Thursday, February 12, 2004

Politics of Trade, a quickie appetizer before the main course

Introduction

The NYT reports that Bush backs down on trade comments by Mankiw:

" Mr. Bush's emphasis on not losing jobs to foreign employers was, at least in part, an effort to spackle over the political damage done on Monday, when the chairman of the White House Council of Economic Advisers, N. Gregory Mankiw, commented on the practice of American companies' farming out production and services to low-wage countries like China and Mexico...

The reaction to those remarks was immediate and unfavorable — and has not gone away.
"

Dan Drezner covers the actual comments and the pro-trade side at more depth. Brad Delong has come out supporting Mankiw on this subject, though he notes that Mankiw could have been more politic when dealing with the press in an election year. Kicking up dust that the President needs to back down about in the middle of a defensive period of bad press on various topics. Or is it payback for being forced to be a toady for so long? Brad Delong has previously written about the gaping holes in the "The Economic Report of the President" that Mankiw has been forced to endorse at serious cost to his own credibility as a serious professor of Economics at Harvard. Indeed Mankiw has been forced under this noxious Administration to publicly repudiate the very principles (WARNING: paraody) that he's espoused in his economic writings (that was a serious reference).

It is testifying on this very same (flawed) report before Congress that Mankiw got piled on about his comments on trade and that Bush has had to back down about.

Dissection: So what's all the fuss?

Mankiw is a serious economist, and he deserves a hearing. In addition the remarks should be taken "in context". Therefore oldman thinks the best way to view the testimony of Mankiw since according to his own admission is that it "covers a wide range of issues, including recent business cycle developments, tax policy, the health system, regulation, and the role of the United States in the world economy." is to go over the testimony point by point and then summarizing. At each point the oldman will give his judgement of the point Mankiw was truthful, misleading, waffling, or lying. At the end the oldman will recap. Call it an autopsy of an economic release gone very very bad. Whether or not one thinks Mankiw should have been blasted for his trade positions, it's clear that this report has been an absolute stinker and credibility sinker all around.

1A: "The U.S. economy made notable progress in 2003, propelled forward by pro-growth policies that led to a marked strengthening of activity in the second half of the year and put the United States on a path for higher sustained output growth in the years to come."

1B: (LIE) As Nathan Newman has pointed out, the money supply is falling. The money supply had been growing earlier. As you can see here, as of Dec 31'03 the money supply has been steadily falling for several months. If you want to you can dig through the Fed's own current numbers.

Well the point is that when money supply contracts then "Economic activity declines and either disinflation (reduced inflation) or deflation (falling prices) results." According to the Fed's own numbers, the economy is stalling out. Since money supply is a leading indicator, we can still have positive GDP numbers but the rug has actually been pulled out of the economy. Mankiw is a good economist, he should know this. That's why the oldman charaterizes this as a lie or deception.

2A: "The recovery was still tenuous coming into 2003, as continued fallout from powerful contractionary forces.the capital overhang, corporate scandals, and uncertainty about future economic and geopolitical conditions.was offset by stimulus from expansionary monetary policy and the Administration.s 2001 tax cut and 2002 fiscal package.

2B: (TRUE) The stimulus did increase economic activity.

3A: "The contractionary forces dissipated over the course of 2003..."

3B: (MISLEADING) As pointed out earlier, the money supply is contracting, but it did begin climbing back up before that indicating some economic expansion. The contractionary forces are back however.

4A: "The economy appears to have moved into a full-fledged recovery, with real gross domestic product (GDP) expanding 4.3 percent over the four quarters of 2003, significantly above the average growth rate since 1960 of 3.3 percent."

4B: (MOSTLY TRUE) His GDP numbers are right, and he should get credit for not trumpeting the higher initial numbers. However as pointed out, whether or not this recovery is sustainable is not clear and has some strong counter evidence at this point.

5A: "The Administration.s pro-growth tax policy, in concert with the dynamism of the U.S. free-market economy, has laid the groundwork for sustainable rapid growth in the years ahead."

5B: (WISHFUL THINKING) There has been no structural change whatsover in the overall economy. There's no basis for assuming that we're going to enter a period of "sustainable rapid growth". What the numbers look like indicate a weak or uneven recovery on various indicators including weak retail and jobless numbers as reported by the Financial Times.

