Economic Implications of the Immigration Order

The most troubling aspects of President Trump's immigration executive order are the moral and national security implications (the later is outside my area of expertise, but its hard to see how betraying our friends, alienating our allies and handing an easy propaganda victory to our enemies advances the stated goal of protecting America).

The economic implications are pretty bad as well.  Although the order currently applies only to people from seven countries, the spectacle of people who've jumped through all the bureaucratic hurdles to get permission to come to the US being detained and turned away at airports by a sudden, incompetently planned and implemented policy change will no doubt deter many others from wanting to come.

In the short run, making it less attractive to come to the US will hurt our tourism and education exports.  In the longer run, it will harm our productivity by diminishing our universities, science, technology and human capital.

One of Trump's stated economic concerns is the US trade deficit, which was -$499.5 billion in 2016 (2.7% of GDP), according to the BEA's advance estimate.   While the US trade balance is negative in goods (-$770.5 billion) that is partly made up for by a $271.1 billion surplus in services.

According to the ITA, the US had 77.5 million visitors in 2015, and Colorado had 461,000.

Tourism is an important part of US service exports.  2016 figures aren't available yet, but in 2015, according to the BEA, $750.9 billion in service exports included $122.4 billion in "other personal travel" (i.e., non-business travel not related to health or education). 

The order won't only deter tourists; in addition to tourism, education services are another major US export.  According to the Institute of International Education, there were just over 1 million international students enrolled in US colleges and universities last year.  In 2015, the US exported $35.8 billion of education-related travel, which includes tuition paid by international students.

In addition to contributing to US GDP and exports, international students play a vital role in US higher education.  At the undergraduate level, an important part of the experience is learning from one's peers - the presence of international students on our campuses enhances the educational opportunities for everyone.

International graduate students play a significant role in the life of our research universities, particularly in the sciences (and economics!).  The impact of the order was felt immediately by scientists (see also this story).  According to the NSF, international students earn more than half of the doctorates granted in the US in mathematics and computer science and engineering and over one third in physical and earth sciences.

The ability to attract hard-working, talented students from around the world is a source of strength for American university research and one of the reasons US institutions dominate global rankings.  US leadership in many fields also means that many of the faculty in US institutions are immigrants and green card holders.

Technology companies have spoken out about the impact of the immigration order on their workforces, but the impact will be more widespread - according to the NSF, 21% of the US science and engineering workforce is foreign born.

If the grad students, post-docs, scientists and engineers who are so vital to our universities and industries find America a less appealing place to live and work - for example, if they have to worry that if they leave to visit relatives, they risk not being able to get back in - they have other options.  The competition for talent is global, and this hands an advantage to non-US universities and businesses.

America is great, but President Trump's order will make it less so.

TPP and Developing Countries

One of the claims about the Trans-Pacific Partnership (TPP) agreement is that it will benefit developing countries.  At Vox, Dylan Matthews spoke with Kimberly Ann Elliot of the Center for Global Development about how it will affect Vietnam, which has the lowest income among the countries negotiating the treaty.

Their discussion highlights a number of broader issues which arise with these regional (or "preferential") trade agreements:

• Trade diversion: part of the perceived benefit for Vietnam would be that its exports would get more favorable treatment than those of other developing countries, like Cambodia, that are not members of the TPP.  This is not necessarily a gain in terms of overall economic efficiency.
• Preference erosion: once countries in an agreement have preferential treatment for their exports, they may resist multilateral reductions in trade barriers with bigger global benefits (i.e., agreements through the WTO), because that would reduce their advantage relative to nonmembers.
• Rules of origin: in an age of multinational production chains, defining whether a good exported from a particular country is eligible for preferential treatment is less than straightforward. Rules of origin (ROOs) are meant to prevent trans-shipment, e.g., bringing Chinese goods to the US through Vietnam, but doing so creates a great deal of complexity in these agreements as questions like how should a shirt made in Vietnam of Indian cloth be treated need to be hammered out.

Overall, this is a further reminder that assessing the economics of these agreements is much more complex than simply applying our findings about the gains from trade.

Krugman: Not Down With T.P.P.

Naughty Curmudgeony by nature, Paul Krugman - whose Nobel prize is mainly due to his important work in international trade theory - disses the Trans-Pacific Partnership:

I’m thumbs down. I don’t think the proposal is likely to be the terrible, worker-destroying pact some progressives assert, but it doesn’t look like a good thing either for the world or for the United States, and you have to wonder why the Obama administration, in particular, would consider devoting any political capital to getting this through.

As Krugman points out, the importance of trade agreements is often overstated:

[A]lmost everyone exaggerates the importance of trade policy. In part, I believe, this reflects globaloney: talking about international trade sounds glamorous and forward-thinking, so everyone wants to make that the centerpiece of their remarks. (The same thing happens to an even greater extent when international money issues like the dollar’s role as a reserve currency crop up.)

While, as a professor of international economics, I have a vested interest in promoting "globaloney," I think he's right about this.  Although international trade certainly has a substantial impact on the US economy, the effects of these trade agreements are pretty marginal.

