Sep 25, 2017

Caroline Freund on the Decline in Global Trade and Trump’s Trade Policy

By exiting the Trans-Pacific Partnership, Trump has not only closed one potential avenue for keeping China accountable, but has also put US economy in jeopardy.
David Beckworth Senior Research Fellow , Caroline Freund

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.

Caroline Freund is a senior fellow at the Peterson Institute for International Economics and previously served as the chief economist for the Middle East and North Africa at the World Bank. Caroline joins Macro Musings to discuss her career in trade policy, her work on the slowdown in global trade since the Great Recession, and also shares her thoughts on President Trump’s trade policies.

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: Welcome to the show.

Caroline Freund: Pleasure to be here.

Beckworth: Yes, I'd like to ask you, as I do all my guests, how did you get into the economics?

Freund: In high school, I loved math and then when I got to college, I took some economics and the idea of maximizing welfare was a lot more exciting than just maximizing Y. So I enjoyed that. But to be honest, I really didn't get into economics until after college. I spent two years in the Peace Corps in Ghana and the question that always comes up and that's plagued economists for hundreds of years is why are some countries poor and some countries rich, and living in Ghana really brought that out for me. When I came back from the Peace Corps, I went to graduate school.

Beckworth: It's often easy, I think, for people like me whose focus is on business cycle frequency, macro, to lose sight of that more important question. I get hung up on FOMC statements and what Janet Yellen is saying. The bigger question is why aren't more people where we are in terms of economic development? Whenever in like Haiti, the earthquake hit, things like that are really sober reminders that these long run economic growth questions are fascinating and important ones. I'm glad there's people like you who keep us focused on the important ones. Tell us about your time at the World Bank and the IMF and the Fed. What was it like there?

Freund: They're very similar places in some ways. You're surrounded by economist but different in other ways. At the Fed, it's very American and there's a common goal, which is forecasting and monetary policy. I really enjoyed my time at the Fed, but as a trade economist and one that likes to work on micro issues and also on development as I mentioned, the World Bank was just really a better fit for me. I had a lot of fun at the World Bank. It's a fascinating place to work and there's so much to do there. It's very easy to get overcommitted. But what I would say is it's a bit of a chaotic place. And if you come up with an idea and you push it, you can get funding for it and you can really push the envelope on issues in a way that I don't think you can at the IMF or the Fed because they're much more constrained, focused types of institutions.

Beckworth: Let's move on to some issues that you've been a big part of and still are a part of. You've written on these in a number of pieces that... We'll make them available on our web page. But you've written about the global trade slowdown which is fascinating. I've heard a few of the people talk about it, but you've written about it. Summarize for us, what's happened? What's the trend in global trade and what's the surprising part about it?

The Global Trade Slowdown

Freund: In the 1990s and early 2000s, trade was growing at about twice as fast as income.

Beckworth: Is that global income or...

Freund: Yeah. For every one percentage point global income grow, trade was growing at 2%. Over that period, global income was growing 3 to 4% and trade was growing 6 to 8%. Just really soaring. That was a new phenomenon. Then what happened, we had the crisis. Trade dropped off completely more than anybody would have thought, but then it came back, which in 2010, but then it just stagnated thereafter. We went from trade growing twice as fast as income to, in recent years, trade growing just about as fast as income growth. What's really flummoxed economists is this sudden change in the responsiveness of trade to income growth. Did something fundamental shift?

Beckworth: What about the... You mentioned the really sharp contraction in 2009 that was greater than expected, what is the explanation for that? Any ideas?

Freund: I think the crisis was really strong and I've looked into that a little bit and what tends to happen in those periods is actually that the responsiveness of trade growth goes up in really periods of big decline. If you look at it and compare this into other periods of decline of global growth slowdowns, it actually wasn't that surprising. It was surprising if you just thought of every year it's been growing twice as fast and all of a sudden it dropped off four times more than income growth dropped off. But what's I think surprised economists more is this stagnation of trade growth in recent years.

Beckworth: What's the explanation for that?

Freund: There are a few different ones. I think the most important one is the slowdown in global growth. Trade is mainly goods and with the slowdown, and it's mainly heavy goods like equipment, transport, the big tractors, a lot of oil refining equipment, things like that, so the slowdown in investment led to a decline in imports of these kinds of heavy goods, which weigh heavily in trade because they're so expensive and that's been the main factor. Just overall growth slowdown, but especially this investment slowed down.

Freund: The other issue is that part of that period of hyper-globalization in the '90s and early 2000s was due to the fragmentation of the production chain. You had instead of a good being produced in one place, parts were coming from all over the world to be assembled into a good, and shipped elsewhere. But that means that these parts are being traded twice once when they go to be... A semiconductor to be put into an iPhone and then again, when the iPhone itself travels, say, from China to the U.S. So you're double counting a lot of goods.

