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Thursday, October 20, 2011

The Selling of Trade Agreements from NAFTA to Today

With last week's passage of three trade agreements (Colombia, Panama, and South Korea), and spurred by Suzy Khimm's article on the Korea trade deal, I was reminded of the storm of numbers proponents of NAFTA threw out there in the run-up to its approval.

Gary Hufbauer and Jeffrey Schott, described by the New York Times (2/22/93; no link but available on Lexis-Nexis) as "the two most influential academic experts on the North American Free Trade Agreement," wrote a book entitled NAFTA: An Assessment in 1992, with a second edition in 1993 (all references below are to this edition). They predicted that the U.S. would gain 170,000 jobs by 1995.

This work struck me as flawed for a number of reasons. In the first place, it was odd that two economists would write about the winners and losers from NAFTA without making any reference to the economic theory on the subject, such as the Stolper-Samuelson Theorem (see below). Second, the authors did computer simulations of the effect of the agreement that said in their long-run scenario (Table 2.1, p. 16) that we would gain low-skill jobs and lose high-skill jobs, pretty much the opposite of what you would expect based on economic theory. I questioned what assumptions would be necessary to get that result. Finally, the book assumed that the U.S. would have a merchandise trade surplus with Mexico, "$7 billion to $9 billion annually through the 1990s, and perhaps $9 billion to $12 billion annually in the following decade" (p. 15) They held this view even though the authors showed on on page 4 that the Mexican peso was overvalued. If the value of the peso were to fall, Mexican goods would become cheaper in the U.S., while American products would be more expensive in Mexico, completely upending the likelihood of a U.S. trade surplus. As we know, the peso fell sharply in the December 1994 "tequila crisis," and the U.S. has had a trade deficit with Mexico ever since. See the table for details.

U.S. Goods Trade Balance with Mexico ($billions)

Year                                  Amount

1985                                    -5.5
1986                                    -4.9
1987                                    -5.7
1988                                    -2.6
1989                                    -2.2
1990                                    -1.9
1991                                    +2.1
1992                                    +5.4
1993                                    +1.7
1994                                    +1.3
1995                                   -15.8
1996                                   -17.5
1997                                   -14.5
1998                                   -15.9
1999                                   -22.8
2000                                   -24.6
2001                                   -30.0
2002                                   -37.1
2003                                   -40.6
2004                                   -45.2
2005                                   -49.9
2006                                   -64.5
2007                                   -74.8
2008                                   -64.7
2009                                   -47.8
2010                                   -66.4
Jan-Aug 2011                     -44.8

Source: Census Bureau

So much for that prediction. According to the then-fashionable claim that $1 billion in net trade surpluses created 19,600 jobs, the fact that the trade deficit worsened from $1.9 billion in 1990 to $74.8 billion in 2007 ($72.9 billion deterioration) implies a loss of 1.4 million jobs at its worst point. This number should be taken with a grain of salt, but it is in one sense what we expect. Still, it's only about 1% of the labor force, though we could certainly use the jobs now. But the effect on labor may have been worse, because the expanded option for companies to relocate to Mexico made it possible for them to threaten their workers with job loss and thereby hold down their wages. Kate Bronfenbrenner of Cornell's Institute for Labor Relations found that shutdowns became much more frequent after NAFTA (15% vs. 5% in the late 1980s) during labor organizing and contract campaigns.

At the same time, a contradictory prediction also failed to hold up. Wolfgang Stolper and Paul Samuelson argued that the expansion of trade was good for a country's abundant factors of production (they are land, labor, and capital) because of added markets abroad, but bad for scarce factors of production because of competition from abroad. Here, "bad" means reduction in real (inflation-adjusted) income. The U.S., which is not densely populated by world standards, is thus labor scarce but abundant in land and capital. My expectation was that NAFTA would therefore lead to lower real income for labor. In fact, however, weekly earnings for nonsupervisory workers in the private sector, which fell from a peak of $341.83 (constant 1982-84 dollars) in 1972 to a low of $266.46 in 1992, have risen ever since, despite the NAFTA and WTO agreements, hitting $284.79 in 2000 and $297.31 in 2010, according to the Economic Report of the President 2011, Table B-47. Of course, we are still $44.52 1982-84 dollars below the peak, or about $95.25 per week in 2010 dollars.

