Category Archive for: International Trade [Return to Main]

Friday, March 02, 2007

Bernanke: Globalization May Have Increased Inflation

Continuing with the post below this one... Recently, it was reported that the relationship between changes in the real economy and changes in the inflation rate is lower than it used to be, something discussed here. Below, Federal Reserve Chairman Ben Bernanke is reported as saying he agrees with these findings:

The relationship between slack in the economy and lower inflation is ''clearly lower'' than it used to be.

Another aspect of the recent debate over monetary policy concerns how globalization has affected inflation, and the Fed's ability to affect inflation through monetary policy. Here's Chairman Bernanke's view, a view that agrees with what I've been arguing:

Bernanke Says Globalization May Boost U.S. Inflation, Reuters: Global factors may on balance have boosted U.S. inflation, but globalization has not affected the ability of the Federal Reserve to influence U.S. financial conditions, Fed Chairman Ben Bernanke said on Friday.

''When the offsetting effects of globalization on the prices of manufactured imports and on energy and commodity prices are considered together, there seems to be little basis for concluding that globalization overall has significantly reduced inflation in the United States in recent years; indeed the opposite may be true,'' he said in a speech at Stanford University. ...

The central bank chief said the Fed finds it difficult to pin down a fixed number for any natural rate of unemployment. ''There are a couple of problems that have emerged with using a fixed number like that for analyzing the macro-economy,'' he said.

The relationship between slack in the economy and lower inflation is ''clearly lower'' than it used to be, Bernanke said.

Bernanke said that globalization has not ''materially affected the ability'' of the Fed to influence U.S. financial conditions, ''nor has it led to significant changes in the process which determines the U.S. inflation rate.''

Overall, globalization has probably spurred inflation in the United States rather than lowered it because recent increases in energy and commodity use in developing countries such as China and India have pushed up prices for such goods, Bernanke said.

He noted a study that found that if the share of world trade and economic growth of non-industrial countries remained at its 2000 level, oil prices would have been as much as 40 percent lower in 2005 and metals prices as much as 10 percent lower.

''Accordingly, in the past several years, the effect of growth in developing economies on commodity prices has been a source of upward pressure on inflation in the United States and other industrial economies,'' he said.

At the same time, increased trade with China and other developing countries has led to slower growth in the prices of imported manufactured goods, Bernanke said.

He cited a study concluding that trade with China alone reduced annual import price inflation in the United States by about 1 percentage point over 1993-2002.

The Fed is devoting more resources and time to trying to understand the effect of increased global integration on inflation and the central bank's ability to maintain price stability and ensure low unemployment, Bernanke said. ...

Update: Here is the speech, "Globalization and Monetary Policy."

Update 2: Here are a few quotes from the speech at Stanford with some of the discussion of the supporting research, e.g. the work on the "global output gap hypothesis" that is part of the recent discussion about the changing relationship between domestic real activity and inflation. One reason we ,ight see a declining relationship between the output gap and inflation is that the relevant concept of the output gap has changed while our measurement of the gap - domestic output minus domestic potential output (which is shaky in any case) - has not. Thus, it is not that the output gap and inflation are unrelated, i.e. that the Phillips curve is dead, but rather the appropriate definition of the gap to use in assessing the relationship has changed. There are quite a few more references and a lot more discussion in the speech itself:

The empirical literature supports the view that U.S. monetary policy retains its ability to influence longer-term rates and other asset prices. Indeed, research on U.S. bond yields across the whole spectrum of maturities finds that all yields respond significantly to unanticipated changes in the Fed’s short-term interest-rate target and that the size and pattern of these responses has not changed much over time (Kuttner, 2001; Andersen and others, 2005; and Faust and others, 2006). Empirical studies also find that U.S. monetary policy actions retain a powerful effect on domestic stock prices.

...

I draw two conclusions... First, the globalization of financial markets has not materially reduced the ability of the Federal Reserve to influence financial conditions in the United States. But, second, globalization has added a dimension of complexity to the analysis of financial conditions and their determinants, which monetary policy makers must take into account.

...

International factors might affect domestic inflation through several related channels. First, the expansion of trade may cause domestic inflation to depend to a greater extent on the prices of imported goods--not only because imported goods enter the consumer basket or (in the case of imported intermediate goods) affect the costs of domestic production, but because competition with imports affects the pricing power of domestic producers. Second, competitive pressures engendered by globalization could affect the inflation process by increasing productivity growth, thereby reducing costs, or by reducing markups. Third, to the extent that some prices are set in internationally integrated markets, pressures on resource utilization in foreign economies could be relevant to domestic inflation.

Some analysts might object to the proposition that globalization affects the inflation process at all on the grounds that the structural changes that globalization engenders can affect only the relative prices of goods and services; in contrast, inflation--the rate of change of the overall price level--must ultimately be determined solely by monetary policy (Ball, 2006). Certainly, monetary policy determines inflation in the long run, and the central bank must take responsibility for the inflation outcomes generated by its policies. ...

However, the conclusion that inflation is determined only by monetary policy choices need not hold in the short-to-medium run.

...

In a globalized economy, the level of resource utilization in the world economy is another potential influence on domestic inflation. Standard analyses of inflation based on the concept of a Phillips curve assign a role in inflation determination to the domestic output gap--the difference between the economy’s potential output and its actual production. According to this theory, the existence of slack in the economy makes it more difficult for producers to raise prices and for workers to win higher wages, with the result that inflation slows. These conventional analyses have considered only the possible link between domestic inflation and the domestic output gap. But in an increasingly integrated world economy, one may well ask whether a global output gap can be meaningfully defined and measured and, if it can, whether it affects domestic inflation. In other words, all else being equal, would a booming world economy increase the potential for inflationary pressures within the United States?

In principle, with the domestic determinants of inflation held constant, reduced slack in the global economy could increase domestic inflation for a time if it led to higher prices for some traded goods and services relative to the prices of goods and services that are not usually traded. For example, suppose that the United States produces personal computers both for export and for domestic use, and that more-rapid growth abroad increases the world demand for computers. Stronger global demand for computers raises the prices that U.S. producers can charge their foreign customers. Moreover, because all computer producers are facing a stronger global market, U.S. producers can charge more for their output at home as well. If producers of many goods face increases in worldwide demand, the net effect could be higher inflation in the United States, even though there may be no measurable effect on the prices of U.S. imports.

The idea is intriguing but again, unfortunately, the evidence is so far inconclusive. Early work, including some done at the Federal Reserve Bank of Boston, found no effect of global demand conditions on U.S. inflation, as did most of the subsequent research. Recently, however, several researchers affiliated with the Bank for International Settlements (BIS) have reported results favorable to the global output gap hypothesis (Borio and Filardo, 2006).

Thursday, March 01, 2007

Holes in the Safety Net

The "curity" part of flexicurity needs improvement:

Federal Aid Does Little For Free Trade's Losers, by Deborah Solomon, WSJ: For more than 80 years, the people of Webb Furniture crafted wooden ... furniture... In January, under pressure from Chinese imports, Webb shuttered its Galax plant and fired all 309 employees.

Tonya Graber lost more than her job... The single mother also lost health insurance for herself and her 12-year-old son. Under a government program aimed at helping workers harmed by trade, Ms. Graber was eligible for federally subsidized health insurance, but she couldn't afford it.

She isn't alone. The Health Coverage Tax Credit, tucked into a 2002 trade bill to win support in Congress, is supposed to cushion the blow to factory workers hurt by imports by paying 65% of the cost of health insurance. ... More than four years after the program began, just 11% of those potentially eligible for the subsidy are taking it...

"It's just not realistic to say that a laid-off worker who's uninsured is going to come up with 35% of the premium," says Stan Dorn, who has studied the program at the Urban Institute...

A common political compromise in Washington involves keeping trade barriers low in exchange for programs compensating those hurt by imports. Free-trade advocates are generally happy to make such a compromise. They figure the winners from trade ... can afford, through the government, to help compensate the losers.

The problem is that compensation programs often add bureaucracy without helping many people. Even if the health-insurance assistance program were working well, it would aid only a fraction of those who lose their jobs. The Labor Department must certify that workers have lost their jobs to imports from certain countries or to a shift in production there. Most workers in ... service industries whose jobs are sent overseas don't qualify.

Another struggling program is wage insurance, designed for workers over 50 who lose their jobs because of trade and then take a lower-paying job. The government makes up half the difference in wages, up to $10,000 a year, but it requires that workers prove they don't have "easily transferable skills." Some can't do that.

The issue: Should Washington give up on such programs, or should it expand them and try to make them work better? For the moment, people on both sides on Capitol Hill say President Bush will need to beef up programs for those hurt by imports if he wants congressional backing for new trade legislation. ...

"There has to be more cushioning for people caught in the maws of free trade," says Sen. Charles Schumer, a New York Democrat who has criticized China's trade policy. "The fact that TAA has not done the job gives those who want to build walls around the U.S. greater currency." ...

On average, according to the Internal Revenue Service, [health] insurance costs $720 a month, with the federal government picking up $468, or 65%, of the cost and the former employee paying the $252 remainder. ...

The administration acknowledges problems. The White House Office of Management and Budget has called the program "not performing," and cited as a reason "the affordability of coverage to potential recipients."... The Senate Finance Committee chairman, Max Baucus of Montana, says he plans to introduce legislation this year "to make this benefit work better." ...

Tuesday, February 27, 2007

Japan's Food Security

Is Japan's protection of its agricultural industry justified by the fact that it is an island nation, or should Japan drop its worries about food security and end the subsidies it gives to domestic farmers? First, here's Malcolm Cook of the Lowy Institute for International Policy in Australia writing for Project Syndicate. He's hopeful Japan's protectionist tendencies in agriculture are subsiding, and that Japan will lead the way for others to relax their agricultural protections. An editorial from the Japan Times follows and gives additional perspective: 

Japan is showing the way forward for agricultural free trade, by Malcom Cook, Project Syndicate: Last year was a bad one for free trade. The Doha Round was supposed to make agriculture the centerpiece of negotiations... But instead of breathing life into free trade in food, rural protectionism in rich countries seems to have killed the Doha Round... Most galling, agriculture is a small and declining part of these "rich club" economies...

Continue reading "Japan's Food Security" »

Saturday, February 24, 2007

Bill Gates: Open the Doors to More High-Skill Immigration

Bill Gates continues his crusade to allow more high-skilled immigrants into the U.S.:

How to Keep the U.S. Competitive, by Bill Gates, Commentary, Washington Post: ...Innovation is the source of U.S. economic leadership and the foundation for our competitiveness in the global economy. Government investment in research, strong intellectual property laws and efficient capital markets are among the reasons that America has for decades been best at transforming new ideas into successful businesses.

The most important factor is our workforce. Scientists and engineers trained in U.S. universities -- the world's best -- have pioneered key technologies such as the microprocessor, creating industries and generating millions of high-paying jobs.

But our status as the world's center for new ideas cannot be taken for granted. Other governments are waking up to the vital role innovation plays in competitiveness. ...

Two steps are critical. First, we must demand strong schools so that young Americans enter the workforce with the math, science and problem-solving skills they need to succeed in the knowledge economy. We must also make it easier for foreign-born scientists and engineers to work for U.S. companies. ...

Our schools can do better. Last year, I visited High Tech High in San Diego; it's an amazing school where educators have augmented traditional teaching methods with a rigorous, project-centered curriculum. Students there know they're expected to go on to college. This combination is working: 100 percent of High Tech High graduates are accepted into college, and 29 percent major in math or science, compared with the national average of 17 percent.

To remain competitive in the global economy, we must build on the success of such schools...

American competitiveness also requires immigration reforms that reflect the importance of highly skilled foreign-born employees. Demand for specialized technical skills has long exceeded the supply of native-born workers with advanced degrees, and scientists and engineers from other countries fill this gap.

This issue has reached a crisis point. Computer science employment is growing by nearly 100,000 jobs annually. But at the same time studies show that there is a dramatic decline in the number of students graduating with computer science degrees.

The United States provides 65,000 temporary H-1B visas each year to make up this shortfall -- not nearly enough to fill open technical positions.

Permanent residency regulations compound this problem. Temporary employees wait five years or longer for a green card. During that time they can't change jobs, which limits their opportunities to contribute to their employer's success and overall economic growth.

Last year, reform on this issue stalled as Congress struggled to address border security and undocumented immigration. As lawmakers grapple with those important issues once again, I urge them to support changes to the H-1B visa program that allow American businesses to hire foreign-born scientists and engineers when they can't find the homegrown talent they need. This program has strong wage protections for U.S. workers: Like other companies, Microsoft pays H-1B and U.S. employees the same high levels...

Reforming the green card program to make it easier to retain highly skilled professionals is also necessary. These employees are vital to U.S. competitiveness, and we should welcome their contribution to U.S. economic growth.

We should also encourage foreign students to stay here after they graduate. Half of this country's doctoral candidates in computer science come from abroad. It's not in our national interest to educate them here but send them home...

During the past 30 years, U.S. innovation has been the catalyst for the digital information revolution. If the United States is to remain a global economic leader, we must foster an environment that enables a new generation to dream up innovations, regardless of where they were born. Talent in this country is not the problem -- the issue is political will.

On High Tech, the fact that more graduates major in math and science in college than at other schools (29% versus 17%) is not, in and of itself, evidence that these schools work since a high degree of selectivity bias is likely present (those who like math and science are more likely to enroll in a "High Tech High" than other students, the web site says they get 3,000 applications for 300 slots). I agree completely with the message on education, but worry that instead of building upon what works, we are too ready to tear it all down and start over. We have a Gates Foundation small schools initiative here in Eugene that broke an existing high school into three smaller specialty schools (an International High School, a school specializing in Invention, Design, Engineering, Arts, & Science, and North Eugene Academy of Arts). If it works, great, but these are kids lives we are playing with and if it doesn't work and outcomes deteriorate, the price of innovation, the risk, becomes very localized and very steep for those students who participate in the failed experiments (and it's not always voluntary). I wish there was a better way to spread the risk of these experiments across the population rather than localizing it in schools that are already, for the most part, having troubles.

As for immigration, I am generally supportive of open door policies. However, I do want to point out that there is another solution for Gates and others. They believe that there is plenty of talent in the U.S., that's not the problem, it's just that workers lack the training they need. Microsoft could provide the training itself instead of free-riding on the educational system. It takes a little longer and costs more, of course, but consistent with advocates of privatization and efficient markets, it forces Microsoft to internalize the costs of training its workers, particularly specialized training. But I can't blame Microsoft for wanting to avoid these costs if it can, and for wanting to increase the supply of labor as much as possible by opening the borders to more high-skill immigration.

The shortage of U.S. graduates in this area may be because students have no certainty that specialized skills in these areas will retain their value in the future, a consequence of changes in technology that undermine existing skills over time, digital technology that allows collaborative work to be performed outside of the U.S., and the prospect of more temporary visas being issued in the future.

My observation is that there is a large set of talented students who respond strongly to expected employment prospects when they choose a major, though there is, of course, a time-delay between the appearance of shortages and surpluses in particular areas and changes in the number of majors. But the effect is there. If U.S. students perceive that an investment in computer science training relative to investing their time elsewhere will have the largest long-run payoff, any shortage will take care of itself. [And, as noted in comments, access to education may not be equal so that another way to increase supply is to increase educational opportunities within the U.S.]

In the long-run, due to technology and globalization and to comparative advantage, trying to close doors to high-skilled workers is, for the most part, a losing battle. We can create artificial barriers to foreign competition and steer our students in particular directions but there is a danger that in doing so, we set them up for a bigger fall later. If the walls keeping out foreign competition cannot be maintained in a digital age, and if we artificially direct students to particular occupations, once the walls do come down people employed in these areas will be very exposed and in danger of a large fall in income and employment prospects due to the increased competition. For that reason, I think we are better off letting the walls come down now, within reason of course, and allowing prices direct our students to the places they will, so far as markets can predict, be most highly valued in the future.

Update: Dean Baker also comments in Bill Gates Comes to the Coward's Corner. PGL too.

Thursday, February 22, 2007

How Secure is Global Capitalism's Future?

Timothy Garton Ash of Oxford University and a senior fellow at the Hoover Institution at Stanford University says that Karl Marx "was prescient" in his description of global capitalism:

Will capitalism fall victim to its own success?, by Timothy Garton Ash, Commentary, LA Times: What is the elephant in all our rooms? The global triumph of capitalism. Democracy is fiercely disputed. Freedom is under threat, even in old democracies like Britain. Western supremacy is on the skids. But everyone does capitalism.

Americans and Europeans do it. Indians do it. Russian oligarchs and Saudi princes do it. Even Chinese communists do it. And now the members of Israel's oldest kibbutz, that last best hope of egalitarian socialism, have voted for salaries based on individual performance. Karl Marx is turning in his grave. Or perhaps not, because some of his writings eerily foreshadowed our era of globalized capitalism. His prescription failed, but his description was prescient.

What, after all, are the big ideological alternatives? Hugo Chavez's "21st century socialism" still looks like, at most, a regional phenomenon best practiced in oil-rich states. Islamism — billed as democratic capitalism's great competitor in a new ideological struggle — offers no alternative economic system (aside from the peculiarities of Islamic finance) and does not appeal beyond the Muslim umma. Most anti-globalists are better at pointing out the failings of global capitalism than they are at suggesting systemic alternatives. "Capitalism should be replaced by something nicer," read a placard at a May Day demonstration...

