SYNOPSIS: Krugman pans a protectionist presidential candidate, who is now the House Democratic Minority Leader
Representative Richard Gephardt, to give him his due, is the only presidential candidate of either party whose campaign is based on specific policy proposals. The pundits have been demanding "substance," and only Gephardt has really given it to us. Beyond all the talk of "flip-flops," he deserves to have his proposals taken seriously. What is he saying, why is it wrong (for it is indeed wrong), and what would happen if his program were implemented?
Gephardt is best known for his get-tough posture on trade. His rhetoric--harsh words blaming foreigners for our economic ills--is backed up with a specific proposal, the Gephardt amendment. Every candidate has said that unfair foreign competition is a problem, but Gephardt has charged that foreigners are stealing our livelihood. When we bought our VCRs from Japan, "we all paid twice. You and I paid the price to buy the product at the store, and our country paid the cost of lost jobs for our workers—because not one single U.S. company has ever made a single VCR." No subtlety here. No complex argument about strategic industries or technological innovation. Gephardt is willing to "boil it all down to just one four-letter word: J-O-B-S."
He specifically asserts that 2.5 million jobs have been lost, although he fudges. The usual phrasing is "2.5 million jobs lost in part because other countries are stopping us from selling our products in their markets." In op-ed pieces he has written of "up to one million" jobs lost because of foreign trade practices. Gephardt has repeatedly conceded that only 15 percent of the trade deficit can be attributed to unfair foreign practices. Thus his rhetoric blames our problems on unfair foreigners, while the fine print assigns them a minor role.
The Gephardt amendment itself also has it both ways. Any country whose exports to the United States are more than 75 percent greater than its imports from the United States would be placed on a list of "excessive surplus countries." The amendment seems to presume that a large bilateral trade surplus is evidence of foul play. (Since overall U.S. imports exceeded overall U.S. exports by 65 percent last year, virtually any country running an above-average trade surplus with the United States would be an "excessive surplus country.") However, there is an escape clause: the U.S. trade representative would have to ascertain "whether the surplus is the result of unfair trade practices." Only if the surplus is found to be "unwarranted" does the act impose its highly publicized penalties until the offending country mends its ways. And the president can waive the penalties if a country has a debt problem or if he declares retailation to be against the national interest.
Like his trade rhetoric, then, Gephardt's legislative proposal sounds tougher than it is. But it represents a significant change in tone, essentially substituting a presumption of guilt for a presumption of innocence on the part of foreign governments. And as with the speeches, it may be the tone rather than the content that is crucial.
Gephardt is responding to a real grievance: the stagnation of living standards in the United States over the past 15 years. Median family income peaked in 1973; since then the average American family has seen better and worse times, but none of the steady rise in welfare that characterized the 1950s and 1960s. And when the average is stagnant, there are bound to be many who are actually worse off. In the 1980s the losers have been concentrated in the American heartland, among farmers and industrial workers. Many Americans have suffered economically, and many of those have been hurt by foreign competition.
But nobody has ever denied that foreign competition can hurt some of the people some of the time. The implication of Gephardt's position is that foreign competition has hurt most of the people, systematically--and that the competition is unfair. So we need to ask: Has the country as a whole suffered from foreign competition, and how much of the competition is unfair?
As recently as 1981 the United States ran a small surplus on its current account (a broad measure of trade that takes into account service trade as well as merchandise), and a surplus in manufactures. So in 1981 the United States could not easily complain that it was unfairly losing jobs to foreign competition (unless we feel that we have the right to run trade surpluses but other countries do not).
When Gephardt asserts that the United States has lost 2.5 million jobs to foreign competition, then he must mean that we have lost 2.5 million jobs to foreigners since 1981. And at this point he runs into two awkward facts: the U.S. share of world employment has been rising, not falling, since 1981, and we couldn't fill 2.5 million extra jobs if we were offered them.
