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Trade and Growth

Warning: This post is probably more for my own benefit than for anyone else’s edification. If you’re tired of arguing about trade, then skip this post. And if you’re not interesting in reading about some rather technical economic research, then skip this post. On the other hand, if you’ve always wanted to see examples of the actual evidence that makes lots of economists think that more trade can be (but isn’t always) a good thing, please read on.

I’ve just finished reading yet another paper on trade and growth. The literature on this topic is enormous, and growing by several papers per year. But that’s important, and (for the most part) probably a good thing.

The most peculiar thing seems to be happening, however. It is starting to seem like the discipline is tentatively considering something approaching the vague semblance of agreement about some aspects of how greater openness to international trade affects economic growth. In the past few years several different papers, using different methodologies, have concluded much the same thing: more exposure to international trade may cause faster economic growth and development, but does not always and necessarily do so, and the determinants of whether trade is good or bad for growth are institutions and other economic policies.

Put simply, this means that if a country is getting other sorts of economic policies basically right, and has a reasonably well-functioning government, then trade can enhance growth and development, and will raise the quality of life for many more people than it harms. But if a country only liberalizes trade without getting the rest of its house in order, more exposure to international trade by itself could make many more people worse off than it makes better off. (Important reminder: international trade, as with most economic transactions, generates some winners and some losers; what we’re interested in is which group is bigger, and how strongly affected they are.)

The number of papers agreeing on the broad outlines of this statement is starting to seem to me to be approaching a critical mass. The paper that I’ve just read is a good example of this thesis: “Openness Can be Good for Growth: The Role of Policy Complementarities”, Roberto Chang, Linda Kaltani, Norman Loayza, World Bank Policy Research Working Paper WPS3763, November 2005. (For a non-technical summary see here.)

They write:

We present some panel evidence on how the growth effect of openness depends on a variety of structural characteristics. For this purpose, we use a non-linear growth regression specification that interacts a proxy of trade openness with proxies of educational investment, financial depth, inflation stabilization, public infrastructure, governance, labor-market flexibility, ease of firm entry, and ease of firm exit. We find that the growth effects of openness are positive and economically significant if certain complementary reforms are undertaken.

They’re piling on to a lot of other good work in the past couple of years. For example:

  • Openness and Growth: What’s the Empirical Relationship?” by Robert E. Baldwin, NBER Working Paper No. 9578, March 2003.

    “This paper briefly surveys this literature and points out the main reasons for the disagreements [among economists concerning how a country’s international economic policies and its rate of economic growth interact]. [A]n important study by Francisco Rodriguez and Dani Rodrik (2001)… show[s] that openness simply in the sense of liberal trade policies seems to be no guarantee of faster growth. However, the conclusion of most researchers involved in either country studies or multi-country statistical tests – that lower trade barriers in combination with a stable and non-discriminatory exchange-rate system, prudent monetary and fiscal policies and corruption-free administration of economic policies promote economic growth – still seems to remain valid.”

  • Trade, regulations, and growth” by Caroline Freund and Bineswaree Bolaky, April 2004.

    “Trade does not stimulate growth in economies with excessive business and labor regulations. The authors examine the effect of openness on growth using cross-country regressions in both levels and changes. Results from the levels regressions imply that increased openness is associated with a lower standard of living in heavily-regulated economies. Growth regressions confirm that the effect of increased trade on growth is absent in these countries…The results imply that countries must create a sound business environment before trade can be used as an engine of growth.”

  • “Globalization and Complementary Policies: Poverty Impacts in Rural Zambia”, by Jorge F. Balat and Guido Porto, NBER Working Paper No. 11175, March 2005.

    “We find that complementary policies matter… by expanding trade opportunities Zambian households would earn significantly higher income. [But] securing these higher levels of well-being requires complementary policies, like the provision of infrastructure, credit, and extension services.”

  • Trade Liberalization and Growth: New Evidence,” Romain Wacziarg, Karen Horn Welch, NBER Working Paper No. 10152, December 2003.

    “[T]here is a vast amount of heterogeneity across countries in the extent to which growth rose after trade reforms. While the average effect obtained in the large sample is positive, roughly half of the countries experienced zero or even negative changes in growth post-liberalization. Second, generalizations about the factors that may explain these differences are difficult to draw. The preexisting institutional environment of countries, the extent of political turmoil, the scope and depth of economic reforms, and the characteristics of concurrent macroeconomic policies all seem to have a role to play.”

Such papers seems to be part of an interesting, and notable, convergence of opinion about the effect of trade on growth.


