The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.

Authors for macroblog are Dave Altig, John Robertson, and other Atlanta Fed economists and researchers.

November 01, 2019

New Evidence Points to Mounting Trade Policy Effects on U.S. Business Activity

Trade worries remain at the forefront of economic news. Average tariffs on Chinese imports now stand at 21 percent, up from 3 percent in March 2018. Earlier this month, President Trump suspended plans for further tariff hikes on Chinese goods. Also this month, the U.S. is rolling out new tariffs on $7.5 billion worth of imports from Europe. On another front, fears are growing that Congress may not approve the U.S.-Mexico-Canada Trade Agreement, the intended successor to the North American Free Trade Agreement. Data from the folks at policyuncertainty.com say that articles about trade policy uncertainty in U.S. newspapers were more than 10 times as numerous in the third quarter of 2019 as the average from 1985 to 2010.

Trade policy worries extend beyond the newswires. We hear concerns about trade policy in reports from Main Street firms in the Sixth District collected through our Regional Economic Information Network and, more broadly, in the Federal Reserve's Beige Book. Amid reports of softening manufacturing conditions in the U.S., slowing growth in payroll employment, and a drop-off in business investment, it's natural to wonder whether trade policy is at least partly to blame. Professional forecasters seem to think so. For instance, the International Monetary Fund (IMF) forecasts that the U.S.-China trade dispute will shave roughly three-fourths of a percent from global output by 2020, which, as the IMF's managing director noted, is "equivalent to the whole economy of Switzerland."

Over the past year and a half, we have been keenly interested in how trade policy worries affect business decision making. In August 2018, we reported that trade concerns prompted about 1 in 5 firms to re-evaluate their capital investment decisions. At the same time, only 6 percent of the firms in our sample had then decided to cut or defer previously planned capital expenditures in response to trade policy developments. Early this year, we noted that the hit to aggregate investment from trade tensions and tariff worries was modest in 2018, but firms believed the impact would increase in 2019.

As U.S.-China trade tensions escalated during the third quarter of this year, we went back into the field, posing another set of trade-related questions to panelists in our Survey of Business Uncertainty (SBU). This time around, we asked both backward- and forward-looking questions about the perceived effects of trade policy, and we expanded the scope of our questions to cover employment and sales in addition to capital expenditures.

Overall, our results say that the negative effects of trade policy developments on U.S. business activity have grown over time, particularly for firms with an international reach. Trade policy effects on the business sector as a whole remain modest but larger than we saw six or 12 months ago.

Twelve percent of surveyed firms reported cutting or postponing capital expenditures in the first six months of 2019 because of trade tensions and tariff worries (see exhibit 1). That's twice the share when we asked the same question a year earlier. Given the capital-intensive nature of manufacturing, it is perhaps more concerning that one in five manufacturing firms now report cutting or postponing capital expenditures because of trade policy tensions.

Exhibit 1: Share of Firms that Cut or Postponed Capital Expenditures in the First Half of 2019 Because of Tariff Worries

We also find that tariff hikes and trade policy tensions now exert a larger negative impact on gross U.S. business investment. Exhibit 2 uses SBU data on whether firms changed their capital expenditures due to trade policy tensions and, if so, by how much and in which direction. Column (1) reports the average percentage impact in the sample, where we weight each firm's response by its capital stock value. To estimate the dollar impact of trade policy developments in column (2), we multiply the weighted-average percent change by actual U.S. business investment in the first half of 2019, which yields an estimated effect on U.S. business investment of about minus $40 billion.

This estimated trade policy hit to aggregate investment is modest but roughly double what we previously found for the second half of 2018. Our results say that investment is hardest hit in manufacturing and construction, though perhaps for different reasons. The larger response for manufacturing is likely due to its higher international exposure, both in direct goods trade and across the supply chain. For construction, the impact is likely due to an increased cost of imported materials and equipment.

Exhibit 2: Estimated Impact of Tariff Hikes and Trade Policy Tensions on Capital Investment Expenditures by U.S. Businesses in First Half of 2019

Exhibit 3 reports the estimated effects of tariff hikes and trade policy tensions on private sector employment and sales in the first half of 2019. According to our results (reached by using the same procedure as in Exhibit 2), these developments subtracted about 40,000 jobs per month from nonfarm payrolls and about $259 billion in sales over the first half of the year. Though this employment impact is sizable, it is not estimated very precisely (one standard error corresponds to about 24,000 jobs per month). The estimates for the impact of tariff hikes and trade policy tensions imply about $110,000 in lost sales per lost job.

Exhibit 3: Estimated Impact of Tariff Hikes and Trade Policy Tensions on Employment and Sales Growth in the First Half of 2019

Notes on Exhibit 3: In Panel A, column (1) reports the employment-weighted mean response to questions about whether tariff hikes and trade policy tensions caused the firm to alter its employment level in the first half of 2019 and, if so, by what percentage amount. We deleted three questionable responses to the employment question that we could not verify. To obtain the aggregate employment impact in column (2), we multiplied the column (1) value by the average nonfarm private sector payroll employment in the first half of 2019. The "Reweighted" row reflects a re-weighting of the SBU data to match the one-digit industry distribution of private sector payroll employment. In Panel B, column (1) reports the sales-weighted mean response to questions about whether tariff hikes and trade policy tensions affected the firm's sales in the first half of 2019 and, if so, by what percentage amount. To obtain the aggregate sales impact in column (2), we multiplied the column (1) value by Nominal Gross Output: Private Industries. According to the U.S. Bureau of Economic Analysis, gross output is, "principally, a measure of an industry's sales or receipts. These statistics capture an industry's sales to consumers and other final users (found in GDP), as well as sales to other industries (intermediate inputs not counted in GDP). They reflect the full value of the supply chain by including the business-to-business spending necessary to produce goods and services and deliver them to final consumers." The "Reweighted" row reflects a re-weighting of the SBU data to match the one-digit industry distribution of private sector gross output. Standard errors are reported in brackets.

We also asked forward-looking questions to assess whether firms think trade policy worries will continue to dampen their business activities in the second half of 2019. Exhibit 4 summarizes our findings in this regard. SBU respondents anticipate that the impact of trade policy on their second-half sales revenue will be similar to what they reported for the first half of 2019, but they anticipate somewhat larger negative effects on their capital expenditures and employment. Across the private sector as a whole, SBU respondents see their capital expenditures as down by 3.8 percent in the second half of 2019 due to tariff hikes and trade policy tensions.

Exhibit 4: Estimated Percentage Impact of Tariff Hikes and Trade Policy Tensions on Outcomes in the Second Half of 2019

In sum, as trade policy tensions escalated in the first half of 2019, our results say that businesses took a hit to their sales and backed off on hiring and investment. Moreover, firms anticipate that the negative effects will continue during the second half of 2019. Our estimated impact magnitudes are rising over time but remain modest.

We should also note that our estimates do not capture certain effects. For instance, they don't capture the pass-through of tariff hikes to American consumers in the form of higher prices or to American companies in the form of compressed margins and lower profits. Tariff hikes and trade policy tensions also slow growth in the global economy, with negative effects on the U.S. economy. These blowback effects are also outside the scope of our investigation.


