Real Keynesians understand imbalanced trade
Trade and Taxes has a post I recommend reading…this is lifted wholesale as a compliment to Howard’s passion and thought on the issue of trade policy and our woes…we might differ on some of the details, but read carefully:
Real Keynesians understand imbalanced trade
by Howard Richman
The United States is being run by pseudo-Keynesians who probably learned their Keynesian economics from an introductory economics textbook. Unlike real Keynesians they do not understand trade deficits.
For example, Obama’s primary economic advisors Lawrence Summers and Timothy Geithner think that one of the biggest challenges facing American policy makers is to persuade the American public not to do anything about the trade deficits. Summers’ and Geithner’s strategy is to first solve the recession through a Keynesian stimulus package and only after that address Chinese currency manipulations.
Real Keynesians don’t think like these incompetents. Real Keynesians understand that the US trade deficit lies at the heart of our current problems. In past postings, I’ve already cited two examples of what real Keynesians say:
* Richard Duncan predicted this global depression in his 2003 book. He argued that global aggregate supply is beginning to outrun global aggregate demand as the countries pursuing export-oriented growth are producing more and more goods without a corresponding increase in income among worldwide consumers. In other words, the excess of savings over investment in the export-oriented countries will drive the world economy into a depression. Eventually, he predicted, US consumers will not be able to borrow more for consumption. Like other debtors they will be forced to pullback, causing the depression.
* George Manbiot pointed out that, according to Keynes, trade deficits in debtor countries cause financial crises. Keynes, himself advocated that the international economic system be built in a way that would guarantee that trade would stay in balance.
The latest evidence of what Keynesians think comes from the December 2008 Strategic Analysis put together by the Levy Economics Institute of Bard College. I learned about their analysis from a commentary by William Greider that will appear in the February 2 edition of The Nation. He wrote:
While Washington debates the terms of Obama’s stimulus package, others see disappointment ahead. The Levy Economics Institute of Bard College, an outpost of Keynesian thinking, expresses its doubts in emotional language that professional economists seldom use. “The prospects for the US economy have become uniquely dreadful, if not frightening,” Levy analysts reported. The institute’s updated strategic analysis warns that the magnitude of negative forces–the virtual collapse of bank lending, private spending, consumer incomes and demand–“will make it impossible for US authorities to apply a fiscal and monetary stimulus large enough to return output and unemployment to tolerable levels within the next two years.” Instead, the unemployment rate is likely to rise to 10 percent by 2010. Obama’s package amounts only to around 3 percent, annually, of GDP in a $13 trillion economy. Levy’s analysis calculates that it would require federal deficits of 8 to 10 percent of GDP–$2 trillion or more–to reverse the economic contraction. And yet, the institute observed, it is inconceivable that this level “could be tolerated for purely political reasons” or that the United States could sustain the rising indebtedness without terrifying our leading creditors, like China.
The Strategic Analysis, authored by Wynne Godley, Dimitri B. Papadimitriou and Genarro Zezza, can be read online. They begin with the trade deficit, pointing out that the private borrowing that sustained the trade deficit during the early part of this decade could not continue. Here is how they put it:
The balance of payments [i.e, the trade balance] (which had been zero in 1992) then moved even further into deficit, on a scale never seen before, reaching over 6 percent of GDP in 2006. Despite the growing subtraction from aggregate demand as a result of this adverse trend, the U.S. economy continued to grow at a satisfactory rate because the balance of payments deficit was offset by a large and growing fall in personal net saving that was fed by a renewed rise in net lending to the private sector, the counterpart to the disgraceful boom in subprime and other ending.
It should again have been obvious that these trends could not continue for long. As early as 2004, in a Strategic Analysis subtitled Why Net Exports Must Now Be the Motor for U.S. Growth, we argued that continued growth in net lending to the private sector was an impossibility, and that at some stage there would have to be a collapse both in lending and in private expenditure relative to income. It would not be possible to save the situation by applying another fiscal stimulus as in 2001, because that would increase the budget deficit to about 8 percent of GDP, implying that the public debt would then be hurtling toward 100 percent of GDP, with more to come. As these processes were nevertheless allowed to continue, we perforce had to bring the short-term prospect into sharper focus. As the turnaround in net lending eventually became manifest, we predicted in our November 2007 Analysis — without being too precise about timing — that, as a result, there would be a recession in 2008. At that time we entertained the possibility that, with the dollar so low, net exports might save the day, after an uncomfortable period of recession.
The processes by which U.S. output was sustained through the long period of growing imbalances could not have occurred if China and other Asian countries had not run huge current account surpluses, with an accompanying “saving glut” and a growing accumulation of foreign exchange reserves that prevented their exchange rates from falling enough, flooding U.S. financial markets with dollars and thereby helping to finance the lending boom. Some economists have gone so far as to suggest that the growing imbalance problem was entirely the consequence of the saving glut in Asian and other surplus countries. In our view, there was an interdependent process in which all parties played an active role. The United States could not have maintained growth unless it had been happy to sponsor, or at least permit, private sector (particularly personal sector) borrowing on such an unprecedented scale….
