I have been thinking about this previous post on trade and wanted to improve my answer to Jon Talton, our free-markets-hating business columnist in the Arizona Republic. In his recent column advocating that we finally give up on all this free trade stuff, he said:
Americans were assured that new trade accords and China's membership in
the World Trade Organization would mean better living standards for
American workers. That's because China and other countries supposedly
would buy American exports.
I thought my answer was OK, but I want to take another shot at it, because I hear the argument all the time that "trade only benefits the US if other countries buy our exports." This is wrong, but this misconception drives many people's thinking on trade.
If we are importing more from other countries but they are not "buying more of our exports," such that we have a large trade deficit, there are two possibilities to explain this:
- The definition of exports is too narrow
- Someone is throwing away value by building up a big pile of US dollars
The first is the most likely explanation. A dollar is valueless in China, and the UK, and France except to the extent someone thinks they can eventually use it to buy something in the US. Dollars that aren't or can't be used to buy dollar-denominated assets of some sort have no value. The money a Chinese exporter accepts from Wal-mart is only valuable if they can recycle it and buy something in the US with it (or trade the dollars to someone else in China who wants to buy something in the US).
So the dollars we send overseas for imports are going to come back. But the reason our trade accounts are out of balance is that the trade deficit numbers they quote on TV define our exports narrowly. In short, "exports" as commonly measured don't include all the things we sell to foreigners for dollars.
One example of this is if a Chinese company takes the $10 million dollars it earns from exporting to the US and then invests $10 million in US materials to build a factory in the US. That sounds OK, right? That seems to be in balance. But in the way we calculate the trade deficit, that would show as a $10 million trade deficit, because goods (and services) that foreigners buy in the US and consume in the US (rather than back in their home countries) are not considered an "export." In fact, I would consider this "better" than an export, since both the dollars and the goods stay in the US. But to trade deficit hawks, this is worse, mainly because their measurement is flawed.
A second example is if a Chinese company take the $10 million dollars it earns from exporting to the US and invests the money in US mortgage bonds. Again, this would show as a trade deficit, but the US economy benefits from lower interest rates. In this case, we are again selling foreigners a product, in this case wealth protection, which the US is very good at since we have a more stable economy and stronger rule of law than any other country in the world. And again, the way we measure "export" does not encompass this product, since our trade measurement has a strong manufacturing bias that does not match the more diverse nature of our economy today. (For those that lament forefingers helping to fund the enormous government debt, I share your pain, but that is a government spending problem and not a trade problem).
But what if the foreigners are totally perverse. What if they ignore their own best interests and refuse to buy our exports and just sit on the dollars they get from trade without recycling them in any way to the US? What if they do this even if by doing so, they would be throwing away billions, even trillions of dollars in value? As absurd as this sounds, this is exactly the concern Talton and other trade-skeptics raise.
Well, the US in this case would STILL be better off. First, the US would be getting whatever goods we are buying overseas cheaper or better (or else people would not be buying them). This would reduce the costs of inputs to other products, and increase money consumers have to spend on other things. The labor that would have gone into making these products domestically would be redeployed to making other things, increasing our net wealth.
By the way, it is this last sentence I think Talton and his peers would not accept. They tend to view employment as zero-sum, ie there are a fixed number of jobs in the world, and if we import, that creates jobs overseas which must reduce jobs in the US. But labor markets have never worked that way. As I wrote before:
I have taken on this zero-sum mentality before,
but it is particularly wrong-headed in this case. Historically, the
argument makes no sense. For example, the automation of the farm
sector wiped out 80 or 90% of the farm jobs in the US over the last
century. By the zero-summers logic, we should be impoverished.
Instead, these people were redeployed to manufacturing and service jobs
that create far more wealth than the old 19th century farm employment.
But while people can sort of accept this historically, they can never
accept this in real-time. But the fact is that when we lose, say, a
textile job to foreign competition, we not only gain because everyone
pays less for textiles and thus has more money to spend on other
things, but that worker gets redeployed over time to higher-value
functions. Look at the old textile belt in North Carolina - what's
there now? Electronics and Bio-tech.
By the way, the other thing that would occur if foreigners just buried dollars in the sand without recycling them is that the value of the dollar would rise to levels higher than it would be at if these countries recycled their dollars, thus further lowering the price of inputs for the US. Talton laments this very effect:
Now, the populists will get a chance to make their arguments,
especially over what the American response should be to Chinese
currency manipulation, tariffs and subsidized exports.
The currency manipulation and subsidized exports have one thing in common: They are both ways that the Chinese destroy value for their own citizens in order to lower prices for American consumers. And Talton claims that the populist argument should be to end these practices? Why? I think its great that the Chinese want to hold billions in dollars just to keep the dollar high and prices low in the US. I think its great that their taxpayers want to subsidize lower prices in the US. I can understand why a Chinese citizen might want this to stop, but why should we, who are the beneficiaries?
Update: By the way, another common misconception is that a trade deficit implies someone is building up a debt. This is not (not not not) at all true. We can run a trade deficit indefinitely without building up a debt. Yes, foreigners are currently investing some of their trade profits in US government bonds necessitated by the federal government's deficit spending, but the two are only weakly related - a trade deficit does not cause government debt. A great way to see if a columnist has any idea what they are talking about is to see if they confuse the federal budget deficit with the trade deficit. It is almost funny how often I see this confusion appears in print. Anyway, this confusion is why people like Talton call the trade deficit "unsustainable". See my posts on why the trade deficit is not a debt (and here).