David R. Henderson  

Dean Baker on Something "All Economists Agree On"

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Meritocracy Bleg... Kahneman and Renshon on Hawkis...

Dean Baker has a post in which he expresses skepticism about fast-track authority for the Trans-Pacific Partnership (TPP) and the Trans-Atlantic Trade and Investment Pact (TTIP). He argues that the deals are not mainly about free trade. Paul Krugman argued earlier, incorrectly, that the deals are not about trade at all. I'll let Obama spokesman Jason Furman weigh in on the fact that there is a large dose of freer trade in the TPP:

The most comprehensive estimates of the benefits of TPP are those of Peter Petri, Michael Plummer, and Fan Zhai, who employ an 18-sector, 24-region computable general equilibrium model to simulate policy changes in more than twenty different areas including tariffs, non-tariff barriers, and rules governing foreign direct investment. They find that by 2025, TPP would raise U.S. incomes by 0.4 percent per year, the equivalent of $77 billion in 2007 dollars, although the actual estimate could vary somewhat depending on the details of the agreement and alternative modelling assumptions. The European Union has said that the United States would gain a comparable amount from T-TIP. Some have described these totals as small, but I think I would risk losing my license to offer economic advice if I counseled anyone to leave $77 billion lying on the sidewalk each year.

Of course, this does not directly contradict Baker because Baker was careful not to say that there were no freer trade elements. It does contradict Krugman.

But I want to challenge another part of Dean Baker's post, the part on trade deficits. Dean writes:

This means that if we want to get back to full employment, we have to reduce our $500 billion (@ 3 percent of GDP) trade deficit. (This is the intro econ on which all economists agree. It can even be found in Mankiw's textbook.) Reducing the trade deficit means taking steps to lower the value of the dollar against other currencies.

It's not true that "all economists agree" about that. I don't. In fact, I would be surprised if even most economists agree.

And why don't many of us agree? Because the trade deficit is endogenous. It's the result of fundamental factors in world economies as well as government policies. One government policy that has traditionally reduced the trade deficit is a policy that causes a recession. It's clear that Dean is not advocating that, but what is he advocating?

Dean proposes lowering the value of the dollar against other currencies. But that's not a policy. The value of the dollar against other currencies is a price. You need a policy to reduce that price. How do you lower the price of a currency? Either by increasing the supply of the currency or by reducing the demand for the currency. He doesn't say which he favors.

UPDATE: Don Boudreaux correctly reminds me, in the comments, that I should reference the late Herb Stein's (who was one of my three favorite bosses of all time) excellent short article in my Encyclopedia. It's "Balance of Payments."


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COMMENTS (18 to date)
Don Boudreaux writes:

David,

Dean Baker simply doesn't understand what a trade deficit (or current-account deficit) really is. His interpretation of it is the standard one shared by uninformed 'men-in-the-street.' (Peter Morici, by the way, suffers from the same misunderstanding.) You should recommend that Baker read Herbert Stein's entry, "Balance of Payments," in your wonderful Concise Encyclopedia.

Each semester I share with my class the following example:

SCENARIO 1: Suppose that Mr. Honda in Japan earns $1,000,000 selling goods to Americans. He then spends that $1,000,000 buying lumber from Alabama in order to build his dream house in Tokyo. This purchase neither adds nor subtracts from America's trade deficit; $$exports = $$imports. Whew! No increased trade deficit!

SCENARIO 2: But now suppose that Mr. Honda uses the $1,000,000 to buy, not lumber from Alabama, but to buy a restaurant in Alabama from its American owner. The American seller of the restaurant then immediately spends the $1,000,000 proceeds from the sale of her restaurant to buy lumber from Alabama to build her dream house in Montgomery.

In the second scenario (and only in that one) the U.S. trade deficit rises by $1,000,000. Yet clearly the amount of American employment that is supported by the transactions in this second scenario does not differ from the amount that is supported by the transactions in the first scenario. In each scenario, a restaurant in Alabama is operated, and an extra $1,000,000 of demand flows to the Alabama lumber industry.

That Baker doesn't see that funds in the U.S. trade deficit flow back to the U.S. on the U.S. capital account - and that the flow of such funds back to the U.S. on the capital account are no less likely to spur or support employment in the U.S. than are funds that flow back to the U.S. on the current account - reveals his poor grasp of balance-of-payments economics.

David R. Henderson writes:

Well said, and I should have said it. I was focusing on his “all economists agree” line. I wish I could say that all economists have thought through what you did above.

Don Boudreaux writes:

David,

I've no doubt that you'd have said even better the straightforward point that I make here. But, of course, your post was aimed at yet another problem with Baker's essay.

It it truly astonishing that, given how very simple the above point is, so many people, including some economists, continue to see current-account deficits as necessarily being net drains ("leakages") of demand from the domestic economy.

