goods by less than 21 percent, then demand would be considered inelastic, the price effect would dominate, and total import value would rise (adding to the trade deficit).  There are plenty of reasons that American demand for Chinese goods is price inelastic including, most importantly, that there are limited substitutes for those goods.  Much of what Americans consume from China is not made in the United States anymore.  So facing limited alternatives, Americans are forced to absorb the higher prices (a fact that currency legislation supporters are undoubtedly unwilling to share with their constituents).  Of course, eventually American consumers might adjust their consumption habits (which speaks to the lag factor).

But closer examination of the data revealed something else.

The fact that a 21 percent increase in the value of the Yuan was met with a 38.7 percent increase in import value means that the quantity of Chinese imports demanded increased by nearly 15 percent after the price change.  Increased!  Higher prices being met with greater quantity demanded would seem to defy the law of demand.

So what happened?  Chinese exporters must have lowered their Yuan-denominated prices to keep their export prices steady. That would have been a completely rational response, enabled by the fact that Yuan appreciation reduces the cost of production for Chinese exporters—particularly those who rely on imported raw materials and components. According to a growing body of research, somewhere between one-third and one-half of the value of U.S. imports from China is actually Chinese value-added.  The other half to two-thirds reflects costs of material, labor, and overhead from other countries. China’s value-added operations still tend to be low-value manufacturing and assembly operations, thus most of the final value of Chinese exports was first imported into China.

Yuan appreciation not only bolsters the buying power of Chinese consumers, but it makes Chinese-based producers and assemblers more competitive because the relative prices of their imported inputs fall, reducing their costs of production. That reduction in cost can be passed on to foreign consumers in the form of lower export prices, which could mitigate entirely the intended effect of the currency adjustment, which is to reduce U.S. imports from China.

That process might very well explain what happened between 2005 and 2008, and is probably a reasonable indication of what to expect going forward.  Yet this elephant in the room continues to be wantonly ignored in the anlayses that push us toward provocative legislation.

It seems that the textbook discussion of currency and the trade account needs to be updated to account for the compelling facts of globalization.

Economists Ignore the Facts in Supporting Chinese Currency Legislation is a post from Cato @ Liberty - Cato Institute Blog

The House is expected to vote today on a bill that would allow U.S. companies to petition the Commerce Department for protective tariffs against imports from countries with “misaligned currencies.” Everybody knows the bill is aimed squarely at China.

Advocates of the legislation say it is about jobs, and they are partly right. The bill is about saving the jobs of incumbent lawmakers who are desperate to appear tough on China trade, which they blame for the loss of U.S. manufacturing jobs.

As my colleague Dan Ikenson and I have argued at length, in blog posts, op-eds, and longer studies,

• A stronger Chinese currency will not put a major dent in our large bilateral trade deficit with China, certainly not any time in the near future.
• The bilateral deficit with China and America’s overall trade deficit is not a drag on growth or a barrier to manufacturing exports and output.
• U.S. manufacturing has not been decimated by trade. In fact it has been expanding as American producers move up the value chain to more sophisticated, high-tech products.
• Provoking a needless trade spat with China will jeopardize the healthy export success American companies have enjoyed in China’s fast-growing market.

Let’s hope cooler, wiser heads in the Senate and the White House save us from this election-season folly.

China Bill All about Saving Lawmakers’ Jobs is a post from Cato @ Liberty - Cato Institute Blog

As usual, Dan Griswold does an excellent job today correcting fallacies about trade and the trade deficit that continue to be perpetuated in the mainstream media (particularly at the Washington Post).  

I just want to add my two cents without belaboring any of Dan’s succinctly-made points.  (Besides, I’ve harped on and on and on and on and on about the problem of trade reporting this year.) It’s a shame that so much time and energy has to be diverted to cleaning up messes left by reporters and editors, who should know better by now.

The bottom line is that neither imports nor trade deficits cause U.S. job loss or slower economic growth.  If anything, the charts below (all compiled from BEA and BLS data) support the conclusion that imports and the trade deficit rise when the economy is growing and creating jobs, and they both fall when the economy is contracting and shedding jobs. 