Does the lack of any clear ideological alternative mean that capitalism's triumph is secure? Far from it. For a start, the history of capitalism hardly supports the view that it is an automatically self-correcting system. ...[G]lobal markets are now more than ever constantly out of equilibrium — and teetering on the edge of a larger disequilibrium. Again and again, capitalism has needed the visible hands of political, fiscal and legal correction to complement the invisible hand of the market.

And the bigger it gets, the harder it can fall. An oil tanker is more stable than a dinghy, but if the tanker's internal bulkheads are breached and the oil starts swilling from side to side in a storm, you have the makings of a major disaster. Increasingly, the world's capital is like oil in the holds of one giant tanker, with ever fewer internal bulkheads to stop it from swilling around.

Then there is inequality. One feature of globalized capitalism seems to be that it rewards its high performers disproportionately. What will be the political effects of having a small group of super-rich people in China, Russia and India or other countries where the majority are super-poor? In more developed economies, such as Britain and the U.S., ... if a lot of middle-class people begin to feel that they are personally losing out as a few fund managers get stinking rich and jobs are outsourced to India, you may have a backlash. Watch Lou Dobbs on CNN for a taste of the rhetoric to come.

Above all, though, there is the inescapable dilemma that this planet cannot sustain 6.5 billion people living like today's middle-class in its rich north. In just a few decades, we would use up fossil fuels that took about 400 million years to accrete — and change Earth's climate as a result. Sustainability may be a gray and boring word, but achieving it is the biggest single challenge to global capitalism today. However ingenious modern capitalists are in finding alternative technologies ... somewhere down the line richer consumers will have to settle for less rather than ever more.

Marx thought capitalism would have a problem finding consumers for the goods that improving techniques of production enabled it to churn out. Instead, it has become expert in a new branch of manufacturing: the manufacture of desires. It's that core logic of ever-expanding desires that is unsustainable on a global scale. But are we prepared to abandon it?

We may be happy to insulate our lofts, recycle our newspapers and bicycle to work, but are we ready to settle for less so others can have more? Am I? Are you?

Tuesday, February 20, 2007

Robert Reich: Minimum Half Median

Robert Reich is trying to broker a deal: renewed trade authority for the president in return for labor standards on future trade deals:

A Labor Standard for Future Trade Deals: Minimum Half Median, by Robert Reich: The Bushies want to renew the President's authority to negotiate trade deals... This gives House and Senate Dems an opportunity to win a long-sought Democratic goal -- putting labor standards into all future trade deals.

But what sort of labor standard? If workers in developing nations were required to have the same, or even nearly, the level of wages and working conditions as Americans, jobs wouldn't go to developing nations. This would be a back-door form of protectionism.

Here's a better idea. First, borrow from standards already issued by the International Labor Organization -- barring slave labor, forced labor, and the labor of young children under 12. ILO standards also recognize the ... right of all workers to form unions. ...

Step two: Encourage developing nations to raise their labor standards as their economies grow. The easiest way to do this is to require that they set a minimum wage that's half their median wage. With this ... standard in place, more of their people will share the gains from trade. ...

Market fundamentalists will object that establishing any minimum wage in a developing nation will force some poor workers out of jobs and into the black market. But that's what market fundamentalists argued almost seventy years ago when America first established our own minimum wage. A minimum wage -- like minimum health and safety standards -- is the hallmark of a civilized society.

The biggest hurdle is that this "minimum half median" standard will force the United States to set and keep our own minimum wage at half our median -- which would be about $7.50 in today's dollars...

This seems reasonable. For many decades, America's minimum wage was roughly half its median wage; only since the late 1970s has it fallen much lower than that. ...

Monday, February 19, 2007

"The Globally Integrated Enterprise"

An email says:

You might wish to discuss this article on your blog. The article traces the development of MNC’s up to the present. It is a celebration of the MNCs and their positive impact on globalization.

Unfortunately, Palisiano (CEO of IBM) does not address the issue of corporate power in distorting the market place and in controlling governments themselves (think K Street). Nor does he seriously address the rising global inequality of wealth (think sweat shop labor).

Nor does he address the issue of global warming, environmental decay, and resource depletion—and the ability of MNC’s to cast doubt on the seriousness of these issues. All of these issues are the dark underside of globalization, on which I tend to focus. He frames the discussion in such a way as to avoid these issues—most economists follow his lead.

Anyway, the article is worth discussing. Most economists would agree with Palisano. ...

I'm a bit rushed until much later today and can't do much with this, so, quickly, here's the beginning and end of the article along with a link to the whole thing. Hopefully, some of you can provide analysis:

The Globally Integrated Enterprise, by Samuel J. Palmisano, Foreign Affairs: Beyond Multinational The multinational corporation (MNC), often seen as a primary agent of globalization, is taking on a new form, one that is promising for both business and society. From a business perspective, this new kind of enterprise is best understood as “global” rather than “multinational.”

Continue reading ""The Globally Integrated Enterprise"" »

Wednesday, February 14, 2007

Edward Prescott: 'Competitive Cooperation'

 Edward Prescott, winner of the 2004 Nobel Prize in Economics, defends globalization:

'Competitive Cooperation' by, Edward C. Prescott, Commentary, WSJ: Of all the thankless jobs that economists set for themselves when it comes to educating people about economics, the notion that society is better off if some industries are allowed to wither, their workers lose their jobs, and investors lose their capital -- all in the name of the greater glory of globalization -- surely ranks near the top. This is counterintuitive to many people (politicians among them), because they view it the government's economic responsibility to protect U.S. industry, employment and wealth against the forces of foreign competition. If the government has any economic role at all, surely this must be it.

Actually, no. Government has a higher calling ..., which is to provide the opportunity for people to seek their livelihood on their own terms, in open international markets, with as little interference from government as possible. That doesn't mean we shouldn't provide short-term social insurance policies to aid those displaced by foreign competition, but the purpose of that aid should be to prepare workers, not protect them. ...

[B]roadly speaking -- and these broad operating principles matter -- those countries that open their borders to international competition are those countries with the highest per capita income. ...

How to explain this phenomenon? The answer lies predominantly with competition ... [I]t is useful to consider the example of the U.S., which, from its early days, created wealth from the healthy competition among businesses and industries in its member states. ...

This same competitive cooperation has been firing the economic engine of Europe for 50 years... And there is other evidence throughout the world for the benefit of international openness. Like the U.S., Australia is also a tale of competition among member states... The five wealthy countries of Eastern Asia -- Taiwan, Singapore, Japan, South Korea and Hong Kong -- were not so well off just a few decades ago, but their subsequent commitment to export markets and international competition put them on an upward trajectory that has improved the lives of millions of people.

And what of Latin America? Unfortunately, the region provides a case study in the perils of protectionism. ... [There is] much evidence to support ... that competitive barriers are to blame for Latin America's retarded growth. ...

Of course, many other factors account for marginal differences in productivity and wealth among countries that are already wealthy -- tax rates being key among those factors -- but they are comparative "frosting on the cake," and the cake in this case is the institutional commitment to international competition. ...

Protectionism is seductive, but countries that succumb to its allure will soon have their economic hearts broken. Conversely, countries that commit to competitive borders will ensure a brighter economic future... This lesson should not be lost on the U.S., the paragon of competitive growth, where politicians and policy makers are contemplating whether to construct more protective barriers. It is openness that gives people the opportunity to use their entrepreneurial talents to create social surplus, rather than using those talents to protect what they already have (or to protect rents, as economists like to say). Social surplus begets a rising standard of living, which begets growth, which begets social surplus, and so on. Rent protection stops growth cold and keeps people poor.

People in all countries are motivated to improve their condition, and all countries have their share of talented risk-takers, but without the promise that a competitive system brings, that motivation and those talents will only lie dormant. ...

Wednesday, February 07, 2007

Kenneth Rogoff: Why Hasn't the Dollar Crashed Yet?

Ken Rogoff looks at "the world's largest foreign aid program," foreign loans to the U.S., why the dollar hasn't collapsed under increasing pressure from the trade deficit, and the risks ahead:

Betting with the house's money, by Kenneth Rogoff, Project Syndicate: Many people have been asking why the dollar hasn't crashed yet. Will the United States ever face a bill for the string of massive trade deficits...? ...[S]taggeringly, US borrowing now soaks up more than two-thirds of the combined excess savings of all the surplus countries in the world...

Foreigners are hardly reaping great returns on investing in the US. On the contrary, they typically get significantly lower returns than Americans get on their investments abroad. ...[T]he central banks of Japan and China are holding almost two trillion dollars worth of low-interest bonds. A very large share of these are US treasury bonds and mortgages. This enormous subsidy to American taxpayers is, in many ways, the world's largest foreign aid program. ...

Most sober analysts have long been projecting a steady trend decline in the dollar... So why hasn't more adjustment taken place already? The first answer, of course, is that the trade-weighted dollar has fallen - by more than 15% in real terms since its peak in early 2002. Yet the US deficits have persisted, and even risen, since then.

The real driving force has been two-fold. First and foremost, America's government and consumers have been engaged in a never-ending consumption binge. On the consumer side, this is quite understandable. ...

Overall, after almost 25 years of stunning prosperity, punctuated by only two mild recessions, most Americans feel pretty confident about their economic situation. ... So it is not surprising that private consumption continues to hold up... People have enjoyed such huge capital gains over the past decade that most feel like gamblers on a long winning streak. By now, they see themselves as playing with the house's (or their houses') money.

It is less easy to rationalise why the US government is continuing to run budget deficits despite a cyclical boom. When a fiscally responsible government launches a war, it typically cuts back on other domestic expenditures and raises taxes. The Bush administration did the opposite. It may not be good economics, but the strategy proved to be good politics, for a time. Unfortunately, it is unlikely the new Democratic majority in Congress will do much about it.

Of course, it takes two to tango. In order for the US economy to run deficits with the world, other countries must be willing to ... supply ... savings. Ben Bernanke ... once famously pinned the whole US current account deficit on a "global savings glut". But it would be more accurate to say that there is global investment shortfall, with investment trending downwards despite the upward trend in global growth.

This investment shortfall is due to many factors, but perhaps the main one is ... substantial medium-term institutional roadblocks to investment in many developing countries, where long-term returns now seem to be by far the highest. The net result is that money is being parked temporarily in low-yield investments in the US, although this cannot be the long-run trend.

What then is future of the dollar? As long as the status quo persists, with strong global growth and stunning macroeconomic stability, the US can continue to borrow and run trade deficits without immediate consequence. Over time, the dollar will still decline, but perhaps by no more than a couple of percent a year. Nevertheless, it is not hard to imagine scenarios in which the dollar collapses. Nuclear terrorism, a slowdown in China, or a sharp escalation of violence in the Middle East could all blow the lid off the current economic dynamic. ...

In sum, the fact that the US trade balance has defied gravity for so many years has made it possible for the dollar to do so, too. But some day, the US may well have to pay the bill for its spendthrift ways. When that day arrives, Americans had better pray that their creditors will be as happy to accept dollars as they are now.

Update: Kenneth Rogoff continues to worry about the stability of the global financial system. This is from the Financial Times:

No grand plans, but the financial system needs fixing, by Kenneth Rogoff, Commentary, Financial Times: What ever happened to all the grandiose plans for improving the global financial architecture? Up until a few years back, leading policy economists seemed to be tripping over themselves to come up with blueprints for radical change. Particularly popular were plans for new global institutions... More modest plans (such as mine) merely called for a sweeping restructuring of the major existing multilateral financial institutions, the International Monetary Fund and the World Bank.

Over the past couple of years, however, all introspection appears to have vanished. Instead, the policy community has developed a smug belief that enhanced macroeconomic stability at the national level combined with continuing financial innovation at the international level have obviated any need to tinker with the system. ... There is no problem that markets cannot solve.

Really? How well would markets handle the fallout from a sharp slowdown in India or China? How would they react to a dirty nuclear bomb in a US city..., and a sudden reluctance on the part of global investors to keep financing America’s 800-plus billion dollar current account deficit? Or a rapid escalation of conflict in the Middle East that encompassed Iran and Saudi Arabia? ...[C]ontrary to market perceptions, global central banks have only very limited instruments for dealing with a genuinely sharp rise in global volatility, particularly one that is geo-politically induced.

True, it is not clear that any of the grand plans of the past couple of decades would better equip the world economy to deal with such catastrophic shifts. The typical grand plan was far too simplistic and heavy-handed... But just because most grand plans were far too simplistic does not mean we should dismiss the deeper problems that they aimed to address. ...

The real shame with the disappearance of grand plans is that they had provided a valuable reservoir of ideas to spur major improvements in the world’s existing multilateral financial institutions. ...

We should bemoan the world’s lack of interest in grand plans to improve the financial architecture, but not because any of them was necessarily perfect. The problem, rather, is a lack of the purpose and energy needed to sustain even more modest, and unambiguously positive, reforms. Which means, of course, that after the next round of crises, we shall be deluged with even more and even grander plans.

Wednesday, January 31, 2007

The "Davos Dilemma"

Can the divide between the world's political and economic forces be bridged? Martin Wolf has some possibilities:

A divided world of economic success and political turmoil, by Martin Wolf, Commentary, Financial Times: The world's economy is in excellent shape, but its politics is disturbing. ..-. The question is whether and how this divergence might end. ...

One possible outcome might be the exact opposite of conventional wisdom: economic disappointment and political stability. ... Today, the underpricing of risk and the combination of low interest rates with fast growth almost invite economic blunders. Meanwhile, the world's political leaders, aware of the risks of conflict and reliant on their people's prosperity for retaining power, may well continue to muddle through. This surprising outcome is quite possible.

A second alternative is that the economic and political tracks would continue in their separate directions. The reason for this would be that, far from being distinct, the contrasting economics and politics are two faces of just one globalising world. ...

The fact that economics is making our world more interdependent and connected, while politics remains national or local, makes the contrast between economics and politics inevitable. ...

It is plausible, therefore, that political disarray and economic success will continue in tandem, the challenge being to avoid the emergence of too wide a gap between the two. For, as we learned in the first half of the 20th century, a big enough backlash is capable of causing devastation. In a nuclear age, that devastation would be greater still. ...

A third possibility is that the politics overwhelms the economics, as it did between 1914 and 1945 and in the communist "second world" and much of the so-called "third world" for much longer. An attack on Iran - a much-discussed possibility in Davos - would bring far closer the clash of civilisations... feared by so many... In that case, the economic optimism of today would prove unfounded - possibly destroyed by a world of $150-a-barrel oil in the aftermath of the closing of the straits of Hormuz through which so much of the world's oil flows.

Yet there is also a far more comforting possibility: the economics overwhelms the politics. One of the stories of our era is the way in which vast countries such as China and India are orienting their politics around the goal of prosperity. This forces them to seek domestic and global stability and accept international openness and mutual dependence. They see no benefit in international conflict. It is surely possible that this view of national priorities will take hold in more of the world, including the Middle East. ...

In such a world, the issues discussed in Davos - climate change, the Doha round and African development - might be handled successfully. The difficulties of collective action are profound. But ..., the less credible are unilateral approaches to a resolution, the more likely are co-operative ones.

This year's "Davos dilemma" - the contrast between the world's favourable economics and troublesome politics - is clear enough. But its resolution is not. A range of possible outcomes, from the perverse and catastrophic to the uncomfortable and even benign, is conceivable. The outcome is not inevitable. We can choose. ...

Tuesday, January 30, 2007

FRB Dallas: Does Foreign Direct Investment Help Emerging Economies?

This Economic Letter from Anil Kumar of the Dallas Fed asks whether FDI helps developing countries grow. With a bit of qualification, the author finds the answer is yes:

Does Foreign Direct Investment Help Emerging Economies?, by Anil Kumar, Economic Letter, FRB Dallas: The gap between the world’s rich and poor countries largely comes down to the financial and physical assets that create wealth. Developed economies possess more of this capital than developing ones, and what they have usually incorporates more advanced technologies. The implication is clear: A key aspect of economic advancement lies in poorer nations’ capacity to acquire more capital and scale the technological ladder. Emerging economies undertake some capital formation on their own, but in this era of globalization, they increasingly rely on foreign capital.

Indeed, total capital flows to developing economies have skyrocketed from $104 billion in 1980 to $472 billion in 2005.[1] The foreign capital has the potential to deliver enormous benefits to developing nations. Besides helping bridge the gap between savings and investment in capital-scarce economies, capital often brings with it modern technology and encourages development of more mature financial sectors. Capital flows have proven effective in promoting growth and productivity in countries that have enough skilled workers and infrastructure. Some economists believe capital flows also help discipline governments’ macroeconomic policies (see box titled “Does Financial Globalization Shape Fiscal Policy?”).

Capital flows come in three primary forms:

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Hal Varian's Answer to Larry Summers

Hal Varian, in response to Larry Summers' column on the steps that must be taken "If America is to maintain its leadership in life sciences," emails:

My answer to Larry Summers: What Goes Abroad Usually Comes Back, With Benefits

Econ 1 trade theory says: invest in those areas in which you have a comparative advantage. I think that you can make the case that we have a comparative advantage in this area [biotech], but of course, the argument should be made.