UPDATE: Regular reader DOR reminds me that there’s one other point of consensus among economists about trade and growth that I think is fair to make: while there’s only a gradually emerging agreement that trade can be good for growth under the right circumstances, there’s near unanimous agreement that protectionism (or the lack of trade) never helps growth.

Even the seminal paper of Rodriguez and Rodrik (2000), “Trade Policy and Economic Growth: A Skeptic’s Guide to the Cross-National Evidence,” which really ignited the empirical research of the past few years by harshly (and fairly) criticizing the previous evidence that trade helped growth, said this:

“Let us close by restating our objective in this paper. We do not want to leave the reader with the impression that we think trade protection is good for economic growth. We know of no credible evidence–at least for the post-1945 period–that suggests that trade restrictions are systematically associated with higher growth rates.

So let me amend my summary of the emerging consensus as follows: sometimes trade causes faster growth, and sometimes it doesn’t. But protectionism is never good for growth.

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GDP Revision

This morning the BEA released its second estimate of fourth quarter GDP. The estimate for GDP growth was revised up substantially, but the level was still very low, and the upward revision was no more than most observers had hoped for. Comparing to the BEA’s first estimate:

The preliminary estimate of the fourth-quarter increase in real GDP is 0.5 percentage point, or $14.1 billion, higher than the advance estimate issued last month. The upward revision to the percentage change in real GDP primarily reflected upward revisions to exports, to federal government spending, to equipment and software, and to change in private inventories that were partly offset by an upward revision to imports.

The estimate of nominal GDP growth went from 4.2% to 5.0%, while the estimate of inflation went from 3.3% to 3.6%.

Most forecasters are suggesting that the US will enjoy much stronger growth during the first quarter of 2006 (most estimates are in the neighborhood of 4.0-4.5% growth), though I’m skeptical that growth will be that strong this quarter, not to mention later this year. We’ll know who’s right at the end of April.


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Housing: Slowing, but Not Crashing

The Census Bureau report released this morning showed January New Home Sale were still strong. In fact, on a Not Seasonally Adjusted basis, January 2006 was the strongest January on record.

Following is a graph of NSA January New Home Sales showing 2006 is a new record.

Click on graph for larger image.

The strong sales may be partially due to the generally nice weather in January (a similar argument has been made for the strong retail sales). Also, New Home Sales is a heavily revised number and may be revised down over the next few months.

There is evidence that housing is slowing (see SA graphs: January New Home Sales), but so far there is no “crash”.

In previous housing slowdowns, the “bust” was a slow and steady process that lasted several years. In Housing: After the Boom, I graphed the real and nominal price declines for several cities for previous housing busts. For those examples, the bust lasted 4 to 8 years and the price declines were up to 40% in real terms. I expect this housing bust will be similar in both duration and in the real price adjustment.

The rapidly increasing inventory of New Homes continues to be a major concern. The following graph shows January New Home inventory.

It appears builders have been able to keep inventories down, as compared to sales, until the last couple of years. From the Census report:

The seasonally adjusted estimate of new houses for sale at the end of January was 528,000. This represents a supply of 5.2 months at the current sales rate.

The months of supply is the highest since 1996 (the end of the previous bust). This appears to indicate an oversupply of New Homes for sale.

Best to all, CR Calculated Risk

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David Rosenberg is a Smart Bear

Via CalculatedRisk comes Reassessing Hard Landing Risks written by David A. Rosenberg of Merrill Lynch. I’m calling David a bear as he is not buying all the Pollyanna stories as to how great the U.S. economy is doing.

There is a lot of material here but I especially liked his comments about the labor market:

In fact, when we canvassed investors as to which statistic it was that altered their perceptions to such a degree, the vast majority said it was the drop in the January unemployment rate to 4.7% from 4.9% – the laggiest of the lagging indicators. Never mind that the entire decline was due to part-time youth unemployment sliding (in a sign of seasonal maladjustment), or that the labor force shrank for the third time in the past four months – which is not what the textbooks tell you should be happening when the labor market is brimming with confidence … To this, all we have to say is that according to the Bureau of Labor Statistics, there were a total of 4.1 million job postings available in December. Yet there were well over seven million unemployed people actively looking for work (and another five million who would engage in a job search if they thought it would lead to success). So, you can’t blindly look at a 4.7% unemployment rate and draw the conclusion that the labor market is tight enough to generate accelerating wage growth when there are as many as three potential job seekers out there for every available position. This still sounds like an excess labor supply backdrop to us, one that is inherently disinflationary, and a key reason why we are concerned that the Fed is on the precipice of a policy mistake if it raises rates much further. We have yet to hear from one policymaker as to how it can possibly be that this is a fully-employed economy when practically every measure of organic work-derived income (wages/salaries from the NIPA accounts; employment cost index; unit labor costs) is running at slower rates now than they were this time last year. And, the fact that real compensation growth per hour managed to decline in each of the past three quarters to stand at -0.4% year-on-year, something that barely happens once every decade, is hardly a trend one would expect from an economy supposedly operating at full employment.