6A: "The tax cuts must be made permanent to have their full beneficial impact on the economy. A stronger economy will also result from progress on the other aspects of the Administration.s economic agenda, including making health care more affordable; reducing the burden of lawsuits on the economy; ensuring an affordable and reliable energy supply; streamlining regulations; and opening markets to international trade.

6B: (LIE) As Dan Drezner has pointed out, the medicare entitlement program is going to be a disaster. The CATO Institute by no means a liberal hotbed documents why Federal Spending is up and why Republicans are to blame. The other stuff is just fluff or shaving pennies compared to this nightmare. However this paragraph let's us jump to the contentios TRADE ISSUES. However first let's give grades for Mankiw's testimony on the intervening parts - but only after we grade Mankiw on his testimony:

OVERALL GRADE SO FAR: Mankiw get's an "E". Sorry, he did try but there were just too many overtly wrong things in his testimony. Even though there were some correct statements he completely misled the audience by lacing them with incorrect and fallacious statements. As the old saying goes, the best lie is mostly truth because then it holds together better.

Mankiw's testimony on Macroeconomic Policy
Oldman's grade: C-. Mankiw uses decent numbers, but the rest is just hand waving. He accurately reports historical trends, but then extrapolates into thin air using the assumptions that Bush's economic plans are actually going to work. For the record, most politician's economic plans don't work. Anyone remember Clinton's health plan? Clinton actually ended up spending not that much, enforced by a disciplined Republican Congress. His proposed spending was quite a bit higher. Assuming that Bush's plans are both going to be implemented and work would be doubtful from a simple historical perspective of various Presidential Administrations. Assuming that they would yeild the uncharacteristic growth yeilds that Mankiw projects are ludricous.

Mankiw's testimony on FISCAL POLICY
Oldman's Grade: B+. What??? Didn't the oldman just get done raking Mankiw over the coals over how Brad Delong shot holes in his number projections? Yep. This was Mankiw's best moment in the testimony. Read for yourself:

"An important implication of the economic analysis of incidence is that, in the long run, a large part of the burden of capital taxes is likely to be shifted to workers through a reduction in wages. Analyses that fail to recognize this shift can be misleading, suggesting that lower income groups bear an unrealistically small share of the burden of such taxes and an unrealistically small share of the gain when capital income taxes are lowered."

Yeah, that's right, Mankiw just came out for capital gains tax cuts (like the dividend tax cut passed last year) that are the cherished first-born sons of the voodoo economists who misuse supply-side theory to justify madness as the oldman as written about. However the problem is that as the oldman has pointed, tax cuts without spending cuts are madness. Supply side theory may suggest that cutting taxes will increase investment, but no one thinks tax cuts and increased government borrowing will stimulate the economy (except loonies of course)!!!

The rest of Mankiw's testimony on this topic should be read carefully. It's kind of cloaked in obscure language. But overall it's a good thing if companies make more money, otherwise how could they pay their workers more? Profits so long as there is profit sharing is a good thing.

Mankiw's testimony on Regulation
Oldman's grade: B. Mankiw has a nice testimony here about regulations and the free market that mostly centers on energy and the environment. It's good in theory. The oldman disagrees with nothing except that there should be more research money put into the development of alternative fuel and higher fuel efficiency standards. The oldman does not believe in attempting to mandate technologies before they are market ready. However, that's no excuse to not bust hump trying to get them to market. Government must help lead the way there. The main shortfall is that the Bush43 Administration record on the environment is terrible. Mankiw's testimony is academically and theoretically true, but disjointed from the "ground truth" of the direction the Bush Administration is actually driving environmental policy.

Mankiw's testimony on Health Care
Oldman's grade: D-. Oh, yeah it was that bad... listen here to Mankiw himself:
"A strong reliance on market mechanisms will ensure that incentives for innovation are maintained while providing high-quality care in the most cost-efficient manner... Health insurance plays a central role in the workings of the U.S. health care market... Over-reliance on health insurance as a payment mechanism leads to an inefficient use of resources in providing and utilizing health care."

