Category Archives: Trade

Whoever won the debate, economics lost


You lose

I try to avoid politics on this blog and keep it focused on economics but sometimes politics and politicians just won’t leave economics alone. When that happens you have a right and possibly a duty to check what they are saying. After watching last Monday night’s presidential debate between Hillary Clinton and Donald Trump, one thing we can say with depressing near certainty is that the next president of the United States will be almost totally clueless about economics.

Hillary Clinton

Investment vs spending

Hillary Clinton seems to have discovered Gordon Brown’s old trick of referring to every penny piece of government spending as ‘investment’. She would not be spending money on this, that, or the other, rather she would be investing money in this, that, or the other. “I want us to invest in you. I want us to invest in your future.”

But investment isn’t just another, cuddlier term for spending. It actually means something. When you invest you are spending money in such a way as to increase your future income. If a driving licence will enable you to get a high paying job then paying for driving lessons is investment. If you spend money on food and clothes, necessary as that me to keep you going in the here and now, it is consumption spending, it is not investment. There are greyish areas. A suit bought for a job interview is clothing and also an investment.

Government can invest but it often doesn’t do it very well. Look, for example, at the histories of Britain’s coal and steel industries. Both had vast sums of money lavished on them by government with the aid of dragging them into the late twentieth century. Almost all of that money was wasted, going on higher wages – consumption – rather than actual investment. But that’s politics. Miners and steelworkers vote. Modern machine tools don’t.

Simply put, an enterprise which, via the government, has access to taxpayer funding has no bottom line to worry about. They can be as inefficient as they like, they will be bailed out. And, yes, many banks are an example of this these days. Competitive businesses however, with access to no funds other than those which people will give them willingly (either as loans, investment, or payment for goods and services) have to worry about their bottom lines. They have an incentive to invest profitably, not in whichever direction is most expedient over the election cycle. And if they get it wrong, they carry the can, not the taxpayer, ie, you.

As an illustration, Clinton gave the politically popular area of renewable energy as an example of somewhere she’d invest: “Take clean energy. Some country is going to be the clean- energy superpower of the 21st century”. The experience of Solyndra – a politically well connected solar panel producer which took took $535 million of taxpayers money and went bust without producing a single solar panel – doesn’t bode well.

Tax the rich

Clinton claimed that she would be able to pay for all this ‘investment’ by taxing the rich. “Because what I have proposed…would not add a penny to the debt…What I have proposed would be paid for by raising taxes on the wealthy, because they have made all the gains in the economy. And I think it’s time that the wealthy and corporations paid their fair share to support this country.”

I’ve written before about the futility of British governments trying to wring a greater share of the national income out of the public in tax revenue: “Whether the top rate of income tax is 83%, as it was in the 1970s, or 40%, as it was in the years before 2010, the British people seem to have decided in some mysterious way that 35% of their income is all the government is going to get.”

Something similar applies in the United States. As you see in Figure 1, in the ten years 1972 to 1981 inclusive, the top rate of Federal income tax was 70%. Over those years the share of national income taken in by the Federal government in tax averaged 11.67%. Over the ten years from 2003 to 2012 inclusive the top rate of Federal income tax was half that level, 35%. And, over those years the share of national income taken in by the Federal government in tax averaged 9.83%: a difference of 1.84 percentage points.

Figure 1


Source: World Bank and the Tax Foundation

You can take any message you like out of Figure 1 depending on which bit you choose. The steep rate cut in 1982 was accompanied by a decline in the share of national income taken by the federal government, but the even steeper cuts of 1987 and 1988 were followed by no such decline. Rises in the top rate of federal income tax from 1991 to 1993 might have started the rise in the federal government’s share of national income beginning in 1993, but this rise continued until 2000, seven years after the rate stopped rising. Indeed, since then, if anything, it looks as though it is changes in the federal government’s share of national income which have led changes in tax rates.

Indeed, as Figure 2 shows, the share of the US national income taken by the federal government in tax seem more closely correlated, in recent years at least, with economic growth.

Figure 2


Source: World Bank and the Tax Foundation

The policy lesson would seem to be that if you want the government’s share of national income to rise you’re better off working to get the economy growing rather than tinkering with tax rates.

Clinton also blamed the housing boom and bust of the 2000s on the Bush tax cuts. “Well, let’s stop for a second and remember where we were eight years ago”, she said, “We had the worst financial crisis, the Great Recession, the worst since the 1930s. That was in large part because of tax policies that slashed taxes on the wealthy, failed to invest in the middle class, took their eyes off of Wall Street, and created a perfect storm.”