CR emphasized “misconception #2”, but I have to ask those putting forth this notion that households are enjoying record net worth – have you folks calculated this series in terms of real wealth per capita?

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Buckley v. Kristol on Iraq

William Buckley says It Didn’t Work:

One can’t doubt that the American objective in Iraq has failed. The same edition of the paper quotes a fellow of the American Enterprise Institute. Mr. Reuel Marc Gerecht backed the American intervention. He now speaks of the bombing of the especially sacred Shiite mosque in Samara and what that has precipitated in the way of revenge. He concludes that “The bombing has completely demolished” what was being attempted — to bring Sunnis into the defense and interior ministries.
Our mission has failed because Iraqi animosities have proved uncontainable by an invading army of 130,000 Americans.

Glenn Greenwald welcomes Mr. Buckley to the reality based community. Should we praise Mr. Buckley for finally noting the obvious?

Talkleft reminds us that:

The current violence in Iraq was anticipated before Bush decided to take down Saddam. As these articles suggest, Bush and his confederates knew what would happen and they went ahead with their invasion plans anyway. They are responsible for this mess.

Note that Mr. Buckley fails to acknowledge that the reason many of us opposed that stupid decision on March 19, 2003 was that we anticipated it would lead to disaster. Mr. Buckley’s own rag (the only accurate description of the National Review) tarnished folks who opposed this decision as traitors. Of course, we will not get an apology for this crowd.

Then again – William Kristol thinks we could have won this thing had the Bush Administration made a serious effort.

Update: While Kristol is now saying we should have had a bigger war effort in Iraq, back in 2002 he had suggested that the cost of this invasion would be at best 0.2% of one year’s worth of GDP. So I was trying to think of something to say about this fellow’s positions beyond the obvious – that he is clueless. Fortunately, Digby has said it for me.

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Polley and Setser on the Yuan

Bill Polley responds to my critique of Michael Darda:

China made a decision over a decade ago to fix its currency to the dollar. This was before the massive explosion of growth and before the Asian financial crisis. They have managed one of the most successful hard pegs in the region, and it probably saved them a lot of grief during the crisis of 1997-98 … Yet, the fact that they had kept such a hard peg for so long began to work against them. With all that growth, people recognized that this exchange rate would not work forever … Most people also realize that a large sudden revaluation would be bad for China. This is a gradual process. Too gradual for some tastes.

Let me concede two things – the term manipulation is not needed here. We both seem to agree that the yuan needs revaluation and I’m certainly not advocating a rapid revaluation. Secondly, Dr. Polley’s post in its own way is a nice summary of what Jeff Frankel has written on this topic – a paper we noted here.

Brad Setser notes that Stephen Jen (not Roach as I originally wrote) is now arguing that China’s fixed exchange rate is creating more problems than benefits. Brad also picks up on my comments about Chinese monetary policy:

China isn’t importing US monetary policy. It is importing a monetary policy that is substantially looser than the monetary policy here in the US. Right now, key domestic interest rates in China – whether the deposit rate or the interbank rate or the PBoC sterilization bill rate – are well below US rates.

OK, this is just a sampling of the latest on Chinese economic policy from Brad. Enjoy the rest of his post.

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Michael Darda’s Fiscal Advice for the FED

There is wee bit in Michael Darda’s latest that I might agree with – but given the following, I have two questions for him and the rest of NRO Financial:

If Congress doesn’t act to extend the 2003 tax cuts, tax rates on capital will rise, which would depress after-tax rates of return to capital and stunt growth … A sensitive-indicators approach at the Fed and lower tax rates on the factors of production would sustain and deepen the expansion. However, higher tariffs, a trade war, and a tax hike on capital could end it. In this vein, the Bush administration should take a stiff stand against protectionism in all its forms and lobby relentlessly for the extension of the 2003 tax cuts. Anything less wouldn’t be prudent – or pro-growth.

Question 1: why do the NRO pundits continue to lecture Chairman Ben on the virtues of tax cuts when most of us know that the Federal Reserve sets monetary policy and not fiscal policy?

