Saturday, January 21, 2017

Tariffs and Exports

    If the Trump administration imposes a tariff on imports, it will result in a contraction of trade--both imports and exports.   Frequently, it is claimed that this will only occur if foreign governments retaliate to tariffs on their exports to the U.S. with tariffs on U.S. exports to their countries.    However, that is not correct.   There is a market process that brings this about even without "retaliation."

     The most direct process occurs with floating exchange rates, which is at least approximately the U.S. regime.   The tariff reduces the amount of dollars paid for imported goods.   This reduces the supply of dollars on foreign exchange markets and so required an increase in the value of the dollar for the market to clear.  This partly offsets the tariff by making the dollar prices of imported goods less, but it also makes U.S. exports more expensive for the foreign buyers.   This results in a decrease in exports.

      The U.S. currently has a trade deficit, and the stronger dollar will tend to reduce it.   While an expectation of an increased value of the dollar will encourage foreigners to invest in U.S. financial assets, once the dollar is higher, U.S. real assets will be more expensive for foreigners.   So, the result will tend to be a lower trade deficit as well as reduced exports.

       The U.S. could use monetary policy to prevent the dollar from rising in value.   This is done by increasing the quantity of money.   The equilibrium consequence of this policy is higher inflation in the U.S.  The higher prices in the U.S. will make foreign imports more attractive, partially offsetting the effect of the tariff, but will also make U.S. exports more expensive for foreigners, causing them to purchase less.   Similarly, U.S. assets will be more expensive for foreigners to purchase, so that the trade deficit will be smaller.

       Like most market monetarists, I think that prices are sticky, and that includes wages.   The inflationary process would not be instantaneous or smooth.   The increase in demand though out the economy would likely result in increases in output and employment.   Wages are also very sticky, even in an upwards direction, so real wages would be depressed which should help employment.   That effect would be especially strong in weak areas of the economy--including import competing manufacturing.   Only in "the long run" would higher prices and wages result in a return to equilibrium.

       It would be possible for the central bank to keep keep the dollar from rising while avoiding inflation by sterilization.   The Federal Reserve would need to sell off dollar assets it holds while purchasing foreign exchange--foreign assets.    This can last as long as the Fed has U.S. assets to sell.   The result should be a reduction in imports and a reduced trade deficit.   Unfortunately, the expansion in demand for the products of U.S. import competing industries will be offset by a reduction in the demand for the products of interest-sensitive industries--construction and capital goods.   Once the Fed runs out of U.S. assets, allowing the dollar to rise would result in financial losses to the Fed.   Perhaps this would lock in the inflationary equilibrium.

       It would also be possible to blame the increase in the value of the dollar on currency manipulations by foreigners.   A higher dollar is at the same time a lower pound, euro, yen, and renminbi.   How dare they devalue their currencies to offset the effects of the tariffs?
 
       Foreign nations could prevent their currencies from losing value by contracting their quantities of money.   In the long run, this would result in them having lower prices and wages, and so U.S. buyers would find their imported goods cheap and they would find U.S. exports expensive.   While that process would likely be long and painful, the effect on U.S. exports would be prompt.   The recession induced by their contract would result in reduced U.S. sales in their markets.

       Finally, they could keep their currencies from losing value by selling off any U.S. assets they hold and instead accumulating other sorts of foreign exchange or else each their own domestic assets.   This would tend to shrink the U.S. trade deficit by reducing the amount of foreign funding of U.S. investment.   This could last until they run out of U.S. foreign exchange.   Again, any expansion in the demand for import competing industries will be offset by a reduction in demand in interest sensitive industries in the U.S.--construction and capital goods.

      Changes in the composition of the Fed's balance sheet or the balance sheets of foreign central banks could shield U.S. exports from the decrease in imports for a time.   It is only if such adjustments are made that a contraction in U.S. exports would only occur due to retaliation of increased tariffs.