November 1, 2019 in Trade | Permalink


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February 25, 2019

Tariff Worries and U.S. Business Investment, Take Two

Last summer, we reported that one fifth of firms in the July Survey of Business Uncertainty (SBU) were reassessing capital expenditure plans in light of then-recent tariff hikes and retaliation concerns. Roughly 6 percent had already cut or deferred capital spending as a result of tariff worries.

Since then, tariff hikes and trade policy tensions have continued to mount, as recounted in the Peterson Institute's Trade War Timeline. U.S. stock market volatility also rose sharply in the last four months of 2018, partly in reaction to trade policy concerns. These developments led us to pose another round of questions about trade policy and investment in the January 2019 SBU.

We first asked each firm if tariff hikes and trade policy tensions caused it to alter its capital expenditures in 2018 and, if so, in which direction and by how much. We use the responses to estimate the net impact of tariff hikes and trade policy tensions on U.S. business investment in 2018.

Exhibit 1: Estimated Impact of Tariff Hikes and Trade Policy Tensions on Gross Capital Investment Expenditures by U.S. Businesses in 2018

We estimate that tariff hikes and trade policy tensions lowered gross investment in 2018 by 1.2 percent in the U.S. private sector and by 4.2 percent in the manufacturing sector. The larger response for manufacturing makes sense, given its relatively high exposure to international trade. In constructing these estimates, we consider firms that raised and lowered investment due to trade policy, and we weight each firm by its size.

To estimate the dollar impact of trade policy developments, we multiply the percentage amounts by aggregate investment values. The resulting amounts for U.S. business investment in 2018—minus $32.5 billion for the private sector and minus $22 billion for manufacturing—are modest in magnitude, in line with our forward-looking assessment last summer.

In January, we also asked forward-looking questions about the potential impact of trade policy worries on business investment. As reported in Exhibit 2 below, 20 percent of firms said they are reassessing their capital expenditure plans in 2019 because of tariff hikes and trade policy tensions, a share very similar to what we obtained in our forward-looking question last July. As before, manufacturing firms were more likely to reassess their capital spending plans due to trade policy concerns.

Exhibit 2: Share of Firms Reassessing Capital Expenditure Plans due to Tariff Hikes and Trade Policy Tensions

Exhibit 3 below speaks to the question of how firms have reassessed their capital expenditure plans. Here, too, results are similar to what we reported last summer, with one important exception. Among firms reassessing, more than half have either postponed or dropped some portion of their capital spending for 2019, compared to just 31 percent in July 2018. Thus, it appears that firms anticipate somewhat larger negative effects of trade policy developments on capital expenditures in 2019 than they did in 2018.

Exhibit 3: How Firms Are Reassessing Capital Expenditure Plans

All told, our results continue to suggest that tariff hikes and trade policy tensions have had a rather modest impact on U.S. business investment. Of course, tariffs and other trade barriers affect U.S. and foreign economies through multiple channels. Even if the near-term business investment effects of trade policy developments are modest in magnitude, trade barriers can disrupt supply chains, raise input prices, and lead to higher prices for consumer goods. That's important to keep in mind as the trade policy outlook remains murky.

February 25, 2019 in Capital and Investment, Economics, Trade | Permalink


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August 07, 2018

Are Tariff Worries Cutting into Business Investment?

"Nobody's model does a very good job of how uncertainty and hits to confidence affect behavior," says Deutsche Bank's Peter Hooper in a recent Wall Street Journal article. Count us as sympathetic to his viewpoint.

That's one reason why a few of us at the Atlanta Fed created a national survey of firms in collaboration with Nick Bloom of Stanford University and Steven Davis of the University of Chicago Booth School of Business. Our Survey of Business Uncertainty (SBU) elicits information about each firm's expectations and uncertainty regarding its own future capital expenditures, sales growth, employment, and costs.

A pressing issue at the moment is whether, and how, firms are reassessing their capital investment plans in light of recent tariff hikes and fears of more to come. By raising input costs, domestic tariff hikes undercut the business case for some investments. They can raise domestic investment in newly protected industries. Retaliatory tariff hikes by trading partners can also affect domestic investment by curtailing the demand for U.S. exports. An uncertain outlook for trade policy can cause firms in all industries to delay investments while they wait to see how trade policy disputes unfold.

Last month's SBU (previously known as our Survey of Business Executives) sheds some light on these matters. We first posed a simple question: "Have the recently announced tariff hikes or concerns about retaliation caused your firm to reassess its capital expenditure plans?" Yes, said about one-fifth of our respondents.

As exhibit 1 shows, the share of firms reassessing their capital plans because of tariff worries is higher for goods-producing firms than service-providers. It's 30 percent for manufacturers and 28 percent in retail & wholesale trade, transportation and warehousing. In contrast, it's only 14 percent among all service providers in our sample. These sectoral patterns make sense, given that manufacturing firms, for example, are more engaged in international commerce than most service providers.

Exhibit 1: Share of Firms Reassessing Capital Expenditure Plans Because of Tariff Worries

We also asked firms how they are reassessing their capital expenditure plans in light of tariff worries. Exhibit 2 provides information on this issue. Among firms reassessing, 67 percent have placed some of their previously planned capital expenditures for 2018–19 "under review," 31 percent have "postponed" or "dropped" previously planned expenditures, 14 percent have "accelerated" their plans, and 2 percent (one firm) added new capital expenditures for 2018–19.

Finally, we asked firms how much tariff worries affect their previously planned capital expenditures. Among firms re-assessing, an average 60 percent of their capital expenditure plans are affected. The predominant form of reassessment is placing previously planned capital expenditures "under review."

Exhibit 2: How Firms are Reassessing their Capital Expenditure Plans

Let's sum up: About one-fifth of firms in the July 2018 SBU say they are reassessing capital expenditure plans in light of tariff worries. Among this one-fifth, firms have reassessed an average 60 percent of capital expenditures previously planned for 2018–19. The main form of reassessment thus far is to place previously planned capital expenditures under review. Only 6 percent of the firms in our full sample report cutting or deferring previously planned capital expenditures in reaction to tariff worries. These findings suggest that tariff worries have had only a small negative effect on U.S. business investment to date.

Still, there are sound reasons for concern. First, 30 percent of manufacturing firms report reassessing capital expenditure plans because of tariff worries, and manufacturing is highly capital intensive. So the investment effects of trade policy frictions are concentrated in a sector that accounts for much of business investment. Second, 12 percent of the firms in our full sample report that they have placed previously planned capital expenditures under review. Third, trade policy tensions between the United States and China have only escalated since our survey went to field. The negative effects of tariff worries on U.S. business investment could easily grow.


August 7, 2018 in Trade | Permalink


Could you please indicate over what time period was this survey conducted? Thank you!