Here’s the column:

What Goes Abroad Usually Comes Back, With Benefits, by Hal Varian, Commentary, NY Times, March 11, 2004: The Jan. 31 issue of The Economist described the consequences of high-tech jobs moving overseas.

According to the story, "with the trans-Atlantic shift in R&D goes many high-value jobs, as well as a greater share of the industry's profits." This trend has led to an "increasing concern" in the industry, with some executives speaking out against the outsourcing trend.

Old news, you might say. The press is filled with articles about high-tech jobs being outsourced to India.

The twist here is that the article is about biotech research jobs being outsourced to the United States from Europe. But the language is eerily familiar: replace "biotech" with "infotech" and switch the roles of Europe and America and this story could pass for yet another Silicon Valley requiem.

Articles like this should remind us that trade is a two-way street.

The money paid to foreign producers, whether businesses or workers, typically comes back home to buy domestic goods and services, thereby generating domestic employment. That is true whether it is European companies paying American biotech researchers, or American companies paying Indian programmers.

Think about it. If Oracle sends $10,000 abroad to pay an Indian programmer, then that money either finds its way back to the United States or it doesn't. If it comes back, it can be used to buy American goods and services, employing American workers. If it doesn't come back then it's even better from the viewpoint of the country: we've sent them paper, while they've sent us valuable goods and services.

Yes, these days it's more likely bits than paper, and maybe they are sending us more services than goods. And perhaps the way the money comes back is via a purchase of Treasury bonds or other financial securities.

But the same principle applies. If the income from the Treasury bonds is used to buy something produced in the United States, it creates jobs. If the money is never spent in the United States, we've gotten something for nothing.

The political problem with trade is simply this: when the dollars flow offshore, it is easy to identify those who are hurt. But when the dollars flow back, it is much more difficult to discern the beneficiaries.

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Saturday, January 27, 2007

A Smaller Share of Larger World Markets

Daniel Gross says that as the rest of the world develops we shouldn't be surprised - or alarmed - that the U.S. is losing market share in financial services and other industries. Because it's a natural consequence of global development, there is no need to relax the regulation of financial markets to preserve competitiveness as some are advocating:

The U.S. Is Losing Market Share. So What?, by Daniel Gross, Economic View, NY Times: Last week, Mayor Michael R. Bloomberg and Senator Charles E. Schumer released a report that warned of New York’s decline as a global financial capital. ...[T]he report, by the consulting firm McKinsey & Company, suggested solutions as diverse as easing regulation on publicly held companies and changing visa requirements so investment banks can more easily recruit foreign math whizzes.

But the report, which focused on domestic issues like securities regulation, overlooked a major economic trend. The United States is losing market share in the global economy, and that is not necessarily a bad thing. ...

For much of the 20th century, China, India and Russia did not participate in the global economic system. As they modernize..., they will grow more rapidly than established economies. ...

Economists note that the United States continues to play an anchoring, even dominant, role in global financial services... In this sphere, the United States is losing out more to European capitals than to Shanghai — and for reasons that have less to do with regulation and more to do with geography and geopolitics.

The euro zone has expanded in recent years to include more countries, thus increasing the appeal of the currency. ... Meanwhile, the capital that the United States exports to China, Russia, India and the Persian Gulf is increasingly being used to develop local financial markets. “It’s not entirely surprising that a certain share of financial activity is migrating to foreign geographical locations where savings growth is taking place,” Mr. Setser said.

Add it up, and the United States, while still the world’s largest single economic power, is clearly no longer the sole superpower. ... Ultimately, the decline of economic pre-eminence may be more damaging psychologically than economically. ...

More broadly, the fact that economies that were closed to outside investment a generation ago are now creating systems of market capitalism should be seen as a victory for the United States, not a defeat. “Many of the countries that are doing well are mimicking the best of what America has stood for — globalization and the export of the American capital markets culture,” said Mr. O’Neill at Goldman Sachs. “There’s nothing that New York and U.S. policies can do about it unless they want to roll back globalization.”

Wednesday, January 24, 2007

Why Globalization is Opposed

Deepak Lal of UCLA gives his theory of why globalization is opposed by the cultural nationalists in the third world and the New Dirigistes in the West:

Why globalising capitalism is hated, by Deepak Lal, Commentary, Financial Times (free): Globalising capitalism is opposed by two major groups - the cultural nationalists in the third world, who fear the westernisation it may bring and the New Dirigistes, proponents of the “third way’” in the West who bear the ancient hatred of capitalism on their sleeves. Why this continuing hatred of, and guilt about, a system which promises unprecedented global prosperity? ...

Whilst ... maverick capitalists existed in all the ancient agrarian Eurasian civilisations, it was only in one that they came to be given their head, ... eventually becoming socially and politically acceptable. This marked the emergence of capitalism as an economic institution which led to the great divergence between the West and the Rest.

My contention ... is that the Great Divergence resulted from a legal revolution in the 11th century instigated by Pope Gregory VII who, in 1075, put the Church above the State and, through the resulting Church-State, created the whole legal and administrative infrastructure required by a full-fledged market economy. ... The 11th century Papal revolution, by creating the church-state, provided a legal bulwark and administrative system whose reach, unlike most of the political states, covered the whole of Western Christendom. It allowed the novelty seeking and risk-taking capitalists to pursue securely their enterprise over a larger space and with myriads of strangers, thus initiating the economic system which has changed the world.

This Papal revolution which changed the West’s ‘material’ beliefs was preceded and precipitated by an earlier 6th century revolution of Pope Gregory the Great which changed the West’s ‘cosmological’ beliefs ( on ‘how one should live’) from the communalism common throughout Eurasia to individualism, particularly in the domestic domain concerning sex and marriage. By promoting marriages based on the universal but ephemeral emotion of love, it went against the common Eurasian pattern of arranged marriages, which eschewed a fickle emotion’s threat to the families needed for settled agriculture. To counter the threat unleashed by individualism..., the Christian Church created a fierce guilt culture which provided its moral moorings, until the Darwinian and Freudian revolutions destroyed its bases of God and Guilt.

These twin Papal revolutions have cast a long shadow. Though temporally conjoined, the change in ‘cosmological’ beliefs promoting individualism is not necessary for the change in ‘material’ beliefs promoting capitalism. It is the latter that globalisation is spreading through the world...

The capitalism thereby promoted has been under attack since the romantic revolt against the enlightenment and its ‘disenchantment of the world’. The arguments have been mainly moral and aesthetic. For both the cultural nationalists and the New Dirigistes, globalisation is seen as a Faustian pact where prosperity is bought at the cost of losing one’s soul. However, unlike their 19th century predecessors, the New Dirigistes can no longer appeal to a socialist utopia to provide a middle way between the creative destruction of capitalism and the settled unchanging way of life in attune with Nature of their agrarian past. They now seek to humanise capitalism through regulation and social and moral paternalism. The demoralisation of societies perceived as accompanying the rise of globalising capitalism has been wrongly attributed to the instrument of their prosperity, capitalism, rather than the growing moral vacuum in the West, which they themselves have promoted, and which has destroyed the West’s traditional and conventional moral moorings.

The moral cement of non-monotheistic Eurasian societies was provided by conventions and traditions transmitted to the young through the moral emotions of shame and guilt. ... The West’s current ‘cosmological’ beliefs ... are incoherent - a mish mash of Enlightenment ideals of individual self-realisation, standards of competitive success in an acquisitive society, and a residual of Christian belief in transcendental salvation.

It is the global transfer of this demoralisation of the West, particularly in the domestic domain, that the cultural nationalists most fear. Eurasia’s wounded civilisations had three responses to the Western imperial impact. The first, like the Japanese, was to accept the material beliefs of the West, whilst keeping their cosmological beliefs. The second, embodied by Gandhi and the current Islamists, was to eschew modernisation as it would lead to westernisation. The third, and most common, was to find a middle way between tradition and modernity though some form of socialism - the extreme Enlightenment version followed by Stalinist Russia and Maoist China, or the gentler Fabian version...

The failure of this path has at last led the two largest Eurasian civilisations, India and China, to follow the Japanese path by recognising that globalising capitalism offers them the means for prosperity without losing their souls. So, it is in the lands where Islamists hold sway and among the New Dirigistes of the West, that hatred of globalising capitalism still remains for essentially atavistic reasons.

Comments so far are not favorable:

tom s.: He lost me at the first two sentences. ...Why would I give any time to someone who starts off saying that the issue is my fear and hate? ... If he was interested in addressing me he would not start off in such an insulting manner; therefore he is not addressing me; therefore I will not read the rest of what he has to say.

nanni: I beg to differ. Among my people, globalisation has negative connotations because it takes away power from the individuals. As a consequences, the communality of daily life has become more and more frustrating and aggressive. ...

dissent: I've noticed that rightwing ideologues often argue against their ideological opponents by ... imagin[ing] the feeling their opponents must, in their view, have, then deride them for it. Often no one has that feeling, it is a strawman argument...

save_the_rustbelt: This guy is really impressed with himself, and gee whiz, he can use a lot of big words. In non-academic terms, he is a pompous windbag.

dale: this is a level of analysis surpassed over 150 years ago. are there still folks who do not see that modernity, in both its cultural form and its economic form is highly ambivalent?

String Quintet in C major: What a load of pretentious, loaded bollocks. The whole thing is ripe for fisking, but one can´t be bothered. ...

Ninjaplease: "Why this continuing hatred of, and guilt about, a system which promises unprecedented global prosperity? ..." Hahahahahhaha! Ah yes, please parade out some more promises. Do you remember the promises, promises... I Doooooo ...

evagrius: I'm curious about the Papal references. While I think the changes resulting from Gregory VII actions resulted in a more "unified" Western Europe by establishing better distinctions between Church and State, I'm not so sure Gregory the Great, who was a monk, had any role in establishing what is now known as "romantic love". From what I remember, "romantic love" came about much later, around the 11-1200's with the troubadors, influenced by Moslem love poetry and music originating from the Indian/Persian area. As for Gregory VII, he might have strenghtened the Church in its struggle against the numerous number of nobility who wanted more power and domination but I don't think that he was the main reason for the establishment of a more universal "market". I would rather put that to the growing influence of cities and the establishment of universities which created a cosmopolitan class of wandering scholars, poets, etc; who, speaking a universal tongue, Latin, were able to travel and communicate over great distances. In any case, neither action by the Popes in question, destroyed the "cosmological beliefs" of the societies they lived in. Those beliefs were destroyed quite a while later. Given all that, the gist of his argument is rather weak. He does not show why material prosperity, ( which as recent events are showing comes at the great price of environmental destruction, pollution, etc; as well as social disruption and loss of human cultures and societies), is any great boon to those who are still, more or less, living in what could be called traditional societies. I'm curious as to his own relation with the culture he seems to be from. Given his name, I take it that he is from India. I wonder what his relations are with the cultures, traditions and beliefs of India.

yan: Another attempt to revive European exceptionalism as explanation for the Industrial Revolution, this time in the form of some rather tangential papal reforms and their impacts on the mentalities in the West. I'm more inclined to give credence to Weber's Protestant ethic than to this fanciful fabrication, although neither is really a historically rigorous explanation.

It is particularly interesting that "Great Divergence" is capitalized in an attempt to engage with the ongoing academic dialogue on the subject. While I don't agree with the full explanations that Pomeranz advances for the Great Divergence, he is extremely convincing on two fronts. First, every major theory of European exceptionalism that has been proposed in the course of the last 150 years is refuted by a presentation of very detailed comparative evidence. Second, he demonstrates that access to coal was simply a matter of good fortune and coal was a sine qua non for industrialization.

(For those not up to date on the latest in economic history the book I am referring to and the one the above author is obliquely criticizing is Kenneth Pomeranz's The Great Divergence: China, Europe and the Making of the Modern World Economy.)

Monday, January 22, 2007

Has the World Decoupled from the U.S.?

Is the rest of  the world heavily dependent on the fate of the U.S. economy, or can other countries, for the most part, withstand a housing led slowdown in the U.S.?:

The Global Question: Who Needs the U.S.?, by Peter Gumbel, Time: ...Nicole Leibinger-Kammüller ..., chief executive of Trumpf, a family-owned machine-tool firm in Germany, has watched orders from the critical U.S. market slow significantly in the past few months. But while the housing-bled U.S. economy has been sluggish, and the dollar weak, it's all proving quite manageable. "We can feel the U.S. slowdown, but it's not unsettling. There's no crash," Leibinger-Kammüller says. Trumpf's sales of its metal-cutting machines elsewhere--to Saudi Arabia, to Singapore and especially in Germany--continue to rack up double-digit growth rates. ...

Economists and policymakers ... have been furiously debating whether the world has "decoupled" from the U.S. economy. The U.S. constitutes about 28% of global gross domestic product (GDP) as measured in dollars, and it accounted for one-fifth of worldwide growth from 2000 to 2006. When the U.S. faltered in the past, the rest of the world staggered. And certainly there are signs of fatigue. A cooling housing market slowed U.S. GDP growth to 2% in the third quarter...

Jim O'Neill, London-based head of global economic research for Goldman Sachs, says that even if the U.S. economy remains soft for much of the year, "we're pretty confident that the rest of the world will withstand it." ... At the German Engineering Federation in Frankfurt, chief economist Ralph Wiechers concurs. "It used to be that the U.S. economy supported the world economy," he says. "Now it's the other way around." ...

Still, even the biggest optimists concede that nobody would escape unscathed if the U.S. economy were to hit a wall. Its big local trading partners, Mexico and Canada, would probably be hurt the most, but the reverberations would be felt worldwide. The key bone of contention is the extent of the suffering.

Those who dispute the decoupling theory point to the seemingly insatiable appetite of American consumers for imported goods, which has been a critical driver of the world's economic expansion. ...

Stephen Roach ... has long warned about the dangers of flagging U.S. demand. Now he's concerned too about signs he sees of a possible Chinese slowdown--one reason why he thinks global growth this year will be "significantly below what most are expecting."

So will it be a "happy slowdown," as Goldman's O'Neill predicts, or a meltdown? You can have your own debate; in the meantime, here are some of the key issues:

THE U.S.: GO YANKEES What economists are struggling to predict is how pervasive the impact of this housing slowdown will be on the rest of the U.S. economy, and abroad. Perhaps most surprising, American consumers are continuing to spend...

ASIA: SPENDERS WANTED Purchases by Asia's rising middle class have made the region far less dependent on exports to the U.S. to power the economy. Today only 16.5% of Asia's exports are sold in the U.S., down from 25.5% in 1993. Yet there are significant regional differences. ...

EUROPE: HOLD ON It's the euro that has so far borne the brunt of the dollar's decline: it rose about 10% last year against the greenback. A stronger currency makes European exports more expensive for foreign buyers. But that hasn't prevented Germany from notching up its biggest trade surplus since the fall of the Berlin Wall 16 years ago. The good news is that buoyant exports have boosted business confidence in Europe's biggest economy and led to an unexpectedly strong increase in domestic demand...

Can Germany take the load off the U.S. and the rest of Europe? Growth in the 13 nations that have adopted the euro is expected to be 2.6% in 2006, unusually strong for the growth-challenged Continent... "Europe is going to have a great year," reckons Harvard professor Kenneth Rogoff, former chief economist at the International Monetary Fund...

Sunday, January 21, 2007

Does Financial Liberalization Help Developing Countries?

This commentary by Gerard Baker makes the claim that developing countries that allowed the most financial liberalization have seen the best economic performance in terms of moderation in the variability of inflation and output:

It is the liberation of markets and the opening-up of choice that lie at the root of the transformation. The deregulation of financial markets over the Anglo-Saxon world in the 1980s had a damping effect on the fluctuations of the business cycle. These changes gave consumers a vast range of financial instruments (credit cards, home equity loans) that enabled them to match their spending with changes in their incomes over long periods. ... The economies that took the most aggressive measures to free their markets reaped the biggest rewards.

I noted that the evidence for this claim that financial liberalization stabilized developing economics is scant (e.g. below it states "Nor, on balance, has liberalization of capital flows stabilized consumption") and there remains quite a bit of uncertainty and ongoing research on the source of the Great Moderation.

This Project Syndicate piece by Dani Rodrik of Harvard continues the discussion on whether financial liberalization is a key factor in generating higher growth and stability for developing countries. He argues that there is little evidence that financial liberalization is beneficial:

The False Promise of Financial Liberalization, by Dani Rodrik, Project Syndicate: Something is amiss in the world of finance. The problem is not another financial meltdown in an emerging market, with the predictable contagion that engulfs neighboring countries. Even the most exposed countries handled the last round of financial shocks, in May and June 2006, relatively comfortably. Instead, the problem ... is ... that relatively calm times have helped reveal: the predicted benefits of financial globalization are nowhere to be seen.

Financial globalization is a recent phenomenon. One could trace its beginnings to the 1970’s, when recycled petrodollars fueled large capital inflows to developing nations. But it was only around 1990 that most emerging markets threw caution to the wind and removed controls on private portfolio and bank flows. Private capital flows have exploded since, dwarfing trade in goods and services. So the world has experienced true financial globalization only for 15 years or so.