Sunday, January 15, 2017

Border Adjustment Tax

     Congress has proposed several reforms of the corporate income tax.   One reform is a border adjustment tax.   This means that corporate "profit" will be calculated with no deduction for the cost of imported goods and with a deduction of revenues from exports.
      This has been characterized as a tax on imports and a subsidy for exports.   Of course, it isn't actually the payment of a bounty for exported goods, but rather a relief from corporate income tax on profit generated from exports.   Still, the economic impact  should be similar to a more transparent tax and subsidy scheme.
       However, a tariff on all imports and subsidy for all exports has approximately no effect on trade.   A tariff on a single import tends to restrict demand for that imported good, but the resulting appreciation of the dollar expands the demand for other imports while reducing exports.  Trade shrinks.
       A subsidy for a particular export will tend to expand the production of that export, while the appreciation of the dollar will slightly contract other exports and expand imports.   Trade expands.
       But if you tax all imports and subsidize all exports the same, there is no reallocation between various imports or various exports nor is there any expansion or contraction of trade.    The dollar rises, leaving the allocation of resources unchanged.
       The result is not a reduction in the trade deficit or increase in the trade surplus unless the tax impacts saving or investment.   For a trade deficit country, either investment must decrease or saving increase for the trade deficit to decrease.   While possible, this is a second order effect.
        The rationale for the border adjustment tax is to shift from taxing profits from production in the U.S. to instead taxing profits from selling in the U.S.   The result should make the tax system neutral regarding location decisions for firms seeking to sell products in the U.S.
          The tax proposal has other characteristics that also are inconsistent with a tax on profit.   All capital expenditures are to be expensed rather than depreciated.   That means that if a corporation invests its profit in capital equipment, it pays no tax on the profit.  Also, interest expense is not deductible.  That means that corporations will be paying tax on the income they pay out to bondholders, so that all investors, whether stockholders and bondholders will be taxed the same.   This should make the tax neutral regarding the financing of corporations by the issue of stocks or bonds, taking away the existing artificial encouragement of leverage (borrowing.)
         And the corporate tax rate is to be reduced to 20% rather than the unusually high 35% that exists today.
         A true value added tax is a tax on income.   However, the typical value added tax allows expensing of investment, which makes it a tax on consumption.  Border adjustment taxes are typically applied, so that the consumption of imports is taxed just like the consumption of domestically-produced goods.   Exports are exempt, because there is no intention of taxing foreign consumption.
         A national sales tax is more transparent, and would involve the taxation of final sales of consumer goods and services.   (A tax on the sale of all final goods and services would be an income tax.)   Consumption of imported goods would be taxed the same as domestic products, and there would be no taxation of exports.
        The proposed reform of the corporate income tax, then, moves it in the direction of a consumption tax, but the process is not complete because payroll expense will still be deductible.   It would seem, then, that the proposal is a tax on consumption of capital income from sales in the U.S.
         While the tendency for the dollar to rise could occur through a prompt adjustment of the nominal exchange rate with the inflation rate unchanged, this could be prevented by open market purchases of foreign exchange. This resulting money creation would raise the inflation rate.   In the long run, equilibrium would return with prices and wages higher in the U.S.   As U.S. prices rise, imports would expand and exports shrink,  returning imports, exports and the trade deficit to its initial value.
          The use of sterilized foreign exchange transactions would be possible.   Here, the Fed would sell off its holdings of U.S. assets and purchase foreign exchange.   This would tend to reduce the U.S. trade deficit by reducing foreign funding of U.S. investment.   It could last until the Fed runs out of dollar assets.   This policy could be introduced at any time, though it would usually generate a decrease in the U.S. nominal exchange rate.  That would tend to shrink imports and expand exports consistent with the reduction in foreign funded investment in the U.S.   This might be more politically acceptable if it limits and restrains what otherwise would be an increase in the nominal exchange rate.
        Foreign exchange operations are the responsibility of the U.S. Treasury, so I suppose this could be implemented regardless of what the Federal Reserve wants to do.   The Fed could either sterilize to keep to its inflation target or allow inflation to rise until the real exchange rate increases the necessary amount.
        My preference, of course, would be to allow the nominal exchange rate to increase enough.  While I do not favor inflation targeting, nominal GDP targeting would be qualitatively similar in this situation.
      

