Trade Policy at a Crossroads

rodeny_ludema_5x7_200_1November 16, 2016 by Rodney D. Ludema

Two events occurred last week that mark what could be an historic shift in U.S. trade policy.  First, voters elected Donald Trump, outwardly one of the most protectionist Presidential candidates in a century. Shortly thereafter, Republican congressional leaders decided to abandon a lame-duck vote on the Trans-Pacific Partnership (TPP), thus mothballing President Obama’s signature trade deal for the foreseeable future.

Since the 1930s, U.S. Presidents have consistently looked to international trade agreements to strengthen the economy and improve international relations.  Congress has occasionally pushed back against such agreements, but in recent decades such push-back has rarely come from Republicans. Thus, if Mr. Trump is serious about his threats to unilaterally impose a tariffs on China and Mexico, renegotiate the North American Free Trade Agreement (NAFTA), which he called the “worst trade deal ever”, and kill Obama’ nascent trade deals, and if Republicans in Congress acquiesce or even provide support, it would represent a complete U-turn of U.S. policy.

Most economists and foreign policy experts agree that such a reversal would be a serious mistake. It would ultimately leave the country poorer, less competitive and less secure. Of course, this matters little to the working class voters who turned out for Trump. For them, globalization is destroying their jobs, their families, their communities, and their dignity, and Trump’s protectionism is the best remedy on offer. Unfortunately, this remedy won’t work. Unless Trump abandons his foolish campaign promises on trade, the working class will face the same problems in four years as they do today, with fewer options to solve them.

It is my sincere hope that Mr. Trump and the Republicans in Congress realize this well before that time.  The best recipe for shared prosperity is to support trade agreements, while strengthening the social safety net and improving workforce adaptability. President Obama pursued this approach but faced a hostile Congress. Mr. Trump could conceivably break that impasse.  Will he try?

The Current Climate of Trade Skepticism

While many factors explain Trump’s election, the proximate cause was the blue-to-red shift in the manufacturing strongholds of Iowa, Michigan, Ohio, Pennsylvania, North Carolina, and Wisconsin, which Trump targeted with this anti-trade message. Manufacturing employment in the United States has been declining for decades, and these states have been hit particularly hard. The localities hit the hardest tend to be those specializing in products that compete with growing imports from developing countries, such as steel, textiles and apparel, furniture and electronics.  This correlation between imports and job loss is evident to the voters in these states, as are the many instances of companies shutting down factories in the United States and opening them in low-wage countries, like Mexico. Trump simply echoed what union leaders, the media, and left-wing politicians had been saying for years, which is that trade agreements are to blame for this sad state of affairs.

Growing income inequality in the United States has also added to the trade skepticism. Depending on how it is measured, median household income has either grown modestly or stagnated in the last thirty years, while income growth for the top 1 percent has been spectacular. The imbalance of income growth is matched by imbalance in US export performance: the lion’s share of exports is accounted for by a handful of large corporations. These corporations tend to lobby in favor of trade agreements, and only seem to criticize them if they don’t go far enough.

Moreover, growth in exports in recent years has been strongest in sectors employing advanced technologies and high-skilled workers. All of this contributes to the impression that exports are a boon to the already well off, that imports crush the average Joe, and that trade agreements (“negotiated in secret,” no less) are the means by which the elite sell out rest of the nation.

This is a powerful narrative, and some of it is even true. However, the scapegoating of trade deals, the TPP especially, is tragically misplaced.

The Reality of the Relationship Between Trade and Jobs

In the United States, manufacturing employment as a share of total employment has steadily fallen since the 1950s, coming down from around a quarter of the workforce to less than a tenth today. Meanwhile, manufacturing output has remained a constant share of GDP.  This is not just a U.S. phenomenon, as similar patterns are observed throughout the world. It is a testament to the rapid labor productivity growth in the manufacturing sector, driven by technological advances. These advances have provided jobs to many high-skilled workers while displacing even more low-skilled jobs. This is by far the most important factor driving the long-term downward trend of manufacturing employment.