Freund: During that period of building up the supply chains, what you end up with is this trade which is measured in gross terms and GDP, which is measured in value added terms growing a lot faster. Part of it is that we're no longer building these supply chains.

Beckworth: That's a one-off development that lasted for a few years, the development of the global supply chain.

Freund: Yeah. It could come back. There's still a lot of countries that aren't in the global supply chain. You could imagine if India liberalized or Brazil liberalized or something like that or with all the new technologies coming out, we could have another period like that. But right now those... I'm not saying the supply chains are retracting just that during the buildup, there's especially rapid trade growth relative to income growth.

Beckworth: You have the one-off event of development, the spirit of the global supply chain. Is China part of that global supply chain story? Or is China itself an independent force? Another one-off that's opening...

The China Trade Story

Freund: Both. It's both a part of the supply chain story and just a one-off event because it's such a big country and you have a country like that coming into the world economy and that's just a boom right there. To that extent, and something I'm working on now, is I think global imbalances that also grew during the same period of globalization also contributed to the rise in or the faster trade growth because countries were no longer constrained to import by their export. In a demand boom in the U.S., you could just keep importing and keep importing. You weren't really constrained. And that contributed as well.

Beckworth: Now, China enters the WTO in 2001, is that right?

Freund: That's right.

Beckworth: That's about the time as I recall that all this talk about outsourcing and trade. We were concerned about China. But I guess my question would be, was it really that discreet of an event? Was it suddenly 2001 and boom, here's China? My sense it'd be more a gradual buildup or was it really a big turn in the early 2000s?

Freund: It was a gradual buildup, but there is this noticeable rise in the 2000s in trade with China. But I wouldn't say... It was because they joined the WTO but it was for a reason that most people don't recognize, which is that they liberalized their own economy. They got more efficient and so they were using resources better and able to export more. A big part of that was lowering their intermediate tariffs, their tariffs on parts and components, because you can't produce a final good if you can't get all the parts and components needed to go into that good.

Freund: Big part of that sudden China supply boom was the fact that they liberalized tariffs. Intermediate started coming in that made their production more efficient. They could export more and just liberalize the whole economy, which helped to grow. It wasn't the fact that the U.S. or Europe or anybody else did any major openings to them. They had the same tariffs they had before. They just had them permanently. It was because they did their own liberalization.

Beckworth: Yeah, I remember reading the WTO to China. It was an excuse for them to do liberalization. They could put the blame on us. We have to abide by these rules. We have to... It makes it easier for the leaders of China to say we have to do internal reform. Is that a good narrative of what... Did they really turn to the WTO as an excuse or a justification to open things up internally?

Freund: Yeah, I think so. I think they wanted to anyway. But it's always good to have that external push because in trade anytime you change policy, you're dealing with winners and losers and it's good to have that background of, "Oh, but we have to do it for this," and have something external to blame it on. So I think it was a good push. I do think they wanted to do it. It was a good impetus for that, for changes they wanted to do and would have done anyway. Maybe just a little bit slower.

Beckworth: How is China doing now? I know you've recently did a piece. You talked about the state-owned enterprises in China becoming important. They've been Important. Is China's liberalization still on path? Is it still going? Is there a lot of progress to be made? What is your sense?

Freund: I think what a lot of people are worried about is a slowdown in the reform of state-owned enterprises in particular. When you look at some of the issues that are straining the global economy, and overcapacity in steel is an obvious one, what you see is that the Chinese firms, the top firms, are all big state-owned enterprises. How do you compete in a global economy when you're competing... I'm thinking about the foreign firms, firms from the U.S. or from France or from India, how do you compete when you're competing with firms that are backed by the government and all the financing or special privileges that that entails? I think that is straining the global economy.

Freund: What I looked at was global concentration. So if you think about any industry, say automobiles, what share of global revenues or value added to the top four firms have? What I was interested in is the changes in this. So in the U.S., people have noted that industrial concentration has increased and they're concerned about this because it could indicate monopoly power.

Freund: I think one has to be careful there because you could imagine in the U.S. maybe we have fewer steel companies now because of global competition, but I would hardly be worried about concentration in U.S. steel because they're competing with foreign firms. It's really global concentration that matters from a competitive standpoint in a tradable sector because the firms aren't just competing with U.S. firms.

Freund: Overall, global concentration has actually fallen, which is a good thing from this kind of monopolistic competition perspective. But in industries were state-owned enterprises are at the top, in those top four firms, you see a rise in global concentration. So it's a real indicator that something is different about these sectors where state-owned firms are present and they're too big and if you look at how profitable they are, they're too big given their profitability. They're growing too fast given their productivity growth. These kinds of things all indicate that China still needs to do a lot of reform in that sector.

