Suppose we proposed giving President Obama the option to put modest tariffs, say 2-3 percent, on imports of various categories of goods and services, if he felt it was important for the economy. Every right-thinking person would denounce this as crude protectionism. The argument for the export-import bank is essentially the same as the argument for selective tariffs.
The big difference is that all sorts of people who would be among the protectionist denouncers are making the case for the Ex-Im Bank. Today’s effort comes from Joe Nocera.
His story begins, “In the real world, markets aren’t perfect.” He then goes on to tell us that the Ex-Im Bank doesn’t just help Boeing sell planes, it also helps thousands of small businesses export their goods.
Let’s get out President Obama’s selective tariffs. Suppose he imposes a 3 percent tariff on planes and aircraft parts. Defenders of the Obama tariffs will point out that this tariff is not only helping Boeing, but hundreds of small businesses that provides parts and services for these planes. See, in the real world, markets aren’t perfect.
We can point out that the government is actually making money off these tariffs, just like it does with the loans provided through the Ex-Im Bank, what’s the problem?
At this point our free traders would jumping up and down yelling that we are paying higher prices for planes because of the tariffs. The government may be making money, but consumers are paying the price.
That’s a good argument, but if our free traders have taken intro economics they would know that by diverting capital to the winners picked by the Ex-Im Bank, we are raising the price of capital for other firms. (Increased demand leads to higher prices.) This means that all the small businesses that are not privileged with subsidies from the Ex-Im Bank are now penalized by paying higher interest rates than would otherwise be the case.
In fact, we could actually treat interest rate subsidies and tariffs as interchangeable forms of protection. We can tell the plane and aircraft industry that it will have the option of either a 3 percent tariff on imports or a 3 percentage point reduction (this may not be the exact number) on the interest rate it pays on borrowing by getting loans through our protectionist bank. Is everybody happy now?
(In fairness, in the current economic environment of zero short-term interest rates and considerable unemployment, the impact of subsidized loans on borrowing costs for others would be essentially zero. However it is also easy to show that protectionist measures would increase output and employment in the current economy.)
Anyhow, it is possible to make an argument for the Ex-Im Bank, but it is an argument that people who like to boast about being free-traders should be embarrassed to make. See you at the Neanderthal dance.
Suppose we proposed giving President Obama the option to put modest tariffs, say 2-3 percent, on imports of various categories of goods and services, if he felt it was important for the economy. Every right-thinking person would denounce this as crude protectionism. The argument for the export-import bank is essentially the same as the argument for selective tariffs.
The big difference is that all sorts of people who would be among the protectionist denouncers are making the case for the Ex-Im Bank. Today’s effort comes from Joe Nocera.
His story begins, “In the real world, markets aren’t perfect.” He then goes on to tell us that the Ex-Im Bank doesn’t just help Boeing sell planes, it also helps thousands of small businesses export their goods.
Let’s get out President Obama’s selective tariffs. Suppose he imposes a 3 percent tariff on planes and aircraft parts. Defenders of the Obama tariffs will point out that this tariff is not only helping Boeing, but hundreds of small businesses that provides parts and services for these planes. See, in the real world, markets aren’t perfect.
We can point out that the government is actually making money off these tariffs, just like it does with the loans provided through the Ex-Im Bank, what’s the problem?
At this point our free traders would jumping up and down yelling that we are paying higher prices for planes because of the tariffs. The government may be making money, but consumers are paying the price.
That’s a good argument, but if our free traders have taken intro economics they would know that by diverting capital to the winners picked by the Ex-Im Bank, we are raising the price of capital for other firms. (Increased demand leads to higher prices.) This means that all the small businesses that are not privileged with subsidies from the Ex-Im Bank are now penalized by paying higher interest rates than would otherwise be the case.
In fact, we could actually treat interest rate subsidies and tariffs as interchangeable forms of protection. We can tell the plane and aircraft industry that it will have the option of either a 3 percent tariff on imports or a 3 percentage point reduction (this may not be the exact number) on the interest rate it pays on borrowing by getting loans through our protectionist bank. Is everybody happy now?
(In fairness, in the current economic environment of zero short-term interest rates and considerable unemployment, the impact of subsidized loans on borrowing costs for others would be essentially zero. However it is also easy to show that protectionist measures would increase output and employment in the current economy.)
