Bill O'Reilly's "The Truth about Political Promises": A Response

I don't know what is setting me off this weekend about the populist windbag; perhaps it's just pent-up frustration that he continues to press economically illiterate talking points and/or political candidates this cycle promote similar perspectives. What set me off in this talking point memo is that he is promoting an anti-trade perspective, especially against China:

Finally, Donald Trump wants to force China from devaluing its currency.
He says if they do not stop that there will be a trade war.
Here Mr. Trump is on solid ground.
The trade deficit with China was $366 billion last year.
That means they get all of those billions free and clear above what we are buying from them.
Donald Trump could certainly renegotiate this appalling situation.  That is a job killer for Americans.

For those who want a more rigorous treatment of the trade deficit issue, Donald Boudreaux regularly blogs on the topic; you can also do a Google search on mises.org with relevant keywords, i.e., China trade deficit. Both sources, which favor open trade, dispel protectionism/neo-mercantilist nonsense like Trump's and O'Reilly's. I'll reference some of the points also made by this mises.org post.

First, no, O'Reilly, Trump is NOT on solid ground. It is true we have a current account deficit with China (which, by the way, is our third biggest export market). But that isn't a bad thing. We also have trade surpluses with other countries (see below chart). In fact, in our daily transactions, we might routinely run surpluses or deficits with various parties; WalMart buys nothing from me, but I've bought many groceries and prescriptions from them. I consider the transactions win-win; the savings I get make me better off. There is a key construct called comparative advantage; there are higher-value goods and services that America's more productive workers do more effectively. (Recall the correlation of income and productivity.) Consider player trading in baseball. Suppose the Yankees have a bumper crop of 6 starting pitchers but are weak at shortstop and the Royals have multiple shortstops but lack a fourth strong starter. A trade would benefit both teams, not to mention the players who otherwise might see limited playing time under the status quo.

It is true that some American and/or Chinese workers can be displaced by the nature of bilateral trade based on comparative advantages, but consumers win from a more competitive marketplace. Displaced workers may find work in other, better-paying occupations with an investment in human capital or more productively used in other parts of the economy which benefit from customers able to stretch their dollars. Let me quote Boudreaux on this point:

Free trade does not create more jobs, but neither does protectionism. Free trade may reduce jobs in inefficient industries, but it frees up resources to create jobs in efficient industries, boosting overall wages and improving living standards. Protectionism, in contrast, attempts to protect jobs that the market will not sustain; it does so at the expense of more innovative industries. Much of the change in the labor force is not the result of free trade but of innovation. Using protectionist policies to “save” a job comes at enormous cost, as opportunities shrink and input costs swell for industries downstream.

For example, domestic sugar subsidies may prop up the business models for Big Sugar growers, say in Florida. It may protect the jobs of a few workers planting or harvesting cane or beets, but those same workers could be available to work on other, more globally competitive crops. Plus the sugar consumers, say Nabisco cookies, wouldn't have to pay artificially high prices for local product, which would improve their own competitiveness

For people going through a transition, it is tough. But businesses are not charities or socialist governments which make work for unneeded employees, what we sometimes refer to as the broken window fallacy. If prices aren't globally competitive, the business is limited to the domestic economy (with 5% of  global consumers)  where in the long run fewer employees are needed as technology improves or unfolds. You really can't market products overseas unless your products are competitively priced. The service sector has been increasing related to the manufacturing sector as a source for jobs literally for decades.

If you look at the jobs lost in US manufacturing from 1987 to 2007, a period during which US manufacturing nearly doubled, nearly all can be attributed to IMPROVED PRODUCTIVITY, not foreign trade. Moreover, we have a trade surplus in services with China; goods are only one part of current accounts, and there is no credible evidence that attributed losses of relevant businesses are statistically significant from the entire economy of jobs. We used to have a large plurality of workers in the agricultural sector, but today the percentage is maybe 2%. The other parts of the economy absorbed the displaced workers displaced by productivity. Mark Perry of Carpe Diem has shown where food costs now account for less than 10% of the typical household budget. This has opened up savings which can be spent elsewhere or deferred through investments.

We simply can't ban improved productivity; in fact, I can gain a competitive advantage as a market entrant over your reluctance to deploy. For example, IBM may have been worried about PC's cutting into mainframe revenues, but Compaq and Dell weren't. Why should we be concerned about the loss of low-value/boring commodity work that requires less than a grade-school education? If the business model worked, it wouldn't be shifting elsewhere

Here's an interesting chart from a 2011 chart from a Fed study showing only about 1.2% of the 11.5% spent on imports goes to China on net; about 6.1% to other countries and the rest (4.2%) in US transportation and distribution (AMERICAN jobs). Moreover, over half of the 2.7% spent on Chinese goods sold is the cost of AMERICAN-MADE parts. On top of that, consider two-thirds of American consumer spending is in services, some 96% AMERICAN-SOURCED.