Posted by: Ksenia | August 10, 2018 at 03:36 PM

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October 14, 2016

Cumulative U.S. Trade Deficits Resulting in Net Profits for the U.S. (and Net Losses for China)

The United States has run trade deficits for decades (1976 is the last year with a recorded surplus). To illustrate this, chart 1 depicts the cumulative U.S. trade deficit since 1980, which now surpasses $10 trillion. As a result, a drastic deterioration in the U.S. net foreign asset position—the difference between the amount of foreign assets owned by U.S. residents and the amount of U.S. assets owned by foreigners—has occurred. That is, as Americans borrow from the rest of the world to finance the recurring trade deficits, the national net worth goes deeply into the red. Not long ago, many commentators predicted that as a result of this increasing U.S. foreign debt, the U.S. dollar was set to collapse, which would trigger a stampede away from U.S. assets. Of course, this has not happened.

Much of the rising U.S. deficit is the by-product of deficits with one country in particular: China. Chart 2 shows that U.S. bilateral trade deficits with China have been growing steadily during these years. In 2015, the total U.S. goods trade deficit was about $762 billion, and the goods deficit with China alone made up nearly half of that total ($367 billion). This situation is not unique to the United States, as many countries find themselves in similar trade positions with China. During the last few decades, China has been running protracted trade surpluses with the rest of world and has accumulated a positive and sizeable net foreign asset position.

Yet, despite accumulating a positive and sizeable net foreign asset position, China is facing increasing losses in net income on its foreign assets. Put differently, China has been accumulating negative returns on its increasingly large portfolio of foreign assets. Chart 3 shows this observation, made in a paper by Eswar Prasad of Cornell University at a recent conference cosponsored by the Atlanta Fed and the International Monetary Fund.

The net income on foreign assets measures the return a nation receives from the foreign assets it owns minus the return paid on domestic assets held by foreigners. In sharp contrast to China, however, the U.S. international net financial income has remained positive and has even increased. This increase comes despite the fact that the United States has consistently run trade deficits, and its net foreign asset position has deteriorated. Chart 4 shows the U.S. income from foreign assets and foreigners' income on U.S. assets, which is reported as a negative number for this series because it is regarded as a liability for the United States. The difference between these amounts is depicted by the middle line, which shows the net foreign income of the United States.

How is this possible? Ricardo Hausmann (Harvard University) and Federico Sturzenegger (currently, the chairman of Central Bank of Argentina) came up with an explanation more than ten years ago: the United States gets a far higher return on its foreign assets than the other way around. Indeed, U.S. foreign direct investments (FDI) often generate a relatively high rate of return. In part, U.S. FDI are benefiting from business expertise, brand recognition, and research and development in new product and service lines. Comparatively, foreigners tend to earn substantially less return on the American assets they own. Foreigners often desire to hold their dollar assets in the form of safe, liquid assets, which—following the "low-risk, low-return" principle—have relatively low returns.

To see this, chart 5 shows the sources of the net financial income of the United States. The U.S. government net income is negative—mostly the by-product of interest payments in government debt held by foreigners. The U.S. gets most of its financial return from FDI. Although much has happened in the world economy during the last decade, the implications of Hausmann and Sturzenegger's analysis remain intact. In sum, the differential return from these foreign assets and liabilities appear to largely compensate for the trade deficits.

Eswar Prasad also showed that China is in a starkly different situation. Most of its foreign liabilities are in the form of FDI, while the vast majority of the foreign assets are reserve assets and foreign exchange reserves—not surprisingly, largely U.S. dollars and U.S. Treasury securities. The rate of return foreigners make on Chinese assets is around twice the rate of return China gets on its foreign assets.

This analysis suggests that focusing on a country's net foreign asset position conveys an incomplete picture of the profitability of foreign assets because it fails to account for the differences in rates of returns that countries earn on their foreign assets. Overall, the United States makes a sufficiently high return on foreign assets that it maintains positive net income on foreign assets. The situation is similar to role leverage in investing; debt can be profitable if you can devote it to purposes that earn a higher rate of return than your cost of borrowing it. Therefore, when viewed in terms of the net income earned on foreign assets the United States holds, the sizable U.S. trade deficits may not be as much of a concern as commonly thought.

October 14, 2016 in Deficits, Trade | Permalink


Re outsized returns on US FDI, I wonder to what degree these numbers may be inflated by manipulated transfer pricing and fictitious sales/profits bookings to foreign subsidiaries by US-owned multinationals as part of their tax avoidance schemes? I also wonder to what degree the income distributional distortions of greater returns to capital and lost/suppressed domestic wages have negatively impacted domestic economic growth?

Absent these two inputs, I wouldn't be so quick to pat ourselves on the back...

Posted by: Chris Lowery | October 15, 2016 at 05:44 AM

"Therefore, when viewed in terms of the net income earned on foreign assets the United States holds, the sizable U.S. trade deficits may not be as much of a concern as commonly thought." This is certainly true of those who receive the income from that DFI, but the problem is that the vast majority of the population have suffered as a result of our trade deficits.

For a country to accumulate foreign debt as it runs a persistent trade deficit is not, in itself, a bad thing. The United States followed this course throughout the nineteenth century and into the twentieth. But throughout that period we used that debt to import capital goods and foreign technology. We invested in public education and other public infrastructure that led to tremendous increases in productivity in agriculture and manufacturing. We built national railroad and telegraph systems and created steel, oil, gas, electrical, automobile, and aviation industries. Our trade policies protected our manufacturing industries as our economy grew more rapidly than our foreign debt, and as Europe squandered its resources in senseless conflicts, by the end of World War I the United States had become a net creditor nation and the economic powerhouse of the world.

This is not the course we have followed over the past forty years. We have exported rather than imported capital goods and technology, and, in return, we borrowed to import consumer goods. We invested less rather than more in our public education, transportation, and other public infrastructure systems than other countries have invested. While we made huge advances in the electronics and computer industries over the last forty years, our trade policies have not protected our manufacturing industries, and we have outsourced the manufacturing and technological components of these industries to foreign lands. As a result, our economy is not growing more rapidly than our foreign debt, and it is the United States that is squandering its resources in senseless conflicts.

The dramatic redistribution of income within our society, the breakdown of the fiduciary structure in our economic and political systems, the increasing prevalence and severity of financial and economic instability in the wake of speculative bubbles, and the dramatic deterioration of our net international investment position are all either a direct or indirect result of the economic policy changes that have occurred over the past forty years. All of these phenomena are interrelated, and, they are also interrelated with another phenomenon we have experienced in the wake of these policy changes—namely, the dramatic increase in domestic debt.


Posted by: George H. Blackford | October 15, 2016 at 03:13 PM

Could you please clarify how this information ties in with the $89 trillion U.S. household and non-profit net worth?

The sentence "That is, as Americans borrow from the rest of the world to finance the recurring trade deficits, the national net worth goes deeply into the red."

Seems were deeply in the green, offset somewhat by this.


Posted by: David Doney | October 18, 2016 at 06:29 PM

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January 11, 2011

The pluses and minuses of reluctant consumers

If you've been keeping up with news from last weekend's convergence of economists at the annual meeting of the Allied Social Science Associations, you will probably have heard of this optimistic-sounding conclusion by Harvard economist Martin Feldstein:

"It is not hard to imagine that a few years from now the current account imbalances of the US and China will be very much smaller than they are today or even totally gone."

