July 04, 2016
Paul Krugman has again waded into trade and employment turf in his latest blog post. I agree completely with the post-Great Recession story where Krugman acknowledges that the trade deficit creates a demand gap that we have not been able to fill.
The problem is that fiscal policy is limited by a bizarre austerity cult that works to prevent larger budget deficits even though the economy clearly needs them to reach full employment levels of output. Monetary policy has been helpful, but with the Fed up against the zero lower bound there is not much more the Fed can do by way of traditional monetary policy to boost the economy. As a result, the trade deficit really does mean lost jobs.
Where I differ with Krugman is in his assessment that the trade deficit did not cost the economy jobs in the pre-recession period. He argues that we were pretty much at full employment in the period prior to the 2008 recession.
“Up through 2007 we basically had a Fed which raised rates whenever it thought the economy was overheating; in the absence of the China shock it would have raised rates sooner and faster…”
Just to refresh folks’ memory, the unemployment rate was 4.0 percent as a year-round average in 2000. In the recovery, we bottomed out at 4.4 percent for several months in 2006 and 2007, although we didn’t get back below 5.0 percent until the end of 2005. But the unemployment rate doesn’t really tell the whole story.
The employment rate for prime age men (ages 25–54) peaked at 89.5 percent at the start of 2000. In the recovery, it never crossed 88.0 percent. When the recession hit at the end of 2007 it was at 87.2 percent, more than two full percentage points below its 2000 peak. This gap corresponds to a drop in employment among this group of more than 1 million.
There are two stories we can tell about this drop. The first and simplest story is that we still had a serious demand gap even at the peak of the 2001–2007 business cycle, leaving more than 1 million prime age men unemployed. Adding in the drop in employment among prime age women would put the shortfall in employment at more than 2 million. The other story is that structural changes in the U.S. economy, like competition from low cost manufactured goods from China, made 1 million prime aged men permanently unemployed by eliminating the demand for their labor. Neither of these stories look very good from the standpoint of those who want to minimize the impact of trade.
If we accept the second story, then trade has had a direct and devastating effect on a large number of workers. Imagine being 45 with no hope of ever being able to find a job again. And this really is a loss of total jobs story since the implication is that these people are permanently unemployable.
In this case the jobs aren’t just shifted, otherwise qualified workers have now become unqualified. It is important to remember that much of this story can be regional. The loss of manufacturing jobs in Detroit and St. Louis means declining retail sales and tax revenue. This means that workers in these sectors lose their jobs as well. And, a weak labor market means lower wages for those still employed, but that is another issue.
The other story, the demand story, is that we were unable to fill the demand gap created by the trade deficit even prior to the Great Recession. On the fiscal side, the austerity cultists were calling the shots even back then. The Very Serious People were at the peak of their power and demanding steps to reduce budget deficits. The leadership of both parties claimed to share this commitment.
In terms of Fed actions, most folks thought lowering the federal funds rate to 1.0 percent was about as good as you could do. Remember, prior to the 2001 recession the federal funds rate had not been lower than 3.0 percent for almost 40 years. The difference between 1.0 percent and zero is not all that much. (Remember, the European Central Bank didn’t lower its short-term interest rate below 1.0 percent until the middle of 2012.) Many thought, possibly correctly, that the unease caused by a further lowering of the federal funds rate would have exceeded whatever benefit was obtained from a further rate reduction.
Regardless of the cause, the data speak for themselves. We didn’t get back the jobs lost in the 2001 recession until January of 2005. This was at the time the longest period without positive net job growth since the Great Depression. In short, it was not easy to replace the jobs lost to the trade deficit even before the Great Recession. This was a big deal for the economy and labor market which we should not ignore just because Donald Trump is the one raising it as an issue.
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