Media Feeds America’s Skepticism about Trade is a post from Cato @ Liberty - Cato Institute Blog

What had been a recurring story line buried in the business pages has now burst onto the front page: “Economic growth slowed by trade gap,” the Washington Post reports this morning in an above-the-fold headline.

The lead sets the stage for a story long on generalizations: “A widening U.S. trade deficit has become a substantial drag on economic growth as the country’s exports struggle to keep pace with the swelling sums that Americans are again spending on imported goods.”

The half truth in the story line is that exports fell by $2 billion in June compared to the month before, and that this has a negative effect on overall GDP growth. In our more globalized world, the rising wealth of our trading partners translates into more production in our own economy, and vice versa.

The fatal flaw of the story line (as I tackled recently here and at greater length here) is that it assumes that rising imports slow economic growth. That assumption, in turn, rests on a simplistic Keynesian view that if a portion of domestic demand is satisfied by spending on imports, that means less demand for domestically produced goods, thus less output and lower employment.

That view neglects the supply-side role of imports. More than half of what we import consists of goods consumed by producers—capital machinery, raw materials, parts and other intermediate inputs. Those imports help us produce more, not less. The Keynesian view also confuses cause and effect: Imports usually grow in response to RISING domestic demand. Consumers more eager to spend “swelling sums” on imports typically buy more domestically produced goods as well.

The bean counters at the Commerce Department “subtract” imports from GDP, not because those imports are a drag on growth, but to avoid double counting. If we want to count the number of widgets and other goods added to the economy in a quarter, we would obviously not count those that have been imported. But this does not mean the economy would have been that much larger if the widgets had not been imported.

The Post story adds to the misunderstanding by claiming: “At a basic level, trade deficits represent a loss of wealth for a country—money flowing abroad for goods and services produced elsewhere, supporting businesses and workers in other countries.”

This betrays a basic misunderstanding of wealth that Adam Smith exposed two centuries ago in The Wealth of Nations. Does wealth consist of money—pieces of green paper or blips on a computer or, in Smith’s day, bars of gold—or does it consist of the actual stuff that people produce to make their lives better, all those goods and services that we consume each year? Smith argued it was the latter. And in that case, a trade deficit at a basic level represents an inflow of wealth from the rest of the world—a cornucopia of cool stuff arriving everyday at our ports and stocking the shelves of our stores.

Of course, even if you think that dollars are the ultimate measure of wealth, obsession with the trade deficit ignores the fact that those dollars spent on imports quickly return to the United States. If they are not used to buy our goods and services, they are buying our assets—real estate, stocks, Treasury bonds, and so on. The “loss of wealth” supposedly represented by the trade deficit is almost exactly offset every year by a “gain of wealth” represented by the net inflow of dollars in the form of capital investment from the rest of the world.

Besides being wrong in its basic economics, making the trade deficit the scapegoat for slow growth poses a double danger for economic policy:

Danger no. 1 is that it tempts politicians to reach for the snake oil of protectionism to create jobs. If only we could stop the flood of imported goods, Americans would make more of those same goods themselves, creating millions of jobs. In reality, higher trade barriers impose a host of offsetting costs on the economy, resulting in lower output.

Danger no. 2 of blaming the trade deficit is that it diverts attention from policies that are far more plausible culprits in dampening growth. Politicians find it much easier to blame imported consumer goods from China for slower GDP growth than huge looming tax increases, expensive new health care mandates, a depressed housing sector, and a generally anti-business climate in Washington.

The trade gap should be the least of our worries.

Is the Trade Gap to Blame for Slowing GDP Growth? is a post from Cato @ Liberty - Cato Institute Blog

It has become conventional wisdom that a rising trade deficit is bad news for the economy. This week’s announcement of an expanding deficit in June prompted such headlines today as this one in the news pages of the Wall Street Journal: “Wider Trade Gap Signals Weak Growth.” As my colleague David Boaz blogged earlier today, the trade deficit is even blamed for daily swings in the stock market.

I’ve been studying and writing about the trade deficit for years, and devoted a whole chapter of my 2009 Cato book Mad about Trade to the subject, and I keep coming back to a basic question: If the trade deficit signals weak growth, why does the U.S. economy seem to perform so much better during periods when the trade deficit is growing, and so much worse when the trade deficit is shrinking?