An advance copy of the article was provided a few weeks ago at Real Time Economics, and considerable commentary has followed since (here, here, here, and here, for example). Not surprisingly, the progress Professor Feldstein envisions has two components:

"The persistence of large current account imbalances reflects government policies that alter the savings-investment balances in both the United States and China.

"The large current account deficit of the United States reflects the combination of large budget deficits (negative government saving) and very low household saving rates. ...

"In contrast, China's large current account surplus reflects the world’s highest saving rate at some 45 percent of GDP [gross domestic product]."

The source of Feldstein's belief that progress will come?

"Consider first the situation in the United States. Current conditions suggest that national saving as a percentage of GDP will rise as private saving increases and government dissaving declines. Private saving has been on a rising path from less than two percent of disposable income in 2007 to nearly six percent of disposable income in 2010. The forces that caused the rise in the U.S. saving rate since 2007 could cause the saving rate to continue to rise. Those forces include reduced real wealth, increased debt ratios, and a reduced availability of credit. ...

"The reduction of the U.S. current account deficit implies that the current account surplus of the rest of the world must also decrease. While this need not mean a lower current account surplus in China, I believe that the policies that the Chinese have outlined for their new five year plan are likely to have that effect. These include raising the share of household income in GDP, requiring state owned enterprises to increase their dividends, and increasing government spending on consumption services like health care, education and housing."

Some skepticism about the probability of a substantial decline in Chinese saving rates was noted in a recent post at The Curious Capitalist, which focuses on some interesting new research that relates high Chinese saving rates to an increase in income volatility. To the extent that the increased income volatility is inherent in China's ongoing transition to a more market-based economy, substantial changes in consumer behavior might be difficult to engineer. That said, only about half of the increase in Chinese saving rates appears explainable based on natural economic forces, and the Chinese government can certainly reduce national saving of its own accord (via deficit spending). Furthermore, according to Feldstein's calculations, a relatively small decline in the Chinese saving rate could eliminate their side of the current account imbalance.

As to the first part of the equation—an increase in saving by U.S. consumers—Atlanta Fed President Dennis Lockhart offered this yesterday in remarks prepared for the Atlanta Rotary Club:

"Households have been actively deleveraging—that is, working down debt levels and saving more of their income. The savings rate has increased from a little over 1 percent in 2005 to more than 5 percent currently.

"Consumer debt as a percent of disposable income has declined markedly over the past three years after rising steadily since the 1980s. Most nonmortgage consumer debt reduction has been in credit card balances. As consumers have reduced their debt, the share of income used to service financial obligations has fallen sharply to the lowest level in a decade.

"Consumer action to reduce debt is not the whole deleveraging story. In the numbers, the decline in overall household indebtedness has been highly affected by bank write-offs. Also, banks' stricter underwriting requirements for new consumer debt have contributed to runoff.

"I expect the phenomenon of household deleveraging to continue."

Restrained consumer spending was one item on a list of three "headwinds" that President Lockhart believes will serve to restrain growth in 2011 (the other two being policy uncertainties and ongoing credit market repair). Not that this is all bad:

"First, today's headwinds to a significant degree reflect structural adjustments that will, in the longer term, place the U.S. economy on a stronger footing. The preconditions for strong future growth are reduced uncertainty, improved consumer and household finances, and healthy credit markets.

"Second, I believe the headwinds I have emphasized will restrain growth but not stop it. I fully expect growth in gross domestic product, in personal incomes, and in jobs to be better in 2011 than in 2010.

"Finally, I acknowledge the potential that economic performance this year could surprise me on the upside. Businesses, for example, are sitting on lots of cash. Cash accumulation is not something that can continue forever, particularly in the case of public companies. It may not take much weakening of headwinds to unleash some of the economic forces that thus far have been bottled up."

Though faster progress would be welcome—particularly with respect to job creation—the Lockhart and Feldstein commentary makes it clear there is a delicate balance between resolving the short-run pain and setting up the longer-term gain.

Photo of Dave Altig By Dave Altig
Senior vice president and research director at the Atlanta Fed

January 11, 2011 in Deficits, Economic Growth and Development, Trade , Trade Deficit | Permalink


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Is there really much evidence of consumers actively deleveraging? So far, the vast majority of deleveraging can be accounted for by defaults and write-downs. Though, I guess walking away from a mortgage could be described as actively deleveraging... ;-)

One other point, can it be determined how much of the fall in the debt service ratio is due to a decrease in interest rates and how much to a fall in debt-to-income levels? I tried looking into this, but it seemed like guess-work.

From 1982 to 2008, debt-to-income levels rose as interest rates generally fell, but not enough to offset the rise in debt levels, so the DSR rose. And this went on way longer than anyone in 1982 would have thought likely.

If we accept a moderately optimistic scenario of continual moderate growth, interest rates will likely begin rising in a year or so. What if we are entering a period of continuing falls in debt-to-income levels, rising rates and falling DSR?

Posted by: Bob_in_MA | January 12, 2011 at 09:32 AM

...Current conditions suggest that national saving as a percentage of GDP will rise as private saving increases and government dissaving declines...

That is an accounting impossibility if the external sector's position doesn't change. Where on earth would private savings come from if not from INCREASING government dissaving?

Posted by: Oliver | January 30, 2011 at 08:11 AM

The deficit is not a recent phenomena , it has just exploded in the past 5 to 7 years. Americans unforunately do not have the capacity to save more. Poor job market means less earnings which in turn means less saving. If people are not earning they eat into their nest eggs to cover expenses. Somehow doubt that this deficit will simply ease away.

Posted by: Michael | February 07, 2011 at 04:58 PM

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December 10, 2008

Credit storm hitting the high seas?

Now that the mystery has been solved concerning whether we are in recession or not, our attention can turn to monitoring the conditions that might signal the contraction’s end. A nice assist in this endeavor comes from the “Credit Crisis Watch” at The Big Picture, which includes an extensive list of graphs summarizing ongoing conditions in credit markets.

In case that list is not extensive enough for you, allow us to add one more item to the list: the condition of trade finance. International trade amounts to about $14 trillion and, according to the World Trade Organization (WTO), 90 percent of these transactions involve trade financing. Trade-related credit is issued primarily by banks via “letters of credit,” the purpose of which is to secure payment for the exporter. Letters of credit prove that a business is able to pay and allow exporters to load cargo for shipments with the assurance of being paid. Though routine in normal times, the letter of credit of process is yet another example of how transactions between multiple financial intermediaries introduce counterparty risk and the potential for trouble when confidence flags.

This is how it works: Company A located in the Republic of A wants to buy goods from Company B located in B-land. Company A and B draw up a sales contract for the agreed sales price of $100,000. Company A would then go to its bank, A Plus Bank, and apply for a letter of credit for $100,000 with Company B as the beneficiary. (The letter of credit is done either through a standard loan underwriting process or funded with a deposit and an associated fee). A Plus Bank sends a copy of the letter of credit to B Bank, which notifies Company B that its payment is available when the terms and conditions of the letter of credit have been met (normally upon receipt of shipping documents). Once the documents have been confirmed, A Plus Bank transfers the $100,000 to Bank B to be credited to Company B.

