The Economic Nationalist

Robert J. Samuelson is a good egg. The man could hardly be wronger on the issue of foreign trade, but he develops his theses logically and concisely and offers plenty of relevant data, thus always affording opponents like me a fair opportunity to argue against him.

Today’s Samuelson article appears in the Washington Post.

WASHINGTON — It’s our versatile villain. Globalization has served as a whipping boy for politicians of both parties and legions of pundits. We blame it for all manner of grievances: lost jobs, greater inequality, shoddy goods. But take this quiz as a reality check. What explains the resilience of the U.S. economy in the face of the deepening housing collapse? (a) Ben Bernanke’s deft management of the Federal Reserve; (b) the tireless spending of consumers; (c) low inflation; or (d) foreign trade.

The best answer is (d).

Maybe. Mr. Samuelson is quite right to deprecate “(b) the tireless spending of consumers” as a cause of economic resilience, but his list of options is materially incomplete. What about (e) the reactivation of idle U.S. industrial plant? Mr. Samuelson might object that my option (e) were not of the same species as his options (a), (b), (c) and (d)—and he would be right in this—but his own options (a), (b), (c) and (d) are not of the same species as one another, either.

The trade deficit has been rising for so long that people forget that it can also fall. Well, it has — to good effect.

During the long years in which the trade deficit was rising, did not free traders repeatedly remind us that that was all right; that the deficit didn’t much matter? But now that the deficit is falling, Mr. Samuelson tells us that it does matter? Which is it? I’m confused.

Through August, the deficit in 2007 was $472 billion, down $46 billion (9 percent) from the same period in 2006. In the second quarter, the U.S. economy expanded at an annual rate of 3.8 percent, even though housing subtracted 0.6 percentage points from growth. But the improved trade balance added 1.3 percentage points, notes economist Edward Yardeni.

Caterpillar, a mega-exporter, exemplifies the turnaround.

But if it’s a “turnaround,” then who was it that created the situation that needed to be turned around? Was it not the free traders?

From 2004 to 2006, its exports rose 44 percent to $10.5 billion. Since the start of 2006, Caterpillar says it has hired more than 11,000 new U.S. production workers. None of this guarantees that a U.S. export boom will prevent an American recession. But the mere possibility suggests that we need to be smarter about globalization — and not simply to parrot popular stereotypes.

In this and other articles of his, Mr. Samuelson seems determined to draw from any data whatsoever the false lesson that globalization were good and protection were bad. The hiring of 11,000 new U.S. production workers at Caterpillar is excellent news, and I hope very much that the trend continues. Go Caterpillar! However, the very existence of a trade deficit tends to imply that foreign manufacturers had captured more of our markets than our manufacturers had of theirs. That is, of the two trade markets in play, the one we give away is bigger than the one we get. Mr. Samuelson seems determined not to grasp fully this basic point.

Now, I want to say: I do understand the economic law of comparative advantage; and I agree with Mr. Samuelson that the law is largely correct. What Mr. Samuelson will not admit is that tariffed trade realizes most of the benefits of comparative advantage he seeks, without decimating America’s industrial base in the process.

Contrary to popular opinion, the trade balance (deficit or surplus) barely affects total U.S. employment over long periods. Domestic job creation and destruction ultimately overwhelm trade’s effects. From 1991 to 2006, the trade deficit rose from $31 billion to $759 billion. In the same period, payroll jobs increased by 28 million and the unemployment rate fell from 6.8 percent to 4.6 percent.

I’m confused again, Mr. Samuelson. I thought that the falling trade deficit was good. Now it doesn’t really matter?

Actually, I am not confused, only Mr. Samuelson is confusing the issue. Absent strong artificial restraints, labor markets have always cleared in the long term (the Great Depression notwithstanding), which Mr. Samuelson knows. The question is not whether labor markets will clear, but at how low a wage level. This is where trade comes in.

But trade — like any form of competition — does affect specific workers. Those vulnerable to imports naturally want to save their jobs, even if open trade is good for the country as a whole (it broadens choices, reduces prices).

