For a third of a century, the entire period of modern globalization, U.S. macroeconomic policy has created and sustained huge trade deficits. The inflow of funds, in turn, leads to a strong dollar.18 The strong dollar helped make U.S. manufacturing uncompetitive, especially as advanced technology was flowing so freely toward China.19
Second, China discovered that by managing its exchange rate, keeping it slightly lower than it otherwise would be, it expanded exports, providing jobs for its burgeoning population and enabling China to industrialize and raise the standard of living for its people very rapidly. The United States accused China of manipulating its exchange rate. In practice, all countries engage in policies which affect the exchange rate. When the United States lowered its interest rates in response to the Great Recession, one of the main ways it helped the U.S. economy was that it led to a lower exchange rate, increasing exports and reducing imports—a kind of beggar-thy-neighbor policy that helped the United States’ recovery at the expense of that in Europe.20 Ironically, by the time Trump began accusing China of exchange rate manipulation, China had reversed course, and was actually intervening to increase its exchange rate, to strengthen its currency, responding to a flow of money out of the country—between 2014 and the beginning of 2017, China lost about $1 trillion in foreign reserves21—which had depressed the exchange rate too far.22
In no country is the exchange rate just a matter of market forces. The most important factor determining movements in a country’s exchange rate is the interest rate set by the central bank—by a public institution, not by the market. The United States has gone around the world trying to persuade governments that they should not intervene in their exchange rate, that it should be determined by market forces. In practice, what that means is that it should be determined by the Federal Reserve, America’s central bank, but not by their own central banks.
In China, matters are even more complicated. China restricts its citizens putting their money abroad. If China removed this restriction, but then let the exchange rate be determined by “market forces,” the exchange rate would plummet as Chinese citizens sought to diversify their portfolios and invest money in other countries. And of course, the United States would complain. What the United States wants is not a market-determined exchange rate for China, but a high exchange rate. Indeed, in the East Asia crisis, the United States put pressure on China to ensure that its exchange rate did not plummet as the other East Asian currencies plummeted. Then, it didn’t want China to let the market determine the exchange rate, for if it had, their exchange rate would have fallen in tandem with that of other countries in the region.
SOME BASIC PRINCIPLES OF TRADE
But the most important point is that any one country’s exchange rate, even that of China, has little effect on the overall U.S. trade deficit. The overall trade deficit is determined by the balance of domestic savings and investment, which is little affected by any particular country’s exchange rate. The value of the renminbi affects the bilateral trade deficit—the difference between exports and imports to China. But that itself is of little relevance. If the United States imported less apparel or shoes from China (because the renminbi strengthened), it would import more from some other developing country like Bangladesh or Vietnam; it wouldn’t produce much more inside its own borders.
Bilateral trade deficits only matter in a barter economy. The reason that money was such an important invention is that it avoids barter—it allows multilateral exchange. We buy more from China than we sell. But China may buy more from Australia than it sells there. And Australia may buy more from the United States than it sells to it. We would all be worse off if each of these three trade accounts had to balance individually.
There are, perhaps, a few people who think that because the United States is better at everything than everybody else we should only be exporting: by definition, in this logic, if someone is undercutting our firms, they must be playing unfair. That’s the kind of mercantilist reasoning that Smith railed against more than two hundred years ago. The citizens of a country benefit from consuming, from enjoying the fruits of their labor. It makes no sense for them just to sell to other countries everything that they produce. We export in order to import. A country exports things that it’s relatively good at, importing things that it’s relatively bad at. And being relatively bad at something doesn’t require ineptitude—it just means someone else can do it at least a little better. It’s not a matter of “unfair play.” We don’t need to export—or to prevent imports—to remain at full employment. As we emphasized earlier, the task of maintaining the economy at full employment is the responsibility of monetary authorities (the Federal Reserve) and fiscal policy. It is not the responsibility of trade policy.
Competing with Cheap Labor and Low Labor and Environmental Standards
The same kind of fallacy arises with complaints about trading partners that have low wages. How can the United States compete? Of course, in competitive markets, the reason that wages are low is that productivity is low—and that translates in turn into lower living standards. It’s unfortunate to have low wages and productivity, but not unfair. These low-wage economies could similarly complain, how could they compete with American technology? Or with an economy where the Federal Reserve sets interest rates at near zero? The theory of comparative advantage describes the benefits that arise from trade whenever countries differ in their relative productivities in doing different things: we are relatively more productive in making airplanes, our trading partners are relatively more productive in making clothes.23 Our trading partner could be far less productive overall—and thus have far lower wages. In the case of trade with poor countries, it should be obvious that there are typically huge differences in relative productivities, and hence huge gains from trade.