Anyhow, it is possible to make an argument for the Ex-Im Bank, but it is an argument that people who like to boast about being free-traders should be embarrassed to make. See you at the Neanderthal dance.
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Every economist knows that when you put a 20 percent tariff on imported clothes it leads to inefficiency and corruption. For some reason they don’t seem to know that when you give out patent monopolies that can raise prices by 2000 percent or more above the free market price that it leads to big-time inefficiency and corruption.
Reality is working hard to teach economists. Today the Washington Post had an article reporting on how many hospitals appear to be profiting from a program that allows them to buy drugs at a discount from the patent protected price. The program is ostensibly designed to provide drugs to low-income people.
This sort of program would of course be unnecessary if drugs were sold in a free market. There would be no reason to establish complicated discount systems if drugs were selling for $5-$10 per prescription, as is generally the case for generic drugs. This would require an alternative mechanism for financing drug research, but folks who have heard of the National Institutes of Health know that alternative mechanisms exist. (Yes, NIH mostly does basic research, but that it a policy choice not a fact of nature.)
Every economist knows that when you put a 20 percent tariff on imported clothes it leads to inefficiency and corruption. For some reason they don’t seem to know that when you give out patent monopolies that can raise prices by 2000 percent or more above the free market price that it leads to big-time inefficiency and corruption.
Reality is working hard to teach economists. Today the Washington Post had an article reporting on how many hospitals appear to be profiting from a program that allows them to buy drugs at a discount from the patent protected price. The program is ostensibly designed to provide drugs to low-income people.
This sort of program would of course be unnecessary if drugs were sold in a free market. There would be no reason to establish complicated discount systems if drugs were selling for $5-$10 per prescription, as is generally the case for generic drugs. This would require an alternative mechanism for financing drug research, but folks who have heard of the National Institutes of Health know that alternative mechanisms exist. (Yes, NIH mostly does basic research, but that it a policy choice not a fact of nature.)
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The Washington Post had a piece discussing a proposal to increase access to child care. The piece told readers the proposal would cost $20 billion a year. It then added this could:
“be financed through a 0.2 percentage-point increase in payroll taxes, which advocates say equals $72.04 a year for the average female worker.”
While the $20 billion figure likely would mean little to most Post readers since few have much sense of how large this is relative to the budget or their tax bill, most readers likely have a clear idea of what a 0.2 percentage point increase in the payroll tax means. This simple addition to the article conveyed essential information to readers that would have been missed if the article had only reported the $20 billion figure.
Now why can’t news stories do this all the time?
Addendum: I see from comments that the calculation here almost certainly refers to the earnings of the median female worker and not the average. Thanks for catching this.
The Washington Post had a piece discussing a proposal to increase access to child care. The piece told readers the proposal would cost $20 billion a year. It then added this could:
“be financed through a 0.2 percentage-point increase in payroll taxes, which advocates say equals $72.04 a year for the average female worker.”
While the $20 billion figure likely would mean little to most Post readers since few have much sense of how large this is relative to the budget or their tax bill, most readers likely have a clear idea of what a 0.2 percentage point increase in the payroll tax means. This simple addition to the article conveyed essential information to readers that would have been missed if the article had only reported the $20 billion figure.
Now why can’t news stories do this all the time?
Addendum: I see from comments that the calculation here almost certainly refers to the earnings of the median female worker and not the average. Thanks for catching this.
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When economies have lots of excess capacity and idle workers, as is the case following a recession, they tend to grow very rapidly. When they are near their potential level of output growth tends to be slower.
This is why the United States economy was able to grow at a 5.6 percent rate in 1978 or a 7.3 percent rate in 1984. In both cases the economy was operating far below its potential so it had lots of room to grow simply to get back to potential. Once it reaches potential, an economy can only grow at the rate of labor force growth plus the rate of productivity growth.
If the Wall Street Journal understood this simple fact it might not have tried to imply that Japan faces some economic disaster because it is projected to have a lower rate of growth in 2015 than the other major western economies. Japan’s economy is much closer to its potential than most of the other economies on the list.
Japan’s unemployment rate is under 4.0 percent. And the percentage of prime age people (ages 25-54) who are employed is now 81.9 percent, 1.3 percentage points above the pre-recession level. By comparison in the United States employment among prime age workers is still down by 2.5 percentage points from pre-recession levels at 76.4 percent. Given this difference in where these economies are in relation to their potential output it would be very surprising if the U.S. economy were not growing more rapidly.
