No, trade deficits don’t cause unemployment

David Henderson directed me to an appalling post by Dean Baker:

There is one other big point which in Mankiw’s piece which needs correcting. Mankiw tells readers:

“Politicians and pundits often recoil at imports because they destroy domestic jobs, while they applaud exports because they create jobs.  Economists respond that full employment is possible with any pattern of trade.

“The main issue is not the number of jobs, but which jobs.”

Mankiw probably missed it, but we had a really bad recession when the housing bubble collapsed in 2007-2009 and the labor market still has not fully recovered. Millions of people are still unemployed or have given up looking for work. Tens of millions are unable to get wage gains because of the continuing weakness of the labor market.

In principle we could get back to full employment with large government budget deficits, but that is not going to happen for political reasons. Aggressive use of work sharing leading to shorter workweeks can also move us toward full employment, but this is also not something we are likely to see any time soon.

This means that if we want to get back to full employment, we have to reduce our $500 billion (@ 3 percent of GDP) trade deficit. (This is the intro econ on which all economists agree. It can even be found in Mankiw’s textbook.) Reducing the trade deficit means taking steps to lower the value of the dollar against other currencies. These trade agreements would be the obvious place to have currency rules. If we don’t address the currency issue here, where exactly are we going to do it?

Finally, Mankiw has been more than a little sloppy in his all economists agree proclamation. Among the opponents of these deals he would find Fred Bergsten, the former president of very pro-trade Peterson Institute for International Economics, Nobel Prize winning economist Joe Stiglitz and Nobel Prize winning economist Paul Krugman.

Where does one begin?  Baker insults Mankiw by suggesting that he doesn’t understand that America has an unemployment problem.  Baker doesn’t seem to recognize that this fact has no bearing on the Mankiw claim about trade.

Then Baker suggests that reducing the trade deficit would magically create jobs, even though standard macro theory provides no support for that claim.  Then he talks about the government “taking steps” to lower the value of the dollar, without mentioning what those steps are.  In standard textbook economics, fiscal austerity lowers the value of the currency. Is that the policy “steps” Baker has in mind?  Or maybe he was thinking about monetary stimulus.  That’s actually slightly more plausible, at least in theory.  But in practice the income effect often outweighs the substitution effect, and hence easier money tends to make the trade deficit larger, not smaller.

I’m not sure what’s more appalling, the fact that Baker thinks reducing the trade deficit would create jobs, or that he thinks all economists agree with him.  The first is almost certainly wrong, the second claim is certainly wrong.

As far as adding “currency rules” to trade agreements, I don’t even know where to begin.  Does he contemplate Congress setting the value of the dollar via fiscal policy?  How about the Fed abandoning its dual mandate to target exchange rates? This isn’t even serious; I can’t believe that even Baker believes the US will start targeting the forex value of the dollar.

As for his appeal to authority, the Paul Krugman that won the Nobel Price was the guy who wrote Pop Internationalism, and who would have supported the current trade deal being negotiated, not the guy who’s moved so far to the left that he’s praising the loony Marxist government in Greece that almost everyone else seems to think is a bunch of crackpots.

[Also check out David’s excellent post, which I ripped off.]


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41 Responses to “No, trade deficits don’t cause unemployment”

  1. Gravatar of Peter K. Peter K.
    29. April 2015 at 10:07

    This is a really bad post. You’re wrong about the trade deficit, Dean Baker and Greece.

    I support NGDP path targeting but many on the left are put off by posts like this and so then are increasingly skeptical about NGDP path level targeting and monetary policy. You aren’t gaining any allies with schlock like this.

  2. Gravatar of Peter K. Peter K.
    29. April 2015 at 10:11

    Net exports shaved a big 1.3 ppts off of this quarter’s real growth rate and 1 ppt of last quarter’s.

    If we wanted to lower the value of the currency we could do what China and others do and buy the debt and currency of trading partners. This would raise the value of their currencies.

  3. Gravatar of ssumner ssumner
    29. April 2015 at 10:28

    Peter, If you are going to accuse someone of writing “schlock”, you might not want to confuse economic and accounting relationships, as you did here:

    “Net exports shaved a big 1.3 ppts off of this quarter’s real growth”

    As far as China, you are confusing policies aimed at changing real exchange rates with policies aimed at changing nominal exchange rates. China has a very high government saving rate—is that what you advocate?