In 1981 the United States had an unemployment rate of 7.5 percent. Total employment has increased 13 percent since then, and the unemployment rate has fallen to 5.7 percent. In every other major country except Great Britain, unemployment rose over the same period. If foreigners were taking away our jobs they were remarkably careless thieves, because they seem to have lost them on the way home.
In 1987 the United States had about 7.5 million unemployed workers, for an overall unemployment rate of six percent. If a third of them would have been employed but for unfair foreign competition, the unemployment rate would have been only four percent. Nobody believes that today's economy can run at four percent unemployment without severe inflationary pressures. When unemployment falls below five to six percent, the remainder are unemployed for reasons that have little to do with overall demand for U.S. products. They lack vital skills, are secondary workers who are unemployed in between jobs, and so on. In other words, right now the country has about as many people employed as it can without risking an inflationary surge. This is a shame, and someday we will have a government that is willing to tackle the problem of structurally high unemployment. But trade policy has nothing to do with it.
The claim that the United States is millions of jobs poorer because of foreign competition, then, is just not right. Indeed, such claims are rarely right. Countries seldom find their employment underminded by foreign competition. If a country can't sell enough on world markets to pay for its imports, its currency normally drops in value until its products find markets. Now, this may seem a strange assertion to make for the United States in 1988. After all, didn't the dollar keep rising for five years despite a massive trade deficit? And worse yet for the conventional wisdom, hasn't the fall in the dollar failed to turn the trade deficit around?
The explanation is that, despite the trade deficit, the United States actually has been selling as much as it buys on world markets since 1981. We've been buying VCRs and BMWs; we've been selling IOUs. The country went on a huge borrowing spree under the Reagan administration and "sold" huge claims on its future. Inevitably, in selling all this debt to foreigners, we had to balance our accounts by a combination of buying more and selling less of other things.
The trade deficit is finally turning around, but with agonizing slowness. As proof of unfair foreign practices Gephardt and others have offered the persistence of the deficit despite the weaker dollar. This brings us to the next question: How serious are these foreign practices? A key part of the Gephardt message is that American failures in international competition are the result not of inadequate performance by U.S. firms or workers, but a mysterious failure of will on the part of the "insiders." We lost markets because foreigners don't play fair, and we let them get away with it. The United States is, as Gephardt wrote in USA Today, "the world's trade patsy."
Of course, governments do interfere with trade in an effort to give national producers an advantage over their foreign rivals. The United States is not exactly innocent: a 25 percent tariff protects our truck industry. An import quota allows our sugar producers to sell their output for prices sometimes more than five times world levels. Arguably, other countries do worse. The question is how important these unfair practices are in causing America's economic problems.
Gephardt's own position papers eventually concede the standard estimate that 15 percent of the U.S. trade deficit results from unfair foreign trade practices. This figure is what U.S. trade officials estimate would be the increase inexports if they could get their whole wish list of measures to open foreign markets--assuming that the exchange rate remains constant. But if the United States got its wish list, the increase in exports would lead to a stronger dollar, which would hurt other exports and encourage imports, so overall the effect on the trade balance would probably be virtually zero.
Despite the tales, often true, of how hard it is to sell in Japan or Korea, not much of the trade deficit with these countries can be attributed to our lack of market access. Consider Japan. We export about 20 cents of manufactures to Japan for every dollar of imports. It is natural to attribute this to the unwillingness of Japan to open its markets. Yet the U.S. position in manufactures trade with West Germany, which imports seven times as many manufactures relative to GNP as Japan, is not that much better: 40 cents of exports per dollar of imports. So even if Japan were as open to U.S. goods as Germany (which would mean not just the removal of legal import barriers but the breakup of that country's cartelized marketing and distribution system), we would still have a huge trade imbalance.