Wednesday, January 4, 2017

Deindustrialization and Unionization

      The long run trend for U.S. employment is up.   The unemployment rate fluctuates with the business cycle, but any trend is at best minimal.   Still, there are constant complaints that imported goods are destroying jobs.   Or perhaps it is just the "good jobs."   And what are these good jobs?   They are factory jobs were men of modest education can earn high wages and benefits.   These jobs are supposed to allow those workers to be part of the middle class.
       Surely, this is why the loss of manufacturing employment is counted as a major concern.   These middle-class jobs disappear and some of those losing the jobs, or perhaps just their children and grandchildren, must must accept low paying jobs in the service sector.   Of  course, some that are more ambitious may accept more responsibility and risk, or at the very least, seek more formal education, allowing for more skilled work.   Even so, people who are little different in terms of skills and attitudes from those who had "good jobs" in the past  must now take substantially worse jobs.
        A simple model of unionization has the union increasing wages in the union sector.   The quantity of labor demanded by the firms in that sector is lower, reducing employment.   The workers who would have worked in the unionized sector seek employment in the nonunion sector.  The increase in supply in the nonunion sector lowers wages in that sector.   In the simplest model, the workers are identical, so the result is that identical workers earn differential wages depending on their industry.   Wages are above the competitive level in the union sector and below the competitive level in the nonunion sector.
       In the nonunion sector, the labor market clears.   In the union sector, there is a surplus of labor.   Workers from the nonunion sector would prefer "good jobs" in the union sector.    If the union sector is "manufacturing" and the nonunion sector is "services," then this would explain why manufacturing is identified with "good jobs" that are "scarce" and the service sector are "bad jobs."
        Unions took off in the U.S. during the Great Depression.   In my view, this was mostly due to money illusion.   There was massive deflation during the first part of the thirties, and substantial decreases in nominal wages.   While real wages actually increased, workers became very interested in joining unions in order to fight the unfair pay cuts.  Federal government policy changed to strongly support unionization, but the workers supported unionization to fight nominal pay cuts despite growing real wages.
          As time passed, the unionized workforce became less significant, mostly because the growth of unionization failed to keep up with the growth of the labor force.   However, many years ago, someone from "management" once explained that there is little benefit for workers to join a union because employers provide pay and benefits for nonunion jobs that are competitive with union pay and benefits.  There appears to be substantial truth to this notion, most obviously in industries and even firms that have both union and nonunion operations.    Keeping pay and benefits low in the nonunion shop is just asking for an organization drive and the loss of the election.
         This suggests that the proper division in the simple model is not between the union and nonunion sectors, but rather between the "easy to unionize" and "difficult to unionize" sectors.   If manufacturing is on the whole easy to unionize and the service sector is difficult to unionize, then manufacturing will provide "good jobs" that pay more than the competitive amount and the service sector will have poor jobs that pay less than the competitive amount.
         It is certainly plausible that manufacturing is easy to unionize because of economies of scale.  There are also substantial sunk costs, which makes exit difficult, which in turn makes entry risky.  In the rest of this post, I will assume manufacturing is easy to unionize and the result is higher than competitive wages in manufacturing.   The service sector is difficult to unionize and so results in lower wages.  
         This ties to trade because it is a way to bypass the inefficiency created by unionization.   The reduced employment in manufacturing results in too low output and too high prices.   The shift of labor to the nonunion sector results in too high output and too low prices.
          By importing manufactured goods, those in the service sector obtain products at lower prices.   This raises their real income.   The domestic manufacturing industry, which is already too small, reduces output further.   However, the need to meet foreign competition lowers their too high prices.   The reduction in employment in the manufacturing sector increases the supply of labor to the service sector, resulting in lower wages.
          Trade must balance, but it is possible to export services.   Tourism is an obvious example, and there are various sorts of financial services that can be provided to foreigners.   It is also possible that a net capital inflow could fund imports of manufactured goods.   Foreign investment funding an expansion of the service sector would fit in well with this account.  
          Certainly, this story does not account for all of the U.S. experience in the late twentieth century.   The simple model ignores sorting in a labor market where workers are not all the same.   Sectors with excessive wages and and a surplus of labor will tend to hire what they perceive to be higher quality workers.   To some degree, workers left in the low wage sector may be less productive.   Manufacturing output has generally increased in the U.S. and not disappeared.  However, the "problem" of a lack of high paying jobs for workers with little education is not solved by a demand for highly-skilled workers in manufacturing.
          Still, I think it does tell us something about the "problem" of the loss of "good jobs."   That just doesn't make much sense in a competitive labor market.   We can image shifts in the share of income going to labor and capital due to changes in trade or technology.  These changes could tend to depress real wages.  These changes simultaneously expand real output so that the net result is ambiguous.   But these processes do not appear to create the phenomenon of the loss of "good jobs" in import competing industries.  
           If a single industry were unionized or were simply subject to unionization, those working in that sector would almost certainly benefit.   They would receive a larger share of a very slightly smaller pie.   When all manufacturing is unionized or even subject to unionization, the loss in total efficiency is more substantial.   The unionized autoworker pays more for shoes produced by union labor.   The expansion of imports similarly has ambiguous effects.   The union shoe maker can buy a cheaper Korean car, while the union autoworker can buy cheaper Mexican shoes.   Still, the analysis treating "manufacturing" as an aggregate provides some element of truth.   Those keeping the unionized or unionizable jobs get cheaper haircuts and the barber pays more for cars and shoes.   An expansion of imports allows the barber to get cheaper cars and shoes, even if there are more former autoworkers and shoemakers who want to set up barber shops.
           Globally, a pattern of international trade that develops because of unionization is inefficient.   World output and income may be higher than without the trade, but it would be higher still if wages in the unionized and unionizable sector were competitive with wages in the service sector.   That is, if workers in the service sector did not covet "good jobs" in manufacturing, and workers in manufacturing did not see service sector jobs as undesirable.   To the degree this makes the domestic production of manufactured goods more profitable and expands the manufacturing sector at the expense of the service sector, the result would be improved global efficiency.  
           