    If the left in this country wants to drink the koolaid provided by the loony leftists in charge of Greece, that’s their right. Just don’t expect me to follow along.

  4. Gravatar of Becky Hargrove Becky Hargrove
    29. April 2015 at 10:52

    Too many people assume important services can only be funded from the proceeds of traditional manufacture and production. Baker is hardly the only one (left or right) who writes from this worldview, and believes that services work cannot be maintained unless the U.S. “gets its jobs back”.

  5. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    29. April 2015 at 10:53

    PK has praised the incumbent Brazilian government, look at whare we are now … 8.2% negative real growth …

  6. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    29. April 2015 at 10:53

    Sorry, 8.2%, slightly negative real growth …

  7. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    29. April 2015 at 10:54

    Again, 8.2% inflation …

  8. Gravatar of Mike Sax Mike Sax
    29. April 2015 at 10:58

    For instance, when Lucas accused Christina Romer of engaging in shlock economics, he properly distinguished between the two.

  9. Gravatar of TallDave TallDave
    29. April 2015 at 11:43

    Today I realized I badly want the Fed to explicitly back NGDP just so I can bet on the Fed and against every single person who believes “liquidity trap” nonsense about CBs being impotent at the lower bound.

    Oh I can just taste those sweet, sweet tears…

  10. Gravatar of TallDave TallDave
    29. April 2015 at 11:59

    In principle we could get back to full employment with large government budget deficits, but that is not going to happen for political reasons

    Hey, it worked for Greece until 2007! Then they fell victim to “political reasons.”

  11. Gravatar of benjamin cole benjamin cole
    29. April 2015 at 15:28

    Printing more money would work. Q1 inflation and GDP dead. So the Fed wants to raise rates?

  12. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    29. April 2015 at 15:49

    Foreign devils send us new cars and televisions because they want our dollars. Which they will use to buy Jack Daniels whiskey, apples and almonds, trips to Disneyland.

    Or invest the dollars in American businesses. I once knew a Japanese man who loved to watch Ichiro play baseball so much, that when he signed with the Mariners the guy moved to Seattle and started a boat building business.

    ‘Supply is (implicit) demand.’

  13. Gravatar of Michael Byrnes Michael Byrnes
    29. April 2015 at 16:59

    That new econ blogger on the Taylor rule:

    http://www.brookings.edu/blogs/ben-bernanke/posts/2015/04/28-taylor-rule-monetary-policy

  14. Gravatar of Jerry Brown Jerry Brown
    29. April 2015 at 17:15

    “In standard textbook economics, fiscal austerity lowers the value of the currency”. I would have thought the opposite. Could someone help me understand this a little better?

  15. Gravatar of E. Harding E. Harding
    29. April 2015 at 17:19

    “Net exports shaved a big 1.3 ppts off of this quarter’s real growth rate and 1 ppt of last quarter’s.”
    -Never reason from a net export change.

  16. Gravatar of Michael Byrnes Michael Byrnes
    29. April 2015 at 17:26

    A shout out from George Selgin:

    http://news.investors.com/ibd-editorials-viewpoint/042815-749983-fed-suggests-it-will-raise-rates-to-head-off-inflation.htm?p=2

  17. Gravatar of ssumner ssumner
    29. April 2015 at 17:41

    Jerry, Remember the “twin deficits” issue form the 1980s? The standard model said Reagan’s budget deficits drove up interest rates, and this raised the value of the dollar, which increased the CA deficit.

  18. Gravatar of Paul Olivetti Paul Olivetti
    29. April 2015 at 19:14

    Dean has been right about far more things than you have over the past 8 years.

  19. Gravatar of ssumner ssumner
    29. April 2015 at 19:25

    Paul, You mean like the effects of that savage 2013 austerity, that caused RGDP growth to almost double?

  20. Gravatar of John Papola John Papola
    29. April 2015 at 20:12

    More proof that Keynesianism isn’t merely a faulty macro model, but an absolute intellectual poison that wholly guts and/or inverts the most basic and fundamental economic principles. Destruction is creation. Consumption is production. Up is down. Black is white. This is the utter bedlam unleashed by this neo-malthusian hogwash.

  21. Gravatar of ssumner ssumner
    29. April 2015 at 20:19

    John, Well it’s not quite THAT bad. But close.

