David R. Henderson  

Conard on Trade and the Trade Deficit

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I'm working on a book review of Edward Conard's book, Unintended Consequences. I'm over half way through the book and, although there are a few cryptic passages, when he's good, he's very, very good. And he's often good. I hate the subtitle: "Why Everything You've Been Told About the Economy is Wrong." Really? Everything? Hard to believe.

But large parts of the chapter titled "The Role of the Deficit" are brilliant. An excerpt:

As the U.S. economy moved production offshore, balanced trade would have required the United States to produce goods for export. Instead of selling goods to offshore producers to balance trade, we sold them assets (ownership rights to future cash flows split into debt and equity; in this case, the United States sold debt to offshore producers). This also allowed the United States to use freed-up resources to increase domestic investment. We also redeployed freed resources to the domestic service sector.
Increased and more productive investments grew U.S. assets faster than the sale of assets to buy and consume imports. While debt owed to foreign economies grew, assets owned by Americans grew even more. Household net worth increased. As long as we continue to produce assets faster than we sell them, the trade deficit can grow forever. As long as the United States continues to earn a higher rate of return on investments than its cost to borrow cheap foreign capital, this can remain the case, and likely will remain so for the foreseeable future.

Later, in discussing why cheap foreign labor is a boon:
Now imagine that those offshore workers were willing to work for free. If their labor was free, how much of it should we buy? All of it. At seventy-five cents an hour, it is effectively free. At that price, surely we can find better uses for our own labor.

And, on "dumping":
When offshore producers "dump" incremental production between full cost, we capture the benefit of lower prices. When foreign governments subsidize trade with tax credits or hold dollars to support their currencies, we capture the value of those subsidies.

I think he uses the word "support" in a strange way. "Support" usually means keep the price of a currency high. But clearly, in context, Conard is using "support" to mean "keep the price of a currency low."


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CATEGORIES: International Trade



COMMENTS (8 to date)
kebko writes:

Good stuff. I saw him on C-Span BookTV, and he was good there, too.

But, the comment on foreign labor costs is a bugaboo of mine. To a CEO, it might look like the lower wages are the cause of the lower cost. But, they are not. The wages are a product of the level of labor productivity, which is a product of local institutions and culture.

I would say that production moves, not to where wages are low, but to where they are rising. The production is moving to that location because improving local productivity is allowing that location to expand its competitive advantage to new areas of production.

The reason production moves to low wage locations is because those are the locations with the most potential for improving institutions and productivity. The causation doesn't run directly from low wages to higher profit, but the rising wages and the surplus profits are both caused by the same effect.

Two pieces of evidence to consider:
1) Production isn't moving to places with low and stagnant wages. It's only moving to places with low and improving wages. And trade is typically highest with high wage trading partners.
2) Production moved to places like Japan, South Korea, and Taiwan "because of" low wages, but production was still productive there even after wages rose.

I think this subtle distinction is an important counterpoint to the conventional anti-trade bias, but it will never be widely understood, because even the businesses moving production overseas think that the low wage is the causal factor.

Costard writes:
As long as the United States continues to earn a higher rate of return on investments than its cost to borrow cheap foreign capital...

This is precisely the problem -- what if cheap foreign capital is a temporal phenomenon? It makes no sense to talk about the "rate of return"; the federal government is running deficits to subsidize consumption, not fund investment. The only enduring aspect of this transaction is the debt incurred, which threatens to becomes onerous if and when the well runs dry.

At that price, surely we can find better uses for our own labor.

In an ideal world, yes. In a free market, quite possibly. But in a modern, regulated state? The virtue of the post-New Deal economy is stability not agility. For us, off-shoring means structural unemployment. Not to mention the costs involved with shifting labor from one location and line of work to another, and the capital destroyed when factories decay and steel towns revert to rust. And these better uses: peddling securities and flipping houses? Or is the best use for American labor - given 8% unemployment - no use at all?

When offshore producers "dump" incremental production between full cost, we capture the benefit of lower prices.

Depends who "we" are. Certainly, our children reap the rewards of over-consumption/under-investment, and our government captures the benefit of concealed inflation and a capital surplus that allows an accumulation of debt. Pretty soon we find ourselves -- right where we are.

MG writes:

@David

Looking forward to the book review, as the many on the mainstream press are too invested on the Bain = Evil meme to address the issues he raises objectively. I am interested in what you think about his views that consumers and wage earners capture the vast majority of value created from investment, and not investors themselves. (He answers this in an interview he had with AEI and I suspect he addresses this in his book -- link below). The numbers he suggests are very high. Were these numbers indeed that high, and were an economist/leader able to articulate this view effectively, I think we would be having a different debate on many issues, starting with inequality.

http://american.com/archive/2012/may/innovation-risk-and-the-most-hated-book-of-the-year/

R Richard Schweitzer writes:
"Increased and more productive investments grew U.S. assets faster than the sale of assets to buy and consume imports. While debt owed to foreign economies grew. . . "

While I find myself in "compatible mode" with Mr. Conard, there is another "spin" that can be put on that particular observation:

The costs and assigned valuations of productive investments (assets)increased faster than the prices obtained through the sale of assets to buy and consume imports.

The composition (nature of repayments sources)of debt owed to foreign economies changed to increase the proportion provided through increased productivity (of those productive assets acquired)decreasing the domestic benefit of the increase in productive assets.

Bryan Willman writes:

It's not the nominal labor rate, but the PPP adjusted effective labor rate, that matters.
This is often a much much higher number.

(As in, people are only paid $5 per day in USD$, but their productivity is terribly low, so that the difference in labor cost of the product is only 10% to 40% even though labor is nominally 75% cheaper. This low productivity might be due to factors such as inadequate education, cultural issues, or inadequate capital support. But it's still a real thing.)

Joe Cushing writes:

"As long as we continue to produce assets faster than we sell them, the trade deficit can grow forever."

Michael Mandel has been making this point for years. It's something that few people understand. They see foreigners (Japanese some time ago and Chinese now) buying our assets and they think they are buying America. The foreigners would not be willing to accept assets in exchange for goods, if they thought the assets would be unproductive. A trade deficit is a sign of prosperity, not of us losing in some economic war.

Joe Eagar writes:

Trade deficits are sustainable if we produce more assets than we sell abroad? What happens when asset prices fall? Especially, what happens when U.S. asset prices fall, but the assets owned by foreigners don't fall as much, or at all.

Joe Eagar writes:

Joe Cushing, but foreigners do think U.S. assets are unproductive. At least, the Chinese have complained bitterly for years about dollar devaluation, and the financial media often speaks of the U.S. as the "least sick" economy. We have the world's reserve currency. People lend to us whether they want to or not.

But even if what you said were true, expectations are not reality. Foreign investors piled into stocks in the late 90s, and housing in the 2000s. Just because foreigners expect good returns on their investments, doesn't mean those investments are wise. Look up "balance of payments crisis" sometime.

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