Freeing up capital flows had an inexorable logic – or so it seemed. Developing nations, the argument went, have plenty of investment opportunities, but are short of savings. Foreign capital inflows would allow them to draw on the savings of rich countries, increase their investment rates, and stimulate growth. In addition, financial globalization would allow poor nations to smooth out the boom-and-bust cycles associated with temporary terms-of-trade shocks and other bouts of bad luck. Finally, exposure to the discipline of financial markets would make it harder for profligate governments to misbehave.

But things have not worked out according to plan. Research at the IMF, of all places, as well as by independent scholars documents a number of puzzles and paradoxes. For example, it is difficult to find evidence that countries that freed up capital flows have experienced sustained economic growth as a result. In fact, many emerging markets experienced declines in investment rates. Nor, on balance, has liberalization of capital flows stabilized consumption.

Most intriguingly, the countries that have done the best in recent years are those that relied the least on foreign financing. China ... has a huge current-account surplus, which means that it is a net lender.... Among other high-growth countries, Vietnam’s current account is essentially balanced, and India has only a small deficit. Latin America, Argentina and Brazil have been running comfortable external surpluses recently. In fact, their new-found resilience to capital-market shocks is due in no small part to their becoming net lenders to the rest of the world, after years as net borrowers.

To understand what is going on, we need a different explanation of what keeps investment and growth low in most poor nations. Whereas the standard story – the one that motivated the drive to liberalize capital flows – is that developing countries are saving-constrained, the fact that capital is moving outward rather than inward in the most successful developing countries suggests that the constraint lies elsewhere. Most likely, the real constraint lies on the investment side.

The main problem seems to be the paucity of entrepreneurship and low propensity to invest in plant and equipment ..., especially to raise output of products that can be traded on world markets...

When countries suffer from low investment demand, freeing up capital inflows does not do much good. What businesses in these countries need is not necessarily more finance, but the expectation of larger profits for their owners. In fact, capital inflows can make things worse, because they tend to appreciate the domestic currency and make production in export activities less profitable...

Thus, the pattern in emerging market economies that liberalized capital inflows has been lower investment in the modern sectors of the economy, and eventually slower economic growth (once the consumption boom associated with the capital inflows plays out). By contrast, countries like China and India, which avoided a surge of capital inflows, managed to maintain highly competitive domestic currencies, and thereby kept profitability and investment high.

The lesson for countries that have not yet made the leap to financial globalization is clear: beware. Nothing can kill growth more effectively than an uncompetitive currency, and there is no faster route to currency appreciation than a surge in capital inflows.

For those countries that have already made the leap, the choices are more difficult. Managing the exchange rate becomes much more difficult when capital is free to come and go as it pleases. But it is not impossible...

Given all the effort that the world’s “emerging markets” have devoted to shielding themselves from financial volatility, they have reason to ask: where in the world is the upside of financial liberalization? That is a question all of us should consider.

I believe in markets and their ability to coordinate economic activity. But we have to pay attention to the evidence. If the evidence just isn't there that opening markets aids economic growth and stability, then promoting open markets for developing countries based upon the belief that markets are always and everywhere the best solution to problems of economic development and coordination is counterproductive. Such advocacy threatens, when success does not follow more open markets, to undermine support for the free-market institutions the advocates of open markets are generally promoting. A better approach would be to drop the ideological promotion of free markets, accept that markets can fail, and figure out what market failure is leading to the sub-par performance of these policies.

Saturday, January 20, 2007

Helping Displaced Workers

The Economist looks at the winners and losers from globalization and how the losers might be compensated:

In the shadow of prosperity, The Economist (open link): Nestled among the wooded Blue Ridge mountains in Virginia's far south-west, Galax is ... home to ... a huddle of textile and furniture factories. Over the past few years, globalisation has hit hard. Unable to compete with Mexican and then Chinese competition, the town's old industries have withered, taking thousands of jobs with them. Last year ...[t]hree big factories closed their doors... More than 1,000 people, around one-sixth of the town's workforce, lost their jobs.

Galax then acquired an “Economic Crisis Strike Force” for displaced workers... [T]he Strike Force helps people apply for Trade Adjustment Assistance (TAA), the government support America offers to those deemed to have lost their jobs to global competition. TAA includes up to two years of unemployment benefits while retraining, temporary subsidies to help pay medical insurance and, for those over 50, a short-term top-up to any lower-paying new job. The centre also co-ordinates more basic help, from child care to food banks run by private charities.

Thousands of people have walked through its doors in the past nine months, many several times. Around one-third of those laid off last year are being retrained. ... For some, particularly those in their 50s, the future looks bleak. At 59, Paul Rotan sees little chance of finding another job with health insurance, but he is still six years away from qualifying for Medicare... He is terrified of what will happen in June when the temporary public subsidies for his health insurance end.

But other, mainly younger, workers are already better off. After 19 years in a textile factory, Bobby Edwards has retrained as a radiologist. ... Few of these people are enthusiastic about globalisation. “No one trusts China around here,” is a common refrain. But government help has cushioned the shock. “I'd be lost if they weren't here,” says Mr Rotan, nodding towards the centre's staff.

In the neat world of economics text-books the downside of globalisation looks much like Galax. Low-skilled workers in a rich country, such as America, suffer when trade expands with a poorer country with plenty of much cheaper low-skilled workers, such as China

If labour markets are efficient in the rich country the displaced workers should find new jobs, but their wages will probably fall. Although the country overall gains handsomely, these people are often worse off. Hence the case for redistributing some of trade's gains and compensating the low-skilled losers. ...

One study suggests that, during the 1980s-90s, 65% of manufacturing workers in America who lost their jobs to freer trade were employed two years later, but most took a pay cut. A quarter suffered pay losses of more than 30%. ...

How much to spend? Nonetheless, help for displaced workers has always been modest compared with the gains from trade. ... The United States spends around $1 billion a year on helping trade-displaced workers. But the economy overall, by one estimate, gains $1 trillion a year from freer trade. ...

Public scepticism about trade is rising in both rich countries and poor. A host of big economic shifts, such as rising income inequality, are blamed on global integration. ... America's elections last November brought in a clutch of lawmakers deeply opposed to freer trade. To control this backlash, globalisation's champions are keen to appear more sensitive to the losers.

Already, some shifts are evident. One of the first bills introduced in the Democrat-controlled Senate is a big expansion of TAA, covering not merely manufacturing workers but also service workers whose jobs have been “offshored”, and offering help not just to individual factories, but to whole industries. ... The fate of the current bill is uncertain, but the Democrats have stressed that their support for future trade agreements depends on more help for workers who lose out. ...

But cause and effect may not be so obvious. ... To judge by the number of people receiving TAA, the [displacement is low]...: fewer than 120,000 workers were deemed eligible for it in 2005. In the much bigger services sector, the share is lower still. For all the hoopla about offshoring, the best estimates suggest that only about 1m American service-sector jobs have actually moved overseas. In short, trade's role in job losses is much smaller than the public angst suggests.

Most economists have long held that technology, rather than globalisation, is the main cause of the rising gap between the pay of the high- and low-skilled. But some argue that the distinctions between trade and technology are increasingly irrelevant. ... (see article).

In the 21st century competition between firms and industries, ... is becoming less important than competition between individual tasks within firms in different countries. Whether he is employed in a furniture company or a hospital, the American data-processor will be competing against someone from Bangalore. Rather than affecting entire industries, or whole factories, global competition will affect individual jobs—skilled as much as unskilled.

Such a shift helps explain the popular nervousness about globalisation. Many more workers are worried that their jobs will be at risk. That, in turn, increases the political appeal of assisting trade's losers. ...

An alluring Danish model As a result, it may be better to focus on policies which improve job prospects for all workers. In Europe, Denmark has led the way. The Danish system of “flexicurity” appears to offer the best of both worlds: dynamic labour markets and low unemployment coupled with generous support for those who lose their jobs. ...

Employers hire and dismiss people at will. Around a quarter of the workforce is unemployed at some point in any year. But the jobless enjoy generous welfare benefits while they look for work, around 80% of their previous wage on average. To ensure this does not deter people from finding new jobs, the Danes oblige the unemployed to be trained and to look diligently for work. ...

But Denmark's approach has evolved over decades and cannot easily be copied. Besides, it is extremely expensive. ... Denmark ... spends more than 5% of GDP on the unemployed, including almost 2% of GDP on its “active” training and job-search programmes. ...

For America, which currently spends a mere 0.16% of GDP on such “active” labour-market policies, the idea of Danish-style “flexicurity” is more a slogan than a serious suggestion. ...

An alternative approach is to give displaced workers a subsidy if they are forced into a lower-paying job. Such “wage insurance” already exists in a modest form on both sides of the Atlantic. ... Since 2002 America's TAA has offered wage insurance to any trade-displaced worker over 50: the government pays half the difference between the old and new wage for two years, up to a maximum of $10,000.

Getting other things right These experiments are too new to evaluate. But in theory wage insurance is appealing. It helps soothe workers' fears that they will suddenly lose income, but also keeps labour markets flexible by encouraging people to find a new job quickly. Many on America's centre-left see it as the key to maintaining political support for trade.

The proposed expansion of TAA would make any trade-displaced worker over 40 eligible for wage insurance. And more ideas are floating around Washington's think-tanks. ...

As public fears of globalisation rise, so will the political appeal of these schemes. But they will have less impact than getting other, more basic, policies right. Globalisation underscores the need for a flexible, dynamic labour market and a well-educated, adaptable workforce. And a worker whose health care is not tied to his job will be less worried about trade than one for whom job loss also spells the loss of medical insurance. The tasks of ... reforming health care ... and improving education ... are far more important than any amount of experimentation with wage insurance or retraining schemes. If politicians really want to respond to the worries caused by globalisation, those are still the best places to start.

In an earlier section, after explaining how an older worker relies heavily on the TAA program, and how a younger worker benefited from retraining ("government help has cushioned the shock"), the article turns to economic theory and concludes: "Although the country overall gains handsomely, [displaced workers] are often worse off. Hence the case for redistributing some of trade's gains and compensating the ... losers." Thus, the article cites both theory and evidence in favor of programs that help displaced workers.

In addition, the article finds further support for the wage insurance component of TAA because it can help with labor market flexibility. The first paragraph of the last section says "wage insurance is appealing. It ... keeps labour markets flexible..." The third paragraph says "Globalisation underscores the need for a flexible ... labour market..." The conclusion? "The tasks of ... reforming health care ... and improving education ... are far more important than any amount of experimentation with wage insurance." Thus, wage insurance is appealing, it's needed, and that leads to the conclusion that it's not very important. I can't explain why the article spends so much time building a strong case for helping displaced workers, then is dismissive of programs that do just that in the final paragraph.

One final point, there is no need to distinguish between workers displaced by technology and those displaced by globalization when talking about which workers deserve help. But both are a form of structural change and cause workers to be hurt for reasons that have nothing to do with their own abilities and effort, they are just unlucky enough to be employed in the wrong industry, and wage insurance and other programs should apply in either case.

Monday, January 15, 2007

An Interview with Joseph Stiglitz

Here are parts of an interview with Joseph Stiglitz from AlterNet:

Globalization Has Increased the Wealth Gap, by Terrence McNally, AlterNet: ...

You write, "...Economists believe incentives matter. There are strong incentives -- and enormous opportunities -- to shape political processes and the economic system in ways that generate profits for some at the expense of the many." Not news to a lot of us, but can you say a few words about that?

JS: ...[E]conomic globalization has outpaced political globalization. Because we are more interdependent, there's a greater need to take collective action and work together. But our political institutions and our mindsets have not really kept pace. We do have certain international political institutions, but they are very removed from democratic processes.

The World Trade Organization and the like --?

JS: Exactly. There's been a heavy engagement in these institutions by the multinational corporations who know how to shape the policies in ways that benefit themselves.

The WTO was basically created by them, wasn't it?

JS: Not really. The idea that you would have a rule of law in international trade is a very old idea, and actually ...

-- not the notion perhaps, but it's always seemed to me that the system of secret tribunals, for instance, in which a corporation is basically able to take a government to court, was set up to serve the multinationals.

JS: Very much so. But I want to point out that this is not inherent in globalization. The idea that a rule of law would govern international trade relations is a very important idea that many idealists thought was good. Back in the '20s one of the factors that contributed to the Great Recession was a series of trade wars, and one of the ideas behind the establishment of the WTO was to try to prevent that from ever happening again.

But you're exactly right; the agenda got seized. ...

Continue reading "An Interview with Joseph Stiglitz" »

Sunday, January 14, 2007

The Split over Trade Is Not Confined to Democrats

There has been attempt after attempt to portray the trade issue as an area where Democrats are deeply divided, and there has been much written about how Democrats will stifle trade and hurt the economy now that they are in power.

But the split is not unique to Democrats. As with immigration, Republicans are no less divided on this issue. First, the article about Democrats:

The Coming Democratic War on Free Trade, by Steve Chapman, Real Clear Politics: It's an elementary axiom of economics that if Person A sells something to Person B, it's good for each of them. Otherwise, why would they bother? It should follow that if Country A sells something to Country B, both again benefit. But Democrats have turned against that basic insight. They think if Americans buy something from abroad, it makes us worse off, and they want to protect us from such folly.

"Free," when modifying "trade," is a four-letter word on the left. Bill Clinton favored breaking down barriers to international commerce, but the idea has lost favor in the Democratic party... The American Prospect, a liberal magazine, reports with glee that "every single newly elected Democratic senator is a critic of free-trade orthodoxy."

Among the most vocal critics of open commerce is Sen. Sherrod Brown of Ohio, who ... vows not to vote for any agreement that doesn't impose strong labor and environmental standards on our trading partners. Brown reflects the views of labor unions... Demanding the imposition of American-style labor and environmental standards on poor nations is merely a ruse for rejecting trade liberalization altogether. ... Likewise with environmental rules. ...

Trade opponents retort that the job growth has been a hollow victory, because the rich are getting richer and everyone else is getting poorer. But the facts indicate otherwise. As economist Alan Reynolds notes in a new study for the Cato Institute..., the Census Bureau calculates that ... income has risen just as fast among the bottom 40 percent of households as it has among the top 40 percent. ...

Brown and others cling to the superstition that we can get rich by sealing ourselves off from the world and paying each other high prices for products made entirely in the U.S. of A. If they manage to erect new barriers to trade, we'll learn once again that protectionism is nothing but fool's gold.

Saying that '"Free," when modifying "trade," is a four-letter word on the left' is a misrepresentation. It's a misrepresentation because the same division appears on both sides of the political aisle, and because many Democrats favor free trade. More on this in a moment, but this is not the only argument the author makes that is misleading. For example, the author cites The American Prospect as gleeful that "every single newly elected Democratic senator is a critic of free-trade orthodoxy." But here's Robert Reich writing in American Prospect, and there are many more examples like this:

Continue reading "The Split over Trade Is Not Confined to Democrats" »

Tuesday, January 09, 2007

Is the High Rate of Worldwide Economic Growth Sustainable?

Martin Wolf discusses the sustainability of high rates of economic growth in both developed and developing countries:

Globalisation’s future is the big long-term question, by Martin Wolf, Commentary, Financial Times: ... Let us ask ... a ... question: how strong and sustainable is the underlying dynamic of the world economy? As Lawrence Summers noted in his most recent column ..., the world economy in aggregate grew more during the past five years than in any five-year period since the second world war. Growth is not merely strong. It is also widely shared. In 2006, ... the economies of the high-income countries probably grew by 3.1 per cent,... Meanwhile, the economies of the developing countries ... expanded by 7.0 per cent, after 6.6 per cent in 2005 and 7.2 per cent in 2004.

This performance has occurred in spite of significant economic and political shocks: the collapse of the stock market bubble in 2000, the terrorist attacks of September 11 2001, wars in Afghanistan and Iraq, the continued uncertainty about future large-scale terrorism, the jump in oil prices, protectionist rhetoric in a number of high-income economies and a breakdown in the Doha round of multilateral trade talks. ...

[T]he underlying engine of the world economy is immensely powerful. ... Today’s world economy is being driven by four closely interconnected forces: technological innovation...; entry into the world economy of the vast majority of human beings ...; the “catch-up” process in these economies; and the integration of global markets in goods, services and capital that we call globalisation...

To these forces should be added the background condition of monetary stability. ... The implication of this perspective is that any slowdown – or “mid-cycle correction” – will be short-term and shallow. Not only would the underlying dynamic remain but such a slowdown would trigger offsetting forces, including more relaxed monetary policies and, in all probability, lower oil prices, as well.

Unfortunately, there is an alternative perspective. It is that much of the world suffers from a huge surplus of savings over investment. ... The effort at absorbing this surplus has had two closely interconnected consequences: the first has been the emergence of the so-called “global imbalances” in which the US has absorbed about three-quarters of the excess savings of the rest of the world; the second has been a long period of relaxed monetary policy, particularly in Japan and the eurozone, but also for some time in the US as well. This, it is argued, has had powerful effects on asset prices, particularly house prices in a number of high-income countries. Strong house prices have, in turn, sustained demand at high levels...