  22. Gravatar of Jerry Brown Jerry Brown
    29. April 2015 at 20:19

    Thanks Scott.

  23. Gravatar of Brett Brett
    29. April 2015 at 20:56

    It sounds like Baker is using Super-Basic Macro-Econ 202, where exports raise your output and imports decrease it.

    To be honest, it’s not really worth even bothering looking at the context of that argument. Baker has literally been repeating the same three arguments for years, including before the recession:

    1. Reduce the trade deficit
    2. End patents
    3. Import more doctors, lawyers, whatever

  24. Gravatar of Ray Lopez Ray Lopez
    29. April 2015 at 20:58

    Sumner is right. This Baker guy seems unstable when he says stuff like: “In principle we could get back to full employment with large government budget deficits, but that is not going to happen for political reasons. Aggressive use of work sharing leading to shorter workweeks can also move us toward full employment, but this is also not something we are likely to see any time soon.”

    In theory we can get to full employment if we practice eugenics and kill off the unemployed too. About as sound long-term as the above. And as Sumner points out, Baker gets the economics theory wrong and the practice somewhat wrong. In theory, surplus balance of payments countries should not correlate with low unemployment; in practice, they do, but then you have countries like Nigeria, with a large surplus but also since the Great Recession a large unemployment rate. Anyway, to expect the USA to become a large exporter is to put the cart before the horse, as the USA is the reason a lot of countries have a positive trade surplus.

  25. Gravatar of benjamin cole benjamin cole
    29. April 2015 at 21:48

    Ray Lopez says another economic observer sounds unstable.

    If people knew how funny macroeconomic blogs are, TV sitcoms would be wiped out.

  26. Gravatar of Dean Baker Dean Baker
    30. April 2015 at 01:11

    Scott,
    Glad to see that I seem to have got your juices flowing with this one. Let’s see if we can figure out the source of the misunderstanding.

    1) I assume the economy is below full employment in the standard Keynesian sense. Perhaps you don’t.
    2) If it is below full employment then any increase in a component of demand (C,I,G, or [X-m]) will boost employment and output.
    3) a main determinant of X-M is the price of goods and services in the United States relative to the price in other countries.
    4) a lower valued dollar reduces the relative price of goods and services in the United States.
    5) central banks can affect the relative price of currencies by buying or selling them.

    Now perhaps you can tell me which one(s) of these propositions you disagree with. FWIW, you will find versions of all of them in Greg Mankiw’s textbook, as I said in my post on his column.

  27. Gravatar of Jim Glass Jim Glass
    30. April 2015 at 04:02

    As for his appeal to authority, the Paul Krugman that won the Nobel Price was the guy who wrote Pop Internationalism, and who would have supported the current trade deal being negotiated, not the guy who’s moved so far to the left…

    That Paul Krugman wrote…

    A balanced view of China’s trade

    by Paul Krugman

    Want an easy way to eliminate the U.S. trade deficit? Just declare New York City a separate “entity,” with its own balance-of-payments statistics. I can almost guarantee you that the trade deficit of the rest of the country–call it “mainland America”–will disappear.

    After all, if New York’s numbers were counted separately, we would no longer treat goods imported into New York as debit items in the U.S. balance of payments. Furthermore, all of the goods that mainland America ships to New York City would be considered U.S. exports. True, the goods that New York ships to the rest of the world would be struck off the export tally, while the goods the city ships to the rest of the United States would henceforth count as U.S. imports. But these would be minor adjustments: New York City is basically not in the business of producing physical objects. So we can be sure that the city runs a huge trade deficit–probably bigger than that of the United States as a whole …

    if it’s the trade deficit you worry about, splitting New York off from mainland America will take care of the problem. Nothing real would have changed, but maybe it would make some people feel better.

    Bonus question: If Manhattan ended its trade deficit with the rest of the world, would it create more jobs and see its rates of unemployment, poverty and inequality go down?

  28. Gravatar of Vivian Darkbloom Vivian Darkbloom
    30. April 2015 at 04:15

    I’m not sure these arguments are responsive to each other.

    Let’s assume that in a trade deal with Asia, Asia countries get 3 additional non-skilled jobs that average $30K each. The US loses 3 unskilled jobs and gets 2 skilled jobs that average $50 K each. As far as GDP is concerned, it is win-win. GDP is increased in both areas due to the comparative advantage of trade.