Wednesday, December 28, 2016

Sumner vs. White on Fiat Money vs. the Gold Standard

    I enjoyed this short video of Scott Sumner and Larry White discussing fiat currency versus the gold standard.   Check it out here.

    Sumner's key argument is that a properly managed fiat currency can out perform a gold standard.   Sumner is optimistic that central banks are learning to do a better job.    White responds that central banks have not done better than a gold standard.   Further, he argues that the very existence of central banks causes problems because they will seek to tinker with the monetary system causing more harm than good.

     I think Sumner pointed out the key problem with a gold standard, and that is its decent performance requires appropriate monetary policy by foreigners.   White argues in favor of free banking.   Suppose that his argument wins the day in the U.S., but China adopts the gold standard while rejecting free banking.   Now the world economy is held hostage to the Chinese central bank's foolish notions.    (Or, the world economy might be improved by wise policy by the Chinese central bank.)

       I don't really agree with White's emphasis on central bank mischief.   A government has no need for a central bank to implement a monetary policy under a gold standard.    The Treasury can sell newly issued government bonds for gold and create an economic contraction.   Or, it can sell off gold and pay down its national debt and create an expansion.    The contraction has an interest cost--it must pay more interest on outstanding government bonds than otherwise.   And the inflation has an upward limit--the government's gold reserve.  

      Of course, there is also the traditional government power of devaluation and revaluation.  Interestingly, central banks have not had that power delegated to them.   I suppose White just would like to forbid that power to government.    My own view is that devaluation would be the least bad response if some foreign central bank pulled a France--accumulating gold reserves.

