May 1, 2017

Daniel Griswold on the Basics of Trade, Trade Deficits, and Protectionism

Protectionism has always been a major drag on the US economy, and the Trump Administration should embrace the tenets of free trade instead.
David Beckworth Senior Research Fellow , Daniel Griswold Senior Affiliated Scholar

Hosted by David Beckworth of the Mercatus Center, Macro Musings is a new podcast which pulls back the curtain on the important macroeconomic issues of the past, present, and future.

Daniel Griswold is a Mercatus Center Senior Research Fellow and Co-Director of the Program on the American Economy and Globalization at the Mercatus Center at George Mason University. He joins Macro Musings to discuss the theory of trade, dating back to Adam Smith, and his work on current US trade policy. Daniel and David discuss some of the misconceptions surrounding trade and why Americans should embrace free trade instead of protectionism.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to macromusings@mercatus.gmu.edu

David Beckworth: Dan, welcome to the show.

Daniel Griswold: David, glad to be with you.

Beckworth: Oh, it's a treat to have you on. So tell me, how did you get into economics and especially into trade policy?

Griswold: Yeah. My original ... My first career was in journalism, I majored in journalism at the University of Wisconsin at Madison. My dad was in the weekly newspaper business, I sort of caught the bug there writing sports stories when I was in high school-

Beckworth: Interesting.

Griswold: And I sort of liked seeing my name in print, getting comments from people. I was also pretty good with numbers. I like calculus and my freshman year in college, I was actually a pre-engineering student, but just found, I enjoyed journalism and writing and public affairs. Worked for a couple of years as a press secretary on Capitol Hill in the early 80s, that was an exciting time. And then my big career break in journalism was being a daily newspaper editorial page editor out in Colorado Springs for a newspaper chain. By then I'd realized I was very much in favor of a free market and limited government. Reagan came in, I'd seen the failures of the Carter administration and sort of liberal big government and agreed with a lot of what Reagan had to say about economics and other matters. So for 12 years I had the pleasure of writing libertarian free market editorials for a daily newspaper back when that was a robust business. That's changed of course in the last 20 years.

Griswold: But in the early 90s we had a big debate in this country over NAFTA and I was writing editorials about local subjects, but also about national and international subjects. And I was writing about NAFTA and of course, I was inclined to support free trade for lots of reasons but there were some more sophisticated arguments and I heard people like Ross Perot criticizing and I knew they were wrong, but I wasn't quite sure exactly all the reasons why. I thought, this economic stuff is really interesting and I got the idea in my mid 30s, a wife and three kids, why don't I go back to graduate school and study economics?

Beckworth: Really? Wow.

Griswold: My wife is British and so we decided if I'm going to take a couple of years off, let's go to England. I got accepted at the London School of Economics, spent two years there studying, got a diploma in economics my first year and a master's in the politics of the world economy from LSC. And of course over in Britain, they have this concept of political economy. Here we're more siloed academically. You have the economists that have these elaborate mathematical models and you have the international relations people who are talking about governments get along and the two don't meet. Well over there you talk about them together, and economics happens in an institutional framework.

Griswold: And I realized if I just stuck with economics, I wouldn't be talking about Adam Smith and the WTO and all these institutions while LSC had this program. It's called the politics of the world economy, international political economy, it was just what I needed to study. And as I was finishing my final exams, I got hired by the Cato Institute to be their director of trade and immigration studies. Spent a wonderful 14 years there, had my four and a half years at the Trade Association where I learned a lot about how trade works on a port level, on a regulatory level day to day. And then here at Mercatus when they were talking about starting a program on international trade and globalization, I thought this is a great opportunity, especially with some of the ill winds blowing during the 2016 campaign, not just Donald Trump, right? But Bernie Sanders and Hillary Clinton turning against TPP and it just all came together.

Beckworth: Well, this has been a busy time for you since the election in fact, might even be a little discouraging, possibly some of the rhetoric coming out of the White House, we'll talk about some of that later. I joked with you earlier though, that president Trump is the full employment act for you because he's going to guarantee you much work given some of the things that he says about trade. So let's talk about an issue that he brings up that may be confusing to some of our listeners. Many of our listeners already understand this, but let's talk about trade deficits. What is a trade deficit? What has its history been in the US and why is Trump so worked up about it?

The Basics of Trade and Trade Deficits

Griswold: Yeah. And the trade deficit has been a source of misunderstanding for centuries. Adam Smith took on the trade deficit, he called it this absurd doctrine of the balance of trade. And it really goes back to mercantilism, right? Which was the dominant trade worldview back in the 1600s into the 1700s, and that is we need to export as much as we can and import as little as possible because the whole idea of trade is to build up your storehouse of gold, right? So you could wage war and when. Adam Smith showed that, that's just absurd. The wealth of nations is not measured by their gold stockpiles, it's measured by how much stuff their people can enjoy and consume in their daily lives. Services, goods. Well, I think Adam Smith delivered an intellectual knockout blow, but politically it still resurfaces.