Another thing he points out is that, since tariffs are already low, the substance of trade agreements isn't really about trade, per se, but about other (arguably) trade-related issues, such as intellectual property protection.  As a net exporter of intellectual property-intensive goods, the US has a mercantilist interest in strong IP protection, but Krugman has an appropriate economist's skepticism of such arguments:

Well, we should never forget that in a direct sense, protecting intellectual property means creating a monopoly – letting the holders of a patent or copyright charge a price for something (the use of knowledge) that has a zero social marginal cost. In that direct sense this introduces a distortion that makes the world a bit poorer.

Tyler Cowen points out a big non-trade related argument for the TPP that Krugman does not mention:

either this deal happens on American terms, or an alternative deal arises on Chinese terms without our participation.  For rather significant foreign policy reasons we prefer the former, and the pragmatic side of President Obama understands this pretty well. - See more at: http://marginalrevolution.com/marginalrevolution/2015/03/why-paul-krugman-is-wrong-to-oppose-the-trans-pacific-partnership.html#sthash.b5KbTNCP.dpuf

Either this deal happens on American terms or an alternative deal arises on Chinese terms without our participation.  For rather significant foreign policy reasons, we prefer the former and the pragmatic side of President Obama understands this pretty well.

Brad DeLong also responds with a set of counterarguments, including:

Paul Krugman says that the potential net gains from freer trade in services and (secondarily) agriculture as estimated by Petri, Plummer and Zhai of 0.5% of GDP “seem high to him”. Suppose that they are half that. In a Pacific region whose GDP is now approaching $30 trillion/year, that is $75 billion/year. Capitalize that at 4%/year and we get a net addition to world wealth of $3 trillion. That is indeed a very small number relative to the wealth of the world both now and discounted into the future. But that is a rather large number compared to other things the U.S. government might do this year. So why not grab for it?

Of course, we have yet to actually get a deal...

Update (3/12): At the Washington Post, Autor, Dorn and Hanson argue for the TPP.

either this deal happens on American terms, or an alternative deal arises on Chinese terms without our participation.  For rather significant foreign policy reasons we prefer the former, and the pragmatic side of President Obama understands this pretty well. - See more at: http://marginalrevolution.com/marginalrevolution/2015/03/why-paul-krugman-is-wrong-to-oppose-the-trans-pacific-partnership.html#sthash.b5KbTNCP.dpuf

either this deal happens on American terms, or an alternative deal arises on Chinese terms without our participation.  For rather significant foreign policy reasons we prefer the former, and the pragmatic side of President Obama understands this pretty well. - See more at: http://marginalrevolution.com/marginalrevolution/2015/03/why-paul-krugman-is-wrong-to-oppose-the-trans-pacific-partnership.html#sthash.b5KbTNCP.dpuf

Trade-Related (?)

Economic theory provides a number of useful tools for thinking about tariffs, and these tend to frame economists' instincts when it comes to discussions about "free trade agreements."  However, in many cases, tariffs are already quite low (perhaps this is a rare success for economists' powers of persuasion...) and the main ingredients of trade agreements concern other things which are trickier to analyze.

One aspect of contemporary trade agreements that is coming under scrutiny in the discussions over the Transatlantic Trade and Investment Partnership (TTIP) and the Trans-Pacific Partnership (TPP) are provisions to protect foreign investors by allowing them to take disputes with governments to arbitration.  This Vox piece by Danielle Kurtzleben is a nice summary of the debate concerning these investor-state dispute settlement (ISDS) rules.

Another issue getting considerable attention in the TPP discussions is the fact that trade agreements typically do not deal with currencies.  As the Times reported, many in Congress are pushing for incorporating a provision to deal with "currency manipulation" into the TPP.

This is a tricky issue which cuts across economics' division between international trade - which uses microeconomic theory to analyze long-run equilibria - and open-economy macroeconomics, which is concerned with monetary and balance of payments issues (which are "short-run" but can have meaningfully persistent effects).  At an institutional level, trade policy is usually the purview of trade ministers (e.g., the US Trade Representative), while currency policy falls to central banks and finance ministers (i.e., the Treasury in the US).  Globally, trade has the WTO, while currencies have the IMF (which, unlike the WTO, does not have any enforcement mechanisms).

Simon Johnson and Jared Bernstein have written in favor of inserting a currency clause, while Edwin Truman argues the contrary.  Janet Yellen expressed concern about the potential for trade agreements to encroach on monetary policy, and Jeffrey Frankel noted that some of the loudest concerns about currency manipulation aimed at China (not currently a party to the TPP) are out of date.

Not Repeating All of Our Mistakes

With all the frustrations and mistakes of the recent years, its easy to miss the good economic policy news, but there is some --

At Wonkblog, Lydia DePillis reports on the lack of a turn towards protectionism on the part of high-income countries during the global slump of the last few years.  The evidence she cites suggests that developing countries have raised trade barriers, but in a fairly muted fashion.

That's a huge improvement over the 1930s which saw widespread increases in trade barriers (including US' infamous Smoot-Hawley tariff).  Though the increases in tariffs and other trade barriers did not cause the depression, most of us economists regard them as a counter-productive response.

The architecture of the GATT and WTO was developed in part to prevent making the same mistake again.  However, the rules do allow for temporary increases in tariffs through "antidumping", "safeguard" and "countervailing duty" measures, but there hasn't been a large increase in the use of these measures. DePillis writes:

So, why did the United States appear to be less aggressive about protecting itself in the face of the latest economic meltdown? It's learned from experience.