The piece also implies that a low growth rate is a major problem. Economists usually look at per capita GDP, that is why they generally think that Denmark is wealthier than Indonesia. Japan’s population is shrinking at the rate of roughly 0.1 percent annually. By contrast, the U.S. population is growing at a rate of 0.8 percent annually. This means that, on a per capita basis, the 1.0 percent growth projected for Japan is equivalent to 1.9 percent growth in the United States. That is roughly the long-run potential growth rate that many analysts now project for the United States.
When economies have lots of excess capacity and idle workers, as is the case following a recession, they tend to grow very rapidly. When they are near their potential level of output growth tends to be slower.
This is why the United States economy was able to grow at a 5.6 percent rate in 1978 or a 7.3 percent rate in 1984. In both cases the economy was operating far below its potential so it had lots of room to grow simply to get back to potential. Once it reaches potential, an economy can only grow at the rate of labor force growth plus the rate of productivity growth.
If the Wall Street Journal understood this simple fact it might not have tried to imply that Japan faces some economic disaster because it is projected to have a lower rate of growth in 2015 than the other major western economies. Japan’s economy is much closer to its potential than most of the other economies on the list.
Japan’s unemployment rate is under 4.0 percent. And the percentage of prime age people (ages 25-54) who are employed is now 81.9 percent, 1.3 percentage points above the pre-recession level. By comparison in the United States employment among prime age workers is still down by 2.5 percentage points from pre-recession levels at 76.4 percent. Given this difference in where these economies are in relation to their potential output it would be very surprising if the U.S. economy were not growing more rapidly.
The piece also implies that a low growth rate is a major problem. Economists usually look at per capita GDP, that is why they generally think that Denmark is wealthier than Indonesia. Japan’s population is shrinking at the rate of roughly 0.1 percent annually. By contrast, the U.S. population is growing at a rate of 0.8 percent annually. This means that, on a per capita basis, the 1.0 percent growth projected for Japan is equivalent to 1.9 percent growth in the United States. That is roughly the long-run potential growth rate that many analysts now project for the United States.
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We all know how hard it is for Wall Streeters to get by in a market economy, but can’t we try a little bit of tough love to see if we can’t wean them away from the public trough. The newest absurdity is the insurance policies that many large companies take out on their employees in order to game the tax system.
Many of us might have been led to believe that these “dead peasant” policies had been eliminated with a 2006 change in the tax law. But no, the NYT tells us that they are still there. Remarkably, the paper doesn’t understand the issues involved at all. It tells readers:
“But critics say it is immoral for companies to profit from the death of employees, while employees themselves do not directly benefit.”
Well some critics might be concerned about the morality of this practice, but the more obvious complaint is its economic absurdity. The article goes on:
“Companies and banks say earnings from the insurance policies are used to cover long-term health care, deferred compensation and pension obligations.”
Okay, that’s it — everything we need to know is right there. Insurance companies don’t give away money. Why are there “earnings” from these insurances policies that are available to “cover long-term health care, deferred compensation and pension obligations.” The answer is that these policies are tax subsidized.
The question then is why are taxpayers subsidizing such absurd insurance policies? If we want to subsidize “long-term health care, deferred compensation and pension obligations,” there is a very simple way to do it, subsidize long-term health care, deferred compensation and pension obligations. That way we would not waste money supporting the intermediaries who undoubtedly collect high fees and make high salaries and bonuses in the process.
Yes, but that would meet cutting out the insurance industry and we know the boys and girls in the industry can’t be expected to make their way in a market economy without a big helping hand from the government. At least they aren’t getting food stamps.
We all know how hard it is for Wall Streeters to get by in a market economy, but can’t we try a little bit of tough love to see if we can’t wean them away from the public trough. The newest absurdity is the insurance policies that many large companies take out on their employees in order to game the tax system.
Many of us might have been led to believe that these “dead peasant” policies had been eliminated with a 2006 change in the tax law. But no, the NYT tells us that they are still there. Remarkably, the paper doesn’t understand the issues involved at all. It tells readers:
“But critics say it is immoral for companies to profit from the death of employees, while employees themselves do not directly benefit.”
Well some critics might be concerned about the morality of this practice, but the more obvious complaint is its economic absurdity. The article goes on:
“Companies and banks say earnings from the insurance policies are used to cover long-term health care, deferred compensation and pension obligations.”