Letter of Credit Process

In general, exporters and importers in emerging economies may be particularly vulnerable since they rely more heavily on trade finance, and in recent weeks, the price of credit has risen significantly, especially for emerging economies. According to Bloomberg, the cost of a letter of credit has tripled for importers in China, Brazil, and Turkey and doubled for Pakistan, Argentina, and Bangladesh. Banks are now charging 1.5 percent of the value of the transaction for credit guarantees for some Chinese transactions. There have been reports of banks refusing to honor letters of credit from other banks and cargo ships being stranded at ports, according to Dismal Scientist.

These financial market woes are clearly spilling over to “global Main Street.” The Baltic Dry Index, an indirect gauge of international trade flows, has dropped by more than 90 percent since its peak in June as a result not only of decreased global demand but also availability of financing that demand, according to Dismal Scientist.

Baltic Dry Index

In the words of the WTO’s Director-General Pascal Lamy, “The world economy is slowing and we are seeing trade decrease. If trade finance is not tackled, we run the risk of further exacerbating this downward spiral.” Since about 40 percent of U.S. exports are shipped to developing countries, the inability of the importers in those countries to finance their purchases of U.S.-made goods can’t help the U.S. exports sector, which is already suffering from falling foreign demand as the global economy slows.

At VoxEU, Helmut Reisen sums up the situation thus:

“As a mid-term consequence of the global credit crisis, private debt will be financed only reluctantly and capital costs are bound to rise to incorporate higher risk. Instead, solvent governments and public institutions will become the lenders of last resort.”

That process has begun. In the last 12 months, according to the WTO, export credit agencies have increased their business by more than 30 percent, with an acceleration since the summer. The increase in this activity, the WTO reports, is being backed by governments of some of the world’s largest exporters, such as Germany and Japan.

Most recently, to support exports of products from the United States and China to emerging economies, both countries decided on December 5 to provide a total of $20 billion through their export-import banks. The program will be implemented in the form of direct loans, guarantees, or insurance to creditworthy banks. Together, the United  States and China expect that these efforts will generate total trade financing for up to $38 billion in exports over the next year.

The sense one gets from The Big Picture charts is that at least some hopeful signs have emerged in developed-economy credit markets. Going forward, progress in markets directly related to trade flows between developed and emerging economies may well be an equally key indicator of how quickly we turn the bend toward recovery.

By Galina Alexeenko and Sandra Kollen, senior economic research analysts at the Federal Reserve Bank of Atlanta

December 10, 2008 in Capital Markets, Trade | Permalink


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Very good post. Glad that you explained the international trade credit situation. This needed to be addressed.

Posted by: Movie Guy | December 10, 2008 at 12:54 PM

The real problem is trade between "developing" countries.

There, neither party has the capacity to finance it through state sponsored agencies like Exim Banks.

Even the large, and relatively healthy large developing countries like India are struggling.

Posted by: D | December 10, 2008 at 03:38 PM

I would think that companies with monstrous cash positions like MSFT would be in good shape as well.

Posted by: K T Cat | December 12, 2008 at 07:07 PM

I have no doubt to say that the data presented here in this report is not only interesting but useful as well. Thanks for this update

Posted by: immo woning | March 19, 2009 at 12:00 AM

this is so true. Well i think this market is coming back. Wells fargo came out with a big profit. i hope this helps the credit market.

Posted by: forex forum | April 09, 2009 at 11:33 PM

Well this is hitting the economy of the whole world. All things have gone back to the 80s.

Posted by: Web design karachi | October 12, 2009 at 03:09 AM

I wonder what people reading this article would say now, 4 years later? Our economy was in fact a lie, built upon the consumer debt that came with an ever rising real estate market, with no real way of sustaining the growth. Four years later and people still have a hard time understanding credit and their own personal finances. Being one of the worlds largest economies means that when the USA crashes, so goes the rest of the world markets.

Posted by: C McCormick | January 30, 2013 at 04:49 PM

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July 17, 2007

US Assets: Still Looking Tasty

It appears that the appetite for dollar-denominated assets is not sated quite yet.  From Bloomberg:

International buying of U.S. financial assets unexpectedly climbed to a record in May as investors snapped up American stocks and corporate bonds.

Total holdings of equities, notes and bonds climbed a net $126.1 billion, from $80.3 billion the previous month, the Treasury said today in Washington...

Brad Setser does his usual fine job with the details: 

Demand for US equities and corporate bonds was particularly strong, which does suggest the persistence of private demand for US assets abroad.  Private investors tend to buy corporate bonds and equities; central banks tend to buy Treasuries and Agencies -- though that is changing.

What causes me trouble is the split between private and official purchases, and specifically the absence of any official inflows in the May TIC data.

In case you need visual confirmation:





Brad isn't buying it:

I have a hard time believing that. May was a record month for official reserve growth. China, Russia and Brazil all added to their reserves like crazy.   Those three together combined to add close to $100b to their reserves – and a host of other countries were adding to their reserves too. That money has to go somewhere...

... the Fed’s custodial data doesn’t show a comparable fall off in official demand in May (June is another story).   

The Treasury helpfully explains why the custodial data may differ from its own data:

    1. Differences in coverage: The most important reason for differences between holdings reported in the TIC and the FRBNY custody accounts is a difference in coverage. First, not all foreign official holdings of Treasury securities as reported by the TIC system are held at FRBNY. In particular, Treasury securities held by private custodians on the behalf of foreign official institutions are included in the TIC but not in the FRBNY figures. In this sense, the coverage of the TIC system is broader than that of the FRBNY custody holdings. Second, the custody holdings at FRBNY include securities held for some international organizations as well as for foreign official institutions. In this sense, the coverage of the FRBNY custody holdings is broader than the foreign official designation in the TIC system.

That description suggests advantage Treasury to me, but Brad offers other reasons for distrusting the official (that is, government) flows reported in the TIC data, and sticks to his guns on the belief that central bank diversification continues on.  I won't -- can't really -- argue.  But at the very least the latest report does little to vanquish the sense that global asset demand retains a strong attraction to the USA.

July 17, 2007 in Capital Markets, Trade | Permalink


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Congratulations David. I heard about your wonderful job as research director at the Atlanta FRB. I hope you will be able to continue to share your insights with us. Welcome down here to Atlanta.

Posted by: me | July 17, 2007 at 09:37 PM

Congrats. Hope you continue to blog. If not; thanks for the balanced insights.

Posted by: dd | July 17, 2007 at 09:57 PM

congrats Professor Altig. Stay away from the biscuits and gravy!

Posted by: jeff | July 17, 2007 at 11:17 PM

Dr. Altig -- I am behind the times, so I didn't realize congrats were in order until reading the comments. let me join the chorus.

