Sunday, December 4, 2016

Why a Protectionist Shock Would Do More to Harm Than to Help the Job Market

Dramatic promises to restrict international trade were a signature element of Donald Trump’s presidential campaign. So far, he seems to be following through, with an early reaffirmation of his intent to withdraw US participation in the Trans-Pacific Partnership (TPP).

An aggressive stance on trade played a key role in gaining the support of working class voters in Midwestern manufacturing states, where upset wins swept him into the White House.  What is more, trade is one area in which Trump, as President, will have the power to act on his own without action by Congress. As Gary Clyde Hufbauer of the Peterson Institute has explained, both the US Constitution and past acts of Congress give the President ample authority to do things like withdraw from the TPP or NAFTA, label China a currency manipulator, or impose retaliatory tariffs on any country he sees as a threat to US economic security.

But how would American workers actually fare under a protectionist regime, especially older workers, and those with few skills and little education, who voted for Trump by wide margins? Not well. Here is why a protectionist shock could do more to harm than to help the US job market.

Calling out China as a currency manipulator won’t help

Trump has repeatedly blamed US trade deficits and job losses on currency manipulation, especially by China, which he charges with weakening the yuan to keep its exports artificially cheap. In fact, calling out China as a currency manipulator will not bring back jobs for the simple reason that the charge is obsolete. Far from holding down the value of its currency, China has, for more than two years now, been fighting to keep the yuan strong. Mexico, another of Trump’s favorite targets for retaliation, has been doing much the same, although the details of its policy differ.

When Chinese authorities want to weaken the yuan (or renminbi), they do so by asking the People’s Bank of China to buy dollars to add to foreign exchange reserves. The Chinese did that consistently until early 2014, but since then, as the following chart shows, China has been selling reserves at a frantic pace in an attempt to keep the yuan strong. Despite those efforts, fears of a trade war have pushed the yuan sharply lower since election day.

Mexican policy works a little differently. Instead of directly manipulating exchange rates by buying and selling reserves, the Mexican central bank, like the US Federal Reserve, focuses its monetary policy on interest rates. Interest rates, in turn, affect exchange rates indirectly, since raising rates encourages capital to flow toward Mexico and boosts the value of the peso. Twice this year, once before and once after the election, the Bank of Mexico has raised its rates, but as in the case of China, its efforts have not been fully successful. The peso has fallen to record lows anyway.

There is a deep irony here. Contrary to Trump’s claim that our trading partners manipulate their currencies to undercut American workers, China and Mexico have been fighting to keep their currencies strong. Yet Trump’s protectionist bluster has spooked the markets so badly that the yuan and the peso have depreciated anyway. On the currency front, the more Trump rants, the harder he makes it for his American working class supporters to hang onto their jobs.

The jobs that come back won’t be the right ones

If Trump, were to impose tariffs of 35 percent, 45 percent, or more on Mexican and Chinese goods, as he has threatened, there is no doubt that some manufacturing operations would return to the United States. However, that is not the same as saying that manufacturing jobs would return.

The problem is that while international trade has contributed to a decline in manufacturing jobs in the United States, it has not been the only or the largest contributor. Total manufacturing employment in the US peaked in the 1970s, when China was still suffering under the Cultural Revolution and long before NAFTA was even conceived. However, the share of manufacturing in GDP has barely changed over the last half century. Most of the decline in manufacturing employment is due to increased labor productivity, not a decline in manufacturing output.

Those trends are not unique to the United States. As Harvard economist Dani Rodrik has shown, manufacturing employment, as a share of all jobs, reached its peak in Mexico in 1980, in Brazil in 1986, in Korea in 1989, and in India in 2002. Reliable data are harder to come by for China, but the most recent available numbers suggest that manufacturing jobs in that country are approaching their peak now, or perhaps even a year or two past it. To put it simply, it is not so much that workers at Ford are losing jobs to workers in China and Mexico as it is that workers in all of these countries are losing their jobs to robots.

What is more, automation is not affecting all manufacturing jobs equally. Rodrik shows that low skill manufacturing jobs have been most strongly affected, not just in the US but everywhere you look. The next chart, based on data from a broad sample of forty countries, shows that in just 13 years, from 1996 to 2009, low-skill manufacturing jobs as a percentage of all low-skill jobs in these economies fell by 4 percent. Meanwhile, even though total manufacturing employment was falling, high-skill manufacturing jobs actually increased as a share of all high-skill jobs.

By implication, even if harshly protectionist policies brought manufacturing operations back to the United States, our newly Made-in-America T-shirts and Christmas ornaments would be fabricated and packaged largely by machines. The technicians who installed and operated those machines would have lots of new jobs, but the low-skill workers who voted en masse for Trump would remain at the cash registers in the Big Box stores where the products were sold—if they had jobs at all.

Falling labor mobility makes the US economy more vulnerable to shocks

Economists have long acknowledged that free trade produces losers as well as winners. To be sure, the Pollyannas among them have assured us that the losses from trade shocks are transitory. Trade-displaced workers, they have said, get back on their feet as they move to new jobs in export industries. Meanwhile, as cheap goods flood the stores, those workers, like everyone else, enjoy a lower cost of living.