Mary Renard writes:

Don,

Question about your example:

Scenario 1 and scenario 2 do differ in that in the second scenario Mr. Honda ends up owning, and is therefore entitled to, profits (or losses) from a restaurant. This is not the case in scenario 1.

The cash flows generated from that restaurant go to Mr. Honda in Tokyo in Scenario 2, whereas they remain in Alabama in Scenario 1.

Does this not contribute to a trade inbalance?

Thanks.

R Richard Schweitzer writes:

The "trade deficit" displays the degree to which others are working for us compared to our working for them.

It may also display our unwillingness to work for them on the same terms or scales they are willing to work for us.

There are also the kinds of things we offer others in response to needs, wants or desires; compared generally to our desires and wants for what they are willing to offer.

What we offer is mainly what we can not (efficiently) consume ourselves - at any particular period. Our offers will increase when there is more to gain from offers than consumption.

James D writes:

Mary Renard,

My understanding of how to answer your question is that Mr. Honda earned the dollars to buy the restaurant selling goods to Americans, so all owning a restaurant changes is that he now also earns the profit that the restaurant makes selling goods to Americans. Regardless of where he earned those dollars, he would still end up using them to purchase other items from America whether they be on the current account, e.g. lumber, or capital account, e.g. another restaurant.

Don Boudreaux writes:

Mary,

Good question.

The simplest response is that the owner of the restaurant presumably recouped in the selling price at least some portion of the net present value of the expected future flow of the profits from the restaurant. Of course, if Mr. Honda manages the restaurant better than did the American owner, then he - Mr. Honda - does indeed capture more profit. But that is surely not a bad thing for America: an asset located within its borders is being operated more productively.

On the other side of the risk scale, it might well be that the restaurant fails (and perhaps the prospect of failure is what prompted the American to sell it).

But step back and change the example: suppose that the American seller of the restaurant spends the $1,000,000 proceeds from the sale to Mr. Honda of the restaurant, not buying lumber to build her dream house in Montgomery, but, instead, buying lumber to build a new business in Montgomery - say, a woodworking shop. In the latter case, if she's successful in her new business venture, she, too, profits just as does Mr. Honda who successfully operates the restaurant in Alabama.
....
One could discuss here the stream of services that the American would get, as a consumer, from living in her house. Because those services aren't monetized as a regular flow of monetary payments, they don't show up readily in economic accounts - but they are real, and not necessarily less valuable or worthwhile to that American as are the monetary profits that Mr. Honda earns from operating the restaurant in Montgomery.

Mary Renard writes:

Don, thank you for your crystal clear response. Makes perfect sense.

Edogg writes:

Krugman doesn't say that the deals are not about trade at all. It's clear from the links to himself and to vox-dot-com that when Krugman says "...this is not a trade agreement," he means the same thing as Baker. In the explanation of why he's a lukewarm opponent of the TPP that he links to, he says, "Because as with many “trade” deals in recent years, the intellectual property aspects are more important than the trade aspects." Both links also reference the same empirical work that Furman references.

Don,

Your example is very contrived for this reason:

You assume that the $1m will be spent in the domestic economy - that the marginal propensity to spend of the receiver of the money is 100%.

In this case, there is no harm to the domestic employment level.

But at every level less than 100% there is harm because less than $1m gets to the lumber producers.

You are correct that it does not as a rule have to lead to unemployment, but in practice you are totally wrong, and I worry for your students.

And I am not even an economist and can see this.

Mike sproul writes:

you don't lower the price of money by increasing its supply or by reducing demand for it. Money is endogenous, A central bank that issued $100 of new money would naturally get $100 of new bonds as backing for that money. The central banks ratio of assets to money would be unchanged, and the value of money would stay the same.

I might try a different Scenario 2 in Don Boudreaux's lesson, being:

Mr. Honda buys $1,000,000 worth of stocks or bonds in US corporations. Those corporations spend the money, let's say, on US-produced products.
But more importantly, I have the impression that all the folderol about "trade deficit" stands only upon the fact that the word "deficit" has negative normative connotation. It sounds like something bad to people who don't know. The naming is an accident of history. The same concept could have been named "trade surplus" if you focus upon who gets the most goods rather than on who gets the most dollars.

Here is a way to clear this up. All teachers of foreign trade should alternate: using "deficit" in their fall-semester classes, then "surplus" in their spring-semester classes, for the same trade concept. The one word is as true to the circumstances as the other.

James writes:

Ari,

If the seller of the restaurant receives $1M, then it will all get spent, eventually.

Whoever introduced you to the concept of marginal propensity to consume probably failed to mention that over a person's lifetime, mpc equals almost exactly one. Any measurement leading to any other conclusion suffers from an arbitrary choice of measurement period. A similar but more obvious form of the same fallacy would say there is a recession every night and a recovery every morning.