With respect to the differences between the TIC data (the treasury also does the survey, so there are really two treasury data sources)and the FRBNY data, i would note the fourth reason for the discrepancy noted on the treasury web page:

"A fourth source of discrepancy arises because the TIC system of monthly net purchases or sales of long-term securities is specifically designed to capture only U.S. cross-border transactions. If a foreign official institution acquires a Treasury security from a private foreign entity on a foreign securities exchange and then has the security held in custody at FRBNY, reported custody holdings will increase. However, there will not be a corresponding TIC-reported foreign official purchase because this is not a U.S. cross-border transaction: it is a foreign-to-foreign transaction."

given that the survey data has consistently revised the TIC data on foreign purchases up -- and given that official reserve growth easily exceeded $100b in may, i would have to give the advantage to FRBNY here. Note that in the tic data showing foreign holdings of treasuries, there is a very consistent pattern -- the series is revised, and chinese holdings of treasuries go up (russian and chinese holdings of agencies also go up, but it isn't as visible) and the UK's holdings go down.

the uk's holdings then build up (in the tIC data) over the course of the year and then get revised down after the survey ...

that seems to me to be a pattern very consistent with 4) in the treasury explanation.

incidentally, i suspect foreign demand for US corp bonds -- a category that includes "private" mbs -- fell dramatically in june, which is why the $'s may rally didn't last.

Posted by: bsetser | July 18, 2007 at 12:00 AM

I wanted to also say congratulations. I read about the promotion yesterday and I do also hope you continue to blog.

Posted by: Nathan | July 18, 2007 at 11:58 AM

are not the foriegners considered dumb money?

Posted by: dh | July 21, 2007 at 03:47 PM

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June 11, 2007

One Savings Glut That Carries On

From the Wall Street Journal:

China's monthly trade surplus soared 73% in May from a year earlier, a state news agency reported Monday, amid U.S. pressure on Beijing for action on its yawning trade gap and the possibility of sanctions.

Exports exceeded imports by $22.5 billion, the Xinhua News Agency said, citing data from China's customs agency. That figure, close to the all-time record high monthly surplus of $23.8 billion reported in October, came despite repeated Chinese pledges to take steps to narrow the gap by boosting imports and rein in fevered export growth. The report gave no details of imports or exports.

The U.S. government has been pressing Beijing for action, especially steps to raise the value of the Chinese currency. Critics say the yuan is kept undervalued, giving Chinese exporters an unfair advantage and adding to the country's growing trade gap.

Apparently, the U.S. Senate is about to officially jump into the yuan-peg fray.  From Bloomberg:

The U.S. Senate will introduce a bill this week to pressure China to strengthen its currency, the Financial Times said today, citing unidentified people close to the situation.

The market, on the other hand, suggests that maybe things aren't so straightforward:

The gap may increase pressure on China to let the yuan appreciate to reduce tensions with trading partners and cool the world's fastest-growing major economy. The currency today had its biggest decline in 10 months and has reversed gains made in May when Chinese and U.S. officials met for trade talks in Washington...

The yuan declined 0.2 percent to 7.6691 against the U.S. dollar at 4 p.m. in Shanghai today, the biggest one-day fall since Aug. 15.

The currency has strengthened 7.9 percent since China scrapped a 10-year peg to the dollar and revalued the currency in July 2005. The 0.74 percent monthly gain in May was the biggest since the end of the fixed exchange rate.

I'm not sure what the story is there, but Nobel Prize winner Robert Mundell warned this weekend that too much pressure on the Chinese may not imply an appreciating yuan.  From the Wall Street Journal (page A9 in the weekend print edition):

... in the unlikely event that the yuan were suddenly made fully convertible, Mr. Mundell predicts that the value of the currency would fall, not rise. Many Chinese savers would want the security of keeping at least some portion of their wealth in foreign currency and would convert quickly, worried that the government might slam the door shut. This might become a self-fulfilling prophecy. In the U.K. in 1947, the Bank of England saw its reserves evaporate in a matter of weeks, and reinstated capital controls. The movement to full convertibility is fraught with danger and must be approached cautiously.

Meanwhile, yet another Nobel Prize winner, Michael Spence, suggests there is something much deeper in play than mere currency policy.  From China Daily:

China has been in a high growth mode since it started economic reforms in the late 70s. Its almost three decades of high growth is the longest among the 11 high-growth economies in the world and part of "a recent, post-World War II phenomenon". And the Chinese economy will sustain its fast growth for at least two more decades...

The high levels of savings and investments both in the public and private sectors, resource mobility and rapid urbanization are the important characteristics of China's high growth, says Spence, who is also the chairman of the independent Commission on Growth and Development. The commission was set up last year to focus on growth and poverty reduction in developing countries. China's saving rate of between 35 to 45 percent is among the highest despite the relatively low level of income of its people. Resource mobility has generated new productive employment to absorb surplus labor in a country where 15-20 million people move from the rural areas to the cities every year.

The most important feature of sustained high growth is that it leverages the demand and resources of the global economy, says Spence. All cases of sustained high growth in the post-War period have integrated into the global economy because exports act as a major high-growth driver.

Enumerating the reasons why the Chinese economy will sustain its high growth rate for another two decades, he says: "There are basically two reasons. One is that there is still a lot of surplus labor in agriculture. The engine for high growth is still there. The second is that the Chinese economy has diversified very rapidly. It's quite flexible and entrepreneurial."

Spence clearly believes that the Western complaints of too low a value for the Chinese currency and too high a surplus in its trade balances will self-correct, with a little help from government policy:

The only way to stop China's high growth would be to shut the economy off from the rest of the world. "It's just not going to happen." Even 20 years later, China will continue to grow because its currency will appreciate, helping raise the income level and increase the wealth of the people...

... To balance the huge trade deficit, Spence hopes China would boost domestic consumption and bring down the saving rate.

He acknowledges, though, that the relatively high-income younger generation is spending more despite the fact that East Asians traditionally are good at saving. A solution to the trade imbalance could also be found by increasing social security and the pension system, making them available to everybody, improving the medical coverage in the rural areas and making education at all levels affordable.

Meanwhile, the move to liberalize domestic financial markets in China took another step forward this weekend.  From Reuters, via China Daily:

China Export-Import Bank (EximBank) is set to issue 2 billion yuan (US$261 million) in yuan-denominated bonds in Hong Kong this month, making it the first Chinese lender to do so, sources told Reuters on Monday.

Exim Bank is to sell the 3-year bonds only to institutional investors, an investment banking source said, adding that the bank would decide on the yield later.

Never boring, is it? 

June 11, 2007 in Asia, Economic Growth and Development, Exchange Rates and the Dollar, Trade , Trade Deficit | Permalink


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Mundell's comments make no sense to me. Why would chinese citizens convert a rising Yuan to a falling USD or falling Euro? Security? If chinese citizens are so concerned with security, why are they pumping money into equities at an alarming rate?

Those who think the Yuan is undervalued can never explain why the PBoC have to excahnge an awful lot of Yuan for USD to keep the currency peg. It's never the other way around.

Posted by: Charlie | June 11, 2007 at 07:38 AM

Mundell may be right about short term allocation issues, but comparing a relatively declining UK do a relatively ascending China isn't analogous.

Posted by: cb | June 11, 2007 at 01:17 PM

Mundell also went for the "everything all at once" approach. It doesn't have to be that way. The yuan can be allowed to float without allowing full convertability. That has been done before, has it not?