      Consider how President-elect Trump would respond if a  gold standard China were to devalue its currency and build up as a gold reserve the resulting gold inflow?    Tariffs?  Or is this an act of war?  
       With a free banking system, the resulting U.S. recession (depression) would almost certainly result in the exercise of the option clause.   The interest penalty for the banks would motivate a measured deflation.   I think the answer is for the government to devalue so that there is no deflation and instead try to guess on a new price of gold so that nominal GDP would continue to stay on its trend growth path.

      Irving Fisher long ago explained how regular devaluations and revaluations of gold would provide price level stability in the context of a gold standard.   Of course, the compensated dollar is hardly a gold standard at all.   It would seem that gold can be dispensed with (though the emphasis of central bankers on interest rates and the odd bicycle nature of interest rate targeting suggest that the compensated dollar might have its uses.)

      And it is that sort of thinking that makes the concept of "fiat currency" defended by Sumner problematic.   It creates the habit of mind where paper currency plays the role of gold.   With free banking, paper money is instead a debt instrument.    Removing gold and using another nominal anchor doesn't change that.   Even under current institutions, paper money is better understood as a kind of government debt.   In my view, the key problem with gold as a nominal anchor is that it serves as a tolerably good money itself.   And changes in the demand for it, from anywhere in the world, results in tremendous economic disruption.

     That is why I prefer free banking to be tied to some other nominal anchor.   Slow and steady growth in nominal GDP looks to be the least bad option to me.

Wednesday, December 21, 2016

Global Warming Boom

 I think that Trump's election has greatly improved the prospects for real economic growth by reducing the prospect of stringent controls on greenhouse gases.   I think it likely that the resulting increase in the production of greenhouse gases will add to global warming, so this is the "global warming boom."

The alarmist rhetoric that mainstream Democrats have adopted regarding global warming would suggest the necessity of highly restrictive regulation of the production of carbon dioxide.   Cold-turkey pollution control is (or should be) a textbook example of a supply-side recession.    If there really were a prospect of planet Earth turning into Venus, a Great Depression scale contraction of real output and real income would be possible and justified.

Of course, few elected officials would support such a policy    Much more likely would be a gradual tightening of regulations so that real output grows more slowly.   Over time, the growth path of real output and real income would be substantially lowered, but at least in terms of design, there would be no periods where regulation would cause it to actually drop.   There would be no supply-side recession, but just simply slower growth.   Given the very slow increase in per-capita real income at best, the result could easily be stagnation in material standards of living.

If the pollution in question were noxious gases emitted into the atmosphere or poisons disposed into rivers, lakes, or oceans, the benefits of a  cleaner environment would be plain.   It is possible that the sacrifice of material goods and services would be worth it--even a rapid Great-Depression scale contraction of real output.  It  seems likely to me that a supply-side recession would be efficient at least in parts of China.  That measures like GDP fail to fully capture changes in human welfare should not be a major concern.   This is just one of many circumstances where the rough rule of thumb that higher and more rapid growth in per capita real GDP improves human welfare fails.

That reduced emission of greenhouse gases into the atmosphere provides a less immediate and obvious benefit does not necessarily mean that it does not increase human welfare on net, but the sacrifice of material goods and services still remains as a cost.   How much benefit from less future climate change will appear in the present?

For all of the apocalyptic rhetoric, there hasn't really been all that much regulation as of yet.   And so, the current economic impact was about expectations of future regulations and somewhat less global warming.   The surprise election of Trump has now caused any increased regulation to recede into the more distant future while the global warming is more likely to be slightly worse.

Anticipated regulations that will reduce real income from what otherwise would be will tend to increase saving.   Current consumption is reduced to cushion the blow to future consumption due to lower future incomes.   However, expectations of global warming should also increase saving.   Consumption is reduced now so that future consumption is protected perhaps from the impact of lower income but also from the need to use future resources to mitigate against problems caused by climate change.    While this implies an ambiguous result for saving, the more immediate and certain cost of the future regulation versus the more distant and speculative effect of global warming suggests more saving now on net.