"We designed the current system in response to what happened in the 1930s," says Chad Bown, a World Bank economist who maintains the database of temporary trade barriers. For one thing, the United States is able to target products more specifically rather than entire sectors. "That helps blow off some political steam and not have overall increases in protection," Bown says.

Another important factor may be that now, unlike the 1930s, the world is largely operating under a (non) system of floating currencies. In Trade Policy Disaster, Doug Irwin argues (persuasively, I think) that the motivation for the increasing trade barriers was more "mercantilist" than "protectionist" - that governments were concerned with preventing trade deficits, which would have led to deflationary gold outflows under the gold standard.  

Today's countries aren't bound the same way.  The one exception is Europe, where the economies of "peripheral" Europe are the hardest-suffering in the world - they can't adjust through depreciation, and the EU prevents Spain and Greece from raising tariffs.

Update: At VoxEU, Chad Bown discusses some findings from the Temporary Trade Barriers Database.

Coming Soon: "Gung Ho 2"?

Reading stories like this in the Detroit papers in the 1980s may have planted a seed in the mind of a young man who would grow up to be an economist specializing in exchange rates:

Bill Ford, executive chairman, put it this way when I talked with him Tuesday:

“It’s all about fairness, really,” he said. “I think what this country went through to re-establish our manufacturing base when we almost lost it. … For us now to give that away in a bad trade agreement makes no sense to me.

“I think manufacturing in this country matters a lot,” Ford continued. “It matters to this area. We’re not only just getting back on our feet, but as you know, really hitting on all cylinders. We’re hiring lots of Americans for both blue-collar and white-collar jobs. But a bad trade agreement could jeopardize that, and we will not let that happen.”

Ford executives are rightly proud that their company — without a federal bailout — took steps to right-size itself, boost productivity, rebuild its credit rating and revamp its product lineup to be competitive with the world’s top automakers.

But then, since last November, they’ve watched as their company’s Japanese rivals got a huge boost from a drop of nearly 20% in the value of the Japanese yen compared to the U.S. dollar.

Oh, wait, that's not from the 1980s - its from last week.  What is going on?

Certainly the fall in the Yen is helpful for Japanese exporters.  According to the Washington Post's Neil Irwin:

It’s been a good year so far for automakers. And it’s been an even better year for Toyota. The company reported its second-quarter earnings Friday, which included this whopping number: Sales were up 14 percent over a year earlier. The company hiked its estimate for 2013 earnings by 8 percent. And operating profit rose 88 percent.

The results were enough to spark a 6 percent rise in Toyota’s U.S.-listed shares, and surely to strike fear in the hearts of Toyota’s competitors. As Bloomberg news points out, while Toyota was edged out by General Motors in number of cars and trucks sold, it recorded more than three times the profit....

Of the 272 billion yen in higher earnings that Toyota reported Friday, 260 billion are attributable to foreign exchange swings, according to Toyota’s own estimates. Toyota has taken advantage of costs that are now 25 percent lower on the global marketplace (at least for those cars and parts built in Japan, rather than in satellite plants elsewhere).

The yen has depreciated about 25% relative to the dollar in the past year:

(Note: the graph shows the yen price of a dollar, so a rise is a yen depreciation/dollar appreciation.)

Is this "currency manipulation" as some in Detroit and Washington would have it?  The most straightforward explanation of the yen's decline would be a more expansionary monetary policy under the new Bank of Japan Governor, Haruhiko Kuroda (appointed by the new government of Shinzo Abe).  One of the effects of expanding the quantity of money is to reduce the value of it, both domestically (inflation) and relative to others (depreciation), and since currencies are traded in financial markets, the effects of expansionary policies can show up quickly in exchange rates (indeed, markets are forward-looking, so only a change in expectations is needed).  In the case of Japan, which has suffered from deflationary sluggishness for a couple of decades now, a shift to a more expansionary policy regime seems appropriate.

Taking a longer view, the recent decline is partly retracing the yen's appreciation during the financial crisis (when, even more than the dollar, it was seen as a "safe haven") and afterwards, when the dollar was falling due to the Fed's "quantitative easing" expansionary policies.

"Manipulation" is a loaded term, and determining when it occurs is subjective (I think the term could reasonably be applied when governments intervene in foreign exchange markets - the evidence of this would be in official holdings of currency reserves).  But its common for trading partners to grumble when your currency falls, even if the depreciation results from a monetary policy appropriate for domestic conditions.  The US was on the other side of this type of criticism a few years ago when the Fed was being accused of stoking "currency wars."

Of course, even if one takes the view Japan is (unfairly) "manipulating" its currency, there isn't really a mechanism to do anything about it.  Mirroring the divide in the economics profession where "international trade" is studied by microeconomists and exchange rates ("international finance") is the province of macroeconomists, the world has separate institutions for dealing with "trade" problems and "monetary" ones.  If a country attempts to boost net exports with a tariff, its trading partners have recourse to the WTO (and, in many cases, provisions of preferential trading agreements as well).  Doing the same thing through currency depreciation, well... the institution that has purview over exchange rates, the IMF, doesn't really have any mechanisms to settle grievances, so government officials are left to hector each other, and, on rare occasion, agree to coordinated policies.