This principle of comparative advantage applies as well no matter how different countries decide to spend whatever income they get, or for that matter how they organize various parts of their economy. They could spend, for instance, more money on preventive health care (as our European trading partners do), and less money on emergency room treatment.24
There are, however, some important instances where there are large market distortions, which mean that observed patterns of trade may not correspond to those of the underlying comparative advantages. Most obviously, a government could provide subsidies to a firm. As simple as this sounds, in practice, going beyond direct subsidies, it is complex. Some complain that when a country (like the United States) sets interest rates at zero, or bails out banks, so that they can in effect charge their customers lower interest rates than otherwise would be the case, there is a subsidy.
So too there is a real societal cost when a firm imposes environmental damage, and not to charge the firm for the costs it imposes is de facto a subsidy. The 2015 Paris Agreement on climate change committed countries to reduce their climate emissions. Many will implement their commitments by imposing charges for carbon emissions. There is a large societal cost to such emissions—the costs arising from climate change. Not charging for such costs is as much a subsidy as having an arrangement by which firms could have free access to labor. Many countries are worried that if some country—say the United States—refuses to impose such a charge, it distorts the pattern of trade. America might produce an emissions-intensive good, like steel, more cheaply not because it is relatively more efficient, but because of the implicit subsidy. Trade based on advantages arising from an absence of environmental regulations or charges for greenhouse gas emissions is “unfair”—or at the very least distorted.
I also noted that imperfections in competition can give rise to distorted patterns of trade. Of particular concern is market power in the labor market—where firms are able to so exploit workers that they provide substandard working conditions.
Trade agreements over the past quarter century have included provisions intended to deal with some of these distortions. When a country provides a subsidy, its trading partners can impose a
“countervailing duty” to offset the effects. Some believe that this provision extends to implicit subsidies, such as not charging for environmental damage, including not imposing a carbon price.25 Recent agreements also include provisions relating to labor and environmental standards, though the evidence is that even the limited conditions are often not enforced effectively.26
It is important to realize, however, that most bilateral trade deficits have little to do with these distortions. Thus, the United States has a trade surplus with the Netherlands (of some $24 billion in 2016). But that doesn’t mean that America is engaging in some unfair trade policies vis-à-vis the Netherlands, and the imbalance cannot be blamed on the United States having worse labor or environmental laws than the Dutch.
And it is also important to go back to the underlying macroeconomic fundamentals: none of this matters for the overall trade deficit, which is a matter of the imbalance between domestic savings and investment.
Winners and Losers: The Distributive Consequences of Trade
Some of the discontent with globalization arises from the fact it didn’t deliver on the promise either of jobs or growth. More apparent than the jobs created were the jobs destroyed. And growth in the era of globalization was slower than in the decades before. But the real discontent arises from the fact that so many people were actually worse off as a result of globalization. That the corporations got more than 100 percent of the gains—all of the growth, and then some of the existing economic pie that had belonged to others—made globalization that much more attractive for them, but that much less attractive to the rest of society.
In fact, honest academics always pointed out that there would be winners and losers in globalization. When globalization worked well, the standard theory arguing for globalization went, the winners gained enough so that they could compensate the losers and everyone would be better off. But the theory said that they could compensate the losers, not that they would. And typically they didn’t. And because they didn’t, many—even a majority of citizens—may be worse off. These are inconvenient truths, which were not widely explained in the heyday of globalization, when the advocates seemed to claim that everyone would win.
With perfectly free trade and well-functioning markets, unskilled workers everywhere in the world would get the same wages27—and moving toward free trade results in unskilled wages in advanced countries going down.28 The argument was simple: trade in goods was a substitute for the movement of the factors of production, the unskilled and skilled labor and capital that go into making the goods. If the United States imports more unskilled-labor-intensive goods from China, there is less of a need to produce those goods in America, and that lowers the demand for unskilled labor in the United States, and hence the wage of unskilled labor decreases.
These insights were never highlighted—indeed never mentioned—by the advocates of globalization. Was it a matter of willful deception, ignorance, or because somehow many politicians, even Democrats, continued to believe in trickle-down economics? Ever since President Kennedy claimed that “a rising tide lifts all boats,”29 the idea of trickle-down economics has persisted without theory or evidence backing it. The last quarter of a century has simply provided more evidence against the idea.30
Weaker Bargaining Power
Workers’ wages were lowered as a result of another force: a weakening of their bargaining power. This had, of course, already been greatly weakened by the attack on unions and changes in labor legislation that began in the United States under President Reagan and in the UK under Prime Minister Margaret Thatcher.31 But now corporations had another tool. They could threaten to move their factory elsewhere, to China or Mexico, where there was cheaper labor. Trade agreements then gave them the right to bring the goods thus made back to the United States—in the case of Mexico, with no duties, in the case of China, typically with very low duties. Workers felt forced to accept lower wages and worse working conditions. There was nothing the unions could do to stop this outsourcing of jobs and the lowering of wages—and with their power thus diminished, so was their membership, in a vicious downward spiral.