The impact on investment is more important.   The likely introduction of strict regulation of carbon dioxide in the near future would immediately depress investment in durable capital equipment that generates substantial carbon dioxide.   This would be especially true for efficient regulations that penalize existing capital goods, such as a carbon tax.   Command and control regulation that applies solely to new investment would not have such an effect.   Quite the contrary, there should be a rush to invest before the regulation is applied.   Cap and trade could have a similar effect if the caps reward those firms that currently emit the most carbon dioxide.

While the prospect of regulation of carbon would make investment in capital equipment that emits relatively little carbon dioxide more profitable, there seems little reason to purchase any of it until just before the new regulations will begin to bite.   It would seem that the most sensible strategy would be to refrain from new investment, including regular replacement of existing equipment, accumulate short term financial assets, and then purchase "environmentally-friendly" capital equipment right before the new regulations are implemented.

What kind of investment would be encouraged by some decrease in the intensity of global warming in the future?   More building in coastal areas?    Agricultural buildings?     Planting fruit trees?

It seems to me that the most likely effect of the prospect of intense regulation of greenhouse gases would be an increase in the saving supply and decrease in investment demand.   This results in a lower natural interest rate.

This would be somewhat temporary.  After the regulations are implemented, the supply of saving would decrease in an effort to maintain consumption.

The demand for investment is ambiguous.   The opportunity to replace capital goods that generate substantial regulatory costs with new capital goods that emit less carbon dioxide and other greenhouse gases would increase investment demand.    However, these techniques would have already been more profitable if they were more effective in producing output.   This suggests that the reduction in investment demand must be at least partially permanent.

Still, there is good reason to believe that the natural interest rate would temporarily decrease before the regulations are implemented and then at least partially recover after carbon emissions are more strictly regulated.     If the prospect for regulation recedes, then the result should be a decrease in saving supply and increase in investment demand and so a higher natural interest rate.

The impact of an increase in saving supply and decrease in investment demand on the allocation of resources between the production of consumer and capital goods depends on which changes more and the interest elasticity of saving supply and investment demand.     At first pass, there is no effect at all--while both changes reduce the natural interest rates, they have opposite impacts on the allocation of resources.    While I would usually think the interest elasticity of investment demand is much greater than for saving supply/consumption demand, in this situation I would anticipate that the effort to save for the future would fail and firms would still postpone investment in capital equipment.  In other words, assuming the interest rate coordinates properly, the result would be increased production of consumer goods and services and fewer carbon-dioxide emitting capital goods.

More troubling is the possibility that the market rate fails to match the decrease in the natural interest rate so that at least part of the reduced investment demand and increased saving supply simply results in idle resources.     Further, the fear of these costly regulations, by deterring investment now one way or another, will begin to adversely impact growth of labor productivity.

Removing the threat of these regulations, then, would have the opposite effects.   The increase in investment demand will quite plausibly generate a substantial increase in  investment and the addition to the capital stock will enhance labor productivity.

That the Fed prefers to target short and safe interest rates has resulted in almost a decade of poor policy because short and safe interest rates are so low.   If firms begin to spend off their large holdings of short and safe securities and instead purchase capital goods, this problem will be greatly relieved.   The "Taylor rule" should begin to work somewhat better.

Finally, if we had the sort of massive contraction of real output that appears justified by the alarmist rhetoric of the Obama administration, the consequences for employment would very much depend on the monetary regime.    The direct and immediate effect of these stringent regulations would be to make the production of goods and services more difficult.   The reduction in supplies would tend to increase the prices of products.   A policy of strict inflation targeting would require that this be offset by reduced demand.   Equilibrium would require a substantial decrease in nominal and real wages.   It is difficult to see how anyone could pay off existing debts in such an evironment, and so widespread bankruptcy and financial reorganization would be necessary.    In other words, inflation targeting implies that a supply-side recession has an impact qualitatively similar to a demand side recession.

With nominal GPD targeting, the decreases in the supplies of various goods and services that require the emission of carbon would result in increases in their prices and so a transitionally higher inflation rate.   Real wages and real debts would be decreased.    With such a wrenching change in real production conditions, there would be substantial structural unemployment and business failures.  However, the collateral damage due to unnecessary bankruptcies and unrealistically high real wages would be greatly mitigated.