In the case of the relative lack of US presence in the Japanese auto market, which has been consistent throughout the ups and downs of the yen-dollar exchange rate, the culprit (to the extent its driven by policy, not consumer preferences) is more likely in "non-tariff barriers" (NTBs).  While tariffs are easy to see, analyze and bargain over, imports can be impeded in more subtle ways that are more difficult to identify and deal with.  Often, what some see as a non-tariff barrier can be defended as a safety or environmental regulation.  In his "proposal to level the playing field" this is how Sander Levin (D-MI; my old congressman) characterizes Japan's auto sector NTBs:

These barriers have included: a discriminatory system of taxes; onerous and costly vehicle certification procedures for imported automobiles; a complex and changing set of safety, noise, and pollution standards, many of which do not conform to international standards and add significant development and production costs for automobiles exported to Japan; an unwillingness by Japanese dealerships to carry foreign automobiles and insufficient enforcement of competition laws to address anti-competitive practices; zoning restrictions that make it difficult, if not impossible, to establish new dealerships in important markets; and exclusionary consumer preferences shaped by decades of government policies directed at promoting the national car companies. 

Of course, that's not exactly an unbiased source (methinks "exclusionary consumer preferences" a bit of a stretch).  The occasion for Levin's proposal is Japan's entry into the negotiations over the "Trans Pacific Partnership" (TPP) trade agreement.  Overall, these preferential trade agreements are somewhat of a mixed bag.  They represent a "deeper" form of integration than the WTO and, as such, tend to extend further into areas typically thought of as "domestic" policy and may include such things as harmonization of regulations.  Whatever else one may think of it, the TPP negotiations may therefore be a good vehicle for addressing NTBs.  The US Trade Representative's office is promising to work on it, and already claiming some progress:

On April 12th, Japan announced its unilateral decision to more than double the number of motor vehicles eligible for import under its Preferential Handling Procedure (PHP), a simpler and faster certification method often used by U.S. auto manufacturers to export to Japan. In the near term, U.S. auto producers will be allowed to export up to 5,000 vehicles annually of each vehicle “type” under the PHP program, compared with the current annual ceiling of 2,000 vehicles per vehicle type. The United States and Japan have agreed to address a broad range of non-tariff measures in Japan’s automotive sector –including those related to transparency in regulations, standards, certification, “green” and new technology vehicles, and distribution – in a bilateral negotiation parallel to the TPP talks. In addition, they agreed to negotiate a special motor vehicle safeguard provision, as well as a mechanism to “snap back” tariffs as a remedy in dispute settlement cases.

Moreover, it appears that the Abe government plans to use the TPP as a cudgel to overcome domestic resistance to various domestic "reforms" that it wants to achieve as part of the "third arrow" of Abenomics.

Nonetheless, I don't think the US automakers should expect a big increase in the number their products cruising the roads of Japan anytime soon.  Issues of "currency manipulation" and non-tarriff barriers are invariably sticky ones - separating currency manipulation from valid monetary policy is subjective, and distinguishing legitimate regulations from disguised trade barriers is often very tricky.  Voluntary export restraints, anyone?

The post title is a reference to this, from the 80s.

Trade, Redistribution, Fairness and Rhetoric

Dani Rodrik has long been a useful critic of economists' rhetoric about international trade.  In a Project Syndicate column, he raises two issues: redistributive effects and procedural fairness. 

The issue of redistribution arises from the Stolper-Samuelson theorem, which is an implication of the basic, workhorse "neoclassical" trade model.  This theory is about changes in "factor prices" - it says that trade leads to gains to the suppliers of resources that are used in higher proportions to produce a country's exports, and losses to those who have the resources demanded more by the import-competing industry.  For example, the US is a net exporter of higher education services and importer of cars, and the theory would predict that college professors would gain, while autoworkers would be hurt by trade (the theory also is very clear that the overall gains outweigh the costs).  As Rodrik put it to a group of Harvard students:

I began the class by asking students whether they would approve of my carrying out a particular magic experiment. I picked two volunteers, Nicholas and John, and told them that I was capable of making $200 disappear from Nicholas’s bank account – poof! – while adding $300 to John’s.  This feat of social engineering would leave the class as a whole better off by $100. Would they allow me to carry out this magic trick?

Those who voted affirmatively were only a tiny minority. Many were uncertain. Even more opposed the change.

Clearly the students were uncomfortable about condoning a significant redistribution of income, even if the economic pie grew as a result. 

The second issue Rodrik raises, "procedural fairness," is less familiar to economists.  He writes:

To pass judgment on redistributive outcomes, we need to know about the circumstances that cause them. We do not begrudge Bill Gates or Warren Buffett their billions, even if some of their rivals have suffered along the way, presumably because they and their competitors operate according to the same ground rules and face pretty much the same opportunities and obstacles.

We would think differently if Gates and Buffett had enriched themselves not through perspiration and inspiration, but by cheating, breaking labor laws, ravaging the environment, or taking advantage of government subsidies abroad. If we do not condone redistribution that violates widely shared moral codes at home, why should we accept it just because it involves transactions across political borders?

I've come to agree with Rodrik that economists sometimes take a too-simplistic view of trade.  In part, I think this is because we feel the need to emphasize the benefits, because we understand them, and the public often seems not to - as evidenced by the mercantilist rhetoric of politicians who emphasize beating out other countries for jobs and exports, rather than mutual gains and the welfare benefits of less expensive imports. 