Griswold: And our politicians to this day have this view that trade is all about exporting. We win when we export, we grudgingly accept imports. And then by that worldview, the trade deficit becomes a kind of scorecard of our success, right? And if we're buying $500 billion more from the rest of the world in goods and services every year than we sell, something must be wrong. And this is where Trump comes in, naturally he's disposed that way. He sees trade as a zero sum game where we win at somebody else's expense or vice versa. He's got advisors like Peter Navarro and others who see the world this way. So I have tried to weigh in both on an academic way, but also burden of my career having my journalism background I'd like to take the sound economics and express them in a main street kind of way and help people understand that the trade deficit is not a problem. It's not what the politicians say.

Griswold: Imports are good, they make our lives better every day. They're important to our production because of globalized supply chains and also foreigners don't take those $500 billion and put them in cookie jars, they spend them in the US economy. It's just that they come back to buy our assets, right? Treasury bonds, real estate, foreign direct investment. And another way of saying that is that's an investment surplus and we benefit from that as well.

Beckworth: Yes. Now, Trump did get elected based in large part, I think on economic angst and uncertainty, and in times like those, it's easy to point a finger at things that seem to be bad, immigrants trade deficits. So I want to do, go briefly with you maybe to a very fundamental level and just talk about trade. You have a great paper that we'll get to in a minute, but before we do that, let's just talk about trade. Is trade natural? Do people naturally trade? Do you have to teach someone to trade? Or if you do ... If you had a plane that crashed and they all ended up on the Island, would trade labor specialization naturally emerge?

Griswold: David, that's an interesting way to put it. And I'd say yes, trade is natural. Again, Adam Smith said something about our natural propensity to truck and barter and trade and yeah, your example of people being on an Island is actually a pretty good starting place. Robinson Crusoe, he was a self contained economy, he didn't have to compete against any sort of imported goods. He was very poor. You think of a small village up at the end of a hollow in the Appalachians, they're very poor because they can't specialize as much. If each state had to have its own automobile industry and its own agriculture and was self-sufficient, think how poor the States would be. And one of the reasons the United States has been so fantastically successful is we basically have a continental free trade area, don't we? The constitution guarantees free trade among the States, we don't think anything of it.

Griswold: Well free trade is just taking that sound principle of people being able to specialize and do what they do best and trade with others, and it takes it to a global level. Nations like States, like people are better off if they can specialize in what they do best and trade with other countries.

Beckworth: Yes. You know it is interesting you mentioned like poor people who have a lack of trade. I think one of the defining characteristics of a developing economy is that people, they're poor people in those countries often attempt to do everything. So someone in a poor village in the middle of Sub-Saharan Africa may make their own clothes, their own tools, build their own huts, grow their own food. Where at a characteristic of a typical person in say Europe or the US is they have a job and they outsource their food production, their car production. And sometimes we take that for granted, but if you sit back and realize, what's going on here in the developing countries as they're attempting the saying, Jack of all trades, master of nothing, right?

Griswold: Yes.

Beckworth: And so if you don't specialize in one thing, you never really get good at it and you can't be productive. And again, I think it's something natural. I think we both agree on this and you mentioned Adam Smith, Adam Smith, when he wrote the Wealth of Nations, he wasn't being so much prescriptive as observing what he saw, why are countries getting rich? Right? He saw this labor specialization and contrast that with like Karl Marx, he much more, this is what we should do. This is the problems, I see what we should do. So I think it's an important point that trade is natural. You don't have to tell a child what you get from trade. My kids, they want to trade baseball cards, they want to make themselves better off and it goes through adulthood.

Beckworth: So the question is, I guess, can we scale up and you've said that we can, I want to get more into this. Can we scale up? What are the costs, the advantage of scaling up from an individual to a state level, to a country level? And let's begin by thinking about what trade is in a more systematic manner. And you have a great paper, a recent paper on this, and the paper is titled Plumbing America's Balance of Trade. And we'll make links to this available on our website, a recent publication by Daniel Griswold. So Daniel, tell us about this paper and how it helps us understand trade better.

Griswold: Yeah. And the title is a kind of play on words because plumbing, we're examining it. We're plumbing the depths of America's balance of trade, but also I use the metaphor in there of our trade relations, the rest of the world being a kind of waterworks. And that is above ground we're trading the goods and services and titles to assets. But of course, as you well know, there's a dollar flow going on underneath. And I tried to do a couple of things in the paper, big things in the paper. One is help Americans understand that our relations with the rest of the world are complex, interrelated. It isn't just trade in goods as important as that is, but it's trade in services, it's investment income and it's investment flows, trading in assets. And our international accounting with the rest of the world is kind of like your basic accounting in a business, it's double entry bookkeeping, debits and credits.

Griswold: So if money flows out to buy an import, that money comes back to the United States. They call it trade for a reason. People don't give us cool stuff like cars and big screen TVs and not expect something in return. Either something cool from us, like a ton of soy beans or a jet engine or they'll accept willingly an asset, a treasury bond, a stake in a factory in the United States, a stock in the US stock market. And low and behold, David, about $4 trillion flows out of the United States every year into the global exchange market and four trillion flows back. It gets balanced. And of course, the transmission belt here is the exchange rate, right? If demand for US assets goes up in the world, oh, say the economy's picking up and people say, I want a piece of America, or they want to invest, there's global uncertainty and they want to buy treasury bonds, they can only do that with dollars.