The more persuasive is this “liquidity” story, the more plausible it becomes that the correction is going to be more painful than conventional wisdom believes. ... How then does one assess prospects? Provided the broad story of economic dynamism remains credible, the world economy will probably overcome temporary difficulties...

So how plausible is maintenance of the underlying dynamic? For economic policy, this raises two big questions: the first is whether inflation will be contained; the second is whether globalisation will be sustained. On the former, there is no reason to forget what we have so painfully learned. On the latter, however, there is greater uncertainty.

One reason for this is that even a relatively mild slowdown might shift policy in high-income countries, especially in the US, in a much more protectionist direction. The widespread perception that the majority of the population has not been gaining from recent growth makes that outcome more likely... An open economy will become unsustainable if a majority concludes it is against its interests.

Even more important are the fragile political underpinnings of global economic integration: the US is on the verge of what may ultimately prove the most significant defeat in its history; an attack on Iran looks possible; and North Korea has become a nuclear power. Above all, we live in a world marked by shifting relative power and religious and political turmoil in much of the Islamic world.

The big question then is not whether there will be some correction – even, at worst, a US recession... The world economy should be able to survive such a jolt, provided its underlying dynamism remains in place. What matters far more is the future of economic globalisation. On that we can hope, but cannot be confident. Its viability will depend on wise leadership – a commodity, as usual, in frighteningly small supply.

Saturday, January 06, 2007

China and the Trade Deficit

Yesterday Michael Spence, the 2001 Nobel laureate in economics, a senior fellow at the Hoover Institution, and a professor emeritus at Stanford University discussed out trade deficit with China. Here's what he had to say followed by the reactions of Brad DeLong and Brad Setser.

First, the editorial:

We Are All in It Together, by Michael Spence, Commentary, WSJ: In 2005, the People's Bank of China ... accumulated $200 billion of additional reserves and is well on its way to holding $1 trillion of reserves... The accumulation ... was the policy action that caused the value of the yuan to remain stable relative to the dollar.

Casual conversation and commentary lead most Americans to think that this accumulation of reserves corresponds to a large trade surplus in China, achieved by holding the value of their currency down. In fact, the Chinese trade surplus is not that large. It is well under 5% of GDP, smaller in percentage terms than the U.S. trade deficit.

The accumulation of reserves in China is not primarily a trade-surplus issue. In 2005, China's trade surplus was $50 billion. Net inbound foreign direct investment was another $50 billion. And then, notwithstanding capital controls, there was an additional, largely unwanted net capital inflow of $100 billion. ...

The combination ... (adding up to $200 billion) would have put strong upward pressure on the value of the currency, risking a sudden and steep loss of competitiveness. To prevent this China bought foreign and largely dollar-denominated assets. ...

China has modest inflation and a reasonable balance between demand and capacity, but is out of external balance. The policy is to maintain internal balance while simultaneously moving toward external balance without losing growth. This involves letting the exchange rate rise but at a measured pace, reducing the excessively high rate of domestic saving and stimulating domestic consumption to take up the slack created by any loss ... in exports. ...

Chinese policy makers understand that holding the exchange rate down and preventing this shifting mix runs the risk of locking the economy into a labor intensive export mode for too long. Letting the currency rise will put the right kind of pressure on the economy to evolve as incomes rise. ...[T]here is a lively internal debate about what the right speed is. ...

The U.S. position on China is politically driven and is partly right and partly incoherent.

Continue reading "China and the Trade Deficit" »

Thursday, January 04, 2007

Globalization, Wages, and Jumping J-Curves

Jagdish Bhagwati of Columbia University defends globalization in this commentary from the Financial Times:

Technology, not globalisation, drives wages down, by Jagdish Bhagwati, Commentary, Financial Times [open link]: We have recently witnessed a flurry of comment in the US on the long-running stagnation of wages. Many believe that the future livelihood of the “middle class” is also at risk.

Lou Dobbs ..., the ... Economic Policy Institute and nearly all the Democrats newly elected to Congress believe that globalisation has much to do with the economic distress of the working and middle classes. Therefore they ... want to lean on the door – even to close it – on trade with poor countries and occasionally on unskilled immigration from them.

Proponents of globalisation ... find themselves in a politically implausible position: they typically ... accept this “distributional” critique of globalisation – yet nonetheless propose that those adversely affected should accept globalisation but be aided...

As it happens, globalisation’s supporters are on firmer ground than they fear. Examine the common arguments linking globalisation to the distributional distress and little survives.

First, all empirical studies, including those done by some of today’s top trade economists (such as Paul Krugman ... and Robert Feenstra ...), show that the adverse effect of trade on wages is not substantial. ...

Second, the same goes for ... studies by the best labour economists regarding the ... influx of unskilled illegal immigrants into the US. The latest study by George Borjas and Larry Katz ... also shows a virtually negligible impact on workers’ wages, once necessary adjustments are made.

Can it be that globalisation has reduced the bargaining ability of workers and thus put a downward pressure on wages? I strongly doubt this. First, the argument is not relevant when employers and workers are in a competitive market and workers must be paid the going wage. As it happens, fewer than 10 per cent of workers in the private sector in the US are now unionised.

Second, if it is claimed that acceleration in globalisation has decimated union membership, that is dubious. The decline in unionisation has been going on for longer than the past two decades of globalisation ...

Has the outflow of direct foreign investment ... contributed to a decline in wages? As I look at the data, the US has received about as much equity investment as it has lost over the past two decades. One cannot just look at one side of the ledger.

The culprit is not globalisation but labour-saving technical change that puts pressure on the wages of the unskilled. Technical change prompts continual economies in the use of unskilled labour. Much empirical argumentation and evidence exists on this. ...

Such technical change is quickly spreading through the system. This naturally creates, in the short-run, pressure on the jobs and wages of the workers being displaced.

But we know from past experience that we usually get a J-curve where, as increased productivity takes hold, it will ... lead to higher wages. So why has there been no such significant effect in the statistics on wages for almost two decades?

I suspect that the answer lies in the intensity of displacement of unskilled labour by information technology-based change and in the fact that this process is continuous now – unlike discrete changes caused by past inventions such as the steam engine. Before the workers get on to the rising part of the J-curve, they run into yet more such technical change, so that the working class gets to go from one declining segment of the J-curve to another.

The pressure on wages becomes relentless, lasting over longer periods than in earlier experience with unskilled labour-saving technical change. But this technical change, which proceeds like a tsunami, has nothing to do with globalisation.

Wednesday, January 03, 2007

The Austrians versus the Neo-Cons on International Trade

We hear a lot about the division among factions in the Democratic Party, the Rubinites and the populists in particular, over issues involving international trade. The implication is that divisions on the right, if they exist at all, are much smaller. But as this shows there is a large divide between the Austrians and the Neo-Cons on this issue:

Yellow Journalism at The Weekly Standard, by By Robert P. Murphy, Ludwig von Mises Institute: Critics of the welfare-warfare state are no fans of the magazine The Weekly Standard. Bill Kristol and its other regular contributors are among the most hawkish of neoconservatives out there. Yet these "right wingers" are also bad on economics too, even though the average person would probably consider them to be laissez-faire.

Of course, there is no real contradiction here: if the federal government (at least with Republicans in control) is good at fixing foreign cultures, then why not use it to improve the economy at home, too?

Today's case study is Irwin Stelzer's recent piece, "Worry About OPEC, Not China." Although international trade can get complicated, especially when fiat currencies are involved, Stelzer manages to pack an impressive amount of nonsense into a fairly short article. I offer this critique to shed some light on these confusing issues.

Continue reading "The Austrians versus the Neo-Cons on International Trade" »

Saturday, December 30, 2006

Exchange Rate Clubs and the Monetary Approach

There is a long comment by Ronald McKinnon on the link between exchange rates and international adjustment at Martin Wolf's blog at the Financial Times. This is a shortened version, just a part of the section at the end -- there's quite a bit more at the (open) link given above:

Exchange Rate Clubs and the Monetary Approach Specialists in exchange rate economics fall into two distinct clubs: A and B. Members of Club A, by far the larger group, have been brought up since they were undergraduates on the elasticities model of the balance of trade. Besides being algebraically tractable, the microeconomics of this model seem intuitively plausible. With nominal export prices 'sticky' in each country’s currency in the short run, the relative price effects of a depreciation in the nominal exchange rate seem to go in the right direction for reducing a trade deficit. The depreciating country’s exports become cheaper in world markets and it sells more, and its imports become more expensive in the domestic currency so it buys less, so the trade balance allegedly improves. Members of Club A focus on this link between the real, i.e., inflation - adjusted, exchange rate and the real trade balance. ...

Continue reading "Exchange Rate Clubs and the Monetary Approach" »

Sunday, December 17, 2006

The Other Side of the Export Coin

Nouriel Roubini dissects Ben Bernanke's recent comment that China's currency policy amounts to an "export subsidy" for Chinese firms and notes it could just as easily be termed an "import subsidy" for the U.S. He also talks about the wisdom of Bernanke raising the issue in the first place:

Is China Subsidizing its Exports or Subsidizing US Imports? By Nouriel Roubini: Is China subsidizing its exports or subsidizing US imports? In his written remarks - but not in his actual speech in Beijing - Bernanke urged China to stop subsidizing its exports via a weak RMB (see also Brad Setser's comments...). He could have as well said that China is subsidizing US imports of Chinese goods, thus keeping Wal-Mart prices and US inflation lower than otherwise. Of course, from an economic point of view subsidizing exports is equivalent to subsidizing imports. But - from a political economy of protectionism perspective - speaking of export subsidies is putting the blame on "unfair" Chinese policies rather than recognizing, as the term "import subsidy" would have conveyed, that this Chinese currency policy is highly beneficial to US consumers and that it is keeping US inflation lower than otherwise.

Also speaking of "export subsidies" in the context of currency policy is loaded and dangerous: export subsidies are illegal within the WTO rules. And arguing that a weak currency is effectively an export "subsidy" could even give legal cover to those in the US who may pursue protectionist legal action against China because of its alleged export "subsidies". This is not an idle threat: when I was at the White House's CEA in the late 1990s we had to fight non-stop bone-headed protectionist proposals by the Dept. of Commerce ... to change US "dumping" rules to include low import prices due to the weakening currency values of some of our trading partners (for example the Asian currencies in crisis). ...

Friday, December 15, 2006

Bernanke: Pegged Renminbi an "Effective Subsidy"

Ben Bernanke stirs up a little controversy by first planning to tell China in a speech that its undervalued currency amounts to an "effective subsidy" for exporters, then softening the language when the speech is actually delivered:

Bernanke backs off from ‘subsidy’ accusation, by Kshrina Guha, Financial Times: Ben Bernanke ... stepped into a political minefield on Friday when he released remarks branding China’s undervalued currency an “effective subsidy” for its exporters which was distorting patterns of production and trade. In what looked to be a last minute bid to avoid controversy, Mr Bernanke then dropped the phrase from his speech to the Chinese Academy of Social sciences, using the less inflammatory term “distortion” instead.

Mr Bernanke’s original text talked about “the effective subsidy that an undervalued currency provides for Chinese firms that focus on exporting rather than producing for the domestic market.” This phrase – even though not finally uttered by the Fed chief – is likely to be seized on by US manufacturers who have long pressed US government agencies to make the same determination in trade cases.

Continue reading "Bernanke: Pegged Renminbi an "Effective Subsidy"" »

Monday, December 11, 2006

Manufacturing Comeback?

The Financial Times says reports of the death of manufacturing in developed countries are greatly exaggerated:

Western industry is learning again to compete, by Peter Marsh, Financial Times (free): If the doomsayers are to be believed, virtually all the world’s production is shifting to low-cost nations such as China, in a process that will make factories in rich countries about as rare as frock-coats and gramophones.

But the reality is different. Certainly, companies have in the past decade relocated a lot of production to countries outside the main developed nations – but western Europe, North America and Japan will this year still account for about three-quarters of world manufacturing output. China’s share is about 9 per cent, albeit substantially higher than the 4 per cent it accounted for a decade ago.

Moreover, an extensive series of interviews by the Financial Times has found top executives of many industrial companies strikingly upbeat about their capability to operate plants economically in in the high-cost countries, often in tandem with other production centres in the lower-cost regions.

It is becoming clear that a wide range of factories in high-wage nations are capitalising on positive factors that offset their larger cost burden. These include the ability to develop products using sophisticated technologies and to produce highly “configured” goods tailored to the needs of local customers. ...

A generally benign economic background – the result of an economic upturn in Europe and Japan along with strong growth in emerging nations such as China and India – has provided a sturdy platform for the strengthening role for manufacturing in the rich countries. “My feeling is that many companies based in the high-cost regions have pretty much reached the limit of what they intend in transferring jobs to China and other emerging economies on the grounds of costs,” says David Hensley, director of global economic co-ordination at JPMorgan, the US investment bank. ...

After a manufacturing recession in 2001, when global factory output fell 2.5 per cent, output increased by an average of 3.6 per cent a year starting in 2002. As part of that, many manufacturers operating in high-wage regions are showing distinct signs of life, though profits for many remain fairly low. ...

[R]ecently, manufacturers have started to explore a middle ground. In steel for example, the rush is on not to acquire production in low-cost developing countries but rather that low-cost producers are struggling to buy high-end plants in Europe and the US that can make specialised, high value-added products...

When the hybrid model works within a single company, linking the two sets of plants is a transfer of know-how in production and design, with the factories in the high-wage nations – the so-called mother plants – capitalising on their higher levels of technology by generally taking the lead in these relationships...

But, illustrating the flexibility of the model, the flow of ideas can also work the other way around, helping the high-cost plants to learn from activities in the low-wage nations. ...

In many instances, companies find the competitive position of their factories in high-wage nations is protected by working in areas of sophisticated technology or design, where the capabilities of rivals in low-cost nations are still some way behind...

Many groups find their high-cost plants to be valuable not just for making products for sale to the final customer. These also sometimes have a role producing high-tech components of use by the companies’ low-cost factories, which operate using lower levels of technology.

With these high-cost plants acting as “feeders” for the low-cost operations, the conventional way in which the hybrid model works – with parts channelled from low- to high-wage nations on the grounds of costs – is reversed. ...

Sunday, December 10, 2006

Summers: Restoring Fairness

Larry Summers tells politicians to listen to their populist mandate and manage it wisely as they search for a way to distribute income more equitably, and he encourages corporations to cooperate. "The place to start," he says, "is by restoring the progressivity of the tax system":

Only fairness will assuage the anxious middle, by Lawrence Summers, Commentary, Financial Times (free): ...Coming from very different parts of the country and very different political perspectives, the new members of Congress have in common that they have all heard from the anxious middle class. They feel under enormous pressure to respond not just to the economic insecurity that middle-class voters feel, but also to voters’ resentment at what they see as disproportionately prospering corporate elites. If the new Congress sees itself as having a mandate for anything in the economic area, it is for policies that “stand up” for ordinary Americans against the threat they perceive from corporate and moneyed interests.

These populist impulses have roots much deeper than campaign rhetoric. In the past, real wages and corporate profitability have moved together... The unique feature of the current expansion is the divergence between the fortunes of capital and the fortunes of labour. While workers normally receive about three-quarters of corporate income, ... the Economic Policy Institute has calculated that, since 2001, labour has received only about one-quarter of the increase ..., as real wages have failed to keep pace with productivity growth. ...

These economic and political trends are and should be of great concern to the business community as well as to policymakers. They have led to populist policy proposals that cut against the grain of the market system by, for example, limiting free trade agreements, restricting outsourcing or limiting the ability of successful companies to expand.

The track record of such populist proposals is dismal. They rarely achieve their objectives and come with huge collateral costs. ... Yet it would not be a sufficient response for business or government simply to explain why populist policies would be counterproductive and to suggest ... a “stay the course” strategy, perhaps with increased attention to the displaced. If the anxious middle’s concerns about fairness are this serious when the unemployment rate is 4.4 per cent, they will be far greater whenever the economy next turns down.

This puts a premium on finding measures that go with ... the market system while also responding to concerns about fairness. The place to start is by restoring the progressivity of the tax system – an area where much can be accomplished before considering changes to the rate structure.

It is neither fair nor efficient to audit disproportionately the tax returns of those in the bottom half of the income distribution at a time when most of the $500bn tax gap comes from those with high incomes. There is no policy justification for allowing the erosion of corporate income tax through pervasive use of corporate tax shelters and manipulation of transfer price rules. Not only does this cost the government revenue, it also puts undue competitive pressure on companies that want to meet obligations to their workers.

Much more can done in a range of areas, from disclosure of executive compensation, to ensuring that the government leverages the volume of its purchases, to making financing of education at every level more equitable, to making sure that businesses continue to take responsibility for their workers’ healthcare costs.

When, as now, concerns become sufficiently serious, those with bad ideas always win out over those with no ideas.

John Kennedy famously challenged Americans: “Ask not what your country can do for you. Ask what you can do for your country.” In the years ahead, this question will be put with increasing force to US corporations. A great deal depends on the vigour with which it is answered.

Saturday, December 09, 2006

Varian: Who Benefits from Increased Productivity?