In am not aware of a serious economist, in their serious work at least, who thinks that tax cuts were even in part behind the housing bubble and its bursting. Indeed, there is a surprising amount of consensus that the causes were monetary, not fiscal.

Joseph Stiglitz has written that following the burst of the dot com boom in 2000

“…Greenspan lowered interest rates, flooding the market with liquidity…[the lower interest rates] worked – but only by replacing the tech bubble with a housing bubble, which supported a consumption and real estate boom”

Nouriel Roubini wrote

“The bubble eventually burst in 2000, and Greenspan’s Fed responded by slashing interest rates by 5.5 percentage points – from 6.5 percent to 1 percent – between 2001 and 2004. The rising tide of easy money helped cushion the bursting of the tech bubble, but it fed another bigger bubble in housing”

Thomas E Woods writes

“That year [June 2003 to June 2004] saw eleven rate cuts. The unsustainable dot-com boom could not, in the end, be reignited…But the Fed’s easy money and refusal to allow the recession of 2000 to take its course led to an even more perilous bubble elsewhere”

The gender wage gap and the minimum wage 

Beyond this, Clinton showed that she is interested in solving problems that aren’t problems and using solutions that aren’t solutions. Paradoxically, she claimed that, while cutting regulations for small businesses, “We also have to make the economy fairer. That starts with raising the national minimum wage and also guarantee, finally, equal pay for women’s work.”

As has been pointed out time and time again, the gender pay gap is a myth. The oft repeated charge that “the typical woman who works full-time earns 79 cents for every dollar that a typical man makes” is completely bogus. It is derived simply by taking a ratio of the difference between women’s median earnings and men’s median earnings: 21 cents. It takes absolutely no account whatsoever of the different types of work men and women do. When factors like that begin to be figured in the gap disappears.

Indeed, Clinton herself might not actually believe it. At one point in the debate she said “(Trump) doesn’t think women deserve equal pay unless they do as good a job as men”, leaving me asking “Well, what’s wrong with that?”

Clinton also said she would raise the federal minimum wage as part of an effort to help the middle class (a policy Trump also supports). It will do no such thing. Put briefly, if an employer estimates that a worker will add $8ph to their revenue, they will hire that worker at any wage up to $8ph as they will be adding more to their income (the revenue) than their costs (the wages) by doing so. If the minimum wage is raised so that that worker cannot now be hired at any wage less than $10ph, the employer will not hire them. Doing so will add more to costs (the wages) than to income (the revenue). No company that increases costs more than income will be around for very long.

All a raise in the minimum wage from the current $7.25ph to $10ph would do is lock out of the labour market workers whose contributions to turnover employers estimated at less than $10ph. These will be the lower skilled workers Clinton presumably seeks to help. As I wrote recently, one way to help these workers is to help them acquire the skills to raise employers expectations of what revenue they might generate. This is somewhere where genuine government investment could play a part.

Donald Trump

Corporate Tax

Indeed, the first bit of economic sense came from Donald Trump. “So what (companies are) doing is they’re leaving our country, and they’re, believe it or not, leaving because taxes are too high and because some of them have lots of money outside of our country.” He went on to argue that one way to bring them back is to lower the tax on corporate profits.

This makes sense. The United States has the third highest rate of corporate tax in the world. You can’t really blame companies which increasingly do business in multiple political jurisdictions for choosing to domicile in one that doesn’t take nearly four in every ten dollars profit they make.

Indeed, the tax should be abolished completely. Just because a tax is called a ‘corporate tax’ does not mean that corporations pay it. The incidence of the tax, ie, who the burden of paying for it actually falls on, is a different thing altogether. In reality, corporation tax is paid by either consumers, shareholders, or workers.

When tax on cigarettes are put up the cost is not paid by the tobacco companies in lower profits but by the addicted smokers in higher prices. The price elasticity of demand for the product is low so the producer can pass the full cost of the tax on to the consumer.

If the price elasticity of demand for a product is high, ie, an increase in its price will see consumers buying less of it, then the tax will be paid by either shareholders or workers. How the burden is split between these two categories depends on how many of each there are relative to the other. If there are lots of workers around, they will accept wages low enough to offset the burden of the corporate tax. By one estimate, the average share of the corporate tax burden borne by workers is 57.6% of the amount raised by the tax.

Monetary policy

Trump was also onto a winner with his comments about Federal Reserve monetary policy.

“Now, look, we have the worst revival of an economy since the Great Depression. And believe me: We’re in a bubble right now. And the only thing that looks good is the stock market, but if you raise interest rates even a little bit, that’s going to come crashing down.”