Griswold: So demand for dollars goes up and so if money's going into assets, that value of the dollar goes up. Of course, that makes our exports a little more expensive. Imports less so and so the trade deficit widens. That's why the trade deficit tends to widen when times are good, US consumers are flush, they're feeling confident, and also the world always wants to buy our exports, they're very popular. The world loves to buy our assets because we're such a big open liquid capital market in the world.

Beckworth: So you mentioned, that we've been talking about, you mentioned the trade deficit, which maybe we could say more generally a trade balance because we could have a trade surplus. Some countries do have trade surpluses. So within that trade balance you also alluded to there is it can be broken down into other categories in particular, there can be a goods balance and a service balance. So the goods balanced are the physical things we trade.

Griswold: Yeah, we call that a merchandise balance.

Beckworth: Merchandise balance.

Griswold: That would things you could drop on your foot. So soybeans, steel, computer chips, and then there's services which some people call invisible trade. And that's things like financial services and consulting and architecture, that sort of thing, travel. When you go on a European vacation, in effect you're importing a service, right? You're spending dollars to buy it. You have to go over there to pick it up, but that's a service import when we travel abroad, when a group of Chinese tourist's comes here to view the Grand Canyon, that's a service export for the United States. And by the way, we run a pretty large deficit on the merchandise side, 700 billion or more, we run a $200 billion or more surplus on a services. We're very competitive in that, that's been growing. And it's interesting, we run a pretty large surplus on investment income, interest and profits and dividends earned on assets owned abroad or in the United States.

Beckworth: So the service part of that trade balance is interesting and maybe a little bit puzzling for some of our listeners. There's one more example, so something that I'm real familiar with being a former professor, we have foreign students who come in. So where I was, we had a number of students from Saudi Arabia, for whatever reasons, [inaudible 00:16:41] Saudi Arabian students in my former university. So how would that be recorded from the US perspective?

Griswold: Right, that would be a service export.

Beckworth: Okay.

Griswold: On several levels if they travel here on a US airline, they're spending dollars on a US service and then on their tuition, in effect we're exporting educational services. Again they, like you go into Europe, they have to come here to pick it up. And so that, we're very competitive in that. And the point in the paper of me talking at some length about this elaborate system is that it's interrelated. If our politicians turn off the spigot of dollars flowing abroad to buy clothes and shoes and electronics from China, that just means fewer dollars out there in global exchange markets. And those students will find it harder to get dollars to spend to come to the United States. And maybe the dollar will get so strong, they'll decide to go to Canada or Australia and we'll lose in other parts and we'll be a less efficient competitive economy in other areas.

Beckworth: Yeah, so your plumbing analogy reminds me of like a water park, right? You see the rides, the actual action above ground, but below ground, there's all this water flowing that is very important, the park that we see cannot function without the plumbing beneath moving water back and forth.

Griswold: Correct.

Beckworth: And also that the education thing of course is near and dear to my heart as I mentioned. So what you're saying is when I gave my invigorating lecture to these students from Saudi Arabia I was helping the US export a service.

Griswold: Right.

Beckworth: Is that right? Okay.

Griswold: Yeah.

Beckworth: All right, so that's where we seem to have done the best. We export more services than we import, so we went up a surplus in that category. But on goods we run a deficit, we import more goods than we export. Now you also went on, so that's the trade balance.

Griswold: And I would say that's okay by the way.

Beckworth: Oh, that's okay. Right. Now, you went on to also mention another category, so we have the trade balance and you mentioned all the investment income. So if we have assets overseas that can earn us income and vice versa, foreigners in the US and what you said is we're earning more investment income net. So my more income is coming in on investment than is going out, is that right?

Griswold: Yeah. And this is maybe one of the more counterintuitive findings of the paper. Foreigners own more assets in the United States than Americans own abroad. They own about $29 trillion of US assets. We own about $23 trillion of assets abroad and of course, that's what you'd expect when year after year, we're running a deficit on the current account, which is all our trade kind of put together in a surplus of investment capital coming into the country, which is just foreigners acquiring $500 billion more in US assets in a year than we acquire abroad. The interesting thing is we still earn more on our investments abroad. Why? Because we get a higher rate of return. US outward investment tends to be focused in direct investments, so think of a US multinational establishing an affiliate abroad to provide goods and services.

Griswold: Foreign investment in the United States tends to be more on the portfolio side. Some in the stock market, but mostly treasury bonds. Right? You know as well as I do, foreigners love US treasury bonds, they own, I don't know, $5 trillion worth the Chinese and the Japanese alone own about a trillion dollars of treasury bonds. But as you also, you and Scott, well know, they don't pay a real high interest rate on that. So foreigners are looking for security and stability, right? A safety of their principal. US companies are out there looking for higher returns. So year after year, we're earning about $200 billion more per year in our investments abroad than foreigners are earning in the United States. And that helps to offset the goods balance. That's one more reason why we shouldn't be obsessed with a goods balance even though I don't think that's a problem.

Beckworth: Okay. Just to go back and to define and summarize a term you use, you use a term current account balance. And that term is a broader, the complete measure of all the international transactions we do.

Griswold: A little narrower than that. So the current account is the trade in goods and services, broadly defined, kind of day to day transactions for goods and services. And of course that includes, when you earn interest on something in effect the owner of the assets paying a return on that to rent it, a treasury bond, right? So that's a kind of service. And then we have another category called unilateral transfers, foreign aid, remittances, that sort of thing. And that's a kind of trade even though they don't expect something tangible in return, so that's the current account side. The other side of the ledger is there's a couple of names for it, but broadly the financial account. So think of that as trade in titles to assets, treasury bonds, property, stock. And that's different of course, right?