Beckworth: That's fascinating. Two countervailing forces. One is this global competition which means you've got to put your focus globally, not on domestic industries, but then at the same time these big state-owned enterprises. Tell us how does China, for example, support a state-owned enterprise like steel? What is it actually doing that that enables these industries?

Freund: It can do different things. Often these firms are literally owned by the state so that means they don't have the hard budget constraint that a regular firm would have, so it could be that they don't have to pay off their loans. It could be subsidized loans. It could be cheap land. There are many different ways. But if a firm is owned by the state, you just really have no idea what its budget constraint is because you can also shift between firms. Often what ends up happening is the stronger, and there are some very profitable state-owned enterprises, the profitable ones end up subsidizing the less profitable ones because they're all backed by the same owner who isn't concerned about profitability the way private shareholders would be.

Beckworth: Is there any hope that these state-owned enterprises can actually become free and independent? I know in Korea they had the chaebols which were big conglomerates. Is there a hope that they could become like that, that they could move out on their own? Are you hopeful?

Freund: I was and I think they did do a significant amount of reform, but it's really slowed down or even stopped in the last few years. Instead of privatizing and dismantling the less productive ones, what they've been doing is just combining them. If you imagine you have four state-owned steel firms, instead of saying, "Okay, let's privatize them all," or "Let's dismantle the one that's just really backwards and privatize the other three," what they've been doing is saying, "Okay, we're reducing the number of SOEs just by combining them into one." In some sense, they're going from many SOEs to a few SOE national champions.

Beckworth: That's interesting. But overall the economy of China is still relatively dynamic. Is it still lots of churn? A lot of creative destruction? Or is the state-owned enterprise weighing it down do you think on balance?

Freund: I think it is weighing it down. That's the strange thing about the policy is if you look at growth... In China, the tremendous rates of gross growth we've seen in the past, it's been driven by the private sector. The private sector is growing despite the fact that too much financing is going to SOEs. The private sector is still growing, still supporting growth. The SOE sector is just taking too much. One could say even China could grow faster at the same level of investment or grow as fast with lower investment if that investment was directed towards the more profitable firms. It'd be good for China to reorient some of these SOEs.

Freund: I think what we have to keep in mind is that there are adjustment costs and that's one thing that China's recognized to a much greater extent than the U.S. So if you get rid of a state-owned firm, there are people who would lose their jobs and there may be some adjustment, maybe the private sector is growing in a different location or in a different industry they'd have to be trained for. China's strategy has always been to do that gradually so that the adjustment costs don't hit any one group of people too much. I think that's worked.

Freund: I think what's worrisome now is that the state-owned enterprises have stopped declining. For a long period, they were slowly moving out of the state-owned enterprises and now what we've seen in the last few years is, if anything, increasing investment going into the state-owned sector.

Beckworth: Fascinating. Now, is it easy to get data on that? It sounds like it is, but I would think that maybe the communists want to hide some of this. But apparently you know enough to make to make these claims.

Freund: China's being more open about data. Actually, back when I was at the Fed, I covered China for a year and in those days, it was hard even to figure out quarterly GDP growth because of the way they estimated it. Of course the fact that they always, always hit their annual target no matter what quarterly growth was. I think now you can piece together data pretty well to get a sense of how things are doing.

Beckworth: Now, you mentioned the lack of dynamism in the U.S., the concentration of business, and you suggested we take a global perspective, which is great, but I want to turn that to my boss here. Tyler Cowen's book, *The Complacent Class,* I'm not sure if you're familiar with it or not, but his argument is in the U.S. at least, it probably applied to Europe as well, we've been so successful that we've become complacent and we want to protect what we have. It's become a kind of a cultural phenomenon that we were very protective of everything from how we raise our kids, we're helicopter parents, to how we run business, to government.

Beckworth: There's more risk aversion than used to be in many aspects of our life. We couldn't build the Hoover Dam again, he would say. It's hard to give massive dynamic growth and he would argue as one of the reasons of the lack of dynamism is this general risk aversion. But he points at the end of his book to a country that doesn't have this problem is China. China can build a city and how long does it take them to do that? A few weeks, a month. They build these great cities. They'll forcibly move a million people, and it comes at a cost clearly over there, but there's a tradeoff.

Beckworth: In the U.S., we don't have the dynamic growth like we once did. China has rapid growth with huge costs. Do you see China eventually conforming to our style? Or do you think any chance that we can then be learn something from China?