That's right. Mankiw thinks that Americans have too much health insurance that pays out "unnecessary expenditures". I wonder if Mankiw has ever had to live without health care? Raised a family without health care? If you look at the Census Bureau historical insurance coverage table you can easily see that private insurance coverage is dropping in percentage (%) terms and Medicare, Medicaid, and Uninsured categories have been rising since just the year 1987.

Total insurance coverage from 1987 to 2002 dropped by 2.3%, and the uninsured rose 2.3%. Hmmm ... wonder if there is any connection between those two numbers ... 2.3% may not sound like allot but in a population of some 280 million people, that means nearly 6.5 million more people have become uninsured. That's not counting those having to go to direct pay plans (pay for their own insurance out of pocket), and that's not counting the separate 3.2% or nine million more people that went on Medicaid that "that pays for medical assistance for certain individuals and families with low incomes and resources". That's just the increases since 1987 mind you and not the actual total number of insured or Medicaid recipients, the actual total number of uninsured and medicaid assisted persons in this country is 26.8% or over 1 in 4 out of the population, or about 75 million Americans. This is not a problem, this is a structural crisis that the market has not solved!!!

Mankiw also has blather / filler on Tort reform but the main part of the section is how he completely drops the ball on health care!!!

FINALLY: Mankiw on TRADE
Oldman's grade: (E) Mankiw starts out strong but quickly degenerates into what are arguably intentional attempts to dupe his lay audience!

Quote1: "Chapter 12, International Trade and Cooperation, discusses how growing trade helps to spur U.S. and global growth..."

Reaction1: (TRUE) The first paragraph is entirely correct.

Quote2: "New types of trade deliver new benefits to consumers and firms in open economies. Growing international demand for goods such as movies, pharmaceuticals, and recordings offers new opportunities for U.S. exporters. A burgeoning trade in services provides an important outlet for U.S. expertise in sectors such as banking, engineering, and higher education. The ability to buy less expensive goods and services from new producers has made household budgets go further, while the ability of firms to distribute their production around the world has cut costs and thus prices to consumers. The benefits from new forms of trade, such as in services, are no different from the benefits from traditional trade in goods... The gains from trade that take place over the Internet or telephone lines are no different than the gains from trade in physical goods transported by ship or plane."

Reaction2: (TRUE) Here Mankiw is talking about the classical side of trade. No one doubts the ability of foreign imports to bring down costs of consumer goods. In addition, the US has benefited from the ability to export goods and services (source: Dan Drezner). As long as the balance between imports and exports in goods and services are about balanced out, the economy benefits.

Quote3: "Outsourcing of professional services is a prominent example of a new type of trade. The gains from trade that take place over the Internet or telephone lines are no different than the gains from trade in physical goods transported by ship or plane."

Reaction3: (MISLEADING) Unfortunately, here Mankiw conflates outsourcing and "offshoring" with traditional trade. The oldman has argued that "offshoring" is NOT equivalent to a classical form of trade, since there are serious reasons to believe it is not equivalent to traditional trading mercantilism and that what it actually represents is that Americans are being unfairly outcompeted with both short and long term consequences both in terms of overall American prosperity declines and is driving a income inequality created by a lack of structural education reform.

If you notice what Mankiw has done, he's done something very clever. He's made a classical "trade is good" (even if it includes services) argument and then overlapped it with another argument - "offshoring is good" argument - because it's just like buying another good or service in the course of regular trade. Only he isn't answering the export side of the question "Okay, what are they buying back in return for this offshoring we're sending them?" Because if he had to answer that question, he'd have to answer the question of why new jobs aren't being created so that displaced workers can move into new professions.

Because then he'd have to answer questions about why the export side of the structural growth equation is stagnant. If we were losing jobs in some aspects to overseas competition or "offshoring" which is a form of importing, but we were also gaining jobs on the other side of the economy with increased goods and services exports then people wouldn't be complaining as much. Yes, some people would be losing jobs but others would be gaining them and somewhere in the middle there would be unfilled jobs for the people who lost jobs to move into. In addition he'd have to answer questions about the kind of jobs being created. With the competition / education crunch structurally choking off true growth that would provide competition for capital to stay here instead of move overseas, even last month's unemployment report showed that most of the 112,000 jobs created were in the retail services - holiday job sales positions versus a net absolute loss of manufacturing jobs.

Quote4: "When a good or service is produced at lower cost in another country, it makes sense to import it rather than to produce it domestically. This allows the United States to devote its resources to more productive purposes."