What’s the role of trade? Estimates vary. One famous study finds that of the roughly six million factory jobs lost between 1999 and 2011, about one fifth was due to import competition from China. (China accounted for 90 percent of the growth in US imports from developing countries over this time period.) While this is nothing to sneeze at, some perspective is in order. Eighty percent of Americans work in the services sector, not manufacturing, and the U.S. economy creates and destroys around five million jobs each month. Moreover, the rise of China, with a working-age population nearly four times that of the United States, from minor player to export powerhouse in the span of two decades, is an unprecedented shock to the world trading system. It is actually remarkable that this rise has not been more disruptive to the U.S. labor market.

What about growing income inequality? Neither technological change nor the China shock can fully account for this. Other developed countries, like Japan and Europe, have experienced these same forces but with far less impact on income inequality. Evidence suggests that declines in minimum wages, unionization, and tax progressivity, along with growing industry concentration, educational disparities, and assortative marriage patterns (marrying within social class) are significant contributors.

Trade Agreements or Law of the Jungle

While international trade certainly can serve as a vector by which global economic and technological shocks impact local labor markets, trade agreements should not be equated with trade. Trade agreements govern trade.

The United States is currently a party to two major trade agreements, the World Trade Organization (WTO) and the North American Free Trade Agreement (NAFTA), and several minor ones. The 164-member WTO is the cornerstone of the world trading system, which was set up 70 years ago, at the urging of the United States, to foster cooperation and prevent the kind of devastating trade wars seen during the Great Depression. There is evidence that China’s accession to the WTO in 2001 boosted its trade and, by extension, impacted the U.S. labor market somewhat. Overall, however, the WTO has contributed immensely to prosperity of the United States, and its legal framework is the single best tool the U.S. has to protect its trade interests and influence the pace and direction of trade reform abroad.  While Trump has called the WTO a “disaster,” he has stopped short of advocating withdrawal.

NAFTA is another matter. Trump regularly calls for its renegotiation or outright repeal on grounds that it has caused job loss due to offshoring, and a ballooning trade deficit with Mexico. These criticisms do not hold up to scrutiny. First, the bilateral trade deficit with Mexico is actually quite modest, but it is also economically meaningless. The U.S. bilateral trade deficit with Mexico has no bearing on U.S. jobs any more than my employment status is affected by the fact that I buy from, but do not sell to, my local grocery store. Second, careful examination of the data reveals that the creation of jobs by U.S. multinationals abroad is associated with more manufacturing jobs in the U.S., not less. This is because offshoring makes firms more competitive. Indeed, the preponderance of net job loss in manufacturing comes within companies that stay at home and do not invest abroad. Of course, the domestic jobs created through offshoring may not be the exact same jobs as the ones moved abroad, and some displaced workers may not easily find new employment; nevertheless, they are the jobs of the future.

The Economic Context of TPP

Advances in technology have changed what we produce and how we produce it, and that has brought global markets closer together. Much of the growth in global trade in recent years is due to the advent of regional and global supply chains, in which goods are produced in multiple countries, each specializing in those segments in which they are most competitive. At the same time, growth in emerging economies has moved hundreds of millions of people out of poverty and into the global middle class. Today, 95 percent of the world’s consumers, and most of the world’s purchasing power, reside outside of the United States.

As manufacturing has spread to emerging markets, advanced economies like that of the United States have moved into the higher end of manufacturing, such as R&D, engineering, design, marketing, and into exportable services, like finance, consulting, insurance, and entertainment. Indeed, the United States is the world’s largest exporter of services, and it runs a substantial trade surplus in this sector.

Because of these trends, the United States and other developed countries have been pushing to establish global rules that facilitate trade in services and help technologically advanced companies access global and regional supply chains, particularly in emerging markets, where heavy regulation and state-owned enterprises make it difficult for them to compete.  Unfortunately, WTO has been slow to adapt, in part because emerging-markets governments seem content with the status quo, in which manufactured goods face low barriers, but governments remain largely free to impede services, e-commerce, investment, intellectual property protection, government procurement and other areas important to developed economies.