The reason is not mysterious. Both Germany and Japan are resource-poor countries that must run large trade surpluses in manufactures to pay for their imports of food and fuel. This means that they naturally run large surpluses with better-endowed manufacturing nations, such as the United States, while running large deficits with resource-rich areas, such as OPEC. When the United States is not running up debt to finance a consumption boom, it has the converse trade pattern: deficits with other manufacturing nations, surpluses with resource-supplying and manufacture-importing countries. Unfortunately, the U.S. bring since 1981 has widened our deficits and eliminated our surpluses--but the willingness of foreigners to extend us credit is not what most people mean by an unfair trading practice.
The slowness of the trade turnaround with the falling dollar has been a surprise and an embarrassment to economists. But the explanation can't be a lack of access to foreign markets--because the bad news on trade has been coming from imports, not exports. The fall in the dollar has produced exactly the kind of export surge that standard economic analysis predicts. From the end of 1986 to the end of 1987 exports grew by a fifth--six times as fast as GNP. What kept the trade deficit high was that imports kept rising. Why? Foreign firms clung on tenaciously to the U.S. market even at a loss (probably because they are not convinced the weak dollar is here to stay). U.S. consumers have been unwilling to stop buying foreign goods even when their prices do increase. Economists disagree on whether the persistence of high imports is only temporary or whether the dollar will need to fall still lower. But whatever the solution to the import puzzle, it has nothing to do with the lack of U.S. access to foreign markets.
Richard Gephardt vehemently denies that he is a protectionist. His aim is supposed to be opening foreign markets, not closing U.S. markets. Nonetheless, he is operationally a protectionist. His program inevitably will lead to invoking the sanctions he claims are only bargaining chips. As Gephardt himself admits when pressed, foreign markets just cannot be opened enough to satisfy the demands of the Gephardt amendment, since lack of access to foreign markets is not the major source of U.S. trade imbalances. Even if "excessive surplus" countries gave us everything we wanted, they would not reduce their surpluses by much. And anyway we are not going to get everything we want. Other countries have their own politics, their own protectionist pressures, and their own politicians who blame their problems on foreigners. Pressure does work, if the demands the United States makes are politically feasible. But a demand that countries radically transform their trade policies within six months, under threat of U.S. retaliation, is far more likely to get our trading partners' backs up and lead to a trade war than to get the results we want.
In practice the threat of retaliatory sanctions would inevitably fail, and we either would have to back down or go through with the retaliation. And what's wrong with that? Gephardt's political success shows that Americans aren't convinced that protectionism is such a bad thing. It is.
The costs of a protectionist turn for the United States are of three sorts. First, there are unilateral costs: protectionist policies will hurt the economy even if foreigners do nothing in retaliation. Second, there are the costs of trade war, as other nations retaliate. And third, there are the political costs as we and our erstwhile allies become locked in economic conflict.
At first blush it seems obvious that if other countries don't open their markets to us, we shouldn't open our markets to them. Leaving on one side the question of how unfair foreigners really are, this is still dead wrong. As the 19th-century economist Bastiat put it, this is like saying that if other countries have rocky coasts, we must block up our own harbors. We would have more trade and more benefits from trade if other countries opened their markets fully. But we still gain from the trade we have, and are punishing ourselves if we cut it off.
The costs of protection to an economy--whatever foreigners are doing--are multiple. Trade allows a country to produce goods at which its workers are relatively efficient or that use its relatively abundant resources, export these goods, and import other goods for which it has no such advantage. Protection denies a country the chance to benefit from the fact that other countries are different.
Protection also fragments markets. Instead of concentrating on certain products and benefiting from economies of scale, a protectionist country tries to produce a little bit of everything--which it does less efficiently. Even the United States, the world's largest economy, both exports and imports many goods whose production demands a global market to achieve efficient production runs.
Finally, protection increases monopoly power. It allows domestic firms and unions to stop worrying about foreign competitors and go back to the business of exploiting domestic consumers. This is not just a struggle over the distribution of income; competition makes firms more efficient.