Question 2: if keeping tax rates low is giving people their money back so they can consume more as George Bush repeatedly says even as he is clueless as to how to reduce government spending, do the NRO pundits think an inward shift of the national savings schedule will lower interest rates and increase investment?

OK – we’ve been done this road many times so let’s go to where Darda and I partially agree (with strong interest in partially):

The neo-mercantilist flat-earth society, which includes members of both parties, doesn’t seem to understand that a fixed (and now sliding) peg for the Chinese yuan simply means that China outsources its monetary policy to the Fed … Fixity is the antithesis of manipulation, not the cause of it. Apparently a passing grade in Economics 101 isn’t a prerequisite for ascending to the U.S. Senate. As Nobel Laureate Robert Mundell recently argued, an appreciation of the yuan could impose deflationary pressures on the Chinese economy, fan tensions in rural areas, and cut China’s growth rate. The result likely would be slower Chinese growth and lower incomes, which would cut the demand for U.S. exports – precisely the opposite of the intended effect. While a modest appreciation of the yuan probably would carry few risks given the dive in the dollar’s value during the last few years, a significant appreciation would surely be deflationary. It is also quite telling that the strongest advocates of yuan appreciation (or tariffs on Chinese goods) never advocated a devaluation of the currency when China was dragged into deflation by the steady appreciation of the greenback. In other words, the protectionists in Congress want it both ways, which means they are both inconsistent and wrong.

Our partial agreement is in two areas: (a) we both oppose trade protection; and (b) we both love to cite the collected works of Robert Mundell. But I suspect Darda and I have different views as to what these collected works should tell us. Mundell examined the different implications of fixed versus floating exchange rates for the transmission of macroeconomic policies such as fiscal policy (which is not set by the FED), monetary policy (what Chairman Ben does address), and trade protection policies. For example – under floating exchange rates, the fiscal stimulus from the Bush tax cuts would tend to be dissipated to the other nations such as China – which would mean it was not as effective at raising U.S. aggregate demand as much of the extra demand from the reduction in our national savings rate spilled over in the form of increased Chinese exports. But the point about allowing the yuan to appreciate is a valid one – it would reduce Chinese aggregate demand and increase aggregate demand in the U.S. But isn’t that the whole point of those who argue for letting the yuan appreciate – U.S. demand growth has been paltry whereas China’s economic growth has been very strong.

But I have one last query for the advocates of a fixed yuan. The price-specie flow argument of David Hume not withstanding, the growth rate for China’s money supply has not been the same as the growth rate for the U.S. money supply – in fact, its growth rate has exceeded 15% per year for the last several years – even with sterilization. As Brad Setser notes:

In 2005, the pace of China’s reserve growth picked up (once necessary adjustments are made for valuation), the pace of sterilization picked up commensurately and the interest rates the PBoC paid on its bills stayed quite low. That combination put less pressure than I expected on China to adjust its currency regime. The core question is whether 2005 demonstrates that it is possible, in fact, for China’s central bank to sterilize (offset the impact of rising reserves on domestic money growth) $250 billion or so in reserve growth on a sustained basis. China seems to have pulled back a bit on sterilization during the middle of the year, allowing a pick-up in broad money growth and building up bank liquidity to buffer the Chinese economy against the impact of a 2.1% revaluation.

Or as Mark Thoma suggested – the Federal Reserve is responsible for U.S. monetary policy, not the monetary policy of other nations.

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Libby’s Lawyers: Our Client is Above the Law

Perhaps you may recall the greymail tactics of Scooter Libby’s defense team. When Special Counsel Patrick Fitzgerald called the defense team on these tactics, the defense attorneys accused Mr. Fitzgerald of lying and were insulted by the allegation – even though the allegation is clearly true. The latest tactic from the defense team seems to suggest that their client cannot be prosecuted by Fitzgerald:

WASHINGTON (AP) – Lawyers for Vice President Dick Cheney’s former top aide asked a federal judge Thursday to dismiss his indictment on grounds that the special prosecutor in the CIA leak case lacked authority … The defense attorneys also said Fitzgerald’s appointment violated federal law because his investigation was not supervised by the attorney general.

The Attorney General, of course, is Alberto Gonzales who had likely impeded this investigation when he was White House counsel. Talk about being above the law. This defense team motion is the height of arrogance, but can you blame them? After all, trying to defend Scooter Libby against the charges of perjury and obstruction of justice is damn near impossible.