Hal Varian, from 2003, on the distribution of the gains from technological change and international trade:

Rising productivity is a good thing, right? Tell that to the newly unemployed, by Hal R. Varian, Economic Scene, NY Times: Recently productivity has been growing at a rate of about 4 percent a year. For the country as a whole, this means that each year we can work as much as we did last year and consume 4 percent more; or we can consume as much as we did last year and work 4 percent less.

That's got to be a good thing, right?

Well, it depends on whom you ask. In truth, those productivity gains have resulted in some people's working 100 percent less, with the rest of us consuming 4.01 percent more. If you are one of the unemployed, chances are you are less enthusiastic about the productivity gains than are those who have enjoyed the increased consumption.

Strangely, productivity growth is not getting much blame for the ''jobless recovery.'' Criticizing technological progress is downright un-American. On the other hand, criticizing foreign trade is a traditional pastime here, as in every other country.

To economists, trade and productivity growth have a lot in common: each allows you to produce more with less.

James Ingram's economics text tells the story of how an entrepreneur built a factory that was significantly more productive than his competitors' plants, and was hailed far and wide for his brilliance.

But then his dirty little secret was revealed: all he was doing was importing goods from abroad through the back door.

In terms of impact on employment, trade is usually better than productivity growth; those dollars sent abroad eventually come back to purchase American products, and employ more workers. By contrast, jobs lost to productivity increases stay lost; try to find someone today who can make buggy whips.

Gains from trade or technology initially tend to accrue to owners of capital. When a company fires a computer programmer and shifts the job to India, the company captures the difference in wages.

It wouldn't have to work that way. Suppose the programmer found his doppelgänger in India, and started exporting tasks on his own. ''Dear Sanjay, please write a subroutine to sort these accounts and send it back to me by 5 p.m. (California time).'' Each week the programmer could cash his $1,000 paycheck and send $100 to Sanjay.

This is only a thought experiment, not a policy proposal. But it illustrates the point that the controversy over trade and technology is not about whether or not they are good things -- of course they are -- but about who will capture their benefits and who will bear their costs.

There is little doubt who wins in the long run: consumers. Virtually all the gains in the standard of living in the last two centuries have come from technology. Trade has had a smaller but still significant effect on growth in per capita consumption.

Achieving the gains from technological advances can be tortuous. Back in 1886, when America's railroads standardized on one gauge, it became substantially cheaper to transport goods. A great boon for everyone, right? Well, tell that to the workers who unloaded and loaded freight at the cities where different-gauge railroads met. They rioted over the change, and understandably so -- the benefits from technological progress came at the expense of their jobs.

Eighty years later, the longshoremen's union was more farsighted. It saw new technology coming for unloading ships and negotiated lifetime employment at high wages. The result was that by 2002 a full-time longshoreman earned $80,000 to $107,000, depending on whether you ask the union or management.

The crucial issue in last year's West Coast port strike was not whether technology for managing shipyards would be introduced -- both sides were in favor -- but whether the new information-processing jobs went to union workers.

The longshoremen's union has tried to ensure that a significant part of the gains from productivity increases accrued to its members. But even the longshoremen recognize, though they might be loath to admit it, that there has to be something for both sides in the negotiation; if all the gains go to labor, there will be no incentive for capitalists to adopt more productive technology.

Capitalists have to get their piece, so they will have an incentive to pony up the money. How much labor ends up with depends on its bargaining power. If workers do not have much bargaining power, they get the short end of the deal.

In the long run, as the new technology becomes widely adopted, competition pushes prices down. The gains that originally accrued to the owners of capital are competed away, and consumers -- meaning workers for the most part -- end up with the benefits.

Look at travel agents. The Internet opened up a new channel for airlines to communicate directly to travelers. Intense competition for passengers meant that most of the gains from the new technology were passed along to consumers, with travel agents squeezed out of their jobs.

But once they find new jobs, those same travel agents will benefit from the lower prices that resulted from productivity gains elsewhere.

Workers who are at a stage of their life where they want to increase consumption, or accumulate assets, naturally resent labor-saving productivity growth or trade. But those who are about to retire, and consume more leisure, find cheaper goods attractive. It's unfortunate when trade or productivity growth causes a 50-year-old worker to lose his job; but the same economic changes can be a boon to a 62-year-old who can then afford to retire a few years early.

In the next decade, the baby boomers will start to retire and we will have to learn to produce more with less labor. Productivity growth and international trade will be important to making a successful transition to a labor-scarce economy.

But if these gains from technology and trade are to be politically palatable, we have to find a way to make sure that all can benefit from the increased opportunities they offer for consumption and leisure.

Friday, December 08, 2006

Protectionism's Winners and Losers

From The Economist:

The perils of protectionism, The Economist: Peter Mandelson is an avowed trade liberal. So it is somewhat embarrassing that as the European Union's Commissioner for Trade, he has presided over the imposition of punitive duties on a wave of Asian imports. ... But on December 6th he had the chance to repair his liberal credentials when he launched a green paper on the EU's trade-defence policy.

The EU's trade-defence rules, which determine when it can impose anti-dumping, anti-subsidy and safeguard measures, were drawn up a decade ago. But they are beginning to show their age. Global supply chains have stretched round the world and many European companies have outsourced production to Asia. As a result, more European companies are being hit by the EU's own retaliation against unfair competition. That has pitted Europe's retailers against some of its manufacturers. As one retail boss puts it, views diverge widely: “They [the manufacturers] see China as a threat and we see China as an opportunity”.

Mr Mandelson's exercise is a chance to rethink what policy would do most good for Europe's economies. He wants the EU to look again at the “community-interest” test—that anti-dumping duties can be introduced only if they are in the wider interests of European business and consumers. Retailers complain that the test is in practice biased towards producers. ...

Here's a question. Many of you favor protectionist measures to protect jobs, and that's understandable. But as the article notes, there are many businesses that benefit from importing cheap goods from foreign countries to sell here, i.e. the businesses all along the import supply chain (which is far more than the employees on the floor at Wal-Mart). And those are benefits over and above the benefits to consumers from lower prices.

If we impose protectionist measures, what about the employees of these businesses? Do their jobs count? Are you willing to tell a dock worker, a truck driver, a rail worker, a worker at Wal-Mart, their managers, the associated support personnel such as accountants, the owners of the import businesses that will fail, etc. that the U.S. would be better off if they were unemployed so that workers in manufacturing could be employed instead? What would you tell these workers if they asked you why you want to take their jobs away? I think the answer might be that the new jobs would be better jobs, but what makes you so sure that if you try to turn back the clock now, the jobs will in fact be better?

Wednesday, December 06, 2006

Rubin, Rubin, We've Been Thinking...

Robert Rubin encounters critics among House Democrats:

Dems Bite Rubin's Hand, by William Greider, The Nation: Robert Rubin, the reigning guru on economic policy for the Democratic party, got a stiff surprise when he appeared today before the closed caucus meeting of House Democrats. A bunch of Democrats, including several of the new freshmen, challenged the former Treasury secretary--instead of listening reverently to Rubin's standard pitch for free trade and balanced budgets.

David Sirota had a source inside the caucus and reports on the blowback. Indiana freshman Rep. Joe Donnelly told about the Delphi employees in his district whose wages have been broken from $21 to $9 an hour, their pension obligations dumped on the government and jobs shipped offshore-- thanks to Rubin's "free trade" system. "What do you say to that?" Donnelly asked.

New Jersey Rep. Bill Pascrell unloaded on Rubin, linking the loss of America's manufacturing base to national security. Freshman Rep. Nancy Boyda of Kansas reportedly tore into NAFTA... Ohio Rep. Marcy Kaptur recalled the US trade deficit was $70 billion when Rubinomics was launched in 1993 and $370 billion at the end of the Clinton presidency (it is now $700 billion and rising).

I have no details on Robert Rubin's responses except that another source ... says Rubin begged off the negative questions by observing that the trade issue is "complicated." One House member reportedly growled that trade may be complicated, but losing your job is not complicated. ...

Monday, December 04, 2006

Nice Work If You Can Get It

Brad DeLong reports:

A +$400 Billion Week: Pierre-Olivier Gourinchas guesses that last week the U.S.'s net foreign asset position improved by $400 billion. Americans' assets overseas, you see, are primarily denominated in local currencies or are real assets. Foreigners' assets here, you see, are primarily denominated in dollars. The weakening of the dollar thus raised Americans' assets minus liabilities by about $400 billion.

Nice work if you can get it. Exorbitant privilege.

Nice work indeed. James Galbraith has some ideas about privilege, and about how easily privilege can be lost:

The dollar melts as Iraq burns, by James K Galbraith, Comment is Free, Guardian: ...[A]s the greenback approaches two to the pound, old-timers will remember the fall of sterling, under similar conditions of deficits and imperial retreat, a generation back. We have to ask: is the American financial empire on the brink? ...

The US economy is going soft faster than the inflation hawks and growth optimists thought. Housing has been in free-fall for months. With the new Congress anxious to display "fiscal responsibility" - cue Robert Rubin who has moved in very fast on Nancy Pelosi - there won't be any help next year from them. If business investment falls off, recession could hit in 2007 or 2008. With that fear in mind, gloomy profit expectations are setting in, and that's not good for the dollar. ...

So here's the big question: is the age of the dollar economy lurching toward an end? Are China, Japan, Saudi Arabia and other big holders of T-bonds about to start a rush, or even a stately promenade, toward the exits? Let's hope not, because the world is unprepared to replace the dollar with anything else. The euro is not suited for the job... An end to the dollar system would therefore be chaotic, inflationary, and very tough on world trade. The best argument for the dollar has always been: it's not in anyone's interest to bring it down.

Could it happen, though? Yes, it could. And it could be connected to that other unfolding disaster. As the "Pax Americana" goes to hell in Iraq ... let's remember that security and finance are linked. Typically, the country that provides global economic security enjoys the use of its financial assets in world trade. And when the security situation changes, that privilege can be revoked. The consequences are unpleasant. Ask the British: after the sterling area folded, it took a generation for the UK to come all the way back. ...

Update: In Response to Galbraith, Stefan Geens at economonitor says:

Stefan Geens, economonitor: I'm not convinced — the US is hardly facing the kind of existential threat the British Empire did 60 years ago. Nor do I see Asian central banks ever deciding to "punish" the US by piling into euros, as it would harm them as much as anybody else. Nose, face, spiting, etc...

Update: Suggested to me: Who's Afraid of the Euro?

Saturday, December 02, 2006

The GOP's Affection for Protection

Ever since the Democrats took control of congress, there has been an attempt to drive a wedge between the populist and free-trade factions within the party. Daniel Gross notes that the wedge is not confined to Democrats, the "Grand Old Protectionists" have a history of erecting tariffs and other trade barriers without any help from Democrats:

Grand Old Protectionists, by Daniel Gross, Commentary, Washington Post: Since the midterm elections, concerned internationalists have fretted that the incoming Democratic Congress will curtail the nation's free-trade policies. In Slate, Jacob Weisberg identified the new breed of protectionist Lou Dobbs Democrats. "So is America headed for a bout of protectionist class warfare?" worried the Economist. "With the Democrats having won a majority in Congress, and disquiet over globalization growing, a party faction that has been powerless -- the economic populists -- is emerging," Louis Uchitelle wrote in the New York Times. Washington Post columnist Sebastian Mallaby, reflecting the consensus, concluded that "the two parties have opposing attitudes on the subject of trade: Republicans see it as a source of growth, Democrats as a source of inequality."

However, these arguments misunderstand the new politics of trade. It's not a left-right split. Since 2000, Bush Republicans have done as much as Democrats, if not more, to erect trade barriers and tariffs. President Bush has talked a good game about free trade, and his administration has negotiated bilateral free trade agreements with Australia, Colombia, Morocco and several other countries. But just as free trade was a bipartisan project in the 1990s, this decade's anti-trade backlash has been bipartisan as well. Sens. Charles E. Schumer (D-N.Y.) and Lindsey O. Graham (R-S.C.) share little in common besides a desire to slap huge protective tariffs on Chinese goods. And all by themselves, Republicans have done great damage to the cause of free trade in the past several years.

Continue reading "The GOP's Affection for Protection" »

Wednesday, November 29, 2006

"Trade Obstructionism"

Robert Samuelson says globalization is a convenient scapegoat for many of our economic problems, but a closer look shows that "It would be insane to hamper our export prospects -- exactly what trade obstructionism threatens":

Globalization Makes an Easy Scapegoat, by Robert Samuelson, Washington Post: We may be about to shoot ourselves in the foot -- or maybe the chest -- on trade. In the name of "fair trade,'' we may punish our own exporters. In 2005, worldwide exports exceeded $10 trillion. Since 1980, they've more than tripled while the overall global economy doubled. Like it or not, massive international flows of goods and services (aka "globalization'') underpin all modern economies. We can accept this reality and try to benefit from it. Or we can rail against it. We seem to be edging toward railing.

Just last week, Democratic congressional leaders signaled they might oppose new trade agreements with Colombia and Peru. Who, if anyone, would benefit is unclear. ...[T]he agreements' darkened prospects have already led to layoffs in Colombia. In the United States, manufacturers believe the agreements would expand their exports. Peru's tariffs average about 10 percent, Colombia's about 11 percent... Most of these would go to zero under the agreements.

We are dealing with ... trade obstructionism: a reflexive reaction against almost any trade agreement. The idea is that much trade is inherently "unfair.'' ...[O]ther countries compete unfairly with low wages and substandard labor practices. (Indeed, the lax labor standards are cited to oppose the Peruvian and Colombian agreements.) Vast U.S. trade deficits measure the destructiveness. If trade is so unfair, why encourage more of it?

Much of this indictment is wrong or wildly exaggerated. For example, American trade deficits haven't destroyed U.S. job creation... Consider. From 1980 to 2006, the trade deficit jumped ... from less than 1 percent of gross domestic product to about 6 percent. Still, employment in the same period rose from 99 million to 145 million. Job creation defies the trade deficits, whose causes ... have little to do with "unfair'' trade practices. ...

U.S. jobs are destroyed for many reasons -- new domestic competition, new technologies, changing consumer tastes, the business cycle. A remarkable statistic: Every three months, 7 million to 8 million U.S. jobs disappear, and roughly an equal or greater number are created. Trade is a relatively minor factor in job loss.

It is, however, an easy scapegoat. It enables critics to blame foreigners and suggest a solution -- restrict trade. Globalization becomes a convenient explanation for many economic discontents, from job insecurity to squeezed living standards.

Hence, trade obstructionism. The timing could not be worse. The U.S. economy is now moving away from growth led by housing and consumer spending... Something will have to replace that spending if the economy is to continue to expand. The obvious candidates are exports and investment (in factories, machinery) related to exports.

It would be insane to hamper our export prospects -- exactly what trade obstructionism threatens. The world is quietly retreating from a multilateral trading system, where all countries simultaneously reduce trade barriers. The latest multilateral trade talks (the Doha round) are suspended; meanwhile, there are now more than 200 country-to-country and regional trade agreements. The United States has 13. But to negotiate more of them, the president needs so-called "trade promotion authority,'' and President Bush's expires in June.

If it's not renewed -- a good possibility -- the United States will effectively prevent itself from negotiating new trade agreements, while other countries are busily doing so. The European Union is now negotiating with India. The 10 Southeast Asian members of ASEAN are negotiating with Japan, South Korea and Australia. The hallmark of these agreements is that they discriminate against outsiders. So American exporters would face higher tariffs than many of their international competitors.

The next Congress must decide whether it embraces the symbolism or reality of trade. If it chooses symbolism, it will perversely harm many of the workers it's trying to help.

Sunday, November 26, 2006

Points of Agreement between Rubinites and Populists

The New York Times has another story about the split in the Democratic Party between the populist/protectionist faction and the free-trade advocates:

Here Come the Economic Populists, by Louis Uchitelle, Commentary, NY Times: For years, the Clinton wing of the Democratic Party, exercising a lock on the party’s economic policies, argued that the economy could achieve sustained growth only if markets were allowed to operate unfettered and globally.

Overcoming protests from labor unions, a traditional constituency, the Clinton administration vigorously supported free trade agreements like Nafta and agreed to China’s admission into the World Trade Organization. If there was damage to workers, then the Clinton camp proposed dealing with it after it occurred — through wage insurance, for example, or worker retraining and other safety-net measures. ...

Over time, this combination — called Rubinomics after the Clinton administration’s Treasury secretary, Robert E. Rubin — became the Democratic establishment’s accepted model for the future.

Not anymore. With the Democrats now a majority in Congress, and disquiet over globalization growing, a party faction that has been powerless — the economic populists — is emerging and strongly promoting an alternative to Rubinomics.

Continue reading "Points of Agreement between Rubinites and Populists" »

Wednesday, November 22, 2006

The Other Battleground

Fareed Zakaria says the U.S. is ignoring the battleground that matters most, the one that ultimately determines the balance of international power:

International Commerce Is the True Battleground, by Fareed Zakaria, Newsweek: President Bush ... is preoccupied almost entirely by Iraq, Iran, Israel, Lebanon, North Korea and, if he has time enough in a day, by Venezuela and Russia. His counterparts in Asia are focused primarily on something quite different: their own economic growth. And while roadside bombs may be what makes the daily headlines, it's ultimately economics that's likely to determine the international balance of power.