Griswold: You buy something to hold it and then resell it later on, whereas you don't buy, generally buy a ton of soy beans or steel to hold onto it and resell it, you consume it or you use it in your production process. And lo and behold, those two, the current account deficit that we have in America is pretty much exactly offset by the financial and there's a smaller part called the capital account surplus that we have. The bean counters can't get it exactly right, so we have something called errors and omissions or the statistical discrepancy, but over time that's no more than about one and a half percent of the overall accounts. It's just that they can't keep track of all the services and everything. And actually, I'm glad they can't keep track of everything, right?

Beckworth: Well, so just to put this differently, the current account balance is one side of the balance of payments and it captures again, the trade balance, interest income, and then any kind of you said unilateral-

Griswold: Unilateral [inaudible].

Beckworth: Like you give a gift overseas, charity.

Griswold: Yes.

Beckworth: And then the flip, so that, all those sum together should be the opposite of whatever is happening in terms of asset transactions, the treasury stocks going overseas.

Griswold: Correct. And that financial inflow, it's kind of hard on a podcast to get into the national income accounts, right? Y equals, all that. But in a nutshell, that inflow of foreign capital comes into the United States because our domestic savings fall short of investment, right? We have a certain level of national investment, which I think is something like 22% of GDP. We have our level of savings, which is somewhat below that, that gap is filled by foreign savings coming in. And another way, another key point of the paper, and of course this is an original to me, economists have been talking about this for decades, but the current account deficit is defined by that domestic level of savings and investment. It doesn't have anything to do with trade policy, unfair trade practices abroad, lack of competitiveness. It's those macro economic, domestic levels of savings and investment.

Griswold: In other words, if you want to fix the trade deficit, and I don't think it needs to be fixed, if you want to change it, you've got to somehow change the domestic level of savings and investment. Getting tough with our trading partners, raising trade barriers, spending more on the EXIM bank. None of that's going to change, fundamentally change our balance of trade. You've got to somehow change the domestic levels of savings and investment.

Beckworth: I want to do one more example to flesh out this idea and we'll move on. To illustrate the idea of the current account versus the financial accounts. So if I buy an automobile from Japan-

Griswold: Yes.

Beckworth: My Honda Odyssey minivan that I actually do own.

Griswold: I have one too, they're great, aren't they?

Beckworth: Older men here with children, kids and families, date ourselves. All right, so I'd buy that from Japan. And what Japan now is looking for is something in return. I don't have the real resources to give them anything, so what I give them instead is I sell them an IOU. I sell them a treasury, maybe I sell them part of ownership of my company. I sell them something and those two transactions have to completely offset each other.

Griswold: Yes they do. And by definition, so what would happen, that's a great example. You buy your Honda Odyssey for $20,000. The Japanese can't pay, let's say it's made in Japan. The Japanese can't pay their workers with US dollars they want Yen, right? So that company will either take those dollars and just exchange them to somebody else who wants the dollars to buy something. Or they may yes, they may put it in a US bank. They may buy a treasury bond, they may invest it in some other facility, some Honda factory in the United States that's making some other car. The point is it comes back to the United States to buy something. People acquire dollars abroad because they want to buy something in the US economy, either one of our assets or a good and service for export.

Beckworth: All right. So the question becomes the causality of that relationship, right? So is it my buying the Honda Odyssey van that triggers a reaction? Well, they got to have something to make up for the van so they'd go after my bond or is it the other way around? Japan has a high savings rate, they're looking for a nice safe asset. They see the US, oh look at that great treasury bond over, let's go grab the treasury bond. But by getting a treasury bond their money's flown into the US then David Beckworth the consumer takes that and buys something, so which way does it causality go?

Griswold: It is complicated and that's the wonder of the free market and price mechanism, and all that. No one can predict it. I would say it's capital flows probably tend to drive the exchange rate more than goods and services. Even though I have a table in the paper that shows how much is flowing in and out and I talk in some detail about how the money's spent. It looks like spending on goods dominates, more than half of that $4 trillion that flows out and in is related to goods. That's a little misleading in that with assets you can buy and sell them multiple times within a period, right? The treasury departments figured that in a given year, the back and forth trading of treasury instruments internationally is something like $27 trillion. So the inflow and outflow of investment dollars on a day to day basis is much higher than for goods.

Griswold: So I tend to think the capital account somewhat drives a foreign exchange or that drives the current account and goods and service straight. And of course, the key price signal there is the exchange rate. So again, if foreigners want those treasury bills, they want to invest in America, that's one reason why you're seeing the dollar jump up under president Trump, there's some hope there, some animal spirits, that the US economy's going to go faster. People want a piece of that, the dollar is going up. The irony, of course, David is this president who's pretty much made it a promise, he's going to shrink the trade deficit, his economic policies if they work, if they ramp up our growth rate, if the government, federal government starts spending money on infrastructure and the federal deficit gets bigger and national savings goes down, if investment goes up and savings goes down, what happens to the trade deficit and the dollar, the dollar gets stronger, the trade deficit expands.