The idea of comparative advantage is a subtle point that is hard for people to get their heads around.  It is one very valuable thing that people take away from an introductory economics class - and for many economists who don't specialize in trade, may be the one idea they hold in their minds about trade.  Since I've had to learn more about trade theory to teach it (I'm an "international economist," but my specialization is on the macroeconomic side of it, while trade theory is a branch of microeconomics), I've learned alot of very interesting things that most non-specialist economists probably aren't aware of that put caveats on the case for "free trade".

Rodrik concludes:

Too many economists are tone-deaf to such distinctions. They are prone to attribute concerns about globalization to crass protectionist motives or ignorance, even when there are genuine ethical issues at stake. By ignoring the fact that international trade sometimes – certainly not always – involves redistributive outcomes that we would consider problematic at home, they fail to engage the public debate properly. They also miss the opportunity to mount a more robust defense of trade when ethical concerns are less warranted.

While globalization occasionally raises difficult questions about the legitimacy of its redistributive effects, we should not respond automatically by restricting trade. There are many difficult trade-offs to consider, including the consequences for others around the world who may be made significantly poorer than those hurt at home.

There's an irony here, since, in general, economists are people who relish thinking about difficult trade-offs.  Indeed, thinking about them is arguably our comparative advantage.

Death, Taxes and Trade Disputes

Douglas Irwin, Free Trade Under Fire (3rd ed., 2009):

The tuna dispute was resolved in 1992 when the United States, Mexico, and eight other tuna-fishing nations signed an international agreement to regulate the conditions of tuna fishing.

Bridges Trade News Digest, Nov. 16, 2011:

At its last meeting on 11 November, the WTO Dispute Settlement Body (DSB) decided to extend the deadline for submitting an appeal on the latest Tuna-Dolphin (DS381) ruling issued in September (see Bridges Weekly, 21 September 2011).

In light of the Appellate Body’s substantial workload, the US and Mexico had jointly requested an extension of the normally sixty-day period, which otherwise would have expired on 15 November. In accordance with the agreed extension, an appeal will have to be submitted no later than 20 January.

Lesson: never use the word "resolved" when writing about trade disputes....

To be fair to Irwin, whose book I recommend (and assign to students), one could consider "Tuna-Dolphin" to be a series of disputes, one of which was resolved in 1992.

Antidumping in Action

Today's Washington Post provides another example of our dysfunctional "Antidumping" rules in action.  This case is about antidumping tariffs imposed on furniture imports from China:

But do tariffs work? In the case of bedroom furniture, they’ve clearly helped slow China’s export machine. In 2004, before tariffs went into force, China exported $1.2 billion worth of beds and such to the United States. The figure last year was just $691 million.

Over the same period, however, imports of the same goods from Vietnam — where wages and other costs are even lower than in China — have surged, rising from $151 million to $931 million. The loss of jobs in America, meanwhile, only accelerated. 

This may be a case where the differential tariff treatment between Chinese and Vietnamese furniture which resulted from the antidumping case induced "trade diversion" - i.e., an efficiency loss because the trade preferences result in imports coming from someplace other than the low cost producer.  However, in this example, it could also be the case that comparative advantage shifted to Vietnam as China's labor costs have risen. 

Furthermore:

The only Americans getting more work as a result of the tariffs are Washington lawyers, who have been hired by both U.S. and Chinese companies. Their work includes haggling each year over private “settlement” payments that Chinese manufacturers denounce as a “protection racket.”

Fearful of having their tariff rates jacked up, many Chinese furniture makers pay cash to their American competitors, who have the right to ask the Commerce Department to review the duties of individual companies. Those who cough up get dropped from the review list.

It is clear from the article that workers in the US industry have suffered from a disruptive wave of furniture imports.  While it may indeed be the case that the US no longer has a comparative advantage in furniture production, standard comparative static trade theory fails to account for the adjustment costs associated with reallocating resources.  That is, trade theory assumes full employment and that workers will be shifted to another sector, ignoring the fact that this process involves losing their jobs in one industry and, usually, a period of unemployment before finding a job in another.

Although it is also less than perfect, a more appropriate remedy in this case would be the application of "safeguard tariffs" which the President can impose (following the recommendation of the International Trade Commission) in cases where industries are disrupted by import surges.  Relative to antidumping tariffs, safeguards have the advantages of being (i) time limited, (ii) at the discretion of the president (who presumably can consider the interest of the nation as a whole, rather than just an affected industry or region), and (iii) not requiring any allegation of "unfair" trade practices on the part of the exporters (which are usually somewhat bogus).

The Spaghetti Bowl is Not Deep

At Vox, Theresa Carpenter and Andreas Lendle ask, "How Preferential is World Trade?"  Their answer:

We find that around half of world imports are from countries that are granted some preference – yet that does not mean that all of that trade is actually preferential. MFN rates may be zero or a product can be excluded from preferences. Overall – but not including intra-EU trade – just 16.3% of global trade has a positive preferential margin. Preferential margins are distributed as follows:

• 10.5% of total trade has a margin of 5 percentage points or less, 3.9% has a margin of 5-10 percentage points, 1.3% has a margin of 10-20 percentage points and only 0.5% has a margin of 20 percentage points and above.
• Around 30% of global trade is not eligible for preferences and subject to non-zero MFN rates, although almost 2/3 of that trade faces tariffs of 5% or less.
• More than half (52%) of world trade is at MFN zero, so no preferences can be granted. 