Freund: I guess I would put it slightly different. I think there's just some convergence and countries that aren't quite as developed, it's a lot easier to grow faster. It's kind of the low hanging fruit argument that there is a lot of things China can do to increase growth. It's a lot harder when you're on already quite advanced country to keep growing at those kinds of rates. I would never expect to see the U.S. growing at 7% for several years in a row. But I wouldn't be surprised if China does. I don't think it's because the animal spirits are so much greater in China. I just think there's a lot more opportunities for business development in China because so many businesses don't already exist.

Freund: I've worked in countries where the risk aversion is so much stronger than the U.S. It's hard for me to think of the U.S. as having problems with that. If you look at the Middle East and North Africa where the fear of failure is strong culturally and also in some countries you can actually go to jail if you don't pay back your creditors, there is no bankruptcy protection. You really don't see business startups. I think the U.S. is still really pretty good on that. Maybe there are some concerns. I think it's very hard to tell how much is just cyclical right now because of this slow recovery since the financial crisis. I don't think I'm quite as pessimistic.

Beckworth: Oh, good. I like optimistic takes. So you're saying is China's Solow growth model still. There's that catch up to?

Freund: Yes.

Beckworth: It's not so much they're more risk loving than us, it's just more that they have the low-hanging fruit.

Freund: I think all people are pretty much the same. I think it depends what institutions you put in place. China has decided to allow people to get rich and that made a big difference. People are going out and starting businesses and growth is doing great. But I think any country where you put the right policies in place in terms of starting a business, in terms of allowing businesses to grow, etc., you would see that kind of growth. Culture might play into it in a small way, but it's really about the institutions and laws in place.

Beckworth: Very fascinating. Let's talk about winners and losers from trade because that's shaped the recent election we've had and discussions in Europe and the U.S. and you've written about this a lot. Actually, it's more than just trade though. I think your writings on this deals with technology, structural change in general, no matter where it comes from and you've talked about... You have an article titled, *The U.S. Needs to Invest in Minds, Not Miners*. Can you explain that to us and what's driving that conversation?

Minds, not Miners: A New Labor Force Direction

Freund: Right now, one thing that almost everybody's talking about is the future of work. What's happening? If you think back to the '80s where one path was finish high school and go to the manufacturing plant and have a pretty good life with a house and two cars. That life is falling away and it's falling away for a number of reasons. One, because of technological change and automation where skill bias technological change. A lot of the routine tasks that people perform can be done by a machine. Those workers can be replaced and what you really need is workers with a little bit of skill that can run these machines and keep them going. There's excess supply of the people who want to do routine, especially manual tasks. That's been a big part of it.

Freund: Trade has contributed to it in the sense that many of those tasks can also be more cheaply done in other countries. These two forces, both in the same direction, have helped to displace some of the workers, especially men and especially in manufacturing. It's part of... I think the backlash against globalization is related to this whole structural change away from those types of jobs.

Freund: Though I would say globalization is being blamed for technology as well because it's so much more tangible to say, "Oh, it's trade, it's the foreigner, it's immigration," and not to recognize that these changes were happening before the period of hyper-globalization. They've continued to happen and we are living in an age where it's a shift from making things with your hands to working with things with your mind.

Beckworth: If you look at... I know you've seen this graph, a figure of manufacturing. Employment is a percent of total employment. I think it's been going on since the '50s or '40s. It's just a perpetual steady decline well before hyper-globalization. Although the rhetoric of the last campaign has been, "Ah, trade is the culprit." It's important, I guess, going forward to really reinforce this, particularly to young people or children, what the future really holds. What do you do though with the people who are discontent? The losers, I guess. What kind of programs or what advice do you give to them?

Freund: One thing is I would just say I don't think it's helpful to call them the losers and I think we do that far too much in economics as we talk about losers. On the other hand, I also think probably it's not that helpful to talk about adjustment costs because that seems to be dismissing the problem. We probably need to find a new language for one thing to talk about this. But we need to do better at retraining people for different types of work and being honest about what the changes are. Talking about these jobs coming back is... They're just not. As you said, if you look at that graph, it's just pretty much a straight line. The only time it went up slightly was during World War II. But I don't think that's a good way to get people into manufacturing.

Freund: In terms of adjustment, what we would want to see is one, people to have some income to fall back on and then some type of mobility that helps people move either regionally if there are no jobs where they are. I think that's one thing Trump got right recently when he talked about people need to move and yeah, people need to move to where the jobs are. Mobility has declined a lot since the '80s. We're not sure why that's happened. People should be moving to where the jobs are regionally and also across industries.