While obviously we see plenty of economic misery today, I'm curious why the trend on this measure, which Bill Clinton brilliantly politicized with "It's the Economy, Stupid," has reversed course, and how it relates to other measures of labor income. Perhaps there is a better measure of wages out there, or perhaps inflation is currently underestimated (there was a huge campaign in the mid-1990s claiming it was overestimated; maybe the Bureau of Labor Statistics paid too much attention to critics), which would overstate real income. Let me know what you think in the comments.

As for the three new trade deals, they are being sold with squishy job projections, just like NAFTA was. While Khimm's interviewees are probably right that the deals' effect on labor will be small, I still think we should go with the Stolper-Samuelson expectation that the effect will be negative.

Sunday, October 16, 2011

Occupy Wall Street points in the right direction

The Occupy Wall Street movement has gotten plenty of press and I've sometimes wondered what I can add to the conversation. But I've decided that it is worth echoing that they are pointing in the right direction regarding how we got into the economic mess we're in. To hear many conservatives tell it, the 2008 financial crisis was caused by the Community Reinvestment Act (CRA), Fannie Mae, Freddie Mac, and ACORN. There is a huge analytical problem with this narrative, though: the financial crisis was a change in outcome, and these supposed wrongdoers had all been around for decades. If the cause doesn't change, it can't be the cause of a changed outcome. We have to look somewhere else for what changed.

The CRA was passed in 1977. Fannie Mae was founded in 1938. Freddie Mac was founded in 1970. The ACORN Housing Corporation, now known as Affordable Housing Centers of America, was founded in 1986. Their existence cannot be what caused a financial crisis 22 years after the last of them (and 70 years after the first of them) was founded. Something had to change.

What changed, of course, was bank regulation and securitization. Laws keeping banks from taking on excessive risk, like the Glass-Steagall Act, were targeted by financial firms and eventually repealed. During the housing boom, private loan originators chopped up mortgages into mortgage-backed securities (MBS), and these mortgages had much greater delinquency and default rates than the ones Fannie and Freddie issued. (F&F did buy some of these securities, but they were not the main player even in that role.) As David Min shows (h/t Paul Krugman), even the riskiest of F&F loans had "serious delinquency" rates in the 2nd quarter of 2010 of under 10.5%, whereas subprime mortgages had a serious delinquency rate over 28%. Private actors got the rules changed in their favor, and dramatically increased their risk-taking to earn huge personal incomes, and the taxpayer bailed them out when it all went bust.

This brings us back to Occupy Wall Street. In the group's "Declaration of the Occupation of New York City," we see that OWS identifies the problem as corporations running government and subverting democracy. As Robert Creamer points out, for OWS politicians are only the problem insofar as corporations (especially on Wall Street) control them. The repeal of bank regulation came about through a decades-long campaign based on political contributions and influence by Wall Street firms. This process is what the Occupy Wall Street manifesto highlights. Occupy Wall Street puts the spotlight on private sector power and greed and demands a change. OWS's manifesto also points out the efforts of corporations to take away employee rights and to use outsourcing to reduce pay and benefits. In a future post, I will discuss the decline of real income in much more detail. It has led to a greater need for two-income families, and then an increase in family debt, in order to maintain a standard of living that was possible on one middle-class income in the 1970s.

I'll close for now with some words from one of my favorite books, Charles Lindblom's Politics and Markets (1977). They could easily have been in the Occupy Wall Street manifesto: "The large corporation fits oddly into democratic theory and vision. Indeed, it does not fit."