    But, is it also possible that in the US, although GDP is enhanced, unemployment is increased? Is that what Mankiw refers to when he wrote “The main issue is not the number of jobs, but which jobs”? That sentence seems to confirm, to me at least, that, as far as unemployment is concerned, the idea of increased GDP due to comparative advantage inherent in a trade agreement and increased unemployment in one trade partner are not inconsistent, at least in the short run. As I understand the statements made by Furman, offered by Mankiw in rebuttal, he seems to be talking about enhancements to GDP as a result of the trade agreement or, at best, *average* wages*, not overall numbers of US employed persons.

    If the argument here is that over time, employment also enjoys a benefit (in terms of fewer persons not working), what is the time frame in which this would be achieved? In the short term, the medium term or the long term? If the latter, how long would that be? Economists taking different positions on issues such as this one can often both be correct if they are talking about different time periods. That is one of the most frustrating things I find about discourse among economists (and politicians).

  29. Gravatar of Anand Anand
    30. April 2015 at 04:40

    Baker had a post just before that one which outlined why he felt that trade deficit matters when one is below full employment. It is something he says all the time, so it might have been assumed as a given when he writes blog posts.

    See here. http://www.cepr.net/blogs/beat-the-press/pinocchio-wars-senator-sherrod-brown-versus-the-washington-post-fact-checker

  30. Gravatar of No, trade deficits don’t cause unemployment « Economics Info No, trade deficits don’t cause unemployment « Economics Info
    30. April 2015 at 06:00

    […] Source […]

  31. Gravatar of benjamin cole benjamin cole
    30. April 2015 at 06:02

    Still…Germany and China run trade surpluses and boom…the Far East boomed on export-a-rama…

    True, the US has prospered with trade deficits but we print dollars…

    I wonder if theory runs aground of structural impediments and institutional imperfections sometimes…

  32. Gravatar of Engineer Engineer
    30. April 2015 at 06:14

    I believe that the trade deficit does not increase unemployment. The imbalance in the trade deficit is offset by the capital account and in theory everything is good. In fact I view the entire trade numbers as suspicious after reading an account on how the iphone supposedly greatly increases our trade deficit even though only about $10 of the price is spent in assembly, which is the only thing done in China…

    But my question is on “currency manipulation”. If foreign countries are “hoarding dollars” such that the trade deficit is not offset, for the purposes of keeping their currency low and helping their manufacturers..what effect does this have on the global economy. What role did this play in the 2008 meltdown? A strong foreign dollar demand had a role in reducing the money supply right? Can governments keep hoarding dollars indefinitely?

  33. Gravatar of Aidan Aidan
    30. April 2015 at 09:24

    Do you think the Autor, Dorn, and Hanson research is wrong? http://economics.mit.edu/files/6613

  34. Gravatar of Aidan Aidan
    30. April 2015 at 09:37

    “In the first three postwar decades, when full employment was much more the norm, the US trade balance as a share of GDP was slightly north of zero on average. Since 1976, full employment periods have been much less common and we’ve run trade deficits every year, averaging -2.4 percent of GDP, and -4 percent since 2000.

    Of course, that’s not the whole story. I’ve long touted the full employment period of the latter 1990s and we posted significant trade deficits in those years, including almost 4% of GDP in 2000 when the unemployment rate was also 4%. So no question we can offset the demand drag caused by persistent trade imbalances. But we’ve done so at the cost of bubbles and budget deficits and that’s proven to be a costly strategy.

    In fact, as Pettis argues, the fact of these reoccurring bubbles is not a coincidence. It’s intimately related to the global imbalances wherein capital inflows from surplus to deficit countries ‘result in some combination of a speculative investment boom, a consumption boom or a rise in unemployment. What typically happens is that in the beginning we get the first two, until debt levels become too high, after which we get the third.’ Sounds uncomfortably familiar, no?”

    http://jaredbernsteinblog.com/full-employment-trade-deficits-and-the-dollar-as-reserve-currency-what-are-the-connections/

  35. Gravatar of Ray Lopez Ray Lopez
    30. April 2015 at 10:18

    @Engineer – you might want to check the works of FT econ columnist Martin Wolf, who wrote an entire book on the themes you mention. Indeed non-US country currency manipulation and financial repression lasting generations (or several decades) creates distortions in the US economy. Another factoid: while 70% of the US GDP households are in ‘services’, only about 34% of Chinese households are in the same category. This cannot be good, no matter what textbooks may say.

