Why trade deals hurt Americans

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A small group of protesters shout at senate offices as they demonstrate against the Trans-Pacific Partnership (TPP) trade agreement REUTERS/Jonathan Ernst

John Komlos reflects upon our current trade deficit and opposes the Trans-Pacific Partnership trade agreement. Photo by REUTERS/Jonathan Ernst.

Now that the U.S. is negotiating the Trans-Pacific Partnership, a massive trade deal with a dozen Asian nations, as well as the Transatlantic Trade and Investment Partnership with the European Union, it is a good moment to reflect upon the disadvantages of our current foreign trade policy. Our nagging trade deficit is the elephant in the room that politicians, as well as economists, unfortunately prefer to neglect. The inconvenient truth is that we’ve been buying roughly half a trillion dollars’ worth of goods more from abroad than we are exporting and we have been doing so for decades. In 2014, our exports of goods and services amounted to $2.4 trillion, while our imports amounted to $2.9 trillion—implying that our deficit was a whopping $500 billion.

In fact, gross domestic product contracted in the first quarter of 2015 at an annual rate of 0.7 percent for this very reason: our deficit in trade in goods and services increased some $77 billion to reach a grand total of $563 billion. If the deficit had not increased but had remained at the previous quarter’s level, then GDP would have risen by 1.1 percent. That’s quite a difference. In other words, instead of talking about “growing the economy,” it is high time to do something about our nagging trade deficit, which weighs heavily on the economy.

Why is our trade deficit a problem? Because the deficit subtracts from U.S. GDP and hurts the lower middle class. By outsourcing jobs, it has relegated millions of U.S. workers—especially the low-skilled ones—to the underemployment rolls. As the country imports products it could have produced at home, the trade deficit relegates many more to poverty (45 million Americans), and to food stamps (46 million Americans), and to near poverty (another 15 million Americans). Welcome to the land of the American Dream.

The flood of imports has kept workers’ wages stagnant in the U.S. for decades and median household incomes declining—all at a time when importers like Wal-Mart and Apple are profiting tremendously from cheap overseas labor. While it costs only $2 to make bands for the Apple watch in Asia, those same bands retail at $49 in the U.S., making Apple a 96 percent profit. No wonder Apple has three times as much cash on hand as Uncle Sam. By shipping jobs overseas, companies make big profits, but deny Americans jobs. So yes, our trade policy is adding to inequality in the U.S.

These deficits add up. During the last two decades, our trade deficit has amounted to a stimulus package of no less than $10 trillion for the rest of the world. That is 12 times more than the “Obama stimulus” of 2009, though, unfortunately for us, it was spent not at home, but abroad. Just think what that kind of stimulus would have done for our economy! At a time when the U.S. is suffering from a jobless recovery—when we do not have nearly enough jobs for the people living in our own communities—it is foolhardy to stimulate the rest of the world by offshoring so many jobs.

It is no wonder then that China is growing in leaps and bounds with the injection of such stimulus. Last year our deficit with China alone was $342 billion—more than half of the total. Instead of buying consumer goods, which disappear quickly, they have been making investments, buying companies, such as their purchase of Smithfield Foods (for $4.7 billion), and real estate, such as their 99-year lease on Waldorf-Astoria (for $2 billion). That means that our income in the future will be lower as the profits of such enterprises will go to their bank accounts and not ours.

FLAWS IN CONVENTIONAL ECONOMIC THEORY

According to conventional economic theory, both sides benefit from the exchange of goods. But those famous theorems of comparative advantage are not working. Comparative advantage assumes that trade is beneficial, because if one country can make a product more efficiently and cheaper and exchange it for another product produced in another country that can make it cheaper, then both countries will benefit. By this logic, it pays for the U.S. to buy labor intensive goods, such as shirts from China, and it pays China to buy soybeans from U.S. farmers. This is all well, but the theory isn’t foolproof. It assumes that the workers who are displaced from their jobs in the contracting sectors will find employment in the expanding ones. An assumption that is hardly valid today. Displaced North Carolina textile workers do not have the credentials to work in the IT sector or on Wall Street, nor will they ever be able to acquire them. They will not have the capital or skills to start producing soybeans. And when trade leads to unemployment, the theory of comparative advantage no longer holds, and both sides fail to benefit as assumed in theory.

In conventional economic theory, the free market should resolve such trade imbalances by adjusting the exchange rates until the deficits vanish. But it has failed to do so, most notably, because China is eager to send us its products for I.O.U.s and has kept its currency artificially low so that its products remain inexpensive. That’s not a free market. That’s a rigged market. And we’ve stood by and allowed the rigging to continue. That’s not in the comparative advantage theory either.

Advocates of free trade often argue that America benefits from foreign trade. But in counting benefits, they add the dollars gained and dollars lost, without looking at who gained and who lost. So if one person gains $10 million dollars and 300 people lose $30,000 each (for a total loss of $9 million) that would be counted as a gain of $1 million, even though those who lost money outnumber those who gained by 300 to 1. That does not sound very democratic. And of course, if the $10 million goes to someone who is already a millionaire, his or her life-satisfaction would not increase substantially, but for the 300 people who lost money, their losses could very well be their livelihoods and mean a devastating decline in their living standard. The accounting of gains and losses should be done in a more democratic fashion.