There is a reason why large, multinational companies are the most successful in this environment: they have the resources and profit margins to overcome many of these barriers. Small and medium-sized companies, even highly innovative ones, can rarely compete. Bringing down foreign barriers and promoting competition abroad is our best hope for democratizing U.S. exports.

Yet the problem goes beyond a stagnant WTO. In recent years, the momentum in trade policy has shifted to bilateral and regional agreements. Asia alone has over 200 such agreements, all of which give preference to the trade of their members over U.S. goods and services.  China is currently pushing its own pan-Asian trade agreement, which is likely to fill the vacuum when and if TPP fails.

The Obama Recipe

The changes in the world economy are here to stay. President Obama, a trade skeptic when he first took office, quickly recognized that helping the U.S. economy adapt to this new reality to benefit all Americans (red states and blue states, present and future), should be the government’s top economic priority. The two major planks of his policy have been: 1) helping workers at home adapt to shocks, whether cyclical, technological or trade-related. Affordable health care and education are critical elements to a well-prepared and adaptable workforce; and 2) joining with likeminded countries in Europe and the Asia-Pacific region to write rules aimed at leveling the playing field so that U.S. companies, large and small, can succeed in the growing global market.

From this emerged the TPP and its nascent European counterpart, the Trans-Atlantic Trade and Investment Partnership (TTIP). In a nutshell, TPP consists of the United States plus eleven other Asia-Pacific partners, six of which already have free trade agreements with the United States and all but one – Vietnam – are high income or upper-middle income countries. The largest partner by far is Japan. This collection of partners is hardly a recipe for disruption of the U.S. labor market. The agreement itself is remarkably forward-looking: it streamlines wasteful non-tariff trade barriers, opens trade to services, helps businesses integrate into regional supply chains, strengthens protections of intellectual property rights, enables digital trade and e-commerce, promotes access for small and medium-sized businesses, neutralizes state-owned enterprises, and provides enforceable labor rights and environmental protections, to name a few.

I had the pleasure of working for the Obama Administration, first in the White House Council of Economic Advisers and then in the State Department. Never once did I see the interests of corporate lobbyists given precedence over U.S. workers or environmental concerns, and, yes, our trade negotiators struck the absolute best deal they could.  At the State Department, the TPP has importance that goes way beyond the economic arguments I have outlined here. The TPP is the centerpiece of our foreign policy in Asia. Without it, our leadership in the region is undermined and the security of our nation, and that of our allies, is threatened.

Sadly, the anti-trade rhetoric of the presidential campaign (on both sides) seems to have doomed trade agreements for the foreseeable future. However, the problems that TPP were intended to address are not going away by themselves, and protectionism is not the answer. Import protection merely pushes the problem downstream onto buyers, many of whom may be just as stressed as the protected industry. It props up dying industries and cruelly draws new workers into sectors that will leave them jobless with time.

Hopefully, President-Elect Trump will see the wisdom in a government that protects people, not industries, and will work to make the American workforce better educated, healthier, and more adaptable.  Trade-Adjustment Assistance program, which provides training and job-searching assistance to trade-displaced workers, is the right idea, but it is too narrow and perpetuates the myth that trade is a special threat to jobs.  Such assistance should be available no matter the reason for the job displacement. But this is just the tip of the iceberg: there are scads of good ideas to facilitate workforce adaptability, and some even have bipartisan appeal. The President should focus on building political support for such policies at the federal, state and local levels. Then, in a year or two, he should quietly return to our like-minded trade partners and try to put something like TPP back together. Mr. Trump seems to have little problem dismissing his outlandish campaign promises as “campaign talk.” His opposition to trade agreements deserves the same treatment.

Rodney Ludema holds a joint appointment in School of Foreign Service and Department of Economics at Georgetown University. He served as Chief Economist of the State Department and Senior Economist at the Council of Economic Advisers in the Obama Administration.