Originally published on September 30, 2011
As economic troubles around the world continue to mount there is increasing pressure uponpoliticians to do something forceful to revive their economies while deflectingcriticism from themselves. One traditional method has always been to blame foreigners for one’sdomestic troubles. In the 1980sthe US blamed Japan and worried that its economic strength would soon lead to adiminished US presence. Today thesame process is playing out only this time China is the presumed enemy.
This week Senator Schumerfrom NY introduced another bill that would brand China as a currencymanipulator and allow the US to take more forceful action against theirpresumed unfair trading policies. This action follows on a report issuedearlier this month by the EconomicPolicy Institute indicating that the US trade deficit with China has cost theUS 2.8 million jobs. Theirline of reasoning is immensely popular and goes as follows: because China fixes its currency at avalue deemed too low by US observers, Chinese goods are kept artificiallycheap, inspiring larger US imports of Chinese goods. The relatively high $ value makes US goods more expensive tothe Chinese thereby discouraging US exports. Thus, if only China would allow its currency to rise invalue, then Chinese imports would fall, US exports would rise, trade will bebalanced and US jobs will be created. It is a convincing story … except for the fact that is not entirelycorrect … the errors lie in the parts of thestory that are missing, the untold story that make the causes and effects quitea bit more complicated.
Let’s firstlook at the 2.8 million jobs supposedly lost due to the trade deficit. Now to be fair, if you read the reportcorrectly, EPI doesn’t actually say that jobs are lost, only that the jobs are“lost or displaced.” Displacementis a more accurate term because the jobs are less likely to have been lost dueto the trade deficit than they are to have been moved to the non-tradablesectors in the economy. In otherwords the trade deficit doesn’t cause a loss of jobs as much as it causes adisplacement to other sectors of the economy.
To see whylet me illustrate the fallacy of trade deficit induced job losses. Between August 2010 and July 2011 theUS imported $288 billion more from China than it exported. If trade had been balanced instead,then either there would be $288 billion more in exports (thereby creatingmillions of jobs) or $288 billion less in imports (creating millions of jobs inimport-competing US industries), or some combination of the two. Seemingly the deficit resulted in moremoney flowing out of the country to buy the extra imports, than flowed back into buy our exports. That lostmoney and the corresponding lost jobs is what EPI is counting in itsestimate. The fallacy is that themoney is not lost and it does not stay in China. What China has done with that extra money is purchase assetsin the US. In other words, theyhave lent the money back to us and are allowing us to use it instead. More technically, any trade deficit(current account deficit really) is offset by a financial account surplus ofequal value, implying that our balance of payments with China is always inbalance … there is rarely any money lost.
Most of themoney that China has lent back to the US has been loans to our federalgovernment. During the past decadeChina has purchased around $1.1 trillion dollars of US treasury securities. This is money the US governmentborrowed to finance its deficit spending. In other words, that $1.1 trillion of money was spent by the USgovernment, inducing demand for US products and creating jobs for USworkers.
So how manyjobs were created by that $1.1 trillion of spending? Well, for that we could use EPI’s own estimates of the jobcreating effects of fiscal stimulus. Across a variety of articles (See hereor here),EPI’s estimates range anywhere from 5,000 to 10,000 jobs created for every $1billion of additional government expenditures. Because $1.1 trillion of those expenditures were made possibleby Chinese loans during the past decade, EPI should conclude that the Chinesetrade deficit “created or displaced” 5.5 – 11 million jobs during the pastdecade because of the added fiscal stimulus made possible by their loans to us.
Thus, usingEPI’s methods, but evaluating the FULL effects of the trade deficit with China,could actually lead one to the conclusion that there was a net increase in thetotal number of jobs. (I’m notsaying this happened, I’m just applying their method in a more completefashion.) It is worth mentioningat this point that if you look at a graph of the US trade deficit with respectto the world, and compare it to the US unemployment rate during the past 30years avery curious thing is seen: whenever the US trade deficit is rising, US unemployment is falling andwhenever the trade deficit is falling US unemployment is rising. This is exactly the opposite of whatyou would expect if trade deficits really did cause job losses!
So EPI’sreport is propagating a fallacy. It is suggesting that the trade deficit with China is costing the USmillions of jobs. It is inspiringpoliticians to stoke up populist support against external entities, surely as away to divert attention from their own mismanagement at home. This is a common political ployused by politicians many times before. When economic times get rough at home, better to stoke up anger againstan external threat, instead of turning attention inward. This political inclination has led todamaging trade wars in the past and even more damaging shooting warssometimes.
The Chineseeconomy is currently in a precarious position. Although the impression in the West is that their economy isbooming at the expense of ours, in reality the Chinese government may have runout of tools to keep things bubbling along. China is facing rising goods inflation and risingwages. They have a propertybubble that looks ready to burst. They face another round of slow demand for their exports and risinganxiety at home. Put that togetherwith a rickety financial sector, a legal system that is years behind the West,and a government that often corrupt and determined to remain in power, and youhave an economy and a society that is just trying to keep things together… not one ready to take over asleader of the world.
Even ifChina responded to US demands right now and gave up defending their currencyvalue, the result might not be what the US hopes for. Suppose for a moment that the Chinese suddenly allowed theyuan to float freely. No morecurrency manipulation! Because ofthe new uncertainties in the Chinese economy though and the prospects ofproperty price declines, many wealthy Chinese might take that as an opportunityto move money to the US and other countries. In other words, in the present environment, the effect mightbe capital flight form China. Ifthat were to occur the yuan would fall even further in value making Chinesegoods even cheaper. Strangerthings have happened in international currency markets.
My point thenis that our ability to adjust simple levers, like the exchange rate value, (orforce other countries to do so) and generate improved outcomes such as jobcreation at home is extremely limited. The world economy is too complex to expect that a simple adjustment inthe dollar-yuan exchange rate will suddenly create millions of US jobs. Our politicians would do better to getour own house in order instead of trying to pin the blame for our troubles onother countries. The blame game isa diversionary tactic and US citizens would be smart not to buy into it.