Freund: Other countries spend more on retraining. Another program that works really well is to offer an earned income tax credit so that you try to get people back to work really quickly. Because once you've been out for a while, there are these kind of scarring effects. It's hard to get back in at a much lower wage than if you rejoin the economy sooner. To provide benefits to people, even if they take a lower paying job than they had just so they get back in the workforce quickly, would be another good way of helping people to find jobs and adjust to the structural change because it's going to happen.

Beckworth: It was interesting for me to learn recently how labor mobility has been going down, an area I hadn't looked at, but I was shocked, to be honest, that labor mobility has been declining since the '80s and it helped me see the other studies about China. To me, it put it in perspective and we've talked about this in some previous podcasts that the headline story from those studies was that China shock was bigger than we thought in terms of costs. But to me the bigger takeaway when I thought about it in this talk, and had the context of declining labor mobility, is that people aren't moving. People hit by the shock are staying put. Why aren't they moving across state lines to where the jobs are? In years past, they would.

Beckworth: Trump has talked about this. I didn't know this. He's talking about what does he want to do? Does he want to give them some kind of subsidy to move or...

Freund: He hasn't gotten that far but he did say that he did make the point that people do need to move more, which I think is good that he's recognizing that. I think we have a number of policies in place that discourage that kind of mobility and one that has been very difficult is related to housing prices, which in part comes from the way we tax housing that encourages people to own and bids up housing prices and such.

Freund: I look at my two best friends from when I was younger and one lives in New York City and one lives in Maine and then I live in D.C. The first house I bought doubled in price. My friend in New York, her house tripled in price, and my friend in Maine, her house was completely stagnant. Now, imagine she wants to move to New York. She's completely priced out of the market. She gets a great job offer then she looks at housing and it's just, "Whoa, I can't move there."

Beckworth: I'm staying in Maine.

Freund: Yeah. I think that's made the... Where the jobs are, housing prices have gone up a lot, which makes it very hard for people to move. And then of course their family reasons and other. Although one would have expected that many of those would have been similar in the '80s

Beckworth: Let me throw something at you, a radical idea, I've seen some people on Twitter, I'm not sure if it's been written up yet, but people I follow, you may have seen it too, but there's talk of moving federal agencies across the country to these rural spots. You'd be making these massive fiscal transfers. Some agencies maybe you couldn't move, but some of them you could. Do you think there's any merit in that?

Freund: Yeah, I do. I guess one would have to think about it because you want the federal agency to be efficient. You have to think about is there going to be a cost to the federal agency of not being near the center. Will it be able to get the right people working for it? If it's an agency where people have to travel, will they be able to travel for... In terms of the agencies, I think you'd have to think about which ones are amenable to these types of moving and whether the agglomeration benefits from all being together, losing those, how costly that is. I think it requires some thought but I do think it has some merit.

Freund: I guess the other way to do it is to just offer tax incentives, which we already do to some extent for private companies that go to declining towns and we certainly do for foreign investors as well.

Beckworth: Yes, we do. Let me ask another question along these lines. You actually alluded to it earlier and this was the global imbalances and the effect it has on demand for goods and stuff. There's been a lot of conversation lately about Germany, in particular, but this also back before the crisis with China, but Germany is running these big current account surpluses and as a consequence draining demand from the world and that accusation was often was thrown at China as well.

Beckworth: As an accounting identity, it's understandable, but I've always struggled with this because I thought at the end of the day demand is determined by monitoring fiscal policy. If they've got a problem with... If some other countries are running a current account surplus for whatever reasons, it might be for legitimate reasons from their perspective, at the end of the day, it's my policymakers ultimate... The buck stops with them. They determine domestic demand. Am I mistaken in that? Should we be concerned about big countries running current account surpluses or should I be more concerned about my policymakers doing the right thing to offset it?

Are Global Trade Imbalances a Concern?

Freund: I think the worry about the countries running current account surpluses is real. The reason I would say that is... If we go back to what trade is, trade is mainly goods. It's 80% goods and it's a large share of manufacturers. Their current account surpluses... Our demand might be determined by our domestic policymakers, but when their exchange rates are misaligned and, in particular, undervalued, they're basically taking demand for those types of goods and especially manufacturers from the U.S. so that accelerates this to some extent this type of adjustment that we've talked about.

Freund: I'm not talking about small surpluses here or there, I'm talking about when you see China as it was in the mid-2000s running a current account surplus of 8, 9% of GDP, which is what Germany is doing right now. That is pulling demand and demand for these goods from other countries and their adjustment costs that we're facing as a result. I think in good times, maybe it's not such a worry. So in the 2000s when unemployment... Now, it's low again, but when unemployment is very low and demand is strong, it might not be something to worry about. But in periods of slowdown, it is taking some demand.