Reaction4: (MISLEADING) The problem here is that there is a big difference between absolute advantage and comparative advantage. When Mankiw is talking about "When a good or service is produced at lower cost in another country, it makes sense to import it rather than to produce it domestically." what he is talking about is Absolute Advantage.

Absolute Advantage occurs when "A country has an absolute advantage over it trading partners if it is able to produce more of a good or service with the same amount of resources or the same amount of a good or service with fewer resources." (e.g. more cheaply). There are many ways to establish absolute advantage. One is to have a natural abundance of a commidity resource. Another way is to artificially manipulate the exchange rate. Another is to develop technological superiority

Comparative Advantage on the other hand is a "win-win" situation. It is important to distinguish whether trading is being done on the basis of absolute advantage or comparative advantage because ONLY comparative advantage necessarily results in "win-win" trade specialization. Comparative Advantage does not depend on who can make the product or service cheaper. That is absolute advantage. Instead, Comparative Advantage depends on opportunity cost. There are many components to opportunity cost, which is why it's more confusing than the lowest cost which refers to absolute advantage. Labor, innovation, productivity, and capital costs are all involved. The simplest way to measure opportunity cost is to use the proxy of return on investment. Simply put, if you could get more $ profit from investing the same amount of money (capital) in venture A than venture B, then the ROI for A is greater than B. The opportunity cost is the cost of choosing A versus B or vice versa. So the lower the ROI the higher the opportunity cost - you could have made a bigger buck elsewhere, etc.

So when Mankiw is talking about how "This allows the United States to devote its resources to more productive purposes." he's really talking about Comparative Advantage and opportunity cost.

So again, he's done something very clever. He's taken two sentences, each which refers to two seprate ideas and put them one after another. Being an economics professor at Harvard I'd have to assume that Mankiw knew exactly how easy it is for most people to confuse the two topics. The average person (including most Congressmen and their aides) would say "But if you have the lowest cost production, don't you also have the comparative advantage?" NO!!!. Comparative advantage has to do with how much more you could have made with the same money elsewhere, not cutting costs here.

It means you should do what you are best at compared to what else you can do. This means if you make shoes best, it means you should do that even if you make shoes more expensively than someone else. Yeah. So going to the low cost supplier can actually mean giving up comparative advantage, and the theoretical benefits of trade. This is doubly true if the "low cost producer" is the low cost producer by artificial means such as lower social structure investment, currency manipulation, subsidies, product dumping at below cost, etc. that prevent equilibrium or parity being reached.

Mankiw is a sharp guy. He must not only know this distinction, he must know how endlessly this idea is confusing to the ordinary person.

Why is it important that he confused the two ideas? Well it is well known that large companies have always been able to use absolute advantage to create barriers to competition. If Mankiw admitted that Absolute Advantage was the basis of our trade treaties, then he would be admitting as much that other countries are running our companies and workers out of business. In fact, that is what is happening. Uneven liberalization means that other countries can compete for selling goods, services, and products in our economy without opening out their economy to our exports. They do this in many ways, consider that India is one of the world's most protected economies even as they compete for our markets.

Mankiw is too smart not to know the difference. Conflating the two kinds of advantages effectively means cloaking the unfair marketshare competition of other countries in our markets, without having to argue why reciprocal production in exports from us are necessarily flowing back to them to balance the equation. Given that Mankiw has just been shown to pull two such "fast ones" in a row makes it increasingly unlikely that he did so innocently. He must have known as a teacher of economics how his comments would be misinterpreted by the layman.

So the fact is that while Mankiw has been piled upon for defending job exports overseas by journalists and Democrats who cannot dissect his argument, he probably deserves it. While Brad Delong and Dan Drezner have defended Mankiw's defense of free trade, they have missed inside the body of his comments the rhetorical tricks he's pulled in order to justify using the known and approved the unknown and the egregious.

Quote5: "A series of financial crises in emerging market economies, however, has raised some concerns that financial liberalization can also involve risks... One approach to limiting the risks from capital flows when legal and financial institutions are poorly developed is to restrict foreign capital inflows. Experience suggests, however, that capital controls impose substantial, and often unexpected, costs. Instead, countries are more likely to benefit from free capital flows and minimize any related risks, if they adopt prudent ... policies..."