  36. Gravatar of Don Geddis Don Geddis
    30. April 2015 at 14:26

    @Vivian Darkbloom: “The US loses 3 unskilled jobs and gets 2 skilled jobs that average $50 K each.

    What happens to that third person? Why can they not be reemployed elsewhere? GDP ought to rise even further than you suppose in your example, because the now freed third person is able to generate additional wealth in a different industry.

    You’re confusing macro with micro. You look at a micro action, that a specific policy may create some jobs “here” and destroy other jobs “there”, and think you can add up the changes in order to see what happens to overall national unemployment.

    That’s not how unemployment works. Unemployment is a function of aggregate demand, which is controlled by the Fed. Other factors include the NAIRU, which puts a lower bound on unemployment. Or supply-side factors like regulations and occupational licensing and unemployment benefits (which affect the NAIRU).

    But “jobs created” and “jobs destroyed”, by industry-specific policies, don’t affect total unemployment (in any significant way, in anything other than the very short term). A nation can run an economy with full employment, with all sorts of different possible trade relationships.

    Is it also possible that in the US … unemployment is increased? Is that what Mankiw refers to when he wrote “The main issue is not the number of jobs, but which jobs”?

    Not, not at all. What he means is that trade policy is irrelevant to unemployment policy. All trade policy can affect is which kind of jobs different nations have, not how many of them.

  37. Gravatar of bill bill
    30. April 2015 at 14:39

    I believe that the last time the US had a trade surplus (a very small one) was during the recession in the very early 1990’s. And of course our GDP boomed as the trade deficit fell in 2009! [Sarcasm]

  38. Gravatar of ssumner ssumner
    30. April 2015 at 19:20

    Vivian, With second order effects literally anything is possible. The first order effects of trade are great. The second order are a mixture of good and bad, with no obvious net effect. So just go with the first order effects. K.I.S.S.

    Ben, Germany had 11% unemployment in 2004 with a trade surplus, and Australia’s run huge deficits for 40 years, with no recession since 1991. So shall we follow Australia? South Korea ran deficits in the 1970s and 1980s, and did even better than China. There are so many examples to chose . . .

    Engineer, I don’t agree with the premise of your question. I don’t agree that artificially holding down the value of your currency helps your economy.

    Aidan, I strongly disagree with your long quote. There is zero evidence that AD policy has any role in so-called “bubbles.” Absolutely zero, either theoretical or empirical.

    I haven’t read the paper you link to, but the abstract doesn’t seem to conflict with anything I wrote. They are looking at micro effects and I’m looking at macro effects. I agree that trade with countries like China can hurt areas that produce similar goods.

    Ray, You said:

    “Another factoid: while 70% of the US GDP households are in ‘services’, only about 34% of Chinese households are in the same category. This cannot be good, no matter what textbooks may say.”

    For once you are right. That’s horrible news for China, reflective of low living standards, lots of unproductive peasant farmers.

  39. Gravatar of Engineer Engineer
    1. May 2015 at 05:25

    “Engineer, I don’t agree with the premise of your question. I don’t agree that artificially holding down the value of your currency helps your economy.”

    I don’t think my question is based on that premise. I would agree artificially holding down the value of your currency is not in the best interest of your country, but isn’t that what many Asian countries have done in the past or are currently doing…essentially subsidizing the export sector by hoarding USDs? When such as large portion of your economy relies on exports it creates a situation where you need to keep doing this or risk collapse? Is this not a common view of many economists on both the left and right…wasn’t Mitt Romney going to label China as a “currency manipulator”?

  40. Gravatar of Floccina Floccina
    1. May 2015 at 05:28

    To be kind to Dean, could one say that accelerating growth in measured, period trade deficits could contribute to unemployment? And could also say that decelerating growth in measured, period trade deficits could contribute to low unemployment?

  41. Gravatar of ssumner ssumner
    2. May 2015 at 06:40

    Engineer, It depends how you define “artificial.” I don’t see this as an important issue. They do not need to do this to prevent collapse. The Chinese CA surplus recently fell from 10% of GDP to 2%, and they are doing fine.

    Floccina, I don’t think so.

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