Posted by: kharris | June 11, 2007 at 01:47 PM

"Even 20 years later, China will continue to grow because its currency will appreciate, helping raise the income level and increase the wealth of the people..."

by correlation: the US currency will continue to fall helping to reduce the income level and decrease the wealth of the people ....

Posted by: zinc | June 11, 2007 at 10:38 PM

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May 01, 2007

I Asked, The Chairman Answered

A post removed from this one I was responding to the most recent blogland debate on free trade with this lament:

The missing ingredient in this most recent installment of the free-trade discussion is evidence in favor of one story or another, a task that is a good deal messier than writing down models.

As luck would have it, Ben Bernanke has stepped in to fill the void.  Mark Thoma has the whole thing, so I'll stick to the highlights:

According to one recent study that used four approaches to measuring the gains from trade, the increase in trade since World War II has boosted U.S. annual incomes on the order of $10,000 per household (Bradford, Grieco, and Hufbauer ["The Payoff to America from Globalization"). The same study found that removing all remaining barriers to trade would raise U.S. incomes anywhere from $4,000 to $12,000 per household. Other research has found similar results. Our willingness to trade freely with the world is indeed an essential source of our prosperity--and I think it is safe to say that the importance of trade for us will continue to grow...

If trade both destroys and creates jobs, what is its overall effect on employment? The answer is, essentially none... To see the irrelevance of trade to total employment, we need only observe that, between 1965 and 2006, the share of imports in the U.S. economy nearly quadrupled, from 4.4 percent of GDP to 16.8 percent. Yet, reflecting growth in the labor force, employment more than doubled during that time, and the unemployment rate was at about 4-1/2 percent at both the beginning and end of the period. Furthermore, average real compensation per hour in the United States has nearly doubled since 1965...

A recent study of twenty-one occupations that are most likely to be affected by outsourcing found that net job losses were concentrated almost exclusively in the lower-wage occupations and that strong employment gains have occurred in the occupations that pay the highest wages [Catherine L. Mann,  "Globalization of IT Services and White Collar Jobs: The Next Wave of Productivity Growth"]...

As I suggested in my earlier post, my instinct is to believe that the issue is not whether trade is a net gain but how to think about distributing those gains, which will almost surely arrive unevenly across the population.  Here, it seems that Bernanke and Alan Blinder find some common cause.  Blinder, via the Wall Street Journal:

Mr. Blinder's answer is not protectionism, a word he utters with the contempt that Cold Warriors reserved for communism. Rather, Mr. Blinder still believes the principle British economist David Ricardo introduced 200 years ago: Nations prosper by focusing on things they do best -- their "comparative advantage" -- and trading with other nations with different strengths. He accepts the economic logic that U.S. trade with large low-wage countries like India and China will make all of them richer -- eventually. He acknowledges that trade can create jobs in the U.S. and bolster productivity growth.

But he says the harm done when some lose jobs and others get them will be far more painful and disruptive than trade advocates acknowledge. He wants government to do far more for displaced workers than the few months of retraining it offers today. He thinks the U.S. education system must be revamped so it prepares workers for jobs that can't easily go overseas, and is contemplating changes to the tax code that would reward companies that produce jobs that stay in the U.S.


Restricting trade by imposing tariffs, quotas, or other barriers is exactly the wrong thing to do. Such solutions might temporarily slow job loss in affected industries, but the benefits would be outweighed, typically many times over, by the costs, which would include higher prices for consumers and increased costs (and thus reduced competitiveness) for U.S. firms. Indeed, studies of the effects of protectionist policies almost invariably find that the costs to the rest of society far exceed the benefits to the protected industry. In the long run, economic isolationism and retreat from international competition would inexorably lead to lower productivity for U.S. firms and lower living standards for U.S. consumers (Bernanke ["Trade and Jobs"] ).

The better approach to mitigating the disruptive effects of trade is to adopt policies and programs aimed at easing the transition of displaced workers into new jobs and increasing the adaptability and skills of the labor force more generally...

Actually, Blinder's prescription is for a sort of labor version of industrial policy.  Again from the WSJ:

He thinks the U.S. education system must be revamped so it prepares workers for jobs that can't easily go overseas, and is contemplating changes to the tax code that would reward companies that produce jobs that stay in the U.S.

Bernanke does not indicate if he would favor so interventionist a strategy.  I would not, but it still looks like about the same page to me, and that page has more and freer trade written all over it.

May 1, 2007 in Trade | Permalink


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There is nothing bad about attempts to improve the educational system - any government should strive for it, regardless of competition from abroad. Targeting preparation for specific jobs that "can't easily go overseas" is more problematic, since who knows which jobs will be under heavy competition in say 15 years. There should be rather a intensive push for overall provision of strong general skills (look at how many kids are poor at reading and writing after leaving schooling), so that you eliminate the bottom segment of extremely low-skilled people. By providing strong general skills, you make the workers much more adaptive to changing conditions.

Rewarding companies for producing jobs that stay in the U.S. is just opening the gates to mass-scale abuse. Any newly open job can then be claimed as a one "that was saved and not transfered abroad".

Posted by: pinus | May 01, 2007 at 11:37 PM

This comment is not totally thought out, but I've always wondered about the benefits of free trade. And I'm pro free-trade by and large. Though I find arguments about fair trade convincing in order to prevent a possible global race to the bottom.

The argument that free trade increases productivity--and wealth--of the entire system makes total sense. Whether it increases productivity and wealth of the components of that system is debatable (as noted above and elsewhere). Components not benefiting may include countries, sectors, or individuals within countries. This is the issue of how benefits of free trade are distributed.

Here's my quandry: I think the benefits should be distributed somehow. But that creates the possibility of a welfare mentality in those receiving the benefits. Whether it be education benefits, unemployment benefits, or otherwise, they could have the opposite effect of what we desire--those not benefiting from free trade indirectly benefit by receiving welfare in one form or another. And it's not clear how effective or efficient this welfare will be.

(Note: to use the term welfare may seem loaded--it's not meant to be, it just seems that redistribution, not matter what form it takes, can be considered a form of welfare).

I'm not sure what to do about it, but this idea bugs me. We've increased the productivity of the entire system by wiping out an entire sector of jobs, for example, and then give welfare benefits to those affected. And those affected are demoralized in some cases.

Is this better than a lower productivity world in which there is less redistribution and less welfare of the form I discuss above? I'm not sure, but it is something I've pondered off and on.

Posted by: T.R. Elliott | May 02, 2007 at 02:17 PM

I am disgusted, utterly disgusted, with this despicable conflation of highly trained people with educated people.
It is the work of the poorly educated numskulls who were trained to write and say any stupid little thing they were paid to blurt out.
As if this disparity in income distribution had anything to do with education; as if those traders and CEOs were geniuses who were making contributions to society that will be remembered beyond the date of their last paycheck; as if the European traders didn't need those canons as they traded freely with the spear chuckers in those otherwise Empty Lands; as if comparative advantage were set in a world free from exploitation...that pits highly trained numbskulls with their canons and directions, against...us, the educated, the Last of the Mohicans.