Beckworth: Yeah. So the irony of the Trump policies is that he's fighting against himself, he doesn't realize one hand is pushing one direction, the other hand is pushing against him, exhausting.

Griswold: That is one of several ironies in the tough economic and trade.

Beckworth: Right, so going back to this idea that the trade flows have to be offset by the asset flows, so one of the big discussions that we had leading into the housing crisis is even since then 2008, is this question of, did the housing boom create a need for us to go borrow from somewhere or as Ben Bernanke argued there was a saving glut, that there was all this excess savings around the world and it needed a place to find ... it needed a home. So in Asia, in China at some point or they say like put the percentage GDP with domestic savings, so it goes looking for a home, the US is a great place to park, your safe, it is safe, maybe higher returns on a risk adjusted basis. And so they parked their funds in the US and those funds found their way into mortgage backed securities and ultimately into housing. So there's this question again of causality. Did the foreigners funds flown into the US help kind of kickstart that housing boom or did the housing boom kind of re-generate a need to borrow from abroad?

Foreign Investment and the Housing Boom

Griswold: Yeah, you're leading me out into deeper waters, David. And I'm going to leave it to you and Scott to dissect the housing crisis and all that. I will say this, I think there's an interplay of the two. I think Ben Bernanke was onto something when he talked about a global savings glut. I would agree with him to this in the sense that while in the US we have investment exceeding our level of savings and the foreign savings come in to fill that gap. As you pointed out in a lot of other countries, Japan being chief among them, Germany, another one, their national savings exceeds their domestic investment. And so yes, their savings go in search of investment opportunities. And of course the United States is, we're pretty good at providing investment opportunities, either very secure treasury bonds or direct investments in the US, so you did see that interplay.

Griswold: The IMF has calculated that foreign investment in the United States, particularly treasury bonds, has kept long-term interest rates down almost a full point, like 80 basis points. I don't think you can blame that for the housing crisis that just made interest rates lower, sort of the market's quantitative easing. It didn't favor subprime loans or anything like that. The banks still have to exercise due diligence, but just in a general way, access to foreign capital makes investment more affordable and realizable here in the United States. Think of it this way, if those foreign savings couldn't come into the United States, the federal government, when it's running a half a trillion dollars or $1 trillion deficit, they'd have to finance that with domestic savings. They'd crowd out. Remember that term we used to hear? We don't hear it too much anymore because foreign investment comes in and there isn't crowding out. We would have had crowding out of investment both in housing and in companies and all the other ways we invest our dollars.

Beckworth: Yeah, I think a great way to think about that is if you go back to the classic movie, It's a Wonderful Life, 1930s depression and the main character gets up, it causes ... There's a bank run going on through savings and loan, with the bank run going on and he gets up on the counter and tells everybody, hey, your savings is in this person's house and your savings is in that person's house. And so effectively the available credit for a mortgage in 1930s was your local community, people saving in your community, by opening the global capital markets not only is my neighbor potentially funding my mortgage, but some person in China is funding my mortgage. So there's a bigger pool of funds to draw from, which makes it better for me. Going back to what you mentioned, but it also means interest rates were a little bit lower on our mortgages because there's more credit available.

Beckworth: And then you're right, that's just one small part of the story while we had a housing boom. So I don't want to overstate that, but it's an interesting discussion. But along those lines I liked that, I am pushing you to the deep end because there's a narrative that I like. This is my own bias, my own view. And that is I like to view the US as a banker to the world and you've alluded to this already, but if you look at our balance sheet relative to the rest of the world, what we owe to the world, what the world owes to us, our balance sheet for the US as a whole looks like that of a bank. Like as you mentioned, foreigners, a disproportion of what they will want, their money comes in, what they want to buy from us are these safe assets, treasury bonds, commercial paper, highly liquid. They buy some other riskier stuff, but mostly it's the safe stuff, the stuff you want to hold on to and quickly turn into purchasing power.

Beckworth: And then we take our funds that we send overseas and invest them as you said, in higher yielding, higher returning foreign investment, factories, stocks, riskier stuff but they pay better. So if you take the difference between what we have to pay foreigners for treasury is very little and what we earn, this great amount of money that's coming in, we look a lot like a bank. And the thing about a bank, look at your local bank, it does the same thing. It takes in deposits, pays very little or nothing on them, lends out in terms of a mortgage, earns a spread. It effectively is taking in more money than it's paying out. Same thing we do, but we don't look at banks and say, ah, evil bank earning a current account deficit with your community. Right? So it's how it's used, what's the motivation? What's the mechanisms behind it?

The Basis of the Current Account

Griswold: Yeah, I think that's a good analogy. And yes, our treasury market is a large part of the assets that we offer to the world. The world does invest here in our companies. I point out in the paper that 6.4 million Americans work for foreign owned affiliates in the United States. So David, maybe one way to summarize it is the US is competitive in a broad range of industrial and service industries. We have a comparative advantage and we sell $2 trillion plus of stuff to the rest of the world. We also have a comparative advantage in investment opportunities. And that's what I think a lot of people may say, oh, America's not competitive anymore, we don't make anything anymore. It's not right, that's dead wrong. We make lots of cool stuff and we sell it around the world, but we're pretty good at also creating investment opportunities.