Think back to the 1990s, the “goldilocks economy” when growth was strong, jobs plentiful, and inflation low. That was also a time of rising trade deficits. In fact, the trade gap grew for eight years in a row, rising from $77 billion in 1991 to $455 billion in 2000. In that same period, the unemployment rate dropped from 7.3 to 3.9 percent.

Again, in the middle of the George W. Bush presidency, the trade gap grew for five straight years, during a period when the economy expanded and the unemployment rate fell from 5.7 to 4.4 percent.

In contrast, the trade deficit invariably shrinks during periods of recession. The trade deficit fell by more than half from 2007 to 2009 as domestic demand and imports plunged and unemployment soared. Sagging domestic demand means fewer imports.

Of course, I’m not arguing that a bigger trade deficit stimulates the economy. I am arguing, contrary to the conventional wisdom reflected in this morning’s headlines, that an expanding trade deficit does not appear to be a drag on growth. In fact, the plain evidence is that an expanding trade deficit is more often than not a signal of stronger growth.

More Nonsense about the Trade Deficit is a post from Cato @ Liberty - Cato Institute Blog

A banner Washington Post headline (page 11, print edition; slightly different online) reads:

Stocks plunge as trade deficit widens

Of course, they could have gone with

Stocks plunge as Linda McMahon wins Senate nomination

Or my favorite:

Stocks plunge as Cardinals sweep Reds

Since national trade deficits are not much more meaningful than baseball scores, it’s unlikely that this month’s report drove stocks down.

Explaining Mr. Market is a post from Cato @ Liberty - Cato Institute Blog

An update from my post yesterday about the bill to establish a Commission to End the Trade Deficit (now called the “Emergency Trade Deficit Commission”): apparently the bill that passed the House was different from the bill initially considered, and to which I linked (and commented). My apologies.

The bill that was passed had many of the most egregious provisions and provocative wording stripped out. There was no talk of eliminating the trade deficit, for example. And the provision that would have prohibited congressional consideration of any trade deal before the Commission reported is, thankfully, gone too. But I would suggest that the underlying message of the bill — that individuals cannot be trusted to make their own decisions about which products to buy, and from where — is intact. There are plenty of references to “improving trade balances,” “enhancing the competitiveness of U.S. manufacturers,” and environmental and labor standards.  I stand by comments about those sentiments.

Maybe a commission is a useful way of distracting members of Congress from actually doing anything, and certainly this bill is less offensive than the original, but it still betrays an unwillingness of some members of Congress to let consumers and firms make decisions without a commission studying, reporting on, and possibly correcting them.

The Letter Is Different, but the Spirit Still Lives is a post from Cato @ Liberty - Cato Institute Blog

• Too bad no one saw this coming: Social Security is now in the red.

• Now that the health care bill is law, you should know exactly how it’s going to affect you, your premiums, and your coverage over the next few years. Here’s a helpful breakdown.

• As the health care overhaul crosses home plate, global warming legislation steps up to bat.

• Appreciate this: Chinese currency rise will have a negligible effect on the trade deficit. For more, read the whole paper.

• Podcast:  “A Plea for Divided Government” featuring John Samples, author of the forthcoming book The Struggle to Limit Government.

Thursday Links is a post from Cato @ Liberty - Cato Institute Blog

Organized labor’s trade “think tank” in Washington, the Economic Policy Institute, claims that currency manipulation is a major cause of the U.S. trade deficit with China, which (along with other unfair trade practices) accounted for 2.4 million American job losses between 2001 and 2008. EPI has been making similar claims for years, getting lots of media attention for its hyperbole, and providing smoke bombs for charlatan politicians to hurl into the discussion to obscure the public’s understanding of trade.   For starters, as conveyed in this new paper, I am skeptical about the relationship between currency undervaluation and the trade account.

EPI’s methodology (to use the term loosely) is not to be taken seriously, though, because it derives from a simple formula that approximates job gains from export value and job losses from import value, as though there were a straight line correlation between the jobs and trade data. It pretends that there are no jobs created when we import, and that import value is somehow an appropriate measure of job loss.

The flaws of those assumptions are many, but perhaps the easiest one to convey is that most of the value embedded in imports from China is not Chinese. (The ensuing discussion is from a forthcoming Cato paper.)

