Free Trade Won't Cure Unemployment

Thursday, 23 December 2010 08:08 By Paul Krugman, Krugman & Co. | Op-Ed | name.

Free Trade Won
(Cartoon: Lailson / Diario de Pernambuco / CartoonArts International)

Now that there seems to be no hope of using reasonable fiscal policy to fix the United States’s economy, I’ve been hearing a different idea lately: that trade can be a driver of economic recovery. Namely, the suggestion that the trade proposal South Korea and the United States recently agreed on can serve as a form of macroeconomic policy.

Um, no.

The problem in the United States is insufficient spending on American-produced goods and services — that is, a lack of demand.

Think of the situation in these terms: Y = C + I + G + X – M

In this equation, C is consumer spending, I is investment spending, G is government purchases of goods and services, X is exports and M is imports. Trade agreements raise X, but they also lead to higher M. On average, it’s a wash.

This, by the way, explains why claims that the Smoot-Hawley Tariff Act caused the Great Depression are nonsense. Signed into law in 1930, this was basically an effort to protect American businesses and farms by raising duties on imports to record levels. To be clear, I don’t think the Smoot-Hawley tariff was a good thing. But did it and other trade restrictions cause the Depression? No.

According to textbook economics, protectionism causes a misallocation of resources, reducing the economy’s efficiency. But it does not cause mass unemployment.

Did protectionism led to falling exports? Indeed. It also led to falling imports. So it’s not at all clear what effect Smoot-Hawley had on overall demand. Insofar as it did effect demand, it was because tariffs were a form of tax increase — but in that case you should be focusing on the whole range of fiscal actions, not just the tariff hikes.

(There’s even an argument out there to the effect that increased trade reduces employment in the current context. Basically, if the jobs gained are higher value-added per worker, or jobs that produce actual finished products considered to be valuable, while those we lose are lower value-added, and spending stays the same, this means the gross domestic product stays the same, but there are fewer jobs in the country.)

So what about the case being made these days for freer trade?

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Well, freer trade may make the world economy more efficient, but it does nothing to increase demand.

If the United States is looking for a trade policy that helps employment, it has to be one that induces other countries to run bigger deficits or smaller surpluses. For example, a countervailing duty on Chinese exports would be job-creating. A revised free-trade agreement with South Korea would not.

If you want the South Korea deal, fine, but let’s not stretch the truth.

Backstory: The Fed Under Fire

Two leading Republicans in the House of Representatives, Paul D. Ryan of Wisconsin and Mike Pence of Indiana, have challenged the monetary policy mandate the Federal Reserve has followed since 1977: keep the United States economy balanced on the fine line between maximum employment and low inflation. Mr. Pence and Mr. Ryan have suggested in recent months that the economy would be better served if officials at the Fed stayed out of the job-creation business.

Both congressmen have called for a change in the Fed’s role — even if the change requires legislative action. They hold that the central bank’s attempts to stimulate the economy have been largely ineffective, and that its latest move — buying $600 billion in Treasury bonds to inject liquidity into the market — is just another example of “meddling,” as Mr. Pence put it.

One of the main criticisms levied against the Fed’s quantitative easing initiative is that it could lead to runaway inflation as more dollars come into circulation through the financial system, and both men have expressed concerns that a devalued dollar might lose its standing as the world’s reserve currency. “It is time to return the Federal Reserve to the singular mission of protecting the fundamental strength and integrity of the American dollar,” said Mr. Pence at a press conference in late November.

He also pointed out that the Fed’s previous round of quantitative easing — purchasing $1.7 trillion in mortgage-related securities and debt between January 2009 and March 2010 — failed to reduce the unemployment rate.

On Dec. 5, Fed Chairman Ben S. Bernanke responded to these comments in a rare television appearance on the CBS news program “60 Minutes,” explaining that the fear of massive inflation is overstated and that the real danger to economic recovery lies not in the quantitative easing plan, but in not taking action. 

Backstory II: Hard-Won Agreement

In early December, the United States government finalized a free-trade agreement with South Korea that had been three years in the making.

If approved by Congress, the deal would be the most important trade accord for the United States since the North American Free Trade Agreement with Canada and Mexico was passed in 1994.

For President Obama’s administration, the agreement represents progress toward a key economic goal: to double American exports within the next five years. The White House predicts that the deal with South Korea will add $10 billion per year in exports and “tens of thousands of jobs” to the economy, a welcomed prediction since the nation is seeing 9.8 percent unemployment.

The agreement, signed initially by President George W. Bush in 2007, had foundered in Congress over concerns about import tariffs, among other issues. American automakers in particular had strongly opposed eliminating tariffs on South Korean cars immediately, as the 2007 agreement required.

According to the more recent version, the United States has agreed to phase out a 2.5 percent tariff on Korean auto imports over five years and, in return, South Korea will slash the current tariff on American auto imports right away, from 8 percent to 4 percent. In five years, South Korea’s tariff will be completely eliminated.

But not all lawmakers are pleased with the trade deal. Representative Michael Michaud, a Democrat, has said the deal does not provide adequate protections from the possibility of jobs moving abroad.

© 2010 The New York Times Company

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Paul Krugman joined The New York Times in 1999 as a columnist on the Op-Ed page and continues as a professor of economics and international affairs at Princeton University. He was awarded the Nobel in economic science in 2008.

Mr Krugman is the author or editor of 20 books and more than 200 papers in professional journals and edited volumes, including "The Return of Depression Economics" (2008) and "The Conscience of a Liberal" (2007).

Copyright 2010 The New York Times.

Last modified on Thursday, 23 December 2010 08:56