Reaction5: (MISLEADING) It's pretty bad how Mankiw glosses over the actual historical failure of the very policies he's suggested, such as the only countries that escaped the recent market meltdowns have been the ones that have rejected the very lifting of capital controls that Mankiw is advocating. This isn't a matter of opinion, but of factual and recent economic history. Malaysia's actions showed that the very capital controls that Mankiw was railing against are the only means of stabilizing economies in certain circumstances.

Quote6: "The Administration has promoted policies to help countries reap the benefits from the free flow of international capital... trade flows and capital flows are inherently intertwined."

Reaction6: (LIE) The administration is openly tolerating a huge China problem in trade and capital flows completely contradicting the very advice on how to fix the problems that Mankiw suggests just above! Mankiw in the previous sentence suggests that "countries are more likely to benefit from free capital flows and minimize any related risks, if they adopt prudent fiscal and monetary policies, strengthen financial and corporate institutions, and develop sound regulations and supervisory agencies."

However, as the BBC reports as of late 2003 "Observers need only look at the chaos caused by the Asian economic meltdown of 1997-8 as an example of how a weak banking system, floating currencies and loose capital controls can trigger crisis, said S&P.

"China's banking system is insolvent, with problem loans estimated by S&P at 45% of total loans, and its risk control systems are ill-prepared to deal with a rapid liberalisation,""

So clearly the Administration can hardly be promoting policies that help countries reap the benefits from capital when one of our largest trading partners' practices - China - are being tolerated even though they completely violate the very advice Mankiw is giving on capital controls. I'm not sure how much more of an outright contradiction you can have!

CONCLUSION

Why would Mankiw justify bad trade deals? Why would Mankiw say any of this nonsense? Well as has been pointed out in the previous parts of the testimony Mankiw has been willing to adopt completely unrealistic projections of economic activity or to retreat to academicly unrealistic models of what is actually happening in order to justify support for the President's economic plans. He is willing to do this even though mainstream economists absolutely cringe at his growth projections and will refuse to defend the fiscal policy he is advocating on behalf of the President. This is why the oldman went through the trouble of analyzing the whole testimony.

Overall it consistently shows a pattern of intentionally misleading, outright unrealistic, or perhaps even openly unsustainable lies all told in the defense and advocacy of President GW Bush's plans. Why should the subject of trade be any different? The journalists weren't sophisticated enough to pick up on it, and nor where the Democratic legislators or their aides. Mainstream specialists probably didn't bother to read and analyze line by line what they felt would just be fodder for the Administration's unrealistic plans.

Yes, Mankiw got jumped on because of his trade comments. Yes, he got jumped on for the wrong reason. Protectionist barriers are not the solution. Directly "stopping" job loss is not the solution. The solution is increased education that promotes competitiveness of the American labor force, equally liberalized trade deals that don't make America a one-legged man in an ass-kicking contest, and increasing R&D for export industries so that we can have something to trade back to the other guys. It's not about how many jobs we keep from being lost, it's about how many jobs we create because we can figure out new and nifty products and services in order to offer back in return. It's not about being against trade, it's about being for truly free trade instead of the imposter that masquerades for it and tries to use economic theory to defend misapplied government policies!!!

So he got pilloried for free trade, and got defended by mainstream economists in that regard. But frankly Mankiw deserved a verbal beating anyway for all the misleading or outright lying crap he put into his testimony to mislead his audience. Most of his testimony was riddled with bullshit that had nothing to do with the real world or played semantic games that hid the real destruction going on in this economy because of bad trade treaties and shitty economic policies. It doesn't matter whether you're on the right or the left, for trade or for jobs, any way you slice it when you look at this testimony carefully it was completely appalling and represents Mankiw completely selling out his integrity. Yes he got a cheap shot in the arm from other economists for "defending" free trade, but what he was actually defending had nothing to do with free trade and had everything to do with covering for a President who can't do the economic math. The numbers just don't add up and neither do the verbal sleights of hand.

Oldman's Final Grade for Mankiw's Testimony: Mankiw get's an "F" for failing - that's failing to tell the American people the truth through testifying to their representatives in Congress.

The whole thing reads like one giant cry for help!

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