Griswold: And no, we're not selling the household China, this Trump's trade advisor, Peter Navarro was trying to make this point the other day, quoting Warren Buffet that conquests by purchase, yes, we have an inflow of foreign investment, but they're buying up all our assets and we'll be left with no assets. That's ridiculous. Yes, foreign assets owned in the United States have gone up to 29 trillion, as I mentioned. What's happened to net household worth in the United States? It's at record highs. If you take household nonprofit and business net worth, it's over a hundred trillion dollars. So we can create assets the same way we create goods and services and we're wealthier, foreign investors in the United States are wealthier. I call that a win-win for trade.

Beckworth: I like that. And I like to throw this out there, this is a joke that was often thrown around early to mid 2000s when people were worried about a trade deficit. In fact, interestingly enough the crisis that was predicted before the housing bust was we were going to have a dollar crisis because they're running these huge current account deficits. Never happened.

Griswold: That scenario, never seems to happen.

Beckworth: And never seen, and I think it's because they failed, many of these critics and observers failed to appreciate this banker to the world role that we play. We provide these great investment opportunities. But another way of saying this a little more crudely and in a way that might make some people uncomfortable is that one of our advantages, one of our comparative advantages, one of our strengths is we know how to export good debt, right? We have a comparative advantage in exporting debt to the world. And you're like, oh, that sounds horrible. But the thing, if you're someone who is saving for retirement, if you have some long-term project, you want to park your funds somewhere safe, right?

Griswold: Right.

Beckworth: And we have the deep capital markets, we've got the rule of law, we have history, we have a financial sector that's sophisticated. We truly have the competitive advantage in exporting debt to the world and that usually, you shutter in horror when you hear that, but we've got to recognize that fact.

Griswold: Yeah. And we're so good at it, we can pay next to nothing for people to park their savings here. Yeah, no, I agree with that. There is the misunderstanding that we're a debtor nation, right? That phrase came and was being used a lot in past years. And I would say, well, yes, our federal government owes a lot of debt and hopefully they'll start to pay that off. But that's a fiscal issue, that's not a trade issue. But you have to remember a lot of that incoming investment here isn't debt it's inequities, it's in direct investment, factories, real estate. And that isn't debt of any sort, is it?

Beckworth: It's equity.

Griswold: There's a Nissan factory in Nashville, Tennessee where a couple of my kids live. That isn't a debt we owe to Japan, that's an investment that Japanese company has made here in the United States in our productive capacity that makes us more productive as a nation.

Beckworth: But even on the debt sides, let's go to the most uncomfortable part of this. If the world is saying, hey, we want your debt, we need ... because our country, we don't trust. I mean, we're providing a valuable service to the world and I do think it makes the life of a politician easier. It makes it easier for Congress and the president to not worry as much about budget deficits and stuff like that because rates are so low. But I also think it means our debt capacity is higher than it would otherwise be. Now whether this can go on forever, it's another question, but let's move on to something else that's come up with this discussion. Part of the Trump administration and this idea that the trade deficit is bad because of an accounting identity. So we've talked about why trade deficits in themselves aren't necessarily bad, but there's this idea that more trade deficits means less economic growth. Can you explain this, this idea? And Peter Navarro is the one who's abdicating this one.

More on Trade Deficits

Griswold: Yeah. And again just picture in your mind it's a standard equation Y which is GDP equals private sector consumption, government consumption, investment and net exports, export minus imports. Well of course, I think the right way to look at that is GDP depends on the factors of production, right? Labor, capital, total factor productivity. And then the right side of the equation is just what we do with it. We make a hundred widgets, there's only four things we can do with it, right? We can consume it individually, we can consume it as the government. We can invest it or we can export it. What Peter Navarro and other people, actually, this is a very common misunderstanding. They look at the right side of the equation and say, well, you add up all these things and you'd get our GDP and you see that in the reporting on the GDP reports.

Griswold: And I have to say the Bureau of Economic Analysis, the department in the commerce department that calculates GDP, they contribute to this because they say, in net exports you have exports minus imports. That's our trade balance. Exports of course are a minus, sorry, imports are a minus. And so in a simplistic way, the more we import GDP must be lower because that's stuff we don't make. Well the problem with that is the government actually calculates GDP, not by counting up what we produce, but by counting what we consume. And then assuming that if consume it, we had to produce it. Well the problem is imports are baked into the those other categories, those other terms. So the government just knows we consume $16 trillion last year, but they don't know how much of that is imports and how much is domestically produced.

Griswold: Same with what the government does, same with investments, same with what we export. Our exports have a certain import component, so they subtract out imports at the end of that so we don't double count them in the other factors. So they're neutral on the growth equation. But Peter Navarro, there's some debate, does he know he's making a mistake and is just doing it for political purposes or does he really believe what he says? I don't know. But he exploits this to make imports and the trade deficit looked like it's a drag on growth when in fact it's not.

Beckworth: And I think that's an important point because Peter Navarro has made this a big deal and there's been some people who've written about why he's terribly confused about this. But you will often see, even like in newspaper stories, GDP this quarter was 3%. It was dragged down by a 2.2% increase in imports. And so you often will see people talking about this account and identity and talk about how our imports were drag on growth. I'm asking that many times, but really all it is a way to avoid double counting.