So protection is costly even if other countries do not change their own policies in response. But they will. If the United States turns protectionist, expect other countries to follow suit, in emulation if not in retaliation. The European Economic Community is nearly as large and self-sufficient as the United States. If we think that we can bully them without fear of retaliation, we have a nasty lesson in the limits of American power awaiting us. If unilateral protectionism turns into a global trade war, the costs will be greatly increased. Some countries will be hurt more than others--a world trade war will hurt Japan worse than Europe or America, and might be devastating to some less developed countries--but there will be no winners.
Then there is the political issue. Today's international trading system was created at the same time as the Western alliance, and not accidentally. Political alliance doesn't require amicable commerce, but it helps. Gephardt is fond of emphasizing the need for economic as well as military security. But how secure would we be if we and our military allies are locked into a trade war?
Trade isn’t the whole Gephardt program. Gephardt's other foray into populist terrain is the Harkin-Gephardt Family Farm Act, a remarkably irresponsible bill that hasn't received the unfavorable publicity it deserves. If Gephardt's trade position is more radical in tone than in substance, his position on agriculture is the reverse. The Harkin-Gephardt bill calls for a system of high price supports backed by marketing quotas. If you want to understand the system, think of New York taxis: the government will guarantee high prices to farmers, and prevent an oversupply by issuing licenses. Farmers would be forbidden to sell their crops without a license.
Gephardt's program would cut government outlays only by imposing an even larger hidden tax on the general public in the form of higher food prices. Moreover, given Gephardt's ostensible concern about the trade deficit, the way his farm program ignores foreign trade is remarkable. This country exports about a third of its agricultural output. A government program that raises U.S. prices above world levels will destroy our exports and produce a rush of imports. The more we restrict production and raise prices, the worse our trade balance will get.
The bill contains language about demanding that foreign countries open their markets and stop subsidizing their exports, but this is the same kind of wishful thinking that is in Gephardt's trade proposals: it is wildly unrealistic to imagine that we could get concessions large enough to do the job. In fact, by restricting our own production, we will make foreign subsidy programs a lot cheaper. Recent cuts in farm support prices, combined with the drop in the dollar, have plunged Europe's agricultural export subsidy program into crisis. European bureaucrats would breathe a sigh of relief if the United States jacked up prices and restricted output.
Production quotas can only work if they are backed up with import quotas and export subsidies of our own. Forget about the supposed budget savings: the inevitable export subsidy war with Europe will eat them all, and then some.
The style of Gephardt's farm program is essentially the same as that of his trade approach: find a group of aggrieved Americans; tell them that you have a program to solve their problems; and pretend that other Americans don't have to pay for it. The difference is that even Gephardt cannot claim that getting tough with foreigners will raise farm incomes very much, so the rhetoric relies on the public not noticing that higher prices for producers also mean higher prices for consumers.
The United States has two really serious economic problems: extremely low productivity growth, which means that we cannot afford a rising standard of living, and a growing tendency to live beyond our means, which is reflected in the lowest national savings rate of any major nation and spills over into our trade deficit. Compared with these issues, the problem of unfair foreign competition that is the centerpiece of Gephardt's campaign is a minor irritant. Yet Gephardt, the man of concrete, "tough" proposals, has no serious proposal to address these truly urgent issues.
Ultimately, that's what is most disturbing about Gephardt's rise. It shows that the electorate is still in the market for snake oil salesmen. In 1980, faced with stagnant productivity and inadequate savings, the country turned to the feel-good promises of the supply-siders. Now productivity growth is no better, and savings are even lower. And the electorate is tempted once again by feel-good promises. Gephardt is telling us that all that we need to do is act tough: stand up to the foreigners, eyeball to eyeball, and all our problems will go away. This is wrong (and Gephardt probably knows it is wrong). Worse, it is childish and irresponsible. Sad to say, it sells.
Originally published, 3.28.88