According to the results from a growing field of research, only about one-third to one-half of the value of U.S. imports from China comes from Chinese labor, material and overhead. Official U.S. import statistics—which pay no heed to the constituent value-added elements—therefore overstate the Chinese value in those imports by 100 to 200 percent, on average. The cited job loss figures are based on import values that are unequivocally overstated because one-half to two-thirds of that value are the costs of material, labor, and overhead added in other countries, including the United States.

What is seldom discussed—because they are often portrayed as victims—is that large numbers of American workers are employed precisely because of imports from China. This is the case because the U.S. economy and the Chinese economy are highly complementary. U.S. factories and workers are more likely to be collaborating with Chinese factories and workers in production of the same goods than they are to be competing directly. The proliferation of vertical integration (whereby the production process is carved up and each function performed where it is most efficient to perform that function) and transnational supply chains has joined higher-value-added U.S. manufacturing, design, and R&D activities with lower-value manufacturing and assembly operations in China. The old factory floor has broken through its walls and now spans oceans and borders.

Though the focus is typically on American workers who are displaced by competition from China, legions of American workers and their factories, offices, and laboratories would be idled without access to complementary Chinese workers in Chinese factories. Without access to lower-cost labor in places like Shenzhen, countless ideas hatched in U.S. laboratories, that became viable commercial products and support hundreds of thousands of jobs in engineering, design, marketing, logistics, retailing, finance, accounting, and manufacturing might never have made it beyond conception because the costs of production would have been deemed prohibitive for mass consumption. Just imagine if all of the components in the Apple iPod had to be manufactured and assembled in the United States. Instead of $150 per unit, the cost of production might be double or triple or quadruple that amount.

Consider how many fewer iPods Apple would have sold, how many fewer jobs iPod production, distribution, and sales would have supported, how much lower Apple’s profits (and those of the entities in its supply chains) would have been, how much lower Apple’s research and development expenditures would have been, how much smaller the markets for music and video downloads, car accessories, jogging accessories, and docking stations would be, how many fewer jobs those industries would support and the lower profits those industries would generate. Now multiply that process by the hundreds of other similarly ubiquitous devices and gadgets, computers and Blu-Rays, and every other product that is designed in the United States and assembled in China from components made in the United States and elsewhere.

The Atlantic’s James Fallows characterizes the complementarity of U.S. and Chinese production sharing as following the shape of a “Smiley Curve” plotted on a chart where the production process from start to finish is measured along the horizontal axis and the value of each stage of production is measured on the vertical axis. U.S. value added comes at the early stages—in branding, product conception, engineering, and design. Chinese value added operations occupy the middle stages—some engineering, some manufacturing and assembly, primarily. And more U.S. value added occurs at the end stages in logistics, retailing, and after market servicing. Under this typical production arrangement, collaboration, not competition, is what links U.S. and Chinese workers.

EPI’s work on this subject provides fodder for sensational stump speeches. But it is also a major disservice to a public that is hungering for truth, and not self-serving advocacy masquerading as truth.

Calling Out Trade’s Myth Makers is a post from Cato @ Liberty - Cato Institute Blog

Lost in the buzz last week over health care was the news that the broadest measure of the U.S. trade deficit fell sharply in 2009 from the year before. According to the Bureau of Economic Analysis, the U.S. current account deficit plunged from $706 billion in 2008 to $420 billion last year — the smallest deficit since 2001.

I’ve been waiting for a few days now for the usual trade deficit hawks to hail this development as great news for millions of Americans looking for work.

In years when the trade deficit was rising, it was common practice for the labor-union-friendly Economic Policy Institute to publish detailed studies showing that larger trade deficits caused the U.S. economy to lose hundreds of thousands of jobs each year. For example, according to an October 2008 EPI paper, rising non-petroleum trade deficits from 2000 to 2006 caused a lost of 484,400 jobs per year, while the shrinking deficit in 2007 lead to the creation of 272,500 jobs.

By the EPI’s own internal logic, the past two years should have been a boom time for job creation. Between 2007 and 2009, the non-petroleum trade deficit dropped by $174 billion as the sagging domestic economy cut demand for impost. If that was good news for jobs, somebody forgot to tell the U.S. labor market. Since the end of 2007, the U.S. economy has shed a net 8 million jobs.