So let’s see how Byron York might pursue this impossible task:

Fitzgerald Refuses to Show Evidence That Valerie Wilson Was Classified – The CIA leak prosecutor tells Lewis Libby it’s none of his business.

That’s the title of the latest spin from York. He continues:

Tomorrow CIA leak prosecutor Patrick Fitzgerald and indicted former Cheney chief of staff Lewis Libby will meet in a Washington courtroom to fight over what evidence will be at the center of Libby’s trial on perjury, obstruction, and false statements charges. In the latest exchange of court motions between the two sides, Libby’s defense team is repeating its request for evidence concerning perhaps the two most fundamental questions in CIA leak investigation: Was Valerie Wilson a secret CIA officer when her name appeared in Robert Novak’s famous July 14, 2003, column, and what damage did the exposure of her identity do to national security? Fitzgerald has so far refused to provide any evidence touching on either question, at times shifting his reasoning as Libby’s lawyers pressed their case.

Since York already knows the charges are perjury and obstruction – whether the leak caused damage to national security is not material to this case. As far as proving Valerie Plame was a overt CIA officer, maybe Mr. York needs conclusive evidence that the earth is round before he takes his next cruise.

On a more serious note (after all – I have yet to read anything of value on this topic from the National Review), Talkleft reports on how the Plame whistleblowers (those who cooperated with Fitzgerald’s investigation) are being sidelined within the State Department.

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Measuring Well-Being

I just came across an interesting paper by David Blanchflower and Andrew Oswald entitled “Happiness and the Human Development Index: The Paradox of Australia“. The paper raises a question of crucial importance to economists who think about development and growth issues: what measures should we use to gauge whether any particular group of people are better or worse off than people in another place or another time?

The paper by Blanchflower and Oswald uses survey data to try to estimate how happy people are in various countries, and to compare their reported happiness with their economic well-being as estimated by traditional measures such as income or the World Bank’s “Human Development Index”. They find substantial variations between the official economic statistics and how happy people say they feel.

The NBER digest provided a bit of non-technical discussion about the paper last month:

Some recent findings from statistical happiness research include the following, the authors note in their paper:

1. For a person, money does buy a reasonable amount of happiness. But it is useful to keep this in perspective. Very loosely, for the typical individual, a doubling of salary makes a lot less difference than life events like marriage.

2. Nations as a whole, at least in the West, do not seem to get happier as they get richer.

3. Happiness is U-shaped in age – that is, it falls off for a while, then stabilizes, and rises later in life. Women report higher well-being than men. Two of the biggest negatives in life are unemployment and divorce. More educated people report higher levels of happiness, even after taking account of income.

4. At least in industrial countries such as France, Britain, and Australia, the structure of a happiness equation looks the same.

5. There is adaptation. Good and bad life events wear off – at least partially – as people get used to them.

6. Comparisons matter a great deal. Reported well being depends on a person’s wage relative to an average or “comparison” wage. Wage inequality depresses reported happiness in a region or nation. But the effect is not large.

I find these results quite compelling. I’ve often wondered how much happier the average middle-class person in the United States is today compared to 1970 or even 1950. It would take some convincing to persuade me that they are substantively happier. Yet the economic profession’s standard measures of well-being (income, GDP, hourly compensation, etc.) show tremendous gains over time for the average person.

One natural question that arises from this line of thinking might be this: if the measured economic gains that the average person has enjoyed over the past, say, 50 years aren’t making people happier, should economists and policy-makers even bother worrying about them? Perhaps we should stop even trying to increase GDP or income or compensation, and focus instead on spiritual development, or the environment, or being nice to animals, or something else.

But I suppose that trying to increase income and GDP and so forth still makes sense, because even if they don’t directly make people happier, those measures of economic well-being do give people more possibilities, with which you can do what you want. However, this paper does make you wonder a bit about how many important contributors to well-being our official statistics are ignoring…


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On Real Wealth Accumulation Since 2001

Via Mark Thoma comes a study by Brian K. Bucks, Arthur B. Kennickell, and Kevin B.Moore on the decline in average real household income and the very modest increase in real household wealth. Their study also shows that wealth inequality has increased. As Tom Bozzo notes:

Also, the low official savings rate, which gets pooh-poohed in some corners, does seem to have translated into the more tangible weak results for holdings of relatively liquid financial assets.

Was Tom’s “some corners” a reference to NRO Financial who emphasize the increase in aggregate nominal wealth when they pooh-pooh the low official savings rate? Of course, these FED economists seem to understand the concept of real per capita wealth, which is why they did not publish their findings over at the National Review.

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