James,

a) you talk as if money can only be spent once

b) it's not much help for the lumberjacks in Alabama who are now unemployed.

At the moment, demand in the world is low. Extra savings cause unemployment/more debt.

I would try reading Michael Pettis for another view.

All the best, Ari

Steve Y writes:

I attended business school in the mid ‘70’s, when the country seemed to be in uncharted waters. The U.S. had gone off the gold standard in 1971 (“sound as a dollar” wasn’t said ironically). Americans had experienced skyrocketing prices and gas lines from the OPEC oil embargo. The “balance of payments” deficit was a big problem, according to news reports. (Did I mention that Watergate and the lost Vietnam war were also in the news?)

Against that everything-is-falIing-apart backdrop, I remember my International Finance professor asking the question:

If we send green pieces of paper to the Middle East and get back oil, and if the Japanese take our dollars while we get TVs and cars, aren’t Americans the ones who are better off? The few who argued with Prof. Adler said that we may have the advantage of the exchange now, but some day there will be a price to pay when other countries stop taking our dollars. He asked us to think through what that would mean, but the discussion got lost in secondary and tertiary effects.

That’s when I decided to become an accountant.

40 years later the “some day” we feared hasn’t arrived, and the rest of the world is still sending us stuff in exchange, not for green pieces of paper, but electrons in the ether.

Don Boudreaux writes:

Ari,

You miss the point. Even if we grant your rather simplistic Keynesian notion that spending is better for the economy than savings - even if we remove our economist hats in order to join you in failing to ask how funds that are saved might be invested productively - Dean Baker's concern about a trade deficit remains unfounded.

The point is that trading internationally is no more (or less) likely to spark the potential problems you identify than is trading domestically.

In my example (in my previous comments), if American consumers had purchased the $1,000,000 of stuff from American, rather than from Japanese, producers, the American producers who made these sales are no less (or more) likely than would be the Japanese producers to save, rather than to immediately spend, some portion of those sales proceeds.

That is, if your concern is that foreign suppliers of American imports will save rather than immediately spend the dollars they earn from American consumers, why are you not equally concerned that American suppliers will not do the same? Merely assuming it to be so doesn't work.

At the base of the case for free trade is that there is nothing economically significant about trade that happens to be transacted across political borders. Economically, all the problems (some more imaginary than others) that opponents of free trade blame on free trade are problems, not with international trade but, instead, with trade - with any trade.

If you don't like the economic change and displacement that comes with, say, Americans increasing their purchases of goods from South Korea, fine - but you must then also equally dislike the change and displacement that come with, say, Americans increasing their purchases of goods from South Carolina. If you lament the lost jobs of Americans who are unemployed because fellow Americans chose, say, to buy more cars from Korea, then you must lament also the lost jobs of Americans who are unemployed because fellow Americans chose, say, to buy more used cars. If, to protect some Americans from losing their current jobs, you call on government to prevent American consumers from freely choosing to buy cars from foreign automakers, you should also call on government to prevent American consumers from freely choosing to buy cars from used-car lots.
....
Perhaps your "worry" about my students is justified; I dare not judge myself on that front. But I do strive to teach them to ask the kinds of questions that lead economists to see many phenomena that non-economists (or that poor economists) do not see.

Mark V Anderson writes:
If you don't like the economic change and displacement that comes with, say, Americans increasing their purchases of goods from South Korea, fine - but you must then also equally dislike the change and displacement that come with, say, Americans increasing their purchases of goods from South Carolina.

Unfortunately, this expansion of unfree trade advocacy to other states is actually very common. Many of those advocating local trade these days talk about the benefits of the revenue going into local pockets instead of some multi-state firm based elsewhere (although it seems none of these advocates seem to realize they are favoring trade wars with other regions).

I think a better argument for free trade (between states and between nations) is that specialization in trades and industry is the greatest contributor increasing wealth over the last couple of centuries. Those countries that are most insular and ban most international trade, are always also the poorest (such as North Korea today and Albania a few decades ago). If we followed the lead of the extreme advocates of local economies, everyone's income would shrink to that of a century ago.

Not that any of this is an endorsement of the current trade agreement. The question is whether it truly increase trade, or just changes around the winners and losers of our current trade.

James writes:

Ari,

Nowhere do I assert or assume that money can only be spent once. Please read more carefully. Here is what you missed:

In the course of each person's lifetime, that person's spending will almost exactly equal that person's income. Any talk of a marginal propensity to consume different from one is based on inappropriate measurement periods.

I get paid on the first and the fifteenth in electronic transfers that take less than a second to complete. In the time those transfers occur, I spend approximately none of my income. For the rest of the month, I receive no paychecks and spend some of my income. Over my life, I will wind up spending every penny I earn, plus or minus some small difference. Do I have an MPC that varies wildly, or an MPC of about one?

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