Recent research suggests, however, that the picture is not quite so bright. Globalization has brought many benefits, to be sure, but the losses have been more persistent and more concentrated than the optimists expected. In a widely cited study, David Autor, David Dorn, and Gordon Hanson examine what the authors call “the China shock,” and reach a number of pessimistic conclusions:
Most importantly, they find that the impact of trade shocks is far from temporary. Job losses and lower wages in hard-hit regions persist for years. Furthermore, because the effects are geographically concentrated, labor mobility is not sufficient to ensure that losses by workers are widely shared across regions and industries. Nor is it true, as some optimists have promised, that workers displaced by trade shocks quickly find comparable jobs in export industries.
Moreover, Autor and his colleagues find that trade shocks disproportionately affect low-wage workers within affected regions and industries. Those who do find work often end up in services or other sectors where jobs do not fit their skills and wages are lower. Others turn to government assistance, including unemployment benefits, disability benefits and food stamps.

To make things even worse, evidence from other studies suggests that it has become harder over time for the U.S. labor market to adjust to trade shocks. One major reason is decreased labor mobility. Falling rates of interstate migration, as shown in the next chart, are just one indicator. Several factors have contributed to decreased labor mobility.

Disincentives in the social safety net are one source of reduced mobility. As mentioned above, Autor's work shows that displaced workers seek temporary relief from hardship by taking advantage of food stamps, unemployment benefits, and other programs. Benefits paid under these programs are reduced or eliminated when the displaced worker finds a new job. As Those benefit reductions, which (according to the Congressional Budget Office) can claw back take 30, 50, or even 80 cents of each dollar of added income. (For a fuller discussion of this issue, see this earlier post).

Less-than-fully-portable healthcare can also make it hard for displaced workers to move to where the jobs are, especially if their coverage comes through the employer of another family member. The Affordable Care Act has made some improvements, but, since much healthcare coverage is still employer-based, and because options vary widely from state to state, it has not full solved the problem of portability.

The spread of occupational licensing to a third of all jobs today, up from 5 percent in the 1950s, is another factor that undermines mobility. The fact that licenses are not automatically transferable from state to state creates an obvious problem for any trade-displaced worker in a licensed profession. Even a displaced worker in a nonlicensed profession may find it hard to move to a new job if the family depends on income from a spouse who is a state-licensed math teacher, manicurist, or pest control worker.

The steady increase in the number of Americans with criminal records has further reduced labor mobility. Most of the 70 million Americans with criminal records do eventually find jobs, but if they are displaced from that job by trade, it can be much harder to find new work.

Protectionism would be the biggest shock of all

The decreasing flexibility of the labor market matters because a sudden turn toward protectionism would itself impose a tremendous shock. Today, after years of painful adjustment to globalization, wrenching moves, and costly retraining, most workers displaced by the China shock, the NAFTA shock, and other trade shocks have found new jobs and new homes. Imposition of new tariff barriers and withdrawal from trade agreements would make it necessary to go through all of that again, in reverse.

Millions of American workers in export industries would lose their jobs as trading partners retaliated, or as those countries simply became too poor to buy Boeing aircraft for their airlines or US-made MRI machines for their hospitals. Millions of other Americans who work in finance and transportation services that support trade would also find their jobs threatened, as would those who work in sales, marketing, and retailing of goods the US now imports.

In fact, it is an oversimplification to say we would have to go through the original trade shocks “in reverse.” In reality, those shocks are not reversible. Workers displaced from jobs they once held in manufacturing would not just be able to move back to jobs in reopened factories in their original home towns. Even if those factories are still standing, they will never reopen. Instead, making America self-sufficient in manufactured goods would mean building a whole new generation of modern, automated factories, in new locations, offering fewer jobs and requiring different skills than in the past.

The bottom line

In short, the dream that protectionism could make America great again in the way many Trump supporters imagine is an illusion. Yes, at considerable cost, a sharp turn away from trade might make America more self-sufficient, but that process, like globalization itself, would create losers as well as winners. The lower-skilled, less-educated, and older workers who voted most heavily for Trump would almost certainly be among the losers.

Fortunately, trade protection apart, there are other elements of the Trump program that could potentially improve the ability of the economy to adjust to future shocks, whether they came from trade, technology, or elsewhere.

One example would be to replace the well-intentioned but overly complex Affordable Care Act with something simpler and more portable. Trump has said he would do that. He has also promised to reduce the burden of government regulations. A good place to start would be to put some federal leadership, perhaps linked to financial incentives, behind sporadic state-level efforts to eliminate unnecessary occupational licensing and harmonize requirements across states where licensing remained.

Further, Trump has said he favors leaving marijuana legalization up to the states. If that means ending criminalization of marijuana at the federal level, it would be a first step toward reducing the number of Americans with criminal records and increasing the number with jobs.

Reforming the corporate tax system would also help. Trump’s tax plan includes a promise to reduce the top rate to no more than 15 percent while closing loopholes. Both Democrats and orthodox Republicans have proposed similar reforms in the past, so a skilled negotiator should find it easy to make a deal across partisan lines. Corporate tax reform could slow or even reverse corporate flight that Trump has so often spoken out against.

In short, despite the criticism here of Trump’s incendiary rhetoric on tariffs and trade pacts, his program includes many sound policy proposals as well. Let’s hope that as President, he will prioritize the promises that are the most constructive rather than those that are the most counterproductive.

Earlier versions of this post previously appeared in the Huffington Post and
You may also want to view or download a related slideshow, "Free Trade Under Fire."

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