Okay, that’s it — everything we need to know is right there. Insurance companies don’t give away money. Why are there “earnings” from these insurances policies that are available to “cover long-term health care, deferred compensation and pension obligations.” The answer is that these policies are tax subsidized.
The question then is why are taxpayers subsidizing such absurd insurance policies? If we want to subsidize “long-term health care, deferred compensation and pension obligations,” there is a very simple way to do it, subsidize long-term health care, deferred compensation and pension obligations. That way we would not waste money supporting the intermediaries who undoubtedly collect high fees and make high salaries and bonuses in the process.
Yes, but that would meet cutting out the insurance industry and we know the boys and girls in the industry can’t be expected to make their way in a market economy without a big helping hand from the government. At least they aren’t getting food stamps.
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That’s basically the punch line in a column telling us Thomas Piketty is wrong to worry about rising inequality. After a long digression on motivations for saving among the very rich, Mankiw tells readers:
“When a family saves for future generations, it provides resources to finance capital investments, like the start-up of new businesses and the expansion of old ones. Greater capital, in turn, affects the earnings of both existing capital and workers.
“Because capital is subject to diminishing returns, an increase in its supply causes each unit of capital to earn less. And because increased capital raises labor productivity, workers enjoy higher wages. In other words, by saving rather than spending, those who leave an estate to their heirs induce an unintended redistribution of income from other owners of capital toward workers.”
To summarize, the story is that by saving rather than spending their money, rich people will make more capital available to firms to invest, thereby raising productivity and wages.
There are two important problems with this story. First, we are operating well below the economy’s potential level of output and are likely to remain below potential for many years into the future according to most projections. This is the story of “secular stagnation” that even folks like Larry Summers have embraced in recent years.
In a context of secular stagnation, more saving is harmful. If people save rather than consume there will be less demand in the economy and less employment. If we think that secular stagnation is likely to be a persistent problem, then the fact the rich save more of their money than everyone is bad news for the economy. It will slow growth and make us all poorer.
The other point is that moderate income and middle income people did actually use to save a larger share of their income. Back in the days when wages were keeping pace with productivity growth, savings rates were considerably higher than they have been in the last two decades when the wealthy got most of the benefits of growth. It tends to be the case that people save a larger share of their income when their income is rising rapidly. This means that we don’t need rich people to not spend. Moderate and middle income people will also save a substantial portion of their income during prosperous times.
That’s basically the punch line in a column telling us Thomas Piketty is wrong to worry about rising inequality. After a long digression on motivations for saving among the very rich, Mankiw tells readers:
“When a family saves for future generations, it provides resources to finance capital investments, like the start-up of new businesses and the expansion of old ones. Greater capital, in turn, affects the earnings of both existing capital and workers.
“Because capital is subject to diminishing returns, an increase in its supply causes each unit of capital to earn less. And because increased capital raises labor productivity, workers enjoy higher wages. In other words, by saving rather than spending, those who leave an estate to their heirs induce an unintended redistribution of income from other owners of capital toward workers.”
To summarize, the story is that by saving rather than spending their money, rich people will make more capital available to firms to invest, thereby raising productivity and wages.
There are two important problems with this story. First, we are operating well below the economy’s potential level of output and are likely to remain below potential for many years into the future according to most projections. This is the story of “secular stagnation” that even folks like Larry Summers have embraced in recent years.
In a context of secular stagnation, more saving is harmful. If people save rather than consume there will be less demand in the economy and less employment. If we think that secular stagnation is likely to be a persistent problem, then the fact the rich save more of their money than everyone is bad news for the economy. It will slow growth and make us all poorer.
The other point is that moderate income and middle income people did actually use to save a larger share of their income. Back in the days when wages were keeping pace with productivity growth, savings rates were considerably higher than they have been in the last two decades when the wealthy got most of the benefits of growth. It tends to be the case that people save a larger share of their income when their income is rising rapidly. This means that we don’t need rich people to not spend. Moderate and middle income people will also save a substantial portion of their income during prosperous times.
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Adam Davidson has an interesting piece in the NYT Magazine noting the rapid growth in the percentage of young adults who continue to live in their parents’ home well into their 20s. The main explanation for this shift is the deteriorating labor market prospects for young people. While the piece does note this fact and has some discussion of the causes, it would be worth going into the latter in a bit more detail.