They predict that private borrowing in the United States will fall by 14% of GDP between the 4th quarter of 2008 and 1st quarter of 2009, specifically:
The implication of these assumptions is that net lending to the private sector falls by about 14 percent of GDP between the first quarter of 2008 and the first quarter of 2009—a drop that has already largely occurred—and that net lending continues negative for a long time after that.
In our view, the unprecedented drop in interest rates recently engineered by the Federal Reserve may not be effective in reactivating standard lending practices, unless confidence in future profits and income growth is restored. However, low interest rates will keep mortgage payments low, sustaining disposable income and helping the economy to recover.
They continue with predictions for the next few years. Their main prediction: “GDP will fall about 12 percent below trend between now and 2010, while unemployment will rise to about 10 percent.”
Although they advocate stimulus packages, they also note that balanced trade must be part of the solution. Specifically:
It is a central contention of this report that the virtual collapse of private spending will make it impossible for U.S. authorities to apply a fiscal and monetary stimulus large enough to return output and unemployment to tolerable levels within the next two years….
Fiscal policy alone cannot, therefore, resolve the current crisis. A large enough stimulus will help counter the drop in private expenditure, reducing unemployment, but it will bring back a large and growing external imbalance [trade deficit], which will keep world growth on an unsustainable path.
At the moment, the recovery plans under consideration by the United States and many other countries seem to be concentrated on the possibility of using expansionary fiscal and monetary policies. But, however well coordinated, this approach will not be sufficient.
What must come to pass, perhaps obviously, is a worldwide recovery of output, combined with sustainable balances in international trade.
Their predictions for the size of the trade deficit depend upon the size of the stimulus package. If GDP is allowed to collapse the trade deficit will disappear. The larger the stimulus package, the larger the trade deficit (which they call the “balance of payments deficit”):
By our reckoning (which is put forward with great diffidence), if the United States now attempts to restore full employment by fiscal and monetary means alone, the balance of payments deficit will rise over the next, say, three to four years to 6 percent of GDP or more—that is, to a level that could not possibly be sustained for a long period, let alone indefinitely. Yet, for trade to begin expanding sufficiently would require exports to grow faster than we are at present expecting, implying that in three to four years the level of exports would be 25 percent higher than it would have been with no adjustment.
In his commentary in The Nation, Greider makes a similar point:
To put it crudely, Obama’s stimulus program might restart factories in China while leaving US unemployment painfully high. In fact, some leakage may occur via the very banks or industrial corporations that taxpayers have generously assisted. What prevents Citigroup and General Motors from using their fresh capital to enhance overseas operations rather than investing at home? The new administration will therefore have to rethink the terms of globalization before its domestic initiatives can succeed….
In other words, trying to stimulate the economy without fixing the trade deficit is like trying to pump up a tire without fixing the leak. Both the Levy Economics Institute and William Greider see the same problem that we do. THE STIMULUS PACKAGE WON’T WORK UNLESS TRADE IS BROUGHT TOWARD BALANCE AT THE SAME TIME! Here is Greider’s solution:
A global recovery compact would require extremely difficult diplomacy but could be possible because it is in everyone’s self-interest. The United States could propose the outlines with one crucial condition: if the trading partners are unwilling to act jointly, Washington will have to proceed unilaterally. A grand bargain could start with US agreement to serve once again as the main engine that pulls the global economy out of the ditch. That is, the United States will have to continue as the buyer of last resort for the next few years, and China and other nations will have to bail us out with still more lending. In the short run, this would dig us into a deeper hole, but the United States could insist on a genuinely reformed system and mutually agreed return to balanced trade, once global recovery is under way.
Congress can enact the terms now–a ceiling on US trade deficits that will decline steadily to tolerable levels, as well as new rules for US multinational enterprises that redefine their obligations to the home economy. Unlike in other advanced nations, US companies get a free ride from their home government when they relocate production abroad. That has to change if the United States is to reverse its weakening world position. Tax penalties plus national economic policy can drive US multinationals to keep more of their value-added production at home. These measures can be enforced through the tax code and, if necessary, a general tariff that puts a cap on imports. Formulating these provisions now for application later, once the worst of the crisis is over, would give every player the time to adjust investment strategies gradually.
Greider’s solution would definitely be a great improvement over what we have now. But it would take cooperation from all the parties involved, including the other countries in the world and American corporations.
In contrast, the solution that we present in our book Trading Away Our Future would work without requiring anything more than US government action. For example, if you plug one of the Import Certificate plans we recommend into the Levi Economics analysis you discover that it instantly causes a recovery:
* American exports increase because they earn Import Certificates.
* Investment in American factories increases because American production becomes profitable.
* American consumer spending increases because American income increases.
* Import Certficates by a trade deficit country don’t cause a trade war. They tie imports to exports. Any trade-surplus country that tries to counter the certificates by reducing its own imports of American goods finds that it is thereby reducing its exports.
The Levi Economics Institute and William Greider deserve a lot of credit for facing the problems honestly. But we are still the only ones with a simple solution that could be immediately put into practice.
Posted by Howard Richman at 12:01 AM
lifted from Trade and Taxes