Freund: With respect to Germany, it's especially hurting the periphery. In Europe. Germany's policies have been extremely painful for Greece. If you look at the charts of Greece's income since this Euro crisis began, it's just devastating. Really Germany could have eased that by allowing a little bit more inflation and reduced stimulating demand at home to help Europe and also, the rest of the world adjust.

Beckworth: No, I'm very sympathetic to that. I think the ECB should have, at least, come close to its target. I had Jay Shambaugh and we talked about this that if ECB had tolerated higher inflation, the real adjustment would have hit Germany first because it's closer to full employment. You would have seen a real appreciation in Germany relative to the periphery and things would have worked out better.

Freund: Yeah, I think that's right. I think that one way would be to allow more because it's easier for the inflation to happen in Germany and then the other countries not to have to cut wages to be effect for that adjustment. They can just maintain. That's a lot easier than having to suffer the deflation they did.

Freund: I think there are also policies Germany independently can do. There's many articles on their falling apart infrastructure that don't sound that different from the U.S. and yet they're not investing in it and they could stimulate demand and inflation in Germany that way, which would also ease the adjustment.

Beckworth: But going back to maybe the question or so, putting aside whether... Maybe there are questions is the Euro good idea in the first place with all these problems, but putting aside with the inflation Germany does... The reason it's a concern, I think I hear you saying is, we say demand, but what it's really causing structural changes as well. You're not just stealing demand. You're structurally changing the economy of the U.S. or whoever you're stealing the jobs from. Is that right?

Freund: Yeah, I think. I think that's part of it. And then I guess the other side of it is that if these countries are running a big surplus, by definition, someone else has to be running a deficit, and those deficits are piling up into debt, which at some point could become unsustainable. That would be the other concern that you're forcing this debt on the rest of the world.

Beckworth: Is it also the case that you would expect or else equal that eventually... Eventually current account deficits have to be paid off. I guess my question is, is that not natural to have... Is having a systemic current account surplus indicative of something artificially being propped up or being done? Is that another way of looking at that?

Freund: Yeah, I think it is. I think when it's getting to 8, 9% of GDP, yeah, there's something wrong there. In the case of both Germany and China, China in the past, I think China has allowed the exchange rate to appreciate and we've seen their current account surplus has come down sharply and is below 3% now. So 3% is kind of the cutoff. We don't really want to see countries staying above that for a long period of time.

Beckworth: This conversation reminds me of the old classical gold standard, the price-specie flow mechanism. So let's avoid the Great Depression and gold standard which was a mess. But there you didn't have these sustained deficits because the gold will flow across countries and it would preserve order. Of course, it would cause domestic pain. That's why it became unpopular later. But it's interesting to think, I guess from that perspective, that the sustained current account surpluses are indicative of something, some policies going on that aren't maybe ideal for the global economy.

Beckworth: Let's move to Trump's policies and trade on the time we have left. At first, I want to talk about Trump's pulling us out of the TPP. Tell us about what is the TPP. Why was it important and what are the consequences of him pulling out? Maybe give its full name first.

Trump and the Trans-Pacific Partnership

Freund: It's the Trans-Pacific Partnership and it was a trade agreement between the U.S. and 11 other countries in Asia and Latin America and North America. Trump said over and over on the campaign trail, the first thing he was going to do was withdraw from the TPP. He was good on his word. That was among the first things he did. I don't think he understood what the TPP agreement was in the sense that it opened up markets to the U.S., to our goods, and actually there was very little change in U.S. policy. It really was a boon for U.S. exporters. We see now the problems of pulling out of it.

Freund: For example, Japan has a policy with beef where if too much beef comes in, they have an automatic tariff hike and that just happened and U.S. is a big exporter of beef to Japan. If we had the TPP that was something that... Not only would the tariff hike not have happened, but the tariff itself would actually be lower. So ranchers are very upset to have lost TPP. I think that another reason we really like TPP is it was a way of working with China and to get China into a more rules based system. Going back to what I said about state-owned enterprises and such, U.S. firms have a hard time doing business in China.

Freund: Many times, they need to be in joint ventures and these to do business. Auto companies have joint ventures with state-owned firms that they share profits with, etc. And the TPP was a way of setting new rules for trade. Among these countries, we could say, "These are the disciplines we're all going to agree to on state-owned enterprises. These are the disciplines we're going to agree to on services trade." The idea was China would be excluded from these preferences and that would hurt China. They'd want to get equal access and they'd have to eventually agree to these new rules.

Freund: So it really served two purposes. One was to open trade for U.S. exporters, like the cattle ranchers, and then the other was to write rules for the 21st century.

Beckworth: That's fascinating. I've heard the first point it opened up our agricultural goods overseas, but I think the second point is probably more important, creating a rules based system for global trade. You bring China on board and make them a part of the game instead we've just kind of stuck our thumb in there.