The country has pursued a set of policies over the last three decades that have the effect of redistributing income upwards. The most important of these at the moment is the high unemployment policy being pursued by Congress. Congress decided that it wanted to rapidly reduce the budget deficit after the 2009 stimulus. This has slowed growth and prevented millions of workers from getting jobs. It has also meant that many workers with jobs are working fewer hours than they would like.
Perhaps most importantly, high unemployment substantially weakens the bargaining power of workers in the bottom half of the wage distribution (these are disproportionately younger workers), so that they end up with lower wages. (See my book with Jared Bernstein, Getting Back to Full Employment.) In short, the decision by Congress to run lower budget deficits has forced millions of young people to move back with their parents.
There are many other policy decisions that have also hurt the wages and job prospects of young people. The decision of the Clinton Administration to have a highly valued dollar back in the late 1990s led to a large trade deficit which is another major cause of high unemployment. The protection of doctors and other highly paid professionals from international competition raises the costs of health care and other services, thereby reducing the real wages of most workers.
And of course the massive government support of the financial sector, in the form of too big to fail services, bailouts, and tax subsidies (other industries are taxed more so that the financial industry can be taxed less), has come at the expense of the rest of the economy which might otherwise be better situated to employ young workers.
Anyhow, the tales in this piece are striking, as many young people continue to need substantial support from their parents at ages where they would have been on their own in prior decades. It is important to recognize the policies that led to this outcome.
Adam Davidson has an interesting piece in the NYT Magazine noting the rapid growth in the percentage of young adults who continue to live in their parents’ home well into their 20s. The main explanation for this shift is the deteriorating labor market prospects for young people. While the piece does note this fact and has some discussion of the causes, it would be worth going into the latter in a bit more detail.
The country has pursued a set of policies over the last three decades that have the effect of redistributing income upwards. The most important of these at the moment is the high unemployment policy being pursued by Congress. Congress decided that it wanted to rapidly reduce the budget deficit after the 2009 stimulus. This has slowed growth and prevented millions of workers from getting jobs. It has also meant that many workers with jobs are working fewer hours than they would like.
Perhaps most importantly, high unemployment substantially weakens the bargaining power of workers in the bottom half of the wage distribution (these are disproportionately younger workers), so that they end up with lower wages. (See my book with Jared Bernstein, Getting Back to Full Employment.) In short, the decision by Congress to run lower budget deficits has forced millions of young people to move back with their parents.
There are many other policy decisions that have also hurt the wages and job prospects of young people. The decision of the Clinton Administration to have a highly valued dollar back in the late 1990s led to a large trade deficit which is another major cause of high unemployment. The protection of doctors and other highly paid professionals from international competition raises the costs of health care and other services, thereby reducing the real wages of most workers.
And of course the massive government support of the financial sector, in the form of too big to fail services, bailouts, and tax subsidies (other industries are taxed more so that the financial industry can be taxed less), has come at the expense of the rest of the economy which might otherwise be better situated to employ young workers.
Anyhow, the tales in this piece are striking, as many young people continue to need substantial support from their parents at ages where they would have been on their own in prior decades. It is important to recognize the policies that led to this outcome.
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Steve Rattner has a column in the NYT in which he correctly argues that robots should not provide any reason for concern about future labor market prospects. As Rattner correctly points out, robots are just another form of productivity growth. As a general rule, productivity growth allows for rising living standards and more leisure. Rattner is also right to point out that productivity growth has actually been unusually slow in recent years, the opposite of the concern about robots destroying jobs.
Where Rattner goes wrong is in arguing that the gainers and losers in terms of labor market prospects have been determined by technology and globalization, as opposed to policies that have been designed to make some groups winners and some groups losers. This is very clear from examining the list of winning occupations on his chart. The highest, with median pay of $187,200 in 2012, is physicians. (Most other sources put the median pay of doctors at well over $200,000.) Our doctors are paid close to twice as much as their counterparts in other wealthy countries. This is primarily because we have a government policy of protecting them from both foreign and domestic competition.
Similarly people in finance can get enormous pay because the government grants large banks too-big-to-fail insurance, meaning it bails them out when their incompetence puts them into bankruptcy. (The I.M.F. recently estimated the size of this subsidy at $50 billion a year.) The government also subsidizes the industry by taxing other sectors more so that the financial sector can largely escape taxation.
Anyhow, Rattner is right that we need not fear productivity growth but he is wrong to claim that the winners and losers have been determined by the natural course of economic development as opposed to deliberate government policy.