By "preferential margin," they mean the gap between the "most favored nation" tariff, which all WTO members are expected to apply to imports from other members, and the lower tariffs which might apply under regional and bilateral trade agreements.  For example, if the US has a 10% MFN tariff on cogs, but under NAFTA, cogs from Mexico enter the US tariff-free, that would mean a 10% preferential margin.

This addresses one of the main complaints about trade agreements: that they lead to preferences.  This can lead to "trade diversion," whereby a country imports a good from someplace that isn't the most efficient producer - in the above example, if Brazilian cogs were 5% less costly than Mexican cogs, without NAFTA, the US would import them from Brazil; NAFTA causes the US to shift to Mexican cogs (and lose the tariff revenue).  As a political economy matter, this might also mean that Mexico is less likely to support multilateral liberalization - e.g., a reduction in cog duties in the WTO Doha round talks - because it enjoys its privileged access to the US market.  That is, preferential agreements lead to worries about "preference erosion" which could hinder broader tariff reductions.

These are two aspects of the general criticism that regional trade agreements create what is known as the "spaghetti bowl phenomenon" described thus in an academic article by Jagdish Bhagwati, David Greenaway and Arvind Panagariya:

The result [of the proliferation of regional trade agreements] is…the ‘spaghetti bowl’ phenomenon of numerous and crisscrossing PTAs and innumerable applicable tariff rates depending on arbitrarily-determined and often a multiplicity of sources of origin. In short, the systemic effect is to generate a world of preferences, with all its well-known consequences, which increases transaction costs and facilitates protectionism. In the guise of freeing trade, PTAs have managed to recreate the preferences-ridden world of the 1930s as surely as protectionism did at the time. Irony, indeed!

One of the interesting questions in trade is whether "free trade" agreements really deserve the name.  Carpenter and Lendle's evidence suggests that perhaps some of the criticisms - while valid in theory - may be overdone in practice.

Econ Journal Footnote of the Year

Foletti, L., Fugazza, M., Nicita, A. and Olarreaga, M. (2011), Smoke in the (Tariff) Water. The World Economy, 34: 248–264

9 The song ‘Smoke on the Water’ was written by Deep Purple and refers to the fire that took place at the Montreux Casino during Frank Zappa’s concert in the 1971 Festival. Montreux is at the opposite end of Lake Geneva from the WTO.

As the article explains, the gap between the tariff limits countries have agreed to under the WTO - "tariff bindings" - and the tariffs they actually impose is known as the "tariff water."  This means that, in practice, countries could raise many tariffs without violating their WTO commitments.  After accounting for tariff bindings that are above prohibitive levels and the constraints of regional trade agreements, the paper looks whether countries have used their available "policy space" to increase protection during the global recession (and finds that, generally, they haven't very much).

Or, one might say they decided not to go (Policy) Space Truckin'.

For a follow-up, might I suggest: Woman from (the) Tokyo (Round) ?

If you think you're not familiar with "Smoke on the Water," after the first 20 or so seconds of this you will realize that you are (its the holy trinity of rock).  Also: Space Truckin' and Woman from Tokyo.

Rebalancing Watch

International trade fell sharply during the worst days of 2008-09, and this was reflected in a sharp decline in the US trade deficit.  One of the big questions in the recovery is whether the trade deficit (or, more broadly, the current account deficit) will return to its pre-crisis level.  That is, was the reduction in the deficit temporary, or have we achieved some "rebalancing"?

Friday's advance estimate of GDP provides some encouragement in this regard.  The US economy still has a long way to go, but it is now at least back to its pre-recession level of output.  The trade deficit remains smaller than it was before the recession - it was 3.3% of GDP in the 4th quarter of 2010, versus 4.9% in the last quarter of 2007.

The widening trend that began in mid-2009 appears to have leveled off or reversed.  Menzie Chinn James Hamilton suspects that the decline in the trade deficit in the quarter was tied to the decline in inventory accumulation:

But the fact that a huge negative contribution of inventories coincided with a huge positive contribution of imports does not seem to be a coincidence. There's a clear pattern in the recent data that when one of these makes a positive contribution to GDP growth, the other makes an offsetting negative contribution. Although we often think of inventories as a substitute for production (you could either produce a good or sell it out of inventories), in the current environment inventories seem to act more as a substitute for imports (you could either import the good, or sell it out of inventories).

Nonetheless, it looks like the trade deficit may not headed back to where it was. What happens going forward depends in large part on what happens with the US' trading partners.  Faster growth in the rest of the world should reduce the trade deficit.  We're seeing this in much of the developing world, which is recovering more quickly (indeed many emerging markets now face a danger of inflationary overheating).

At Project Syndicate, Martin Feldstein argues that one of the major surpluses, China's, will come to an end because its astronomical saving rate is headed down:

China’s national saving rate – including household saving and business saving – is now about 45% of its GDP, which is the highest rate in the world. But, looking ahead, the five-year plan will cause the saving rate to decline, as China seeks to increase consumer spending and therefore the standard of living of the average Chinese.

The plan calls for a shift to higher real wages so that household income will rise as a share of GDP. Moreover, state-owned enterprises will be required to pay out a larger portion of their earnings as dividends. And the government will increase its spending on consumption services like health care, education, and housing.