Griswold: Correct. We're just subtracting them out because they were originally added in, in these other terms.

Beckworth: So I guess instead of putting all the blame on Peter Navarro, I think maybe us as the economics profession should have been doing better all along that journalists, economists, the BEA, I think in their press releases, what they will also say, this has been a drag on. Instead of saying that we should just let me look at GDP, net of ... Look at the growth of GDP and not get hung up on what imports and exports have done.

Griswold: And of course, the irony is as David, the faster the economy grows, the faster imports grow. There's a cause and effect both ways, right? As the economy expands, both consumers and businesses import more, but of course the imports also fuel growth. They allow US businesses to produce their final products at a more competitive price. And so, I've done some analysis of this over the years and there's a pretty strong relationship between the size of the trade deficit and the expansion of the US economy. The faster the US economy grows, the more we import and the bigger the trade deficit tends to be. The flip side is, the trade deficit will fall often sharply when we hit into recession. Why? Foreign investment tends to dry up, consumers don't spend as much on domestic or imported goods. So they repeat this over and over again. I'm talking about the financial press and other people who don't understand it. And yet the plain facts contradict it.

Beckworth: Yeah. So there's a cyclical component to this confusion, right? As the business cycle goes up and down, it affects it and so it adds to this confusion. Well, let's move on. We've really, I think, kind of gone down into the depths of plumbing of balance of trade. Let's talk about some of the critiques of trade that had been lobbied, thrown at people like you and me and others about the challenges it creates. So one of the critiques is look at the US in historical perspective, we imposed trade barriers. We did trade protectionism to help us grow faster. Why can't other developing countries do the same thing? So what is your response to that?

Critiques of Trade

Griswold: This is a historical argument. You hear Pat Buchanan and other people have said the US had high trade barriers and we were a protectionist country up until the 1920s and 1930s. And of course, we expanded in breathtaking fashion in the late 1800s and became an industrialized power in the world. The problem with that narrative is that, and Douglas Irwin of Dartmouth has shown this and others, is that the sectors where we advanced most dramatically in the 1800s weren't the protected sectors. They were services and utilities and railroads and things like that. So it wasn't protectionism, it wasn't the protected sectors that were leading our growth. In fact, the trade barriers tend to inhibit our growth because they made some of their protected commodities more expensive for industry.

Griswold: And of course, one thing the protectionists don't mention is during the, basically from the civil war to world war one, we ran continuous trade deficits. Why? Kind of the same story as today, David. A lot of foreign investment coming into the United States in particular British investors investing in American railroads and mines and industry. And then of course, we had mass immigration on a scale that's actually in proportion to our population higher than it is today. So the Pat Buchanan's of the world who cite protectionism as the key, one, the protectionism wasn't the decisive factor. That was also an era of large trade deficits and large scale immigration.

Beckworth: That's interesting. So what you're saying is that our growth may have been even higher had these trade barriers not been in place because the economy has grown robustly anyways, these other sectors. But you mentioned that the ones that were protected may have clogged up some of the economic activity, so maybe we could have done even better?

Griswold: I think we would have done better, yes. And again, Douglas Irwin's calculated that if you look at total factor productivity, ours was actually about the same as great Britain's, which was free trade. So we didn't get any advantage in sort of overall efficiency. We just grew faster because Britain's a little Island, we're a continental sized market. We had these huge infusions of labor, of foreign labor and foreign capital really helped to make the United States the industrial giant that it became.

Beckworth: And that's, I guess what many of the critics Pat Buchanan's and others who want to claim, hey, developing economies who follow the US model, there's very unique circumstances to the US that doesn't apply to these other places.

Griswold: Correct. And of course, you look around the world and those countries that have developed the fastest and achieve the highest incomes tend to be those that have, if not perfect, free trade, at least more free trade and are more engaged in the global economy. Protectionism is a failed policy, whether you're a richer country or a poor country.

Beckworth: All right, let's move on to another critique. And this speaks to the winners and losers from trade and every one including you and me, when I would teach the class, we'd always say, look, trade overall makes the country richer. The net welfare goes up. However, there will be losers. So textiles workers in the US have lost out to other countries as factories and these jobs got export exported. But overall we're a richer country because of it. And economists have always been honest about this and I think that they've always been clear about this. They never had any illusions.

Beckworth: However, there's been a number of recent studies by David Autor, David Dorn, Gordon Hanson, that made kind of a splash because they found that these affects, the loser effect was actually larger than many economists had expected. And it was tied to China. China comes to the WTO, the World Trade Organization, 2001, big, big splash in the world economy. I mean, you're opening over a billion people into the world economy. And so it's a huge shock. So what are your thoughts on that? What do these studies actually tell us and how are they misinterpreted and what should we take away?

Griswold: Yeah, that was the China shock paper that has gotten a lot of comment. In some ways there wasn't anything new there, just as you said, we've always known that some ways it's the idea of trade, right? We do less of what we're less competitive at and more of what we're more competitive at. So when you open up an economy to trade, you're going to have some sectors that will shrink and they'll lay off their workers, that's nothing new. But also we know from theory and experience that the overall economy grows, it becomes more efficient and living standards rise overall. And by the way, trade isn't the only disruptive force, millions of Americans are displaced from their job every year. Vast majority of them displaced, not by trade, but by technology, changing consumer tastes.