Steve Rattner has a column in the NYT in which he correctly argues that robots should not provide any reason for concern about future labor market prospects. As Rattner correctly points out, robots are just another form of productivity growth. As a general rule, productivity growth allows for rising living standards and more leisure. Rattner is also right to point out that productivity growth has actually been unusually slow in recent years, the opposite of the concern about robots destroying jobs.
Where Rattner goes wrong is in arguing that the gainers and losers in terms of labor market prospects have been determined by technology and globalization, as opposed to policies that have been designed to make some groups winners and some groups losers. This is very clear from examining the list of winning occupations on his chart. The highest, with median pay of $187,200 in 2012, is physicians. (Most other sources put the median pay of doctors at well over $200,000.) Our doctors are paid close to twice as much as their counterparts in other wealthy countries. This is primarily because we have a government policy of protecting them from both foreign and domestic competition.
Similarly people in finance can get enormous pay because the government grants large banks too-big-to-fail insurance, meaning it bails them out when their incompetence puts them into bankruptcy. (The I.M.F. recently estimated the size of this subsidy at $50 billion a year.) The government also subsidizes the industry by taxing other sectors more so that the financial sector can largely escape taxation.
Anyhow, Rattner is right that we need not fear productivity growth but he is wrong to claim that the winners and losers have been determined by the natural course of economic development as opposed to deliberate government policy.
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The Washington Post noted Kentucky Senator Mitch McConnell’s efforts to block President Obama’s new proposal for reducing carbon dioxide emissions by closing coal plants. It told readers:
“coal is a major source of energy and jobs in McConnell’s state and in several others represented by Democratic senators who are seeking reelection this year.”
According to data from the Bureau of Labor Statistics Current Employment Situation survey, the coal industry employs 11,600 workers in Kentucky. This is equal to 0.6 percent of total employment (1,862,000). This puts Kentucky in second place to the 4.2 percent share in West Virginia, but in every other state represented by Democratic senators who are seeking reelection this year the share of employment in the coal industry is considerably less than in Kentucky.
Note: The share in West Virginia was corrected. The post originally said 1.6 percent.
The Washington Post noted Kentucky Senator Mitch McConnell’s efforts to block President Obama’s new proposal for reducing carbon dioxide emissions by closing coal plants. It told readers:
“coal is a major source of energy and jobs in McConnell’s state and in several others represented by Democratic senators who are seeking reelection this year.”
According to data from the Bureau of Labor Statistics Current Employment Situation survey, the coal industry employs 11,600 workers in Kentucky. This is equal to 0.6 percent of total employment (1,862,000). This puts Kentucky in second place to the 4.2 percent share in West Virginia, but in every other state represented by Democratic senators who are seeking reelection this year the share of employment in the coal industry is considerably less than in Kentucky.
Note: The share in West Virginia was corrected. The post originally said 1.6 percent.
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Paul Krugman may have misled readers of his blog yesterday with the comment:
“the trade balance is a macroeconomic phenomenon, determined by the excess of savings over investment.”
As an accounting identity the trade deficit is equal to the excess of national investment over national savings. However it would be wrong to conclude that the U.S. trade deficit is caused by our failure to save enough, especially in the current context where the economy is well below its potential level of output.
To take a simple example, suppose that we all become virtuous savers and reduce our consumption by an amount equal to 1 percent of GDP (@ $170 billion annually). This would reduce demand in the economy by $170 billion. In more normal times we might tell a story where this fall in demand would lead to a drop in interest rates, which would in turn spur additional investment. Lower interest rates should also lead to a lower valued dollar (fewer people want to hold dollar denominated assets at a lower interest rate). The lower valued dollar would lead to more exports (our goods are now cheaper to foreigners) and fewer imports (foreign goods are now relatively more expensive than domestically produced goods).
In this story, the end result is that we have the same level of output with higher levels of investment and net exports replacing the lost consumption. We have a somewhat higher level of national savings (the increased investment partially offset the rise in savings) and a lower trade deficit.
That would be the standard story of how a savings-investment balance determines the size of the trade deficit. However, no one can tell this story in today’s economy. If everyone started saving more as described above, it would mostly just lead to a fall in output and employment.