And then there was no one to speak up for what was happening to America’s working people. That had also been the role of the Democratic Party. But as elections increased in cost (each party had to spend about a billion dollars in the 2016 election), the Democratic Party had to move increasingly close to the sources of the money—the bankers and the new tech entrepreneurs of Silicon Valley—and increasingly distant from their traditional base. Even when I served in the Clinton administration, when either I or Robert Reich, the secretary of labor, spoke out against the regressivity of our tax system (very rich people actually pay a much smaller fraction of their income than those who are not so rich) or the unwarranted subsidies to our banks and corporations, which we derisively referred to as corporate welfare, we were put down as fomenting class warfare.32
Of course, many politicians simply didn’t care whether trickle-down economics worked or not: as long as enough of their constituents—or enough of those who financially supported their politics—were doing well, that was all that mattered. And the top 1 percent has been doing very well.
Given this, our politicians didn’t want to think about the consequences of their policies for ordinary Americans; they didn’t want to hear the voices of those economists who warned of the large potential consequences for America’s and Europe’s middle class.33 They listened only to what they wanted to hear.
Balancing Interests under Managed Trade
The globalization which emerged at the end of the twentieth century and the beginning of the twenty-first was not based on “free trade,” but on managed trade—managed for special corporate interests in the United States and other advanced countries, balancing those interests even as the agreements put little weight on the interests of others—either workers in advance countries or those elsewhere.
One of the lessons that students in public policy schools take to heart is that a new law should have a name that is the opposite of what it actually does. Thus, a free trade agreement is actually not about free trade. If it were about free trade, it would be short, a few pages—each country gives up its tariffs, its nontariff barriers to trade, and its subsidies. The Trans-Pacific Partnership (see introduction), ran upward of 6,000 pages. I was once asked by a South American president whether he should sign a so-called free trade agreement with the United States. I suggested he propose a true free trade agreement: if he did, almost surely, the United States would refuse. It has consistently refused to do away, for instance, with its agricultural subsidies.34
To see that these “managed trade” agreements represent a balancing out of special interests within the advanced countries, imagine, say, congressional reactions to alternative rules. As I have noted, it is almost unimaginable that Congress would have supported a true free trade agreement that would have eliminated both the overt agricultural subsidies and the more covert subsidies for fossil fuels (some of which are hidden in the tax system). In the Uruguay Round of trade negotiations completed in 1994, the United States demanded, and got, a ten-year delay in the elimination of protection for textiles. Given the shortsightedness of the corporate sector, ten years is an infinity. Of course, when the ten years expired, the industry wanted an extension of its protection.
Technology or Globalization
Defenders of globalization argue that globalization is only one of several forces contributing to the growing inequalities and the decline in incomes of unskilled workers. It is (in this view) unjustly being treated as if it is the only, or the major, contributor to inequality.35 Technical change is more important—advances in technology have made Rust Belt jobs obsolete and reduced the demand for unskilled workers. In a market economy, lowering wages is the inevitable result.
Most of the job loss in manufacturing is in fact due to technology. Even if there were no globalization, the fact that productivity growth in manufacturing is so much greater than the gr
owth in demand would have led to major reductions in manufacturing jobs. By some reckoning, one can explain some 65 to 80 percent of job losses in manufacturing in the United States in this way.36
So too Trump has made much of the loss of jobs in coal mining—this time blaming regulations. But the real reason is simple: advances in technology resulted in a massive increase in the supply of natural gas, making coal uncompetitive. The United States exports coal to Europe—depressing coal prices and production there. If the Europeans had the same “protectionist” mentality that the Americans are assuming, they would, of course, keep American coal out. (Trump, like most protectionists, seldom thinks of what would happen if everyone acted as he does.)37
Perceptions of ordinary citizens toward technical progress and globalization differ—partly, but only partly, because of how certain politicians have made globalization the villain. To oppose technical change is to be antediluvian. No one wants to wear that label. Moreover, it is hard for individuals to think of what one might do to stop technological progress. There’s no activism disposed to smashing machines, as in the nineteenth century Luddite movement.
Besides, optimistic Americans as well as workers elsewhere in advanced countries believe that they can respond to technical progress. They see it as increasing living standards—there is a clear link between that and the new products they love. Moreover, embracing progress is part of the American identity. The ability to innovate and to adapt is part of the success of the country. Many in other countries feel similarly.
Globalization, though, is shaped by politicians at home and abroad. And so it’s easy to think of what one could do to stop imports: impose trade restrictions. Those “others” are engaged in unfair competition. When I was chairman of the Council of Economic Advisers, I frequently heard pleadings from those in the business community who were resolutely in favor of competition and against subsidies for others. But they were eloquent in explaining how at that moment and in their industry competition was unfair and destructive, and a little government help—sometimes in the form of subsidies, often by protecting them from “unfair” competition from abroad—would be of enormous benefit, not to themselves personally, but to their workers and their communities. When those who seem to be outcompeting oneself are foreigners, the inclination to say that they are engaging in unfair competition is irresistible: to argue otherwise is to suggest that one simply doesn’t measure up.
Globalization and Its Discontents Revisited Page 7