Oops, maybe it’s time for EPI to rework its model.

Trade Gap Plunges in 2009, but Where Are the Jobs? is a post from Cato @ Liberty - Cato Institute Blog

• Busy with an ambitious domestic agenda, the Obama administration has put trade issues on the back burner. Let’s hope it stays that way.

• A little lesson on how government works. (As opposed to how it’s supposed to work.)

• There has been talk that House Democrats are planning to “deem” the health care bill into law without calling for a vote. If you’re not sure how that process works, read this.

• Contrary to a growing belief in Washington, revaluing China’s currency will not cure the trade deficit.

• Podcast: “ObamaCare Threatens Innovation” featuring Michael F. Cannon.

Wednesday Links is a post from Cato @ Liberty - Cato Institute Blog

During his SOTU address last week, the president declared it a national goal to double our exports over the next five years.  As my colleague Dan Griswold argues (a point that is echoed by others in this NYT article), such growth is probably unrealistic. But with incomes rising in China, India and throughout the developing world, and with huge amounts of savings accumulated in Asia, strong U.S. export growth in the years ahead should be a given—unless we screw it up with a provocative enforcement regime.

The president said:

If America sits on the sidelines while other nations sign trade deals, we will lose the chance to create jobs on our shores. But realizing those benefits also means enforcing those agreements so our trading partners play by the rules.

Ah, the enforcement canard!

One of the more persistent myths about trade is that we don’t adequately enforce our trade agreements, which has given our trade partners license to cheat.  And that chronic cheating—dumping, subsidization, currency manipulation, opaque market barriers, and other underhanded practices—the argument goes, explains our trade deficit and anemic job growth.

But lack of enforcement is a myth that was concocted by congressional Democrats (Sander Levin chief among them) as a fig leaf behind which they could abide Big Labor’s wish to terminate the trade agenda.  As the Democrats prepared to assume control of Congress in January 2007, better enforcement—along with demands for actionable labor and environmental standards—was used to cast their opposition to trade as conditional, even vaguely appealing to moderate sensibilities.  But as is evident in Congress’s enduring refusal to consider the three completed bilateral agreements with Colombia, Panama, and South Korea (which all exceed Democratic demands with respect to labor and the environment), Democratic opposition to trade is not conditional, but systemic.

The president’s mention of enforcement at the SOTU (and his related comments to Republicans the following day that Americans need to see that trade is a two way street — starts at the 4:30 mark) indicates that Democrats believe the fig leaf still hangs.  It’s time to lose it.

According to what metric are we failing to enforce trade agreements?  The number of WTO complaints lodged? Well, the United States has been complainant in 93 out of the 403 official disputes registered with the WTO over its 15-year history, making it the biggest user of the dispute settlement system. (The European Communities comes in second with 81 cases as complainant.)  On top of that, the United States was a third party to a complaint on 73 occasions, which means that 42 percent of all WTO dispute settlement activity has been directed toward enforcement concerns of the United States, which is just one out of 153 members.

Maybe the enforcement metric should be the number of trade remedies measures imposed?  Well, over the years the United States has been the single largest user of the antidumping and countervailing duty laws.  More than any other country, the United States has restricted imports that were determined (according to a processes that can hardly be described as objective) to be “dumped” by foreign companies or subsidized by foreign governments. As of 2009, there are 325 active antidumping and countervailing duty measures in place in the United States, which trails only India’s 386 active measures.

Throughout 2009, a new antidumping or countervailing duty petition was filed in the United States on average once every 10 days.  That means that throughout 2010, as the authorities issue final determinations in those cases every few weeks, the world will be reminded of America’s fetish for imposing trade barriers, as the president (pursuing his “National Export Initiative”) goes on imploring other countries to open their markets to our goods.

Rather than go into the argument more deeply here, Scott Lincicome and I devoted a few pages to the enforcement myth in this overly-audaciously optimistic paper last year, some of which is cited along with some fresh analysis in this Lincicome post.