Freund: Yeah, I think it actually should have been sold. It was sold a little bit along those lines about writing the rules and the Transatlantic Trade and Investment Partnership, which is a trade agreement between the E.U. and the U.S. that's under negotiation, goes even further on rules. You can imagine a world where U.S. and Europe have a free trade agreement. U.S. has with Japan vis-a-vis the TPP. Japan and EU are negotiating a trade agreement. All of these are going to cover these kind of new rules, much deeper integration, the kinds of investor protections that we'd like to see.

Freund: If China's outside that system, they have a choice, either play by the new rules or you will be discriminated against. Without those agreements and without working with our trade partners, it's hard to see how we're going to get China to make the next step. They did a big liberalization in the 2000s but they need the next round of liberalization now and to really open up their economy.

Beckworth: Yeah. I was reading your work and some of others. It's taken eight years... It took eight years to negotiate TPP. Is that right?

Freund: Yeah, that's right.

Beckworth: Now, we've just completely squandered all that work, all that effort for something that would have, I think, put us on the right trajectory. It's kind of mind boggling. I guess what you're hearing from the Trump administration is they want to do all these bilateral agreements, which I mean, no sense of perspective on how difficult that's going to be and how much harder to coordinate. I wonder, they haven't accomplished a lot on trade. Are they getting the sense that maybe they've blew it, do you think? Is trade negotiators... Is Trump himself thinking, "Maybe we should've done things differently?"

Freund: Yeah, I don't think they internalized at all how difficult it is and that every time you change trade policy, as I said before, you create winners and losers, and the steel was a perfect example where they thought, "Oh, this is an easy one. We want to protect our steel workers. Old American product. Exactly the kind of thing I campaigned on. I'm going to put in tariffs on steel." Then he tries to do it and he realizes, oh, there's all those companies he also campaigned to who actually use steel. The carrier or the auto companies, etc., that actually use steel in their products. So raising the price of steel is going to hurt them, especially when they compete with companies around the world who face lower prices of steel.

Freund: These things are complicated. I guess one thing I'd say is what you realize in a lot of the... Besides TPP where there's a big difference there, the gains hadn't been realized. There were these projected gains for the ranchers, etc., but they hadn't yet been realized. So there aren't actual losers. They just lost those potential gains. In any other trade policy, they're going to be losers and that makes it a lot harder to make the changes.

Freund: I take heart in the fact that the main policy lately has been delayed. If a delay on the trade deficit report, a delay on the steel tariffs, they talked about a 301 but it seems to be delayed. I really take heart that the main policy now is delay because it means they're thinking about it at least. They're considering all aspects or at least maybe they're being bought by lobbies but at least they're listening to people and taking some time to understand. That overall is a good thing that they're not rushing into this.

Beckworth: I just want to mention yesterday, I believe it came out yesterday, August 7th because this will come out later. A political header, a special report titled *Trump's Trade Pullout Roils Rural America.* You talked about the potential gains these farmers were looking forward to. They made play. They spent money on it. And it was interesting, I encourage our listeners to take a look at it, some of them have torn loyalties now. The article says they don't like the coastal elites. They love Trump. They're beginning to question... They've built all this money into expanded farm production and moreover, the other sobering part of this piece was, is that the other countries have gone on ahead. It's not just the potential gains, the losses actually could be bigger because now the U.S. is left out of these arrangements and farmers may even face a harder, uphill battle.

Beckworth: Let's move to NAFTA. The other big one... Just quickly, has NAFTA been good, bad, mixed for the U.S.?

NAFTA and Its Impact on the US Economy

Freund: NAFTA has been good for the U.S. It's actually been pretty small. Mexico is not a big country compared to the U.S. so it's hard to imagine how any major losses have come from NAFTA. The China effect has been much larger and since they happened at a very similar time period, I think, the two are often conflated. NAFTA became a bad word in part because it happened during this period of hyper-globalization more generally and technological change.

Freund: But overall NAFTA has been good and the way I think it's been most helpful for the U.S. is in terms of supply chains. We've developed with Mexico and Canada supply chains in many industries that make our firms more competitive so they can compete with factory Europe and factory Asia. Auto is the biggest part of that. A huge amount of trade in North America is in autos where Mexico produces the labor intensive parts and U.S. produces the highest tech components and Canada also specializes in some of the medium skilled parts. And you put this together and you have a lower priced vehicle so you can sell more. It's good for the American consumer. It's also makes the companies more competitive with firms from around the world.

Freund: If you look even... I've hit on Germany for its big surplus, but they have a trade deficit with their low cost suppliers in Eastern Europe. It's very normal to have these trade relations that we see. I think the concern with what the Trump administration is thinking about, which is renegotiating NAFTA, is that they do it in a way that disrupts these supply chains.