No argument here. Mr. Samuelson is correct. But here comes the wake-up gong:

Although protectionism is a logical response, it’s too late.

Now he tells us?

Startled by the loud noise of the gong, perhaps, Mr. Samuelson retreats half a step, then turns to deflect an arrow shot from the bow of organized U.S. industrial labor:

The right time would have been 30 years ago before the trade deficit exploded. Those jobs are now gone, and most aren’t coming back.

So, we should now do more of what caused those jobs to disappear in the first place?

Perversely, being anti-trade today will weaken the employment prospects of trade sensitive industries.

True.

A case in point: The Bush administration has proposed “free-trade agreements” with Peru, Panama, Colombia and South Korea. Together, they would modestly bolster U.S. exports.

And modestly suppress domestic sales. Mr. Samuelson forgets to mention this.

In today’s anti-trade climate, none has yet passed Congress.

That should have been, “(f) In today’s anti-trade climate, none has yet passed Congress.” Has it not occurred to Mr. Samuelson that the failure to pass of these very “free-trade agreements” might help to explain “the resilience of the U.S. economy in the face of the deepening housing collapse?” Admittedly, Mr. Samuelson would probably object that the “free-trade agreements” in question were too small to explain much of anything; but, if so, then why the rush to pass them?

The shrinking trade deficit reflects two realities. First, the dollar has depreciated. Since 2002, it’s down 21 percent against a basket of 26 currencies. That makes U.S. exports cheaper abroad and foreign imports more expensive here….

This is the central point, and Mr. Samuelson finally reaches it here. The dollar has indeed depreciated. It is true that letting the dollar depreciate is one way to balance trade accounts. It just is not a very good way. The other way—the traditional American way, under which the U.S. rose from an agrarian backwater in 1812 to become by 1939 the mightiest industrial power the world had ever seen—is to keep the dollar strong by transferring a substantial fraction of the federal tax burden from domestic producers to importers. This is done by means of a tariff, and the U.S. has at least 127 years of solid, practical experience to show how well the tariff actually does what it is designed to do (the persistently misinterpreted Smoot-Hawley tariff of 1930—Franklin D. Roosevelt’s scapegoat for his own incompetent exacerbation and prolongation of the Great Depression—notwithstanding).

If the choice is whether (i) to balance trade accounts on a weak dollar while burdening domestic production with income taxes; or (ii) to balance trade accounts on a strong dollar while bolstering domestic production with tariffs; then this writer leaves it to the reader to judge which is the wiser.

“At a time of subdued U.S. consumption,” [economist Jim O’Neill of Goldman Sachs] writes, “the world is helping the U.S. economy.”

This of course is welcome. We need all the help we can get. The next time the world is hurting the U.S. economy, I wonder if Messrs. Samuelson and O’Neill will remember that they said this.

There is a larger lesson. We wrongly blame globalization for much that ails us. It’s easier to denounce faceless forces beyond our borders. But globalization is not, as another IMF study shows, the chief culprit in rising economic inequality. New technologies probably deserve that distinction by widening pay gaps between skilled and unskilled workers.

This is a good point. Mr. Samuelson states it well.

On globalization, we should focus on the right worries. China’s currency remains undervalued; that’s a problem.

No. China’s currency is China’s business. Our currency is our business.

Not everything Mr. Samuelson writes is to be argued against. His next words are largely wise ones:

The swollen U.S. trade deficits have long been a legitimate anxiety. Would the flood of dollars overseas trigger a currency crisis, as global investors dumped the dollar, causing a sharp depreciation and disrupting well-established trade and investment patterns? Against these doomsday possibilities, a gradual dollar depreciation and decline of the U.S. trade deficit would be reassuring. But the crucial word is gradual. Abrupt changes could wreak enormous economic damage.