Sure, the USTR can bring even more cases to try to force greater compliance through the WTO or through our bilateral agreements.  But rest assured that the slam dunk cases have already been filed or simply resolved informally through diplomatic channels.  Any other potential cases need study from the lawyers at USTR because the presumed violations that our politicians frequently and carelessly imply are not necessarily violations when considered in the context of the actual rules.  Of course, there’s also the embarrassing hypocrisy of continuing to bring cases before the WTO dispute settlement system when the United States refuses to comply with the findings of that body on several different matters now.  And let’s not forget the history of U.S. intransigence toward the NAFTA dispute settlement system with Canada over lumber and Mexico over trucks.  Enforcement, like trade, is a two-way street.

And sure, more antidumping and countervailing duty petitions can be filed and cases initiated, but that is really the prerogative of industry, not the administration or Congress.  Industry brings cases when the evidence can support findings of ”unfair trade” and domestic injury.  The process is on statutory auto-pilot and requires nothing further from the Congress or president. Thus, assertions by industry and members of Congress about a lack of enforcement in the trade remedies area are simply attempts to drum up support for making the laws even more restrictive.  It has nothing to do with a lack of enforcement of the current rules.  They simply want to change the rules.

In closing, I’m happy the president thinks export growth is a good idea.  But I would implore him to recognize that import growth is much more closely correlated with export growth than is heightened enforcement.  The nearby chart confirms the extremely tight, positive relationship between export and imports, both of which track similarly closely to economic growth.

U.S. producers (who happen also to be our exporters) account for more than half of all U.S. import value.  Without imports of raw materials, components, and other intermediate goods, the cost of production in the United States would be much higher, and export prices less competitive.  If the president wants to promote exports, he must welcome, and not hinder, imports.

Time to Lose the Trade Enforcement Fig Leaf is a post from Cato @ Liberty - Cato Institute Blog

Why blame only media and politicians for the public’s confusion about imports and trade deficits? Surely economists deserve some scorn. Some of the misunderstanding can be traced to the famous National Income Identity, which expresses gross domestic product, as: Y = C + G + I + (X-M). That is, national output (Y) equals personal consumption (C) plus government spending (G) plus investment (I) plus exports (X) minus imports (M).

The expression clearly lends itself to the wrong interpretation. The minus sign preceding imports suggests a negative relationship with output. It is the reason for the oft-repeated fallacy that imports are a drag on growth. Here’s why that conclusion is wrong.

The expression is an accounting identity, which “accounts” for all of the possible channels for disposing of our national output. That output is either consumed in the private sector, consumed by government, invested by business, or exported. The identity requires subtraction of aggregate imports because consumption, government spending, business investment, and exports all contain, in various amounts, import value. Americans consume domestic and imported products and services, the aggregate of which shows up in Consumption. Likewise, Government purchases include domestic and imported products and services; businesses Invest in domestic and imported machines and inventory; and, eXports often contain some imported intermediate components. Thus, the identity would overstate national output if it didn’t make that adjustment for iMports. After all, imports are not made on U.S. soil with U.S. factors of production, so they shouldn’t be included in an expression of our national output.

To reiterate, it is a simple matter of accounting: as an expression of national output, the National Income Identity subtracts imports only because imports are that portion of consumption, government spending, investment, and exports that are not produced on U.S. soil with U.S. factors of production. If we did not subtract an aggregate import value, then national output would be overstated.

But what unnecessary confusion that identity has created. Economists are often indecipherable, but here was an opportunity to actually connect with the public and describe a relatively easy concept in relatively easy terms. Why has it not been commonplace to use notation that conveys in no uncertain terms that C and G and I and X include some amount of imports? Maybe something like this:

Y=C(d)+C(m)+G(d)+G(m)+I(d)+I(m)+X(d)+X(m)-M,

where (d) connotes domestic; (m) connotes imported; and M=C(m)+G(m)+I(m)+X(m).

Again, imports are subtracted, not because they are a drag on output, but because imports are included in the other constituent elements of the identity. I’ve always found it misleading that the parentheses go around X-M – which isolates the expression “net exports,” but in the process can obscure the fact that imports are subtracted from the whole expression.