Beckworth: Has NAFTA been also good for Mexico and then therefore good for us in the sense maybe it's brought some stability to Mexico, some growth?

Freund: Yeah, it has. For sure. Mexico has attracted a lot of investment because of NAFTA and it's helped. Not just NAFTA, Mexico has been very good about going out and signing trade agreements and it has some 19 trade agreements with other countries around the world and that helps pull in investment. But NAFTA came first and was very important and it wasn't even just for... It helped drive economic reform, but it also helped drive political change. Mexico became a full democracy under NAFTA. I would say NAFTA helped steer that because any shift away from democratic values could always be met by retaliation of some form from the U.S. Just having those protection of NAFTA, "We're doing so well under this, we want to keep these trade preferences," was part of the guiding force for Mexico in liberalizing their political system.

Beckworth: Fascinating. Now, Trump is wanting to renegotiate parts of NAFTA, all of NAFTA. What's going on with that? What is he trying to do?

Freund: He's talking about renegotiating all of NAFTA. A couple of weeks ago, they released their negotiating objectives. They're some 20 objectives. They are areas that they want to renegotiate. I don't see that happening. Really doing a full renegotiation of NAFTA will be very difficult. You look at trade agreements and how long they take to negotiate and the only agreements that have been negotiated in under a year are with Jordan, Bahrain, Oman, countries where trade is very small, where they have a king who can just sign off on these things.

Beckworth: Make it so.

Freund: If they do a full modernization of NAFTA, they would take ownership of NAFTA. It's the same kind of problem they were having with the Affordable Care Act where if they do something and it's not good, it becomes Trumpcare and everyone hates Trumpcare and you don't want that to happen. If they do something with NAFTA and people still don't like NAFTA and now it's there, now they're owning it, that's going to be a problem.

Freund: I just don't see any way they can do a full modernization. I think what will ultimately happen is they'll either do some small agreements on very specific things. Autos is likely one. They've really been picking on that sector and as I said it's a big part of trade and a big part of the trade deficit with Mexico, which is something they worry about. I think that's one area where they might go or it's just going to be something that drags for a long time, but never really gets resolved. I don't see any way to do a full modernization in the time frame they're talking about.

Beckworth: Let me go on that. Trump also had proposed a border tax and you've written about this and talked about this. Is that all the dead now?

Freund: Yeah, it is dead. I would say Trump didn't propose it. It was Paul Ryan and Kevin Brady. It came from the House and they proposed it before anybody thought they were going to own the shop. I think it was an idea and there's a lot of economic reasons why you may want to do something like that. You may not want to do some something like that as well, but it basically died under pressures from lobbying. One thing I've been pointing out to people is... It also died right when Foxconn happened to invest in Paul Ryan's county. I can't help but wonder if that had something to do with the death of the bat.

Beckworth: That's fascinating. With the time we have left, I want our listeners to know about the book you've written. Tell us about your book. What are the highlights in it?

*Rich People, Poor Countries*

Freund: The book is called *Rich People, Poor Countries.* It looks at how people get super rich in different countries. Going back to my interest in development, I think how people make money, big money, tells you a lot about what's working and not working in those countries. Because if people get rich by cronyism, by natural resources, by inheritance, there may be something wrong if you don't have those kinds of new businesses. And then in some countries, you see people getting rich because they start new businesses with products they sell around the world. So real innovation. Where you see more of those, the creators instead of the cronies is where we think things are going well. That is what the research shows.

Freund: So in a country like China, you see mostly creators. People who started companies. I'm not saying there's no government involvement. There might be... At some point, you do have to work with the government in China. But these are people who started real businesses that sell real products that didn't exist before and help the country to grow and create jobs.

Freund: In Latin America, you see a lot of inherited wealth. In the Middle East, North Africa, you see inherited wealth and also, the cronyism type wealth in Russia. It's almost all cronyism. It very much coincides with what we know about those economies.

Beckworth: The places where you find the Steve Jobs are the places that have flourishing growth and the right kind of ingredients for sustained development and economic growth.

Freund: Absolutely. That's a nice way of putting it.

Beckworth: Okay, I got to ask. Carlos Slim because I used to work... I was a Mexico desk officer. Where would he fit on that?

Freund: I had a characterization of people and he fell into the crony characterization. Anybody who got their wealth mainly from a business that was privatized by the government. There was a government connected element to their getting wealthy would fall in that category as well as all natural resource wealth fell there as well.

Beckworth: All right, our time is up. Our guest today has been Caroline Freund. Thank you so much for being with us today.

Freund: Thank you.

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