Abrupt changes could indeed wreak enormous economic damage, but though Mr. Samuelson’s diagnosis is literally right his interpretation and prescription are somewhat mistaken. Mr. Samuelson observes correctly that the excessive number of U.S. dollars in foreign hands poses a threat to U.S. economic stability, but he then fails to ask himself the connected question: how did such an excessive number of U.S. dollars accumulate in those foreign hands in the first place? How did we become so vulnerable? Was it not through the practice of free trade?

A decline in the value of the dollar, the bitter fruit of decades of an ill advised adherence to an extreme free-trade ideology, has long seemed likely to economic nationalists to occur; and though I could not have predicted when the decline would occur I surely am not surprised to see it happening now. Further decline in the medium term may now indeed be inevitable. However, in addition to a gradual depreciation of the U.S. dollar we ought also to seek a gradual appreciation of U.S. tariff rates—that is, a gradual transfer of the U.S. federal tax burden from domestic producers to importers—to be followed in due time by a gradual recovery of the U.S. dollar. Indeed, as Mr. Samuelson writes, “the crucial word is gradual,” but Mr. Samuelson should not be so dismal; he should perk up, let go of the fanatical free-trade ideology, and start planning for a strong dollar’s eventual recovery under a restoration of traditional, 1812–1939-style U.S. tariffs.

I would hope that Mr. Samuelson would agree that one bolsters economic confidence in a thing by making it more valuable, not less. The U.S. dollar is no exception. International confidence in the dollar should never have become a major concern of ours, but however it has come to pass, international confidence in the dollar is in fact a major concern of ours now. Mr. Samuelson however views the problem backward. I suggest to Mr. Samuelson that the best way by far to bolster international confidence in the dollar is to assure the foreigners who hold excess dollars that the U.S. means soon substantially to increase its manufacturing of attractive exportable goods that those strong dollars will be able to buy, which weaker currencies cannot so easily afford. And the best way to achieve industrial recovery with a strong dollar is through a tariff.

And, incidentally, over the long term, a traditional, moderately high level of U.S. tariffs would bring most of those excess dollars back home (because foreigners would buy with them American manufactures they want)—while permanently preserving the dollar’s now slipping status as the international reserve currency (which Mr. Samuelson’s plan fails to do)—such that Americans need not worry about potential economic instability caused by excessive foreign dollar holdings, the next time global economic crisis threatened. (Dollars held abroad as central bank reserves are not excessive holdings so long as the dollar remains strong; they serve the role in those countries that the gold in Ft. Knox used to serve in our country, while incidentally ensuring that American citizens find that their dollars continue to be accepted as payment almost anywhere in the world, any time, for any purpose, at a favorable rate of exchange. And if the U.S. dollar grows so strong that some foreign central banks find that they can do with fewer dollars as reserves, so much the better; the newly excess dollars can then buy U.S. manufactures and thus come home. The U.S. dollar cannot serve an effective reserve role abroad at all, however, once its value has collapsed.)

All the ritualistic denunciations of globalization are not harmless. Psychology matters. If global investors fear that the United States might make its economy less open to foreign trade and investment, the result might be the very dollar panic that everyone fears. The dollar’s status as the world’s central international currency depends on its usefulness in buying and selling. The more we restrict, the less useful it becomes. Globalization’s casual bashers should remember that. They think they’re playing only to a domestic audience, but the world is listening, and it may not like what it hears.

All right, Mr. Samuelson. Fair enough. But I ask you: why are Americans now in a position that we must worry so much about the psychology of foreigners? Who got us into this fix in the first place? Was it not the free traders? And if it was the free traders, then why should we heed their advice now?

Free trade is not free. It comes at a price. In a roundabout sort of way, economists like Mr. Samuelson are finally coming to acknowledge the fact. It is too bad for those economists that in the process, as a community, they have so deservedly blighted their own collective reputation for sound judgment, but this they have brought freely upon themselves. In the meantime, maybe, just maybe, the political wheel really has turned, and the era of inept political dominance by the extreme ideology of liberal free trade is finally, at long last, drawing to a close.

HJH

This entry was posted on Wednesday, October 24th, 2007 at 3:17 pm and is filed under Trade. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.