“We are in a big, fat, ugly bubble. And we better be awfully careful. And we have a Fed that’s doing political things. This Janet Yellen of the Fed. The Fed is doing political — by keeping the interest rates at this level. And believe me: The day Obama goes off, and he leaves, and goes out to the golf course for the rest of his life to play golf, when they raise interest rates, you’re going to see some very bad things happen, because the Fed is not doing their job. The Fed is being more political than Secretary Clinton.”

This echoes something I wrote three years ago

“As interest rates are lowered in response to an adverse shock investment, calculations change, especially when, like Alan Greenspan, those behind the policy publicly promise its continuance. To the extent that this fosters a wealth effect, consumption, as well as investment, may be stimulated. And this, in fact, is exactly the way the policy is supposed to work.

But the rates cannot stay that low indefinitely, nor, despite the jawboning by monetary policymakers, are they intended to. At some point they will rise. Again, this actually is the way the policy is supposed to work.

And when those rates do rise what happens to those marginal investors who made their decision when rates were at their lowest? What happened to the NINJAs who bought condos in Michigan when interest rates were 1 percent when the rates went up in 2006? They were scuppered. And what will happen to all the enterprises which are currently dependent on interest rates remaining at their historic lows when those rates start to rise? It is because more people are now asking that question that markets have turned skittish recently, since Ben Bernanke even began to discuss a possible future ‘tapering’ of Quantitative Easing.

Those rates will have to rise at some point. But, when they do, whichever bubble we have now will burst. Our monetary authorities have printed themselves into a corner.”

Shortly afterwards I wrote

“On Aug. 15, the London Telegraph reported that British retail sales had risen unexpectedly sharply and that American unemployment had fallen to a six-year low. This would usually be promising macroeconomic news, but that day major indexes—the Dow Jones Industrial Index, the S&P 500, the CAC 40, among others—tumbled. Markets, hooked on the Fed’s cheap liquidity cocktail, were terrified that an improving U.S. economy might see the punch bowl removed with a Fed “taper” of quantitative easing.

A day later, when the results of a U.S. consumer confidence survey came in “far worse than expected,” stock markets rallied. Markets are supposed to be driven by the expectations of a stock’s perceived profitability, not the pursuit of speculative gains caused by the manipulations of central bankers. Now the economy appears to be in a position where the interests of financial markets are precisely at odds with the interests of the rest of the economy.”

International trade

And then he went and blew it. “You look at what China is doing to our country in terms of making our product” he said, “They’re devaluing their currency, and there’s nobody in our government to fight them. And we have a very good fight. And we have a winning fight. Because they’re using our country as a piggy bank to rebuild China, and many other countries are doing the same thing.”

I recently wrote

Indeed, it is true that policymakers in Beijing have tried to keep the yuan weaker against the dollar that market forces might allow…But…this has not been a costless exercise for the Chinese.

By holding down the value of the yuan the Chinese government has held down the purchasing power of Chinese producers. This has effectively worked as a subsidy from Chinese producers, with an average GDP per capita of $14,100, to US consumers, with an average GDP per head of $56,000. If anyone should be angry about this arrangement, it should be Chinese producers.

Indeed, the argument that the Chinese have been using the US as a piggy bank to fund investment in China is exactly the wrong way round. Instead, the US has been using China as a piggy bank to fund American consumption.

Trump often talks of international trade as a struggle with winners and losers. But trade is not a zero sum game in which the benefits for one are offset exactly by losses for another. This fallacy, the root of much modern misguided economic rhetoric, is based, essentially, on the ancient misunderstanding that for two things to exchange for each other these things must have an equal value.

But logically that must be wrong. If I hand over £1.10 for a tuna sandwich I do so because I value the tuna sandwich at more than the £1.10. Conversely, the unnamed supermarket where I buy my lunch values the £1.10 more than the tuna sandwich. If I valued the tuna sandwich as much as I valued the £1.10, why would I exchange the latter for the former? I wouldn’t and the supermarket wouldn’t either. In fact, trade can only take place because people value things differently. ‘Value’ is not a property inherent in a product, it is entirely a function of the human mind and these value different things differently at different times and in different places. Value is entirely subjective.

It follows from this that people trade less valued things for more valued things. They accumulate value through trade. Both parties gain. Trade is a positive sum game.

The verdict

The United States has been woefully governed by both parties for a long time. On the strength of this debate, that won’t be changing for at least another four years.