The implication of inflation targeting in the more realistic scenario where the regulations are implemented gradually so as to solely limit growth would have similar effects, but much less severe.   Spending growth must slow to prevent the slower growth in productivity/supplies from creating inflation and nominal and real wages must grow more slowly as well.   Stagnation in real wages is a real possibility given how slowly they grow anyway.  

When it is simply a matter of the prospect of more stringent regulations in the future, there is no immediate tendency for supply to be depressed other than the gradual impact of reduced investment on the capital stock and labor productivity.   If the market rate has failed to fall with the natural interest rate, inflation might well remain low.   Even so, nominal wages would need to grow more slowly in order for employment to be maintained.

Nominal GDP targeting would allow result in in modestly higher inflation when real output growth is slowed due to the gradual tightening of regulation.   Since nominal wage growth appears to have substantial momentum, the higher inflation will slow the growth of real wages and so tend to reduce any unnecessary reductions in employment.   The inflation will also modestly reduce real interest rates, and so help avoid the scenario where the market rate fails to decrease with the natural interest.

And if the threat of these regulations recedes into the distant future?    The need for  a lower real market interest rate and slower growth in nominal and real wages disappears.

The global warming boom--more investment, more productivity, more rapid growth in real and nominal wages, and more employment.   And a somewhat greater threat of harm from global warming.




Tuesday, December 20, 2016

Moving Jobs to Mexico

         President-elect Trump and other critics of NAFTA seem especially concerned about U.S. firms moving manufacturing operations from the U.S. to Mexico and then exporting their products to the U.S.    U.S. domestic production is decreased and U.S. imports are increased.

        The concern is especially described as a transfer of jobs from the U.S. to Mexico.   U.S. workers lose their jobs and Mexican workers obtain jobs.   One of the common economic fallacies in the notion that "jobs" are a limited resource and this appears to redistribute some of the scarce jobs from Americans to foreigners.

         Of course, it is labor that is scarce rather than "jobs."    Shifting production of some good from the U.S. to Mexico is only efficient if there is a comparative advantage in Mexico relative to the U.S.   That means that the opportunity cost in Mexico is lower than the opportunity cost in the U.S.

         Perhaps it is a matter of too much abstraction in my thinking, but the process by which Mexican production of some good partially or fully displaces U.S. production of that good would involve entry by Mexican entrepreneurs with lower production costs  who then drive the higher cost U.S. producers out of business.     Having the U.S. producers promptly shut down and open a new facility in Mexico would seem to be a more efficient means of accomplishing the same end.

       The logic of comparative advantage is that the expansion of Mexican production comes at the expense of other Mexican industries with relatively higher opportunity costs.   Labor and other resources are pulled away from the production of products where Mexico does not have the comparative advantage.  

      Further, the contraction of this U.S. industry frees up labor and other resources to produce products with relatively lower opportunity costs.   Resources are pushed into the industries where the U.S. has the comparative advantage.

       However, the "moving jobs" to Mexico scenario combines this with a shift of capital resources from the U.S. to Mexico.    Imagine the factory is loaded onto a giant truck and hauled across the border.   Capital would literally move from the U.S. to Mexico.

       The shift of capital resources away from the U.S. would typically reduce the demand for complementary factors in the U.S., in particular U.S. labor.   While this would tend to lower wages and labor income, the reduction in the supply of capital in the U.S. would tend to result in a higher rate of return on capital in the U.S.   When combined with the earnings on foreign investment, total income would rise.   The result would tend to be lower U.S. GDP but higher U.S. GNP.

       This process of factor income equalization is not tied to the trade flows that depend on comparative advantage.   Suppose there were no trade in goods and services between Mexico and the U.S.    They could still put the factory on a truck and shift it over the border and sell their product in Mexico.   The remaining U.S. producers would earn more profit and there would still be lower U.S. wages.