These policies are motivated by domestic considerations, as the Chinese government seeks to raise living standards more rapidly than the moderating growth rate of GDP. Their net effect will be to raise consumption as a share of GDP and to reduce the national saving rate. And with that lower saving rate will come a smaller current-account surplus.

Of course, declining savings only reduces the current account if investment doesn't also fall with it.

Real exchange rates play a role, too, and in this regard, inflation in China is causing its exports to become more expensive, its intervention to hold down the nominal exchange rate notwithstanding.  The Times' Keith Bradsher reports:

Inflation is starting to slow China’s mighty export machine, as buyers from Western multinational companies balk at higher prices and have cut back their planned spring shipments across the Pacific...

Already, the slowdown in American orders has forced some container shipping lines to cancel up to a quarter of their trips to the United States this spring from Hong Kong and other Chinese ports. 

See also this recent post.  Whether it comes by inflation or a movement in nominal exchange rates, a Chinese real appreciation would take some pressure off other developing countries which are shadowing China in holding down their currencies.

Effective Protectionism

One of the lessons in international trade class is that tariffs on input goods harm upstream domestic industries - e.g, a tariff on steel would put domestic automakers at a disadvantage by raising their costs relative to foreign competitors. To account for this, economists use a measure known as the "effective rate of protection" which calculates the net effect from the tariffs on the final product that protect an industry and the input tariffs that harm it.

Economists have a strong reflex to sigh when we see a headline like "House Passes Tariff Bill to Help Manufacturers," so it was a relief to read beneath it:

The House of Representatives approved a bill on Wednesday to help U.S. manufacturers by suspending import duties on hundreds of raw materials they use to make finished goods.

That is, the House is increasing the effective rate of protection by lowering tariffs. Perhaps they're more clever than I thought...

The Daily Show on Global Rebalancing

The reduction in the trade deficit means a shift in tradable goods production to the US. Or, as the Daily Show's Aasif Mandvi puts it: "you're telling me that we Americans have to make our own cheap plastic crap?"

The Daily Show With Jon Stewart	Mon - Thurs 11p / 10c
Wham-O Moves to America
www.thedailyshow.com
Daily Show Full Episodes Political Humor Tea Party

Even before China's recent decision to allow the Yuan to resume appreciating, increasing costs due to higher inflation meant it was becoming less undervalued in real terms.

Looking at the factory in the background suggests that Wham-O's manufacturing in the US is very capital-intensive, as standard trade theory would predict since the US is, relative to China, a capital abundant country (however, this may be an example of a violation of the "no factor intensity reversals" assumption...).

See also this report on the Daily Show's visit from Wham-O's local paper.

Hardball with China?

A useful article by Keith Bradsher in the Times points out a weakness in international economic governance - while the WTO provides a system of rules and an enforcement mechanism for trade, the IMF does not have the power to do the same for exchange rate policies. China has made use of this asymmetry, he writes:

Seeking to maintain its export dominance, China is engaged in a two-pronged effort: fighting protectionism among its trade partners and holding down the value of its currency.

China vigorously defends its economic policies. On Sunday, Premier Wen Jiabao criticized international pressure on China to let the currency appreciate, calling it “finger pointing.” He said that the renminbi, China’s currency, would be kept “basically stable.”

To maximize its advantage, Beijing is exploiting a fundamental difference between two major international bodies: the World Trade Organization, which wields strict, enforceable penalties for countries that impede trade, and the International Monetary Fund, which acts as a kind of watchdog for global economic policy but has no power over countries like China that do not borrow money from it.

Paul Krugman argues that it is time for the US to confront China over its exchange rate policies:

Some still argue that we must reason gently with China, not confront it. But we’ve been reasoning with China for years, as its surplus ballooned, and gotten nowhere: on Sunday Wen Jiabao, the Chinese prime minister, declared — absurdly — that his nation’s currency is not undervalued. (The Peterson Institute for International Economics estimates that the renminbi is undervalued by between 20 and 40 percent.) And Mr. Wen accused other nations of doing what China actually does, seeking to weaken their currencies “just for the purposes of increasing their own exports.”

But if sweet reason won’t work, what’s the alternative? In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. At this point, it’s hard to see China changing its policies unless faced with the threat of similar action — except that this time the surcharge would have to be much larger, say 25 percent.

I don’t propose this turn to policy hardball lightly. But Chinese currency policy is adding materially to the world’s economic problems at a time when those problems are already very severe. It’s time to take a stand.

The Economist offers a more cautious view:

Will the administration’s new tough talk move things in the right direction? Those who argue in favour of sabre-rattling do so on two grounds: first, that it is likely to shift China’s position, and second, that a stronger stance against China’s currency from the White House will diffuse protectionist sentiment in Congress. Both are dubious. China’s reactions so far suggest that American complaints make an imminent currency shift less, not more, likely. And a row could spur rather than diffuse anti-China action in Congress.

Rather than raising a bilateral ruckus, America would be far better off convincing other big economies in the G20 to press together for a yuan appreciation as part of the world’s exit strategy from the crisis. Cool and calm multilateral leadership will achieve more, with fewer risks, than a Sino-American currency spat.

Dani Rodrik, on the other hand, has suggested China's policy is a defensible development strategy.

Speaking of hardball and China, the Economist reports they're not taking to it.

Update: More on Krugman's blog. Free Exchange is harshly critical of his column, and he responds, and is answered. Scott Sumner also disagrees with Krugman. See also Ambrose Evans-Pritchard, who sees China spoiling for a fight it won't win.