Consider a paradox: over the past five years, political turmoil has swept the world. It began with the attacks of 9/11, followed by bombings in Bali, Casablanca, Istanbul, Madrid and London. There have been two major American-led wars, in Afghanistan and Iraq, which are ongoing, protracted, expensive and increasingly destabilizing. Add to this the war between Israel and Lebanon, deadlock in Palestine, Iran's bid for regional supremacy, North Korea's nuclear test and Russia's growing clashes with some of its neighbors.

During this same period, the world economy has experienced its fastest five-year growth spurt in more than three decades. In fact, per capita GDP growth ... is higher than any comparable period in recorded history. ...

Markets are supposed to be smart. What are they telling us? That the current era of globalization is more powerful, widespread and resilient than many people realize. Today we are living through something practically unique—simultaneous growth worldwide. The United States, Europe and Japan are all doing well, but so are China, India, Brazil, Turkey and a whole slew of former Third World countries. ...

If this sounds as if everything will work out fairy-tale style, it won't. Global growth has its own complications. Demand for raw materials and energy is high and will keep rising. Countries that possess such resources—Iran, Russia, Venezuela, Saudi Arabia—become islands of exception to the very rules of markets and trade that are sweeping the world. Thus global capitalism produces its own well-funded anti-capitalists. Growth is also producing environmental degradation on a colossal scale. ...

For the industrialized world, the new global economy produces new stresses and strains. With hundreds of millions, if not billions of new entrants to global markets, Western workers fear for their wages. With new players in the global economy, industries of all kinds face new competitors.

There is no way to turn off this global economy, nor should one try. Every previous expansion of global capitalism has led to greater prosperity across the world. The story of the past 100 years is one of an ever-expanding pie. But this is a massive, complex process and requires enormous focus and attention. And while other nations around the world, from China to Chile, are playing to win, the United States as a government has barely focused on any of the major challenges or opportunities that it presents. We're too busy settling disputes between Sunnis and Shiites in downtown Baghdad.

A century ago, another great global power was similarly occupied halfway across its world, fighting a war and organizing the constitutional arrangements of Dutch farmers in the Southern Transvaal. Great Britain eventually won the Boer War, but it lost its focus on the economic challenges it faced. And finally it lost something else: its standing as one of the great global powers.

Monday, November 20, 2006

Has Job Security Declined? (Update)

[Updates at the end]

The Economist blog, Free Exchange, says outsourcing and technological change have not impacted job security - it's all a myth:

Unstable?, Free Exchange: Last month, unemployment hit 4.1% in America, the lowest ... in thirty years. Yet at the same time, Democrats are vowing to protect American jobs from foreign competition... If globalisation is sending jobs abroad, how is it that unemployment is so low?

Continue reading "Has Job Security Declined? (Update)" »

"Bad Economic Policy, Bad Energy Policy, and Bad Foreign Policy"

James Surowiecki of The New Yorker explains why tariffs, quotas, price guarantees, and subsidies in the sugar and ethanol markets are "bad economic policy, bad energy policy, and bad foreign policy":

Deal Sweetners, by James Surowiecki, New Yorker: America ... consume[s] ... close to ten million tons of sugar every year. But American sugar producers aren’t satisfied with supplying the most sweet-hungry population in the world. They’ve relentlessly sought—and received—special favors... The government guarantees producers a fixed price for domestic sugar and sets strict quotas and tariffs for foreign sugar.

Economically..., this has many obvious bad results. It keeps sugar prices in the U.S. at least twice as high as the world average. It makes it harder for companies that use lots of sugar to do business here—in the past decade, an exodus of candy manufacturers from the U.S. has eliminated thousands of jobs. And import restrictions make Third World countries poorer than they’d otherwise be. But protecting sugar also has a surprising consequence: it’s hurting America’s efforts to become more energy-efficient. ...

In recent years, as politicians have tried to deal with high gas prices, concerns about global warming, and America’s dependence on OPEC, a new savior has been found: ethanol. Ethanol has all sorts of virtues. ... So Congress has mandated that four billion gallons of ethanol annually be blended with gasoline, and it also subsidizes ethanol production with a fifty-one-cent-per-gallon tax credit. These policies have stimulated an ethanol boom...

Unfortunately, the ethanol produced in the U.S. comes from ... corn. Corn ethanol’s “net energy balance” ... is significantly lower than that of other alternatives, and modern corn farming isn’t easy on the land. By contrast, ethanol distilled from sugarcane is much cheaper to produce and generates far more energy per unit of input—eight times more... In the nineteen-seventies, Brazil embarked on a program to substitute sugar ethanol for oil. Today, every gallon of gas in Brazil is blended with at least twenty per cent of ethanol, and many cars run on ethanol alone, at half the price of gasoline.

What’s stopping the U.S. from doing the same? In a word, politics. The favors granted to the sugar industry keep the price of domestic sugar so high that it’s not cost-effective to use it for ethanol. And the tariffs and quotas for imported sugar mean that no one can afford to import foreign sugar and turn it into ethanol, the way that oil refiners import crude from the Middle East to make gasoline. Americans now import eighty per cent less sugar than they did thirty years ago. ...

We could, of course, simply import sugar ethanol. But here, too, politics has intervened: Congress has imposed a tariff of fifty-four cents per gallon on sugar-based ethanol in order to protect corn producers from competition. ... [T]he Bush Administration proposed eliminating the ethanol tariff this past spring, but Congress quickly quashed the idea ... [T]he sugar quotas appear to be as sacrosanct as ever. ...

Our current policy is absurd even by Washington standards: Congress is paying billions in subsidies to get us to use more ethanol, while keeping in place tariffs and quotas that guarantee that we’ll use less. ... Because of the ethanol tariffs, we’re imposing taxes on fuel from countries that are friendly to the U.S., but no tax at all on fuel from countries that are among our most vehement opponents. Congressmen justify the barriers to foreign ethanol with talk of “energy security.” But how is the U.S. more secure when it has to import oil from Venezuela rather than ethanol from Brazil? These tariffs are bad economic policy, bad energy policy, and bad foreign policy. ...

Should Environmental and Labor Standards Be Part of Trade Negotiations?

Should we refuse to trade with countries with low environmental and labor standards, or countries that have very low taxes or subsidize exporting industries because this gives them an unfair advantage? Here are arguments against insisting on "fair trade" standards as a condition for trade liberalization:

What Should Trade Negotiators Negotiate About? A Review Essay, by Paul Krugman, March 1997: ...The economist's case for free trade is essentially a unilateral case - that is, it says that a country serves its own interests by pursuing free trade regardless of what other countries may do. Or as Frederic Bastiat put it, it makes no more sense to be protectionist because other countries have tariffs than it would to block up our harbors because other countries have rocky coasts. So if our theories really held sway, there would be no need for trade treaties: global free trade would emerge spontaneously from the unrestricted pursuit of national interest. ...

Fortunately or unfortunately, however, the world is not ruled by economists. The compelling economic case for unilateral free trade carries hardly any weight among people who really matter. If we nonetheless have a fairly liberal world trading system, it is only because countries have been persuaded to open their markets in return for comparable market-opening on the part of their trading partners. Never mind that the "concessions" trade negotiators are so proud of wresting from other nations are almost always actions these nations should have taken in their own interest anyway; in practice countries seem willing to do themselves good only if others promise to do the same.

But in that case why should ... we demand ... only of trade liberalization? ... In particular, environmental advocates and supporters of the labor movement have sought with growing intensity to expand the obligations of WTO members ..., making adherence to international environmental and labor standards part of the required package; meanwhile, business groups have sought to require a "level playing field" in terms of competition policy and domestic taxation. ...

In 1992 Columbia's Jagdish Bhagwati ... and Robert E. Hudec ... brought together an impressive group of legal and economic experts in a three-year research project intended to address the new demands for an enlarged scope of trade negotiations. Fair Trade and Harmonization: Prerequisites for Free Trade? ... is the result of that project. ...

In this essay I will not try to offer a comprehensive review of the papers; in particular I will give short shrift to those on competition and tax policy. ... Instead, I will try to sort through what seem to be the main issues raised by new demands for international labor and environmental standards.

Continue reading "Should Environmental and Labor Standards Be Part of Trade Negotiations?" »

Saturday, November 18, 2006

NBER Reporter: Firms in International Trade

What are the characteristics of firms involved in international trade? Are these firms more productive? Do they pay higher wages? What are the effects of trade liberalization on employment, labor skill levels, and survival?

Firms in International Trade, by Andrew B. Bernard, NBER Reporter, Fall 2006: For most of its lengthy history the field of international trade largely ignored the role of the firm... Traditional trade theory explained the flow of goods between countries in terms of comparative advantage... Even the research focusing on differentiated varieties and increasing returns to scale that followed Helpman and Krugman continued to retain the characterization of the representative firm.¹ However, the assumption of a representative firm, while greatly enhancing the tractability of general equilibrium analysis, is emphatically rejected in the data. My research ... has been an attempt to ... understand the decisions of heterogeneous firms in shaping international trade and their effects on productivity growth and welfare.

Continue reading "NBER Reporter: Firms in International Trade" »

Is the "Capitalist Domino" About to Fall?

Robert Reich says the U.S. should normalize trade relations with Vietnam. I agree:

The New Domino Theory, by Robert B. Reich, American Prospect: President Bush arrives in Hanoi today for discussions about regional economic issues. He would do well to discuss frankly America’s fears about the "dominoes" of Asian capitalism.

You may remember the old domino theory of Asian communism. Four decades ago, American policy makers clung to the idea that the big domino of Soviet Communism had toppled China, and the domino of Chinese communism had then toppled North Vietnam. Unless the United States propped up South Vietnam, it was assumed, all of Indo-China would become communist.

Tens of thousands of Americans died in that war before America got out and let the dominoes fall where they may. But then a strange thing happened. Soviet Communism disappeared. China became the fastest-growing big capitalist nation in the world. And Vietnam became one of the hottest markets in Southeast Asia.

The real domino turned out not to be communism, but capitalism.

Yet the capitalist domino seems almost as threatening to America today as the communist one was forty years ago. This week, Republican leaders in the House called off a vote on a measure that would have given Vietnam permanent normal trade relations with the United States. They didn’t think they could get the votes needed to pass it.

Talk about shooting ourselves in the feet. Early next year, as part of its entry into the World Trade Organization, Vietnam will reduce tariffs on foreign goods and open its telecom and financial services sectors to foreign investment. But as things now stand, America won’t benefit from these measures because Congress won’t normalize trade relations with Vietnam.

Why not?

Continue reading "Is the "Capitalist Domino" About to Fall?" »

Wednesday, November 15, 2006

Exchange Rate Models "Not as Bad as You Think"

Charles Engel says there has been progress on exchange rate models since Meese and Rogoff's famous finding that the models are no better than a random walk at predicting the out-of-sample evolution of exchange rates:

Exchange-Rate Models, by Charles Engel, NBER Reporter, Fall 2006: Recent research that my co-authors and I have undertaken, as well as related research by other NBER researchers, suggests that theoretical models of foreign exchange rates are "not as bad as you think." ...

Should Exchange Rate Models Out-predict the Random Walk Model? For many years, the standard criterion for judging exchange rate models has been, do they beat the random-walk model for forecasting changes in exchange rates? This criterion was popularized by the seminal work of Meese and Rogoff.[1] They found that the empirical exchange rate models of the 1970s that seemed to fit very well in-sample tended to have a very poor out-of-sample fit. ...[S]ubsequent work has evaluated exchange rate models by the criterion of whether they produce forecasts with a lower mean-squared error than the simple random walk forecast of no change. Mark's (1995) paper was important in reviving interest in empirical exchange rate models.[2] He found that the models were helpful in predicting exchange rates at long horizons. Subsequent work has cast doubt on whether exchange rates can be forecast at long horizons, so there is a weak consensus that the models are not very helpful in forecasting...

West and I question the standard criterion for judging exchange rate models.[3]

Continue reading "Exchange Rate Models "Not as Bad as You Think"" »

Tuesday, November 14, 2006

Yesterday's Lou Dobbs

Guess where Perot "giant hypocrite sound" Systems is setting up operations?:

Company Ross Perot Built Is Now Hiring, in Mexico, by Elisabeth Malkin, NY Times: Remember Ross Perot’s “giant sucking sound”? The Texas billionaire and onetime presidential candidate railed against the North American Free Trade Agreement in the early 1990s, arguing that it would create a “giant sucking sound” of good American jobs pulled to low-wage Mexico.

But things change. Last week, Mr. Perot’s Texas company announced that it was hiring — in Mexico. The Perot Systems Corporation, which manages information technology for companies, is setting up a technology center in Guadalajara where it expects to employ 270 engineers by the middle of next year. ...

Perot Systems, based in Plano, Tex., had sales of $2 billion last year and employs 20,000 people in more than 20 countries, 6,000 of them in India alone. ...

Back in 1992 and 1993, Mr. Perot’s anti-Nafta harangues made him highly unpopular in Mexico... But a dozen years into Nafta, Mexicans are willing to let bygones be bygones. And so, it seems, is Mr. Perot...

Wednesday, November 08, 2006

Populism vs. Nationalism

I think this is a useful distinction:

A poll victory for economic nationalism, by Jacob Weisberg, Commentary, Financial Times: The bums, or at least many of them, have been thrown out. So the political conversation turns to the question of what the Democrats will do now... While it may be too soon to answer that question, we have seen enough to be alarmed about one tendency in particular: economic nationalism...

Most of those who reclaimed Republican seats campaigned against free trade, globalisation and any sort of moderate immigration policy. That these Democrats won makes it likely that others will take up their reactionary call...

There is an important distinction to be made between economic populism and economic nationalism. Many of Tuesday’s Democratic victors stressed familiar populist themes: corporate misbehaviour and tough times faced by working people. ... Raising the minimum wage (which Republicans foolishly failed to do before the election) is a classic populist position. Opposing Bush tax cuts for the wealthy is another. But in places where Democrats made their most impressive inroads ..., one heard a distinctly different message of economic nationalism. Nationalism begins from the same premise that working people are not doing so well. But instead of blaming the rich at home, it focuses its energy on the poor abroad. The leading economic nationalist today is probably Lou Dobbs, who natters on against free trade, outsourcing, globalisation and immigration...

The most prominent nationalist candidate this year was Sherrod Brown, who unseated incumbent Senator Mike DeWine in Ohio, a state that has lost 200,000 manufacturing jobs since George W. Bush became president. Mr Brown is the author of a book called Myths of Free Trade: Why American Trade Policy Has Failed. Here is a snippet from one of his television advertisements: “Sherrod Brown stood up to the president of his own party to protect American jobs, fighting against the Mexico and China trade deals that sent countless jobs oversees.” For some reason, economic nationalists never seem to complain about job-killing Dutch or Irish competition. The targets of their anger are consistently China and Mexico, with occasional whacks at Dubai, Oman, Peru and Vietnam.

One heard similar themes in the other pivotal Senate races. ... A much harder-edged nationalism defined many of the critical House races, where Democrats called for a moratorium on trade agreements, for cancelling existing ones, or, in some cases, for slapping protective trade tariffs on China. These candidates also lumped illegal immigrants together with terrorists and demanded a fence along the Mexican border. In Pennsylvania, Democratic challengers defeated Republican incumbents by accusing them of destroying good jobs by voting for the Central American Free Trade Agreement and being soft on illegal immigration. “Fair trade” candidates also won back formerly Republican seats in Ohio, Indiana, Iowa, North Carolina and Wisconsin.

Economic nationalism is not unique to Democrats – nor is it a new theme for them. The protectionist wing of the party first emerged in the 1980s when America’s manufacturing decline was linked to imports. ... But during his 1992 campaign, ... Mr Clinton espoused a free-trade position and embraced globalisation through his presidency. This set the direction for his party despite significant resistance in Congress. Mr Clinton’s argument was always that government should address the negative consequences of open trade through worker retraining programmes and by ensuring benefits not tied to employers, like healthcare and portable pensions. But the human capital part of Mr Clinton’s globalisation agenda never went anywhere, which partially explains the current backlash. ...

It would be going too far to say that the 2006 election ushers in a new protectionist consensus. But free trade has definitely left the building.

The populist, economic nationalists versus the populist, economic globalists.

I think Democrats should leave the globalist-nationalist debate aside and focus on areas of agreement first - implementing smart populist policies - because once that's done, the nationalist arguments will be less compelling and hopefully will then fall by the wayside. Here's a similar view:

Thus, ... the best road forward [is] to (a) make the Democratic coalition politically dominant through aggressive populism, and then (b) to argue for pragmatic reality-based technocratic rather than idealistic fantasy-based ideological policies within the Democratic coalition.

Tuesday, November 07, 2006

The New Globalization

I'm not sure this says as much new about globalization as the author claims, e.g. the Blinder work he refers to is discussed in "Offshoring: The Next Industrial Revolution?," but it's worth repeating in any case:

The new globalisation, by Anthony Giddens, Guardian: Globalisation is in the news again, following Gordon Brown's call yesterday to "rout the anti-globalisation forces of protectionism". ... Since ... globalisation has been debated so intensively and so continuously ... it is tempting to think that nothing original can any longer be said about it. But such a thought would be wrong. Anyone interested in how globalisation is changing our lives, and our economies, would do well to ponder the recent writing of a group of eminent economists at Princeton University. They are Professor Gene Grossman, Alan Blinder and their colleagues, together with a British author working in Geneva, Richard Baldwin, who has commented usefully on their work.

