Posted by: Dirk | January 11, 2017

President Obama and the gains from trade

Going through my inbox, I found this quote from President Obama from November 2016:

That’s why I firmly believe that one of our greatest challenges in the years ahead — across our nations and within them — will be to make sure that the benefits of the global economy are shared by more people and that the negative impacts, such as economic inequalities, are addressed by all nations.  When it comes to trade, I believe that the answer is not to pull back or try to erect barriers to trade.  Given our integrated economies and global supply chains, that would hurt us all.  But rather the answer is to do trade right, making sure that it has strong labor standards, strong environmental standards, that it addresses ways in which workers and ordinary people can benefit rather than be harmed by global trade.  All of this is the central work of APEC.

Looking back at the elections of 2016, I think it shows a lot of what went wrong.

According to standard international trade theory, the Heckscher-Ohlin model, there are winners and losers from trade. The model suggests that the gains from trade are higher than the losses, so that the winners can compensate the losers so that everybody wins. That, obviously, is the world we want to live in. Economists help politicians to make the world a better place – for everybody!

However, even the textbook “International Economics” by Krugman/Melitz/Obstfeld contains some insights in why things did not work out that well. They have a graph showing that the computer industry declined in terms of jobs badly between 2000 and 2009, even worse than the industrial sector as a whole. The graph looked something like this (but only for 2000-2009), which I got from the World Bank:

Employment in industry (% of total employment)

employmentThere has been a fall in industry jobs, and that means that there have been losers from trade. It has been very obvious that the jobs went elsewhere as the US started to import manufactured products from abroad, with much of the increase coming from Asia, where China was used as a platform to export Asian products to the rest of the world.

According to the Heckscher-Ohlin model, the winners from trade are the owners of capital. Capital is abundant in the US, and scarce in China. Obviously, the model does not allow US firms to move their machines to China, even though this is what happened to some extent. The losers are the workers, which see their jobs leave to never return. The sensible policy that an economist using the Heckscher-Ohlin model should give to the US government is to increase taxes on capital and cut taxes on labor. In reality, the opposite happened. George W Bush cut taxes for the rich, and the relatively poor and the middle class was left to itself.

Incoming President Trump does not seem to keen to rely on economic advisors, as a recent Bloomberg article makes clear:

Economists aren’t shying away from joining Donald Trump’s administration and would be willing to pitch in if asked, according to former economic policy makers now in academia. […] Alan Krueger, who led the CEA in the White House of President Barack Obama from 2011 to 2013 before passing the torch to incumbent Jason Furman, suggested that it might be more of a matter of Trump not wanting many economists in his administration, rather than the other way around.

With the record of advice of the recent past, it will be difficult for economists to resume their role at the table of the powerful. Of course, US policy was not completely driven by economists, but then I can’t recall any dissatisfaction of economists from the early 2000s with the tax and trade policies of George W Bush. Yes, it was pointed out that the rich stood to benefit, but where was the connection to international trade?

Here is what I found on Greg Mankiw’s blog, written by Bob Frank who debates him (link):

While serving as chairman of the Council of Economic Advisers, Greg actively supported the Bush tax cuts targeted at top earners by arguing that the cuts would spur them to work harder. Greg would have been astonished to observe such a response from his colleagues at Harvard. Does he have a behavioral model that leads him to expect different behavior from high achievers in other occupations? Or does he have one that explains why any such differences consistently fail to reveal themselves in the data? In the absence of a plausible behavioral model backed by persuasive empirical evidence to the contrary, I stand by my conclusion that trickle-down theory is supported neither by economic theory nor by empirical evidence.

That to me seems like the typical economist of the early 2000s.

UPDATE JAN 11, 2017: Since Obama mentioned his job record in his farewell speech, I’d like to add another statistic which includes the latest data and comes from the BLS. Here is the number of employees in US manufacturing (in thousands):

manu

As you can see, there was an upward movement from 2010-2015, but that has fizzled out and the sector is on decline again. Again, this is not a good record for the average American. If the new jobs were not created in manufacturing, they must come from the service sector. But these jobs normally don’t pay so well. This is one of the crucial issues that the new administration might address – or paper over, using economists to confuse and mislead the public over what determines the size of the manufacturing sector and the rate of unemployment. We’ll have to wait and see.

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