       The primary effect of combining the two processes--shifting U.S. capital to Mexico while importing products from Mexico is that U.S. consumers and workers benefit from lower import prices while seeing some increase in imputed labor demand from export industries.    GDP is decreased by the shift of capital resources but increased due to the reallocation of resources according to comparative advantage.  The effect on domestic production and labor income is ambiguous while the effect on capital income, when including the return on foreign investment, is positive.

       Now, in reality, the U.S. has a net capital inflow.   While the shift of factories from the U.S. to Mexico is a capital outflow, it is more than offset by other shifts of capital to the U.S.   We know this from observing the U.S. trade deficit which is matched by a net capital inflow.   Real interest rates in  the U.S. are at historically low levels, suggesting that U.S. labor incomes are not suffering due to a process of international factor price equalization.

       The process of factor price equalization--the transfer of capital resources from where the returns are low to where they are high--raises world output and income.   It raises income from capital on the whole.   But it does tend to reduce labor incomes in those areas that had what in hindsight was an over-abundance of capital.  

        However, the phenomenon of convergence, by which lower income countries grow rapidly and approach the level of per capita income of high income countries, is not primarily a matter of comparative advantage or capital flows.  The key is rather adopting better technology.  This should be understood broadly to include new products and production techniques, but also methods of organization and even policies and social norms.   This allows what were desperately poor people to produce more, earn more, and consume more.  For the most part, they demand the added products they supply.
       

Thursday, December 8, 2016

Trump and Carrier

Trump has made a variety of statements associated with the Carrier deal.  It might be a mistake to take what he says (tweets) too seriously.   Still, I find myself thinking about the effects of a policy of imposing tariffs specifically on firms that close a plant in the U.S. and relocate it outside the U.S.

The actual Carrier deal appeared little different from standard state-level economic development programs.   State governments have long offered special enticements to large firms considering opening a plant.   The different state governments see themselves in competition with other locations--other states and other countries.   When firms are considering a move away from a state, this same apparatus frequently kicks in.   What can state and local government do to convince  a major employer to stay?   For the most part, what is unusual with the Carrier deal is that normally the governor of a state and various local elected officials takes credit, but we now have a President grandstanding.   The other complication is that Carrier's parent company, United Technologies has federal defense contracts, and some think that Trump threatened future defense contracts.

No, it is not the enticements included in the actual deal that are interesting, but rather Trump's proposal for a special tariff on firms that move outside the U.S.   It is not at all clear that this was a threat that worried Carrier or United Technologies. 

But what would be the effect of such a policy?  I think the presumption should be that such a policy would have no effect.   Uneconomic plants located in the U.S. would still be closed.   New plants would still open in other countries for the purpose of exporting products to the U.S.  

A special tax on the products imported from firms that have "moved" from the U.S. would simply result in an end to talk about moving.    A firm opens a new plant in Mexico and then a year or two later, closes the U.S. plant.   Open the new plant during the expansion, and close the U.S. plant during the recession.   Of course, if the policy is nothing but window-dressing, then just  open one plant and close another.  Just don't say it is a move.

Sufficiently draconian controls could stop a particular firm from shifting operations across national borders.   If a firm closes a plant in the U.S., then tariffs are imposed upon any of its product from other countries that it seeks to export to the U.S.  

But in the extreme, the result could simply be that a new firm, or perhaps a subsidiary of a French or German firm, opens in Mexico producing a product such as air conditioners.   Profit and depreciation costs from the uneconomic U.S. plant are paid out to the Carrier stockholders, who purchase stock in the firm that operates in Mexico--whatever its name.   

It would seem that all the Trump approach can hold hostage is the brand name "Carrier."    And I suppose I shouldn't be surprised that Trump puts a lot of stock on brand names.   Since they do have value, it should have some impact of delaying the shift of operations from less economic domestic production to more economic foreign production.

Of course, a policy of imposing tariffs on imported air conditioners would have a greater impact than simply punishing U.S. firms that "move" production of air conditioners to Mexico.   And all of these policies have approximately no effect on the total employment in the U.S., but rather shift the pattern of employment in the U.S. in a way that reduces total U.S. and foreign income and output.