The buy-now-pay-later strategy has been a weapon of mass destruction across the Rust Belt, destroying neighborhoods and annihilating millions of jobs. Detroit and Baltimore are two key examples. As a trophy of urban blight there are now 17,000 homes (or 8 percent of the housing stock) unfit for habitation and abandoned in Baltimore. Detroit has 70,000 abandoned houses and 90,000 vacant lots, and 40 percent of the street lights do not work. The Soviet Union was not powerful enough to do such damage; nor were our other enemies, the Empire of Japan or the Third Reich. China, however, has outsmarted U.S. by turning our capitalist-free trade ideology into a weapon against us. A brilliant move for which we were unprepared—welcome to real world economics.

GEOPOLITICAL IMPLICATIONS AND THE THREAT OF CHINA

As a consequence of our deficits, China has amassed a surplus of foreign assets in value of $4 trillion. As expected, the country is translating that wealth into economic power—see the Asian Infrastructure Investment Bank—and military power—see their activity in the South China Sea. In other words, our trade deficits have geopolitical implications as well, and it’s being overlooked by the policymakers in Washington. The U.S. has strengthened an adversary, which like most rising economic powers, Germany in the 1900s, Japan in the 1930s and the Soviet Union after World War II, is already using that power for sabre rattling to enhance its place in the firmament of stars.

The conflict is fueled by U.S. thirst for cheap consumer goods on credit. This is not a phantom threat. In May, a newspaper owned by the Communist Party wrote brazenly that “war was ‘inevitable’ between China and the U.S. unless Washington stopped demanding Beijing halt the building of artificial islands” in the South China Sea. The article continued: “’risks are still under control’ if Washington takes into account China’s peaceful rise. ‘We do not want a military conflict with the United States, but if it were to come, we have to accept it.’” Déjà vu.

Needless to say, both sides have a lot to lose from a confrontation in either cyberspace or in the South China Sea. Given our cultural and political differences it will not be easy for either side to back down. Although no one is saying that conflict is inevitable, we have to come to terms with this problem by discussing it seriously. The threat of a potential misunderstanding is looming in the background. The fact that the plans for the Trans-Pacific Partnership excludes China is misconceived. As China feels more isolated, it may well become even more assertive, forging a strategic alliance with Russia, which would exacerbate international tensions even further. A Pacific Partnership that excludes China is an unfriendly act and will be interpreted as such.

A SOLUTION TO OUR NAGGING TRADE DEFICITS

Fortunately, a solution to the chronic problem of our trade deficits exists, although it has been nearly forgotten. The famous investor Warren Buffett warned us more than a decade ago to “halt this trading of assets for consumables.” He proposed an ingenious way to fix the problem without raising tariffs and without singling out China or any other nation. Buffet argued that the U.S. government should issue import certificates to all exporters in amounts equal to the value of their exported goods. In turn, the exporters could sell these certificates to importers who would not be allowed to import goods without them. By establishing a market for import certificates, firms would have powerful incentives to bring the trade deficit into balance. Importers would have to buy the certificates in appropriate amounts from our exporters and a market in certificates would make our trade deficit disappear.

In addition, the price of our exported goods would decline depending on the amount that exporters received for the certificates from importers. This would give U.S. firms an advantage in finding new buyers abroad. Implicitly, importing firms would pay an export subsidy. U.S. companies would find it easier to export their products and therefore, could afford to hire many of the underemployed and unemployed. This would be real job creation at last—beyond worn-out slogans.

If we use the rule-of-thumb that $1 million worth of exports creates roughly 5 jobs in the U.S., then the elimination of the $500 billion deficit would create some 2.5 million jobs. Not bad for starters. The income of the new workers would also generate new government tax revenues and ease the budget deficit. Additional jobs would be created through the multiplier effect, as these newly employed workers spend their money, that money filters through the economy to become other people’s income.

Importantly, our trading partners would not have the means to retaliate, because if they tried to import less from us, their own exports would automatically and simultaneously decline. It would not pay for them to try to hurt us. We would be merely mimicking the workings of the free market and doing what it is supposed to do, namely, bringing the external balance back into equilibrium.

Admittedly the price of some imports might increase somewhat depending on the price of the certificates. But note that the gains would be concentrated among the underemployed who desperately need a break, while the inconveniences would be diffused through the rest of the population. This would be a tiny price to pay for giving the underemployed new opportunities and taking a step toward a fairer economy. The question is: would you be willing to pay an extra dollar for a shirt in order to end this jobless recovery?

A more nuanced version of the import certificate policy could allow for some modifications. There could be exemptions for strategic products, such as oil that could be imported without a certificate. We could also have “threshold values” so small importers could be exempted. Additionally, the policy could be phased in over a number of years to give everyone time to gain experience with the certificate market. The point is, we need to recognize that our current trade policy is hurting us and start doing something about it.

Shortly after Buffett’s publication, two U.S. senators introduced a bill to turn a certificate market into law, but it went nowhere. The fast-track trading authority that Congress just handed the President is in actuality, a fast track to nowhere. It does not allow amendments to the trade agreements being negotiated. Such a take it or leave it option is not congenial to a democratic process and will not make sure that no one is hurt by the agreement. Before passing the final agreement, Congress should do something about the pestering and festering problem of our endemic deficits and end what Buffett referred to as an exchange of assets for consumables.

We know that standard economic theory is not working. We know very well that slogans about growing the economy are not working. We know that the U.S. underemployment rate is still 11 percent and among African Americans it’s about 22 percent. We know that median household income has shrunk by $5,000 since 1999. We know that the economy shrank in the first quarter of this year. How long are we going to wait before we actually do something about it? It’s high time to stop stimulating the rest of the world’s economy with our dollars. We need to keep the purchasing power at home, which will create millions of jobs. Giving the President fast-track authority to negotiate the Trans-Pacific Partnership is a dead-end policy. Instead, Congress should insist on fair trade that is balanced trade.

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