Griswold: I was just reading the other day Sears is probably going to go bankrupt, not because of international competition, but internal competition. As I mentioned earlier, I'm a refugee of the newspaper business, right? 60% of daily newspaper jobs in America have disappeared in the last 20 years, not because of imports, because of technology. So in that sense the Author paper is just pointing out something we all knew. And of course it's a monumental event really in human history that China has rejoined the global economy, 1.3 billion people, so that was going to have some ripple effect. I think the Autor paper has been a kind of misused, and David Autor himself will say the last thing he has in mind is trade barriers against China. He says he's in favor of free trade as a vast majority of economists are, I think a couple of ways their paper has been misunderstood.

Griswold: They calculate just under a million manufacturing jobs disappeared in the United States, basically in over a decade, basically from the late 1990s into the 2000s. That's a large number, but it is spread over a decade. So you're talking about 100,000 people a year displaced by imports from China. Well, David, that's half a months job creation in the United States, we have two or 300,000 people applying every week for unemployment insurance. So in the vast churn of the labor market, that really isn't that big an amount. And as other economist pointed out, China's joining the world economy and the World Trade Organization was a onetime event. They're kind of settling into an equilibrium now, we're already seeing China's growth and its export numbers starting to level off. They're still growing, but as a share of the world economy and US imports, it's starting to level off.

Griswold: So I think it would be a mistake. Yes, real people lost their jobs, they weren't unique in that respect. During that same time period, we lost about five million manufacturing jobs overall and a study by Ball State University a year or two ago, calculated more than 80% of those were because of technology. Right? Automation. The main reason we've lost millions of manufacturing jobs over the last couple of decades isn't because of trade, it's because of efficiency and automation. Our overall levels of output of manufacturing, real manufacturing output, manufacturing value added is at or near record highs. We're just doing it with fewer workers because there's so much more productive.

Beckworth: Yes, so you look at the one million number they come up with compared to the five million number that happened because of automation. So one million due to China effect, five million due to automation. In some ways this China shock may just be hastening what was already going to happen because of automation. So again, that's not to say we need not to be worried about these workers, it's real loss and we need to find ways to reeducate them, retool them to come back in the labor market.

Griswold: That's the key in a subject for another show-

Beckworth: Right, absolutely.

Griswold: But the right policy response is not to raise barriers to trade or to stop technological change for that matter. It's to equip our fellow Americans, particularly the younger generation, to fill the jobs being created today and tomorrow. Not to somehow bring back the jobs of the past, which I don't think we can do anyway. So better education, particularly in the STEM subjects. More labor market flexibility, things like portable health and retirement savings. All these things will help people adjust to a changing economy.

Beckworth: One of the things that's surprising about this is how the Trump administration has really pushed hard to get back these manufacturing jobs in addition to bringing back what is now the global supply chain. So there's a couple of comments. One, I don't think the Trump administration realizes how disruptive his policies would be to the global supply chain. And it would adversely affect many places in the US that are a part of that. So a car, a piece of a car, it's made in China, then a piece gets made in some small town in Mississippi and these parts are shipped back and forth and it's like throwing a bomb into that complicated global supply chain.

Beckworth: The other thing though that really is striking and I guess I can forgive Trump and many people for not appreciating the global supply chain. You have to really sit down and think hard about it. But one thing that he should know, that Peter Navarro should know, is that manufacturing jobs as a percent of the labor force have been declining and I'm looking at a chart here, since the 1940s. It's almost like a linear trend.

Griswold: It's like a straight line, you couldn't find in that line when China joined the WTO, when we signed NAFTA.

Beckworth: So I guess it's striking to me if we've been losing jobs in manufacturing since the 1940s at a steady pace, why do we think we can get them back? I mean, surely Peter Navarro is aware of this trend. Maybe Trump isn't but his advisor should be ... I don't understand how they think we're going to get back manufacturing jobs that have been lost to robots, to machines.

Griswold: We're not. And that chart we're looking at is true for every advanced economy. Germany, China, China is losing millions of manufacturing jobs, they're going to lower cost places like Vietnam and other places. We couldn't reverse it. Think what we'd have to do to our economy to get 10% of our population back into farming. Right? It was 40% a century ago, now it's 2%. What if somebody said we were a great nation back when 10% of Americans were in farming, we'd have to turn the economy upside down and by the way, go back to a much lower standard of living. So we've actually been adding some manufacturing jobs as we become more competitive in certain industries.

Griswold: But as a percentage of the workforce, every advanced economy, we can go macro in a large scale here. Every advanced economies followed the same pattern, right? Farming jobs start dropping from the beginning. Manufacturing tends to rise as a share of the population and then start to fall. Service jobs are always rising. The mark of an advanced economy is a rising share of the workers in the service sector where you could make a very good living. We have some very advanced service sector jobs, it doesn't mean we don't farm, we graze record amounts of agricultural products with only 2% of the population being farmers because they're so productive. We're producing record amounts of manufacturing output with fewer factory workers because their so much more productive. Isn't that the essence of economic advancement?

Beckworth: On that positive note, we're going to have to end because we're out of time. Our guest today has been Dan Griswold. Dan, thank you for being on the show.

Griswold: David, it's been my pleasure.

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