Finally, if the description above makes sense, then you’ll agree that imports have NO impact on national output. Regardless of how large or small, the import value embedded in the four constituent elements of national output is fully deducted by subtracting M. Thus, imports are neither a drag on GDP, nor can they cause GDP to rise. That conclusion may sound like it contradicts one of my assertions in yesterday’s post—that imports are pro-cyclical—(at least that was the claim of a NBER economist responding my post yesterday), but I think the conclusions are harmonious. To say imports are pro-cyclical means that they rise when the economy is growing and fall when the economy is contracting. It says nothing about causation.  That pattern has been amply and consistently demonstrated through expansion, recession, and recovery.

Another Reason Imports Get a Bad Rap is a post from Cato @ Liberty - Cato Institute Blog

Just when you have a pretty good sense of who is dishing protectionist nonsense and from where, along comes Robert Aliber, who — according to the byline of his commentary in yesterday’s Financial Times – is professor emeritus of international economics and finance at the University of Chicago.  Et tu, Chicago?

Aliber considers the US-China trade imbalance unsustainable and, because the Chinese government continues to prevent the value of its currency from rising sufficiently, proposes that the United States impose an across-the-board duty of 10 percent on all Chinese imports, which (after 6 months) would ratchet up 1 percentage point per month every month until the Chinese trade surplus with the United States declines to $5 billion per month. 

We’ve heard this tune before — but from politicians who are presumably far less adept at economics than a University of Chicago economics professor ought to be.  Yet, even Chuck Schumer ultimately acknowledged the banality of his (and Lindsey Graham’s) thrice-introduced legislation to impose a 27.5 percent tariff on Chinese imports as a proxy and incentive for renminbi appreciation.

If Aliber limited his argument to the assertions that the bilateral imbalance is unsustainable and that the Chinese government should allow the value of the renminbi to be determined by supply and demand, I’d have much less to quibble with.  I’d still be plenty skeptical that bilateral trade accounting tells us anything meaningful in this age of cross-border investment and transnational production and supply chains.  I’d still break from the implication that balanced trade should be an objective of policy or that it is more important than economic growth. And I’d still remain unconvinced that an increase in the value of the renminbi alone would have much of an impact on bilateral trade flows.  But I’d agree that a market-determined exchange rate would increase the likelihood that investment, consumption, and production decisions would better reflect underlying conditions in labor, financial, and goods markets, and in that regard would be a more useful guidepost for informed decisionmaking.

But Aliber’s proposal — and the numerous fallacies upon which it is predicated — goes well beyond that point, and appears to be the product of something like acute tunnel vision.  He is so fixated on the bilateral trade account that nothing else — including the impact of his proposal on the economy broadly — commands his attention. 

Aliber utters all of the classic fallacies about the insidious impact of China’s currency on U.S. manufacturing; the leverage and sway China allegedly holds over U.S. policymakers, as our banker of last resort; and, how China caused our trade deficit by purchasing U.S. securities.  I disagree with all of those assertions, vehemently, and have explained why in various places, but I want to focus presently on his proposal, which is one of the worst ideas in circulation.

Consider this passage, which Aliber apparently considers evidence of the cleverness of his plan (but really exposes its inanity):

Because many Chinese exports contain large amouts of embedded imports, the 10 per cent import tariff in effect is a tax of more than 30 per cent on Chinese value added. With electronics and other high-tech exports, where the import content may be 70 or 80 percent of their value, the  10 per cent tariff might be equivalent to a tax of 60 or 80 per cent on Chinese content.

Neat.  But isn’t the fact that Chinese exports contain so much import content enough to soundly reject Aliber’s plan in the first place?  Has he forgotten that we don’t import dangling Chinese value added?  What we import are products, some of which comprise 20 percent Chinese value added, some 80 percent, and according to the most recent research, an average of about 50 percent Chinese value added.  And what does that mean?

It means that on average 50 percent of the value of components, raw materials, and labor embedded in the typical cargo container from China unloaded in Long Beach, California is other countries’ value added.  It means that slapping a duty on imports from China is the same as restricting imports from countries indiscriminately (I know, non-discrimination is what the GATT/WTO rules are all about, but you get my point). It means restricting our own exports to China, which are embedded in the “high-tech” products that we import from China. (High tech is in quotes because the category consists mostly of computers and electronics, like cell phones and iPods, but protectionists like to exaggerate the security angle of our alleged trade follies by pointing to a bilateral deficit in “high tech,” even though Chinese value-added in those goods is well below average, and our imports of them support high-paying U.S. jobs). 