Posted by: calmo | May 02, 2007 at 02:26 PM

“A recent study of twenty-one occupations that are most likely to be affected by outsourcing found that net job losses were concentrated almost exclusively in the lower-wage occupations and that strong employment gains have occurred in the occupations that pay the highest wages”

Isn’t that exactly what a protectionist would expect? In the short run, there are more jobs for rich people and fewer jobs for poor people. In the longer run, wages adjust, and the rich get richer, while the poor get poorer. That’s what comes out of the Heckscher-Ohlin model with skilled and unskilled labor as the factors, and that’s exactly why people like Paul Krugman are finding trade harder to defend than in the past. I would suggest that the solution involves not just retraining but broader redistributionist policies.

Posted by: knzn | May 02, 2007 at 05:11 PM

The EITC substitute for a decent job? LOL.

"Training" for the middle aged with a family to support? LOL.

This is America. We do prisons better than we do redistribution. Redistribution is a hoax.

The elites wanted their candy, their trade pacts, their union busting, their Congress, their minimum wage, their wars. Now their credibility is shot, in so far as what they've delivered to the American people. "The business of American is business": HAH. Poor, poor richies. So hard to be 'envied'. So hard to wake up to the consequences of the spree.

Posted by: dissent | May 05, 2007 at 09:42 PM

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April 29, 2007

What Are You Going To Believe -- Theory Or Your Own Lying Eyes?

The blogger epicenter of the free-trade debate is rumbling at Harvard, with Greg Mankiw and Dani Rodrik engaged in a terrific -- and important -- conversation about winners, losers, and how (or whether) economic theory divides the two.  You can check-in on the state of the debate at Angry Bear, where pgl provides the appropriate links.  It is highly recommended reading, but I think it ought to come with a few warning labels.  For example, Professor Rodrik responds to Professor Mankiw with this claim:

... there is no theorem that guarantees that the partial-equilibrium losses to import-competing producers “are more than offset by gains to consumers from lower prices.”

In a related vein, pgl opens his post with:

As we were applauding Dani Rodrik, Greg Mankiw was defending the Dan Drezner lower prices from free trade benefits everyone fallacy.

Let's be perfectly clear:  There are no theorems in economics that guarantee anything about the real world.  Economic models are not descriptions of physical realities but formalizations of stories about how social interactions deliver particular outcomes.  Different, equally coherent, stories deliver different predictions about the world.  The claim that "free trade benefits everyone" is not a fallacy, but a particular outcome based on a particular model.  Different models deliver different answers, so theory alone does nothing beyond eliminating stories that are internally inconsistent.

Or, perhaps, unconvincing.  The missing ingredient in this most recent installment of the free-trade discussion is evidence in favor of one story or another, a task that is a good deal messier than writing down models.  What makes matters worse is that adjudicating the issue is not a mere matter of counting up winners and losers.  In the court of determining what is "good" or "bad", economists have standing to address one question, and one question only:  Can someone be made better off without making anyone worse off?  That too depends on the model at hand, and in fact it's even worse than that.  The Rodrik-Mankiw debate revolves in part around a result known as the Stolper-Samuelson theorem. Greg Mankiw does a good job explaining Stolper-Samuleson and its relevance to the subject at hand, but I'll note one item from the Wikipedia description of the theorem

If considering the change in real returns under increased international trade a robust finding of the theorem is that returns to the scarce factor will go down, ceteris paribus. A further robust corollary of the theorem is that a compensation to the scarce-factor exists which will overcome this effect and make increased trade Pareto optimal.

In simple terms, there are losers, but the winners can win enough to more than match those losses.  All would be well with the world if the winners and losers could be easily identified, and an appropriate compensation scheme implemented.  But what if that is not feasible?  What is the right move then?  To protect the losers at the expense of significant opportunity cost to potential winners?  The other way around?  I've yet to encounter an economist trained to answer those questions, and you should be very suspicious of any who speak as if they are.

April 29, 2007 in This, That, and the Other, Trade | Permalink


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As always, I'll have to complain about the use of the appellation "free trade" in reference to a trading system in which China actively pegs the yuan against the dollar at one-fifth its purchasing-power-parity value, and Japan actively manipulates the yen by a zero-interest-rate policy (no longer using obvious direct intervention as in 2003-2004, when it openly bought $320 billion and budgeted for $1 trillion of additional intervention).

This exchange-rate manipulation creates trade barriers just as real as tariffs of the same magnitude. If absent the manipulation the yen-dollar exchange rate would be around the 80 yen/dollar level of the mid-90s, when Japan-US trade was starting to come back into balance, then the current manipulated rate is equivalent to a 50% tariff in Japan on imports from the US.

Posted by: jm | April 29, 2007 at 02:49 PM

You make the same point Greg did in his comment to my post. The efficiency gains are such that IF the winners decide to compensate the losers, there is still a net gain. No one denies this. What Dani was saying - and I think he's right - is that SINE compensation, there will be losers. You don't deny this - and now Greg is claiming he does not either. So what's the debate here?

Posted by: pgl | April 29, 2007 at 03:47 PM


That's a good post, taken as a whole.

I go a step further, though. Once trade policy is implemented, the issue is then based on real world outcomes, not theorems. And it's about at that point that many economists appear to get lost if not intentionally disappear if all isn't going well or according to preconceived notions.

Long before Alan Greenspan stepped to the microphone and explained that U.S. offshore production shifted to China-based operations could be impacted with U.S. trade policy but that such offshore production would not return to the U.S. but rather would flow elsewhere to another cheap global production source...well, long before that I had written, forwarded, and blog post my brief Economic Hydrology Theory (EHT) statement and principles. That statement summarized the offshore production growth situation in clear and precise language.

Economic reality and related outcomes are based on real world results, not classroom dogma whether pitched to kids or adults. Theorems only go so far. Economists who can't venture beyond the academic bounds of such devices and evaluate the real world results, recommending appropriate adjustments in the metrics are not economists that I recommend that any corporate clients hire.

Unlike many, you are an exception. Well reasoned thinking is what I am seeking. And you have it.


Posted by: Movie Guy | April 29, 2007 at 08:00 PM

Go tell "pareto optimal" to dead Iraqis why don't we. (if we ever find the documentation we are stealing oil from Iraq)

economist can be dangerously obtuse creatures.

Posted by: andy | April 30, 2007 at 06:23 AM

Had to run an get my glasses after that wallopin, eye-bulgin title Dave...I take it all back --Finnegan's Wake by what'shisIrishface is so Irishly over-rated.

jm, has most of my view of that matter without giving any space to the transnationals who are always neglected in this play ...especially with Paulson's vaulted connections. Same sorta vaulting with energy pricing and this administration...the sacking of Rome by a very few --not the hordes of barbarians as previously thought. [The barbarian critique of History]
Dave writes:
"All would be well with the world if the winners and losers could be easily identified, and an appropriate compensation scheme implemented. But what if that is not feasible?"

And it is hard to believe that the winners cannot be easily identified: those HF managers, those CEOs, those large shareholders.
The appropriate compensation scheme OTOH should be left to the hordes of barbarians because QED the present scheme is FUBAR...such is the inappropriate view of the losers whose eyes as andy points out may be no longer seeing much of anything.

Posted by: calmo | April 30, 2007 at 02:03 PM

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