They have produced what they call a "new paradigm" of globalisation... One can see globalisation as involving several distinct phases of the disentangling of previous integrated economic activities. Starting in the late 19th century, sharp reductions in transportation costs meant that many goods no longer had to be made close to the place of their consumption. Since about the 1970s, because of a further leap in the ease of communication and transportation, stages in the actual manufacturing process can be separated from one-another and carried out at a distance. Transnational firms have developed a global division of labour...

But now a further phase of is occurring, Grossman et al say, coming from new processes of electronic offshoring, which are affecting services rather than manufacture. So far so conventional, because we are all aware of the growth of call centres in India... However, the authors say, electronic outsourcing is likely to go far deeper than call centres. Any service job can be outsourced that displays four characteristics - if it involves the heavy use of IT; its output is IT transmittable; it comprises tasks that can be codified; and if it needs little or no face-to-face interaction. Blinder believes that somewhere between 30 and 40 million service jobs in the US will be open to offshoring in the future. Since all manufacturing jobs can be offshored too, this would lead to a total of between 42 and 52 million. He doesn't mean that all those jobs will be offshored. However, the workers in those jobs will be exposed to competition from people overseas who will do the same jobs, to the same standards, for much lower wages.

Electronic offshoring is the basis of the new paradigm of globalisation. ... In the next phase of globalisation, global competition is occurring at the level of the individual job, or type of job, rather than at industry or trade level. The same type of job, in other words, can be outsourced across firms and industries of widely different types. It will hence be less useful in the future to see the winners and losers from globalisation in terms of the sector to which they belong or even their skill group. ... The winners and losers will be much more difficult to predict. ...[It] is [not] necessarily the case that the winners will be the highly educated or highly skilled, since the consequences will depend upon the actual task they are carrying out, not the overall competitiveness of the firm or industry in which they work - or their level of education.

The wages of many jobs are set by the fact that ... they are not affected by international competition. A cab-driver in London earns a lot more than a cab-driver in Manila not because he or she does a better job, but because ... cab-driving is non-tradeable. It will remain so, unless someone discovers a way of driving taxis remotely. The same does not apply at all for a host of workers in offices, hospitals or banks who previously believed they were safe from direct competition from workers overseas. ...

Take as an example the work of surgeons. More and more operations almost certainly will be carried out at a distance,... It may be possible for the surgeon to carry out many more operations in the working day than when he or she was confined to a single hospital. Should this happen, the best surgeons will be in much greater demand than the poorer ones, who will find their income dropping and perhaps their livelihood disappearing altogether. Globalisation will be helping one highly qualified worker, but harming the prospects of the other - even though they are both in a sector where overall Western countries have a competitive edge.

Offshoring so far has only affected a small proportion of jobs in the advanced economies, so all this is at a relatively speculative stage. But there are some clear policy implications. Wherever possible, skills training should not be too specialised. What will matter most will be flexibility and adaptability, both at the level of the firm and the overall workforce. It will probably not be the unskilled and semi-skilled who will have to make most adjustments, as has been true in the recent past. ... We need to revise our ideas on these issues, starting now. Mr Brown is right to argue against protectionism, but if we don't get our thinking right the trend might accelerate rather than diminish.

Monday, November 06, 2006

Worker Security, Social Insurance, and Protectionism

More on the decline in worker security:

US faces globalisation without safety net, by Alan Beattie, Commentary, Financial Times: If Americans are feeling ever more insecure about inequality, jobs and globalisation, they are not alone. The concerns of the “anxious middle” income earners are echoed across the Atlantic. But ... Americans have tended to display a much greater tolerance for the type of economic dislocation that can accompany globalisation...

Statistically, the European Union and the US show the same level of enthusiasm for foreign trade and globalisation. Trade also accounts for a similar percentage of both economies. But Europeans demand a larger social safety net ... to shield them from the vagaries of competition, judging by studies of trade, taxes and welfare payments. ...

Meanwhile, differences in inequality between the US and Europe owe as much or more to redistribution as to unequal wages. ...[W]hile wage disparities are similar, in the US government cash benefits reduce the proportion of households in poverty by less than one-quarter, while elsewhere in the OECD welfare systems reduce that proportion by more than half. Among rich countries, the US is thus left with the largest proportion of households living in poverty.

European workers are also much more cushioned if they become unemployed. ... On top of this the European workforce receives a higher “social wage” – public education, healthcare and housing provided free or heavily subsidised by the state – whether employed or not. ...

Who's responsible for the decline in worker security in Europe and the U.S.? According to this, you are:

Consumers Are Killing the Welfare State, by Gabor Steingart, Spiegel: Consumers just want a good deal -- they don't care where a product has been made or whether there is any social safety net in that country. ... We ... expect legally mandated vacations, protection from being fired and sick days. If everything goes wrong in life, we fall back on welfare...

And therein lies the rub: With its surcharges to fund the social safety net, ...[this] significantly increases the labor costs of each employee... [O]ne of the primary reasons for price differences between new and old members of the world labor market is the welfare state. ...

Continue reading "Worker Security, Social Insurance, and Protectionism" »

Tuesday, October 31, 2006

Can "State-Business-Union Collaboration" Save the Middle Class?

In one of the comments in Martin Wolf's forum about Larry Summers commentary on the difficulties globalization is causing for the middle class worldwide, Robert Wade writes:

Robert Wade: Larry Summers says: "The economic logic of free, globalised, technologically sophisticated capitalism may well be to shift more wealth to the very richest and some of the very poorest in the world, while squeezing people in the middle." A new study by Peter Edward presents confirming evidence (... 2006, 'Examining Inequality: Who Really Benefits from Global Growth?', World Development...). Of the increase in world consumption between 1993 and 2001 between 50 and 60 per cent accrued to those in the top 10 per cent of world PPP income in 1993, of whom four-fifths lived in the (old) OECD and most of the rest in Latin America. ...

Most of the rest of the increase accrued to the burgeoning middle class of China. Hardly any accrued to those living on less than $1-a-day, though 'hardly any' in percentage terms may have been sufficient to push enough people up ...[so] that the number under $1-a-day fell while the number between $1 and 2-a-day rose.

So when Larry talks of the "global middle class" being squeezed he is talking about the vast majority of the world's population, and the even bigger majority of the world outside the OECD and China. This should qualify any easy assertion that "globalization works"...

Larry also says: "[W]ithout its [the global middle class'] support it is very doubtful that the existing global economic order can be maintained." ... Elites are likely to sponsor measures that lower inequality only when their legitimacy is seriously threatened. We see fluctuations in after-tax inequality over time in response to the degree of threat to the capitalist order or to the survival of particular states... But despite the ... constancy (not fall) of world income inequality (the fast rise of China and India notwithstanding), inequality has hardly [been] an issue [in] global or even national policy discussion. ...

Finally, Larry says that 'the combination of low wages, diffusible technology and the ability to access global product and financial markets has fuelled an economic explosion' in Asia, especially in China. The problem here is that low wage labour is available all over the place, not just in Asia, and diffusable technology is, from the supply side, diffusable all over the place. Asian economies have certainly benefitted from being able to access global product and financial markets... But they have adopted policy regimes that depart in major ways from the principles that Larry keenly promoted from the US Treasury, whose spirit is caught in his remark in this column, 'protectionism [note the 'ism', as though it is a creed, like communism] is counterproductive'.

The governments of the successful economies (think Japan, Taiwan, South Korea, Singapore for starters) have in practice adopted a variety of policy instruments to accelerate the national integration of the economy, as a complement to Larry's central interest in 'international integration'. In the first three, these policy instruments included managed trade regimes with substantial amounts of protection ... in line with a larger development strategy. Larry refers to 'middle-income countries without natural resources struggl[ing] to define an area of comparative advantage'. I suggest that the struggle to define and exploit areas of comparative advantage in the context of increasing competition in world markets may ... involve a more pro-active directional thrust from the state (the direction established through state-business-union collaboration) than Larry would be happy to endorse. ...

I don't think state-business-union collaboration is the answer to this problem. Do you? Martin Wolf also comments on the article.

Sunday, October 29, 2006

Summers: The Global Middle Cries Out for Reassurance

Because of the problems globalization and technological change have created for middle class workers, Larry Summers believes that the advancement of global integration will depend upon "what can be done for the great global middle" through policies enacted by the "best parts of the progressive tradition." He has in mind progressives who "do not oppose the market system," instead "they improve on the outcomes it naturally produces":

The global middle cries out for reassurance, by Larry Summers, Commentary, Financial Times (free): ...Neither the after-effects of September 11 2001 nor a tripling in oil prices has prevented the world’s economy from growing faster in the past five years than in any five-year period in recorded economic history. Given this recent performance and the ... optimistic outlook, one might have expected this to be a moment of particularly great enthusiasm for the market system and for global integration.

Yet in many corners of the globe there is growing disillusionment. From the failure to complete the Doha trade round to pervasive Wal-Mart-bashing, from massive renationalisation in Russia to the success of populists in Latin America and eastern Europe, we see a [growing] degree of anxiety about the market system...

Why is there such disillusionment? Some anti-globalisation sentiment can be seen as ... arising from the Bush administration’s foreign policy misadventures. But there is a much more troubling source: the growing recognition that the vast global middle is not sharing the benefits... – and that its share of the pie may even be shrinking.

Continue reading "Summers: The Global Middle Cries Out for Reassurance" »

Friday, October 27, 2006

"Twin Deficits, Twenty Years Later"

A new paper from the New York Fed looks at the twin deficits debate. Here's the introduction explaining the debate, part of the conclusion, and a link to the paper:

Twin Deficits, Twenty Years Later, by Leonardo Bartolini and Amartya Lahiri, Current Issues in Economics and Finance, October 2006  Volume 12, Number 7: In recent years, the twin-deficit hypothesis—the argument that fiscal deficits fuel current account deficits—has returned to the forefront of the policy debate. The argument first emerged in the 1980s, when a significant deterioration in the U.S. current account balance accompanied a sharp rise in the federal budget deficit. Now, with the U.S. current account and fiscal balances plunging by 3 and 4 percent of GDP, respectively, from 2001 to 2005, the view that the two deficits might be closely linked has attracted new interest. Changes in U.S. fiscal policy have also been viewed as playing a key role in widening the nation’s current account deficit since the turn of the millennium and thus in determining whether global current accounts will be rebalanced over the next decade.

According to the twin-deficit hypothesis, when a government increases its fiscal deficit—for instance, by cutting taxes—domestic residents use some of the income windfall to boost consumption, causing total national (private and public) saving to decline. The decline in saving requires the country either to borrow from abroad or reduce its foreign lending, unless domestic investment decreases enough to offset the saving shortfall. Thus, a wider fiscal deficit typically should be accompanied by a wider current account deficit.

Casual observation suggests that the twin-deficit hypothesis accurately captures the U.S. experience in the 1980s and the first years of the new century. However, the hypothesis does not explain the U.S. record of the late 1990s, when a substantial current account deficit coexisted with a federal budget surplus. Nor does it accord with Japan’s experience during the 1990s, or the experience of many other countries undergoing sharp swings in fiscal policy over the past two decades. Many empirical studies have also failed to find a strong relationship between fiscal and current account deficits, perhaps because they have used data on a very limited number of countries or have focused on periods that were too short to yield reliable evidence in a variety of environments and over time.

This edition of Current Issues contributes to the debate on the twin-deficit hypothesis by analyzing the link between fiscal and current account deficits across a larger sample of countries and over a longer period than examined in earlier studies. Reviewing the international record over the past thirty years, we revisit both key components of the twin-deficit hypothesis: the relationship between fiscal policy and private saving, and the response of current account balances to fiscal policy changes. Our findings confirm the broad wisdom that private saving indeed tends to decline when fiscal policy loosens. However, this response may have weakened over time. Saving now tends to fall by about 35 cents in response to each extra dollar of fiscal deficit, down from the decline of 40 to 50 cents that researchers have reported for earlier periods. In addition, much of the decrease in national saving is matched by a drop in the current account, whose deficit rises by 30 cents for each extra dollar of fiscal deficit.

These results offer some support for the twin-deficit view. They suggest, however, that the effects of fiscal policy on saving and the current account balance are too weak for deficit reductions in the United States to play a central role in correcting the nation’s current account imbalance with the rest of the world.

...

Conclusion ...Our estimates suggest that even if the federal fiscal deficit—currently about 2 percent of GDP—were fully erased, the nation’s current account deficit would improve by only a fraction of its current 7 percent of GDP. For example, if the U.S. current account continues to respond to fiscal changes as it has, on average, in our sample of OECD countries—by 30 cents on the dollar—a full elimination of the federal fiscal deficit would improve the U.S. current account by only 0.6 percent of GDP, or less than one-tenth of its current level. While these calculations are based on historical correlations that could break down if circumstances change in unexpected ways, they are nonetheless suggestive of the likely magnitude of the effects at work.

Friday, October 13, 2006

Mishkin: Globalization: A Force for Good?

The newest Fed Governor, Frederic Mishkin, gives his first speech. The topic, the globalization of financial markets, has been covered here recently in an commentary by Mishkin from the Financial Times, and an interview from Crooked Timber about his book on the same topic. Here's one small section of the speech:

Globalization: A Force for Good?, by Frederic S. Mishkin, Board of Governors: ...Can more globalization--in particular, financial globalization--be a force for good?

The globalization of trade and information over the past half century has lifted vast numbers of the world's people out of extreme poverty. Despite the doom and gloom that you often hear, world economic growth since the Second World War has been at the highest pace ever recorded. What we are seeing in countries that are export oriented, and thus able to take advantage of the present age of globalization, is a reduction in poverty and a convergence of income per capita toward industrial-country levels. In India and China, for example, globalization in recent years has lifted the incomes of more than 1 billion people above the levels of extreme poverty. ...

The benefits of globalization of trade in goods and services are not controversial among economists. Polls of economists indicate that one of few things on which they agree is that the globalization of international trade, in which markets are opened to flows of foreign goods and services, is desirable. But financial globalization, the opening up to flows of foreign capital, is highly controversial, even among economists...

For example, in his best-selling book Globalization and its Discontents, Nobel laureate Joseph Stiglitz is very critical of globalization because he sees the opening up of financial markets in emerging-market economies to foreign capital as leading to economic collapse. Even Jagdish Bhagwati, one of the leading economists defending globalization of trade (after all, his book is titled In Defense of Globalization), is highly skeptical of financial globalization, stating that "the claims of enormous benefits from free capital mobility are not persuasive." George Soros, the prominent financier, opens his book On Globalization with a chapter entitled "The Deficiencies of Global Capitalism."

One reason for the controversy is that opening up the financial system to foreign capital flows has led to some disastrous financial crises causing great pain, suffering, and even violence. These crises can arise when bad policies encourage excessive risk taking by financial institutions, policies that rich elites in the developing countries often advance for their own profit. There are those (including Stiglitz and Bhagwati) who put the primary blame for the failures of financial globalization in emerging-market economies on outsiders, specifically on the International Monetary Fund, or what they refer to as the Wall Street-Treasury complex. The evidence has brought me to the conclusion that institutions like the IMF or the U.S. Treasury are not primarily to blame, although neither are they blameless--public and private financial institutions active in the international capital markets have often aided and abetted poorly designed financial globalization, although that was not their intention. ...

We have seen that the repression of the financial system is a great obstacle to economic growth and the reduction of poverty in poorer countries. Yet, if financial development offers such tremendous benefits, why doesn't every country jump on the path to growth and prosperity by imitating the institutions of the advanced economies? Part of the answer is that good institutions need to be home-grown; institutional frameworks that have been developed in the rich countries frequently do not translate well to poorer countries. This is a lesson that many in the advanced economies of the world have yet to learn. The development of good institutions in the advanced countries took hundreds of years; as they grew, they adapted to local conditions. Poor countries must develop their own institutions, and the citizens of these nations must feel they have ownership of the institutions or the institutions will be ineffective and short lived. ...

I will conclude by saying that those who oppose any and all globalization have it completely backward: Protectionism, not globalization, is the enemy. It is true that, by itself, globalization in both finance and trade is not enough to ensure economic development and that economies must position themselves to handle foreign capital flows. But as I said, to be against globalization as such is most assuredly to be against poor people, and this is presumably not the position antiglobalizers want to take. Developing countries cannot get rich unless they globalize in both trade and finance. Making financial flows truly worldwide and creating robust, efficient financial markets in developing countries is not optional: It needs to be the focus of the next great globalization. In sum, I want to challenge those who oppose globalization to rethink their objections. As Kofi Annan, the Secretary General of the United Nations, has put it, "The main losers in today's very unequal world are not those who are too much exposed to globalization. They are those who have been left out." Rather than opposing or limiting globalization, we in the rich countries and those in the developing countries must, as a moral imperative, work together to make globalization work for the general good of people all over the world.