Having obviously not read my new paper, Aliber still sees global commerce as a competition between “Us” and “Them.”  He writes: “It should not take long for the Chinese to learn that they are much more dependent on access to the US market than Americans are dependent on Chinese goods,” and goes on to say that Americans can make those product here or buy them elsewhere.  Of course we could get them elsewhere, but the fact that we prefer to get them from China means that there would be costs associated with switching sources. 

Aliber is a fixed-pie-kinda-guy who fails to recognize the enormous wealth that has been generated by the elimination of political, trade, communications, and transportation barriers, and the highly stratified division of labor this barrier erosion unleashed.  He fails to recognize that Chinese labor and American labor are more often complementary than competing, and that the factory floor has broken through its walls and now spans oceans and borders. 

Imposing 10 percent duties on products invented and designed in the United States, consisting of components produced in Japan, Singapore, Thailand, and the United States,  consuming Australian minerals in the production process and Chinese labor in the assembly process is akin to taking a sledge hammer to a random station along a traditional production-assembly line.  It impedes the production process and raises the cost of bringing products to consumers, inflicting damage that is felt at all nodes in the design/production/assembly/supply chain, including those in the United States.

It means making it more difficult to support higher value-added U.S. manufacturing and service activities because with uncertain or compromised access to lower cost component production and assembly operations in China, it will be more difficult for ideas hatched in American labs to come to fruition in the form of the next gadget or convenience or life-saving device.

China’s position as the final point of assembly in so many different supply chains, as evidenced by the fact that 50 percent of the value of its exports to the United States consists of Chinese material, labor, and overhead, means that the impact of currency appreciation on the bilateral trade account is uncertain.  A stronger renminbi vis-a-vis the dollar means that Americans should pay more for imports from China, but a stronger renminbi also means that Chinese-based producers/assemblers will pay less for imported raw materials and components, lowering their cost of production/assembly.  That cost savings should enable Chinese exporters to lower their prices to American consumers, possibly compensating entirely for the higher renminbi-dollar exchange rate.

Of course, there are plenty of other reasons to eschew Aliber’s proposal, not the least of which is the fact that it certainly would be found WTO-illegal and would invite discrimination against U.S. exporters.  Considering that increased U.S. exports — and not just reduced imports — can help reduce the bilateral deficit, it is curious that Aliber would propose a remedy that would likely curtail U.S. exports.  It would also raise costs throughout the supply chain directly, and by introducing enormous uncertainty into the trading system.

Now that he’s seen the light, maybe Chuck Schumer should give Aliber a call.

A Trade Proposal Unworthy of an Economist is a post from Cato @ Liberty - Cato Institute Blog

According to a Washington Post story today, “the weak dollar is one problem the United States loves to have.” The story reports how the fall of the dollar against the euro and other currencies in the past year has boosted U.S. exports and discouraged imports, cutting the trade deficit and allegedly boosting the U.S. economy. A weaker dollar has spurred complaints in Europe and elsewhere, but here at home the Post story leaves the impression the approval is practically unanimous.

Nowhere in the 1,058-word story is the impact on consumers ever mentioned. But it is American consumers who pay the biggest price when the dollars we earn buy less on global markets. We are paying more for oil, which not coincidentally has zoomed toward $80 as the dollar flounders. A weaker dollar means higher prices than we would pay otherwise for a range of goods, from imported shoes and clothing to food, that loom large in the budgets of American families struggling to make ends meet in this difficult economy.

Ignoring consumer interests is widespread in reporting about trade. It reflects the strong bias of elected officials to see trade issues strictly through the lens of producers and never consumers. After all, it is producers who form trade groups and hire lobbyists to promote their exports or protect themselves from imports. Nobody in Washington represents the diffused, disorganized but much more numerous 100 million American households.

The dollar’s value should be set by markets, and I have no reason to believe the dollar is over- or undervalued. But pardon me if I dissent from the consensus that a falling dollar is unambiguously good news.

Ask Consumers if They Like a Weak Dollar is a post from Cato @ Liberty - Cato Institute Blog