All Quiet on the Banana Front

In the Times, Eduardo Porter looks back at the long running trade dispute over the EU's preferential treatment of banana imports from former colonies, which has finally come to an end. He writes:

When this started, trade was trumpeted as the single most important tool for development. Europe insisted that its special treatment of its former colonies was central to its post-imperial responsibilities. The United States and Latin American countries vowed to hold the line for free trade — over bananas at least — to make it a tool of development for all.

Today nobody talks about bananas. Stalled global trade talks (remember Doha?) barely get mentioned. There are a lot of problems out there, including the collapse of world trade in the wake of the global recession and the looming threat of protectionism. Yet there has also been a rethinking about trade’s supposed silver bullet role in economic development.

Bridges Weekly Trade News Digest has more on the case, and Paul Krugman laments, for a rather selfish reason.

Yo NAMA

The Times reports from Copenhagen:

The focus on reducing emissions from land use change is an important shift from the Kyoto Protocol, the first attempt by the nations of the world to develop a global plan to limit climate change. Current drafts circulating here would allow land-use activities that reduce emissions to be included in the United Nations Nationally Appropriate Mitigation Activities program, or NAMA, so countries could use that to achieve emissions reduction goals or targets.

But at the WTO in Geneva, NAMA is Non-Agricultural Market Access. Not only is the Doha round sputtering, it appears they are also losing control of their acronyms...

Anti-Dumping in My Backyard

Southwest Ohio's friendly neighborhood steelmaker, AK Steel, is among those being hit with antidumping tariffs by China, the Oxford Press reports:

The head of locally-based AK Steel said the company will “vigorously appeal” a decision by China, the world’s biggest steel consumer, to impose anti-dumping import taxes of up to 25 percent on specialized steel imports from Russia and the United States.China’s Ministry of Commerce said today, Dec. 10, that U.S. and Russian companies are selling flat-rolled electrical steel, a product used in the power industry for items such as transformers, at unfairly low prices in China. Starting Friday, Dec. 11, importers will need to pay anti-dumping deposits ranging from 10.7 percent to 25 percent to import the product from U.S. companies such as AK Steel.

Historically, the US steel industry has been a leading user of antidumping actions, so one naturally wonders if this is another example of the retaliation dynamic studied by Feinberg and Reynolds.

Van Customs

The US imposed a 25% tariff on imported trucks and commercial vans ("motor vehicles for the transport of goods," in the words of the Harmonized Tariff Schedule) in 1963 as retaliation for European tariffs on chicken. However, "motor vehicles principally designed for the transport of persons" face a much lower (2.5%) tariff rate. Via Autoblog, we learn of some cleverness on the part of the folks at Ford. They manufacture Transit Connect vans in Turkey and then:

They actually ship the Transit Connects here with the vans classified as wagons. Then, once they reach a processing facility in Baltimore, they are transformed into cargo vans, totally side-stepping the Chicken Tax. Smart, huh?

The process of transforming a passenger "wagon" into a cargo van works like this. The rear windows are removed and replaced by a sheet of metal that's quick cured in place. The rear seats and seat belts are then removed and a new floorboard is screwed into place. Voila – five minutes after they start as five-passenger wagons, Ford has a bunch of two-seater panel vans. The seats are then shredded and the material is used as land fill cover. No word on what happens to the glass.

Hmmm... I never expected that my reading of Autoblog would yield an example for my international trade class. All that time I was working, after all.

The Wall Street Journal has more.

A Tiresome Tariff?

President Obama has imposed "safeguard" tariffs for three years on Chinese tires, but at a lower level than the ITC recommended, the Times reports:

The International Trade Commission, an independent federal agency, ruled in late June that Chinese tire imports had indeed disrupted the domestic industry.

The panel recommended that the president impose tariffs for three years, starting at 55 percent and then declining. Mr. Obama, who was required by law to decide on the recommendation by Sept. 17, announced slightly lower tariffs that will start at 35 percent and drop to 25 percent in the third year.

Economists are mostly nonplussed... Brad DeLong says "really stupid." But not unusual, notes Douglas Irwin:

Regardless of party, every president, at some point, and often for political reasons, has imposed restrictions on imports. George Bush did, Bill Clinton did, Ronald Reagan did (a lot), Jimmy Carter did, and so forth...you get the drift. With some exceptions, most of these restrictions were not too costly or too important: they usually involved small industries, and the restrictions eventually expired. So on the broad canvas of presidential trade policy, Obama’s decision is unexceptional. Of course, the timing of the administration’s action, coming off the economic crisis and increasing fears of protectionism, makes it a bit riskier than most. And China’s response could make a bad situation worse; let us hope that it is posturing for its domestic audience. Still, the disruption to world trade is significantly less than Bush’s steel safeguard action early in his term.

Also, Dean Baker notes:

When China was admitted to the WTO it agreed to allow the United States to impose tariffs to temporarily counteract the disruptive effects of an import surge. The agreement did not require the United States to show that China had in any way acted unfairly, simply that the growth of imports had seriously disrupted the domestic market.

This clause was an important factor in selling China's entry to the WTO to interest groups in the United States. Therefore, it should not be surprising that the government would occasionally take advantage of a clause that it had demanded.

Real Time Economics rounds up more reaction.