Trump, the United States, and the bogeymen


Still there

“I know from a common sense financial standpoint that something has to burst. When a country is losing billions and billions and billions of dollars a year and when other countries are making hundreds of billions of dollars, something is going to burst” That was businessman Donald J. Trump on America’s trade deficit 27 years ago. It could be candidate Donald J. Trump on the trade deficit today.* The worry then, widely shared, was Japan. Now it is China. Now, as then, the worries are on the wrong side.

In the first half of the 1980s the dollar surged as a result of the Federal Reserve’s tight money to fight inflation. Partly as a consequence, Japanese imports poured into America and US companies lost market share. So pressured was America’s car industry that the Reagan administration forced Japan to agree to Voluntary Export Restraints. As the ill-fated Mr Takagi explained to John McClane in 1988’s Die Hard, “Pearl Harbor didn’t work so we got you with tape decks”

The Louvre Accord of 1985 ended this. Central banks worldwide agreed to boost their currencies against the dollar. Now, as the dollar/yen rate shifted the other way, Japanese capital poured into America buying iconic assets such as the Biltmore Hotel and the Mobil Building. There were worries about a “corporate Japanese takeover” of America.

And, in 1989, something burst but not, perhaps, what businessman Trump expected. To meet its Louvre Accord commitments the Bank of Japan brought its policy rate down from 7.44 per cent in November 1985 to 3.37 per cent in August 1987 and kept it there. This fuelled an asset price boom: in 1988 the land surrounding Japan’s Imperial Palace was said to be worth more than the whole of California. The Nikkei Stock Index rose from 22,621 in November 1987 to 38,130 in December 1989 when it accounted for more than one third of the world’s stock market capitalization.

But inflation eventually ticked up and the Bank of Japan acted. The policy rate was increased from four per cent to six per cent between March and August 1990, climbing to 8.15 per cent in February 1991. This popped the asset price bubble. By December 1990 the Nikkei was down to 23,470, reaching 17,390 in December 1992. House prices fell by two thirds and remain at that level today.

Today the worry is China. Candidate Trump frequently lambasts the Chinese for devaluing their currency. In 2014 he told the CPAC that “China, which I’ve been talking about for the last five years, yesterday, right in our face, they just devalued their currency…what they’re basically doing is saying ‘We’re really ripping you big league, nobody’s ever done it better than us, but now we’re going to really do it again’”, adding “they’re taking our jobs”

Indeed, it is true that policymakers in Beijing have tried to keep the yuan weaker against the dollar that market forces might allow. This has helped Chinese exporters. By extension it has also, some say, enabled China to buy ‘everything between Portland, Maine, and Portland, Oregon’, including Starwood Hotels and $1.2 trillion of US government debt.

But, as for the Japanese before them, this has not been a costless exercise for the Chinese.

By holding down the value of the yuan the Chinese government has held down the purchasing power of Chinese producers. This has effectively worked as a subsidy from Chinese producers, with an average GDP per capita of $14,100, to US consumers, with an average GDP per head of $56,000. If anyone should be angry about this arrangement, it should be Chinese producers.

What of concerns about China’s purchase of American assets? While some say that America is ‘hostage’ to China because of the vast debt it owes the People’s Republic, it is just as true to say that China is hostage to America for the same reason. In the event of a flashpoint between the two countries, the Chinese could dump their dollar assets, forcing US interest rates up. But the prices of China’s US bond holdings would tumble representing a capital loss for Beijing. As John Paul Getty put it, “If you owe the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s problem”

There is even less to worry about with tangible assets. If tension flares between America and China the Chinese owned AMC movie theatre in Inver Grove Heights, Minnesota, will still be in Inver Grove Heights, Minnesota, just as the once Japanese owned Biltmore Hotel is still there on LA’s South Grand Avenue and the Mobil Building is still at 150 East 42nd Street in Midtown Manhattan. When someone says that the Chinese have bought ‘everything between Portland, Maine, and Portland, Oregon’, remember that those things are still somewhere between Portland, Maine, and Portland, Oregon. They have not been shipped to China, only the paper claims on them have.

Finally, by pegging the yuan to the dollar Beijing has essentially been importing US monetary policy. As the US has expanded its money supply so has China. Debt, much of it bad, has increased in China to levels some analysts believe to be higher than in America on the eve of the subprime crisis. China’s empty cities, like the abandoned properties of Michigan a decade ago, are monuments to malinvestment. 

Free trade benefits both parties, they wouldn’t trade if it didn’t. But trade that is distorted by tariffs, quotas, and currency manipulation, can blow up horribly. “Something has to burst”, as a man once said but, as with Japan a quarter of a century ago, it might not be the Americans who should be most worried.

* As a sign of the topsy-turvy times, it could also be candidate Bernie Sanders