The currency issue is more complicated; let's point out that the Fed's targeting of interest rates is also manipulative. There's a nominal exchange rate, which most people consider, and then there's the real exchange rate. What demagogues fail to point out is that the Japanese yen vastly appreciated against the dollar after Nixon closed the gold window, but it didn't really change the fact of our trade deficits with Japan; the demagogue's theory would be as American dollar depreciated, we should have seen deficits diminish, even turn into surpluses. Instead, the Japanese surplus actually expanded. Similar considerations come into play for China; in fact, if you look at 2005-2010, the nominal exchange rate actually increased by about 25% (i.e., an appreciating yuan), but the real exchange rate  was nearly double that (because, e.g., Chinese labor costs increased more than American labor costs over that period). Did the relatively cheaper dollar reduce/eliminate the trade surplus? No.

And this is a point I've raised in the past: devaluations can be counterproductive and inflationary: just as I explained above in the fact that many inputs to Chinese exported goods actually come from American suppliers; imported energy supplies become more expensive. This erodes profit margins (price increases to pass along increased costs?) and improves the competitiveness of other global trading partners. Economists argue that trade really reflects comparative advantages, not short-term currency fluctuations.

Furthermore, as I pointed out in an earlier tweet, the Cato Institute identifies the fact that nearly 60% of our imports are NOT consumer goods but business materials or capital goods. Our esports are really the price we pay for imports that leave consumers and businesses better off. If the government devalues our currency, it raises consumer prices and business costs, not good for our economy.

Finally, we must have an accounting perspective, offsetting entries between a current account (surplus/deficit in traded goods/services) and capital accounts (asset deficits/surpluses: real estate, stocks, bonds, government securities). Companies do not trade something for nothing. Foreign investors need dollars to purchase assets; they compete against foreign consumers of American goods and services. The competition for dollars make our exports more expensive and imports less expensive. If we run a trade deficit, we need to have an offsetting capital surplus, i.e., we sell more assets than we purchase elsewhere. When Japan runs a current account surplus, it needs to run a capital account deficit, i.e., buy more assets than it sells, e.g., purchase foreign investments from excess savings. (Excess savings may look for alternatives to limited domestic investments.)

Griswold reminds us of various points and myths:

• Trade surpluses do not necessarily reflect a robust economy. For example, the US has been running trade deficits for decades, including periods of strong growth. In the mid-90's, Mexico went from a trade deficit to a surplus, but this reflected a recession with falling consumer demand (imports) and domestic investments (capital flight). Germany, which normally saw trade surpluses, during reunification swung to trade deficits in the process of financing domestic investments.
• Trade deficits/surpluses may not reflect "unfair" trade policies. Mexico's trade surplus post-NAFTA was an artifact of a recession, not of discrimination against American products; Mexicans bought fewer domestic and foreign goods and invested less. On the other side, Brazil has in the past trade barriers to American goods while running a trade deficit with the US. [I worked for a few months in 1995 in Brazil--and found that purchasing PC software was almost double the price I would pay in the states.] Griswold also notes that we have maintained alternate surpluses and deficits with individual EU countries, despite a common tariff policy. Japan's trade surpluses with the US actually increased, despite an appreciating currency and a market more open to American goods and services; in part, this reflected capital liberalization, allowing the Japanese seeking higher investment returns to invest here.
• Devaluation is not a panacea. A cheaper dollar means more expensive imports, including higher prices for consumers and higher costs for business materials and capital goods. Foreign investors may also be attracted by lower asset prices and bid them up. The result? Inflation and a lower standard of living.
• Trade wars don't resolve the issue. First of all, any protectionist moves against Chinese products would likely be mirrored against American products. Let's recall that America has 5% of the world's population and China roughly 4 times that, with a rapidly growing middle class. The scales of global trade allow the American economy to specialize more efficiently. Second, it is rather like trying to grasp a balloon; even if you narrow the current account here, it would likely bubble up for other trading partners, say for example Mexico. What matters is the net global demand for our assets. Now if the government was to reduce its massive deficits and debt and/or Americans saved more, there would be less need for foreign capital.
• America hasn't lost its competitiveness. America, in fact, has never produced or sold more. The reason the trade deficits are high is because we've imported even more. What's changed is the mix of products we've specialized in. For example, we buy more foreign-made clothes and shoes. But we sell other things, e.g., airplanes and pharmaceutical drugs.
• We aren't exporting jobs to other countries. What happens is that we're freeing up labor resources from globally unsustainable business models.  Labor shifts to where it is more effectively utilized. Yes, the job losses from a closed plant are very real. But job losses also occur, not because of a zero-sum game with nefarious foreigners, but because of improvements in technology: you don't need telegraph or telephone operators anymore. The point is that during the times we've been running trade deficts, more and more Americans have found work, not lost opportunities to foreigners. It's just the jobs are distributed differently in alignment with comparative advantage. In fact, unemployment tends to vary inversely with trade deficits; that is, recessions tend to shrink deficits as described above.
• The trade deficit is not a drag on economic growth. Keep in mind that if we don't sell assets, we can't run a trade deficit. But without foreign investment, who would buy the same government bonds, etc.? With reduced competition, the government would likely need to cut the price of bonds/increase interest rates. Higher interest rates translate into higher business costs and lower profits. Businesses look to cut costs, and labor is typically a big cost. The end result is reducing the deficit could trigger a recession--not economic growth.

Census Feb 2016 Data