The reason is that the adjustment process would not come close to offsetting the loss in demand. With the short-term interest rate already at zero we would see no help there. Long-term rates could fall some, but the reduction in longer term rates would at best have a trivial effect on investment. The dollar may not move at all, both because interest rates will have changed little and also because many countries (yes, China is the biggest) have a policy of targeting the price of their currencies against the dollar. If market forces started to push the value of the dollar down against their currencies they would respond by buying more dollars to keep up the value of the dollar.
In this story, savings will actually rise by considerably less than the initial $170 billion increase in savings because GDP will have fallen. This means that people who had been saving instead find themselves unemployed and spending from past savings (dissaving). The government will also be saving less (running larger deficits), since it is collected less in taxes and paying out more in transfers like unemployment benefits. There would be some reduction in the trade deficit since at lower levels of GDP we buy less of everything, including imports, but for the most part the trade deficit and national savings balance is maintained by lower savings from the reduction in GDP offsetting most of the increased in intended savings.
By contrast, if foreign countries suddenly started buying more of our stuff (say the dollar fell by 20 percent) then we would see an increase in employment and output. This would lead to more savings as formerly unemployed workers get jobs and can now start putting money into the bank. Also government savings increases as increased employment means more taxes and less money paid out in transfers. The net effect is that a lower trade deficit leads to more net national savings.
When considering these accounting identities it is important to keep the stories on causation straight, otherwise you get some really bad policies. Paul Krugman of course knows this and has made the same point many times (here for example), but we must work hard to prevent confusion on the topic.
Note: link fixed, thanks Squeezed Turnip. Also, typo corrected.
Paul Krugman may have misled readers of his blog yesterday with the comment:
“the trade balance is a macroeconomic phenomenon, determined by the excess of savings over investment.”
As an accounting identity the trade deficit is equal to the excess of national investment over national savings. However it would be wrong to conclude that the U.S. trade deficit is caused by our failure to save enough, especially in the current context where the economy is well below its potential level of output.
To take a simple example, suppose that we all become virtuous savers and reduce our consumption by an amount equal to 1 percent of GDP (@ $170 billion annually). This would reduce demand in the economy by $170 billion. In more normal times we might tell a story where this fall in demand would lead to a drop in interest rates, which would in turn spur additional investment. Lower interest rates should also lead to a lower valued dollar (fewer people want to hold dollar denominated assets at a lower interest rate). The lower valued dollar would lead to more exports (our goods are now cheaper to foreigners) and fewer imports (foreign goods are now relatively more expensive than domestically produced goods).
In this story, the end result is that we have the same level of output with higher levels of investment and net exports replacing the lost consumption. We have a somewhat higher level of national savings (the increased investment partially offset the rise in savings) and a lower trade deficit.
That would be the standard story of how a savings-investment balance determines the size of the trade deficit. However, no one can tell this story in today’s economy. If everyone started saving more as described above, it would mostly just lead to a fall in output and employment.
The reason is that the adjustment process would not come close to offsetting the loss in demand. With the short-term interest rate already at zero we would see no help there. Long-term rates could fall some, but the reduction in longer term rates would at best have a trivial effect on investment. The dollar may not move at all, both because interest rates will have changed little and also because many countries (yes, China is the biggest) have a policy of targeting the price of their currencies against the dollar. If market forces started to push the value of the dollar down against their currencies they would respond by buying more dollars to keep up the value of the dollar.
In this story, savings will actually rise by considerably less than the initial $170 billion increase in savings because GDP will have fallen. This means that people who had been saving instead find themselves unemployed and spending from past savings (dissaving). The government will also be saving less (running larger deficits), since it is collected less in taxes and paying out more in transfers like unemployment benefits. There would be some reduction in the trade deficit since at lower levels of GDP we buy less of everything, including imports, but for the most part the trade deficit and national savings balance is maintained by lower savings from the reduction in GDP offsetting most of the increased in intended savings.
By contrast, if foreign countries suddenly started buying more of our stuff (say the dollar fell by 20 percent) then we would see an increase in employment and output. This would lead to more savings as formerly unemployed workers get jobs and can now start putting money into the bank. Also government savings increases as increased employment means more taxes and less money paid out in transfers. The net effect is that a lower trade deficit leads to more net national savings.
When considering these accounting identities it is important to keep the stories on causation straight, otherwise you get some really bad policies. Paul Krugman of course knows this and has made the same point many times (here for example), but we must work hard to prevent confusion on the topic.
Note: link fixed, thanks Squeezed Turnip. Also, typo corrected.
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