The outcome of the fast-track debate that opened this month will determine whether the United States continues to lead the world toward a more open global economy or whether, for the first time since the end of World War II, it sends the opposite message.
An unusual coalition of opponents in both political parties and across the ideological spectrum now shares the fear that increasing globalization of the world economy is bad for the United States. Recent opinion polls suggest that the critics have substantial public support.
The authors argue that this is a misdiagnosis that could harm the U.S. economy. They urge policymakers to adopt a novel trade adjustment program to help those who have been displaced.
POLICY BRIEF #24
Until now presidents have had relatively little difficulty getting congressional approval for trade negotiations. This time could be different. Recent opinion polls suggest that the critics have substantial public support. The uneven performance of the U.S. economy has contributed to the prevailing climate. The good news is that the economy continues to generate more jobs without pushing up a very low rate of inflation. The critics pounce on the bad news, however—slow growth in wages, widening inequality, and job anxieties across the middle class—and blame it on trade.
We contest this critique, but argue that policymakers must address the valid concerns of those who stand to lose when we lower our own (already very low) trade barriers. We offer a novel compensation mechanism to ease their adjustment.
Trade: What’s in It for the U.S.?
Trade negotiations historically have resembled nuclear arms reduction talks. Other countries have barriers; we have barriers; we’ll lower ours if they’ll lower theirs. Since shortly after World War II, this logic has fueled eight rounds of multilateral trade negotiations: huge affairs, involving in the latest round more than 100 countries. Since 1980, the United States has also negotiated free trade pacts with Israel, Canada, and Mexico. The results have been heartening: average tariffs in industrialized countries have fallen from over 40 percent to just 6 percent.
In strictly mercantilist terms the United States has been a big winner from these past deals, since U.S. tariffs have been generally lower than those abroad, so we ended up reducing our tariffs by less than other countries. In the most recent Uruguay round we lowered our tariffs by about 2 percentage points, while other nations chopped theirs between 3 and 8 percent. Likewise in NAFTA, Mexico has reduced its tariffs on U.S. products, which averaged about 10 percent before the agreement, while we have eliminated the 2 percent duties levied on Mexican exports.
With tariffs now already so low, however, it would seem that little is left to negotiate. Not so. In most developing countries, tariffs on many products range up to 30 percent and higher, while agricultural quotas, barriers to foreign service providers, and other investment restrictions translate into tariff-equivalent rates of 50 percent or more.
Developed countries also continue to maintain significant barriers in key sectors: although the Uruguay round commendably converted most agricultural quotas into tariffs, tariffs on dairy items and sugar exceed 100 percent in the EU and are nearly 100 percent in the United States, while in Japan dairy tariffs exceed 300 percent and tariffs on wheat remain above 150 percent.
The United States has much to gain from further reductions in trade and investment barriers. America has the world’s most efficient producers of agricultural commodities and the world’s leading software, telecommunications, entertainment, and financial companies—all of whom would benefit from enhanced access to foreign markets.
It is understandable why specific industries, such as textiles and apparel, whose trade protection could be lifted as part of any future trade deals, may not be enthusiastic about letting the president negotiate them. Opposition to freer trade has been considerably augmented, however, by a wide-ranging attack against globalization—increasing trade and investment linkages among all countries.
This attack—which we call Globaphobia—comes in different versions and is found in both the left and the right of the two major political parties. It is also increasingly found abroad, especially in Europe, where unemployment has been high for decades.
Those whom we label pure globaphobes blame trade for both the long-term stagnation of average real wages since the mid-1970s and much of the widening inequality of wages, especially those earned by the lowest-income Americans. Increasingly, these low-income Americans find themselves in competition with workers in less-developed countries earning a fraction of what they earn. This is the basis of the sucking sound Ross Perot warned about in NAFTA: low-wage Mexicans taking the jobs of Americans either by exporting more or benefiting from the movement of American firms to Mexico.
A second form of globaphobia—softer only because its advocates claim they are for freer trade in principle—objects to new trade agreements with countries that look very different from ours in two major respects: they do not protect workers or the environment as we do.
The continuing, and indeed even remarkable, economic expansion of the United States has masked several disturbing trends, which have combined to fuel the globaphobics’ discontent:
- Wages of the typical American worker have barely grown in more than twenty years, after growing at about 2 percent annually from the end of World War II until the early 1970s.
- Low-wage workers in particular have suffered an erosion in their real wages since the late 1970s.
- Even highly educated workers in the United States have not been immune to the forces of change. While they lose their jobs at a lower rate than less-educated workers, more highly skilled workers have suffered the largest increase in the rate of job loss since the mid-1980s.
Trade looks like an easy culprit because the access of American consumers to foreign goods also effectively expands the labor pool against which our workers must compete. With more workers and only a limited demand for the goods they produce, shouldn’t the elementary laws of economics imply that trade must force down the wages of American workers?
A small army of economists has been busy in recent years attempting to answer this very question, using a wide variety of sophisticated techniques. But, with a few exceptions, most have concluded that greater trade has played only a small role in the widening inequality of wages and virtually no role in the slow growth of wages overall. There are several reasons why:
- We trade primarily with rich countries where wages are high, not poor ones, where wages are low. In fact, imports from countries where wages are less than 50 percent of U.S. wages amounted to only 2.6 percent of our GDP in 1990 (up modestly from 1.8 percent in 1960).
- Even among rich countries, the United States is a low-wage manufacturing country itself (figure 1). Clearly, European and Japanese countries cannot be bidding down our wages if they are paying their workers.
- More fundamentally, firms pay attention not to the wage rates they pay their workers, but to the labor costs per unit of output, or wages adjusted for productivity. Professors Dani Rodrik of Harvard and Paul Krugman of MIT, however, have documented that poor countries pay low wages because their workers are far less productive than ours are. Furthermore, wages in many countries we used to think of as developing—such as the Asian Tigers—have been increasing much more rapidly than those in this country.
A related often-heard, but wrong, critique is that increasing globalization is reducing the number of jobs in America. Trade moves jobs around, from low-paying importing-competing industries to higher-paying export industries. But trade does not affect the total number of jobs, which depends on how fast economic policymakers—the Federal Reserve in particular—let our economy grow. Absent signs of rising inflation, the Fed has allowed the expansion to keep rolling, generating more jobs as it goes, despite our rising appetite for imports. The creation of 14 million new jobs over the past five years and an unemployment rate of less than 5 percent (a twenty-four-year low) refute claims that increasing trade shrinks employment.
Simple economic fundamentals also explain the absence of any giant sucking sound after NAFTA. The claim was absurd on its face since Mexico’s economy is about 4 percent the size of ours, and, while Mexico is our second largest trading partner, imports from Mexico account for just 1 percent of our total demand for goods and services. Measuring the impact of NAFTA, meanwhile, is complicated by the financial crisis in Mexico, which had nothing to do with the trade agreement. While estimates of the net job impact of NAFTA conflict, all of the numbers pale compared with the more than 2 million jobs that turn over in the economy every month.
Slow Wage Growth: Is Trade the Culprit?
If increasing globalization is not to blame for slow wage growth and rising inequality, then what is? Since wages basically depend on how productive workers are, it is no surprise that slow productivity growth explains slow wage growth. Some have criticized this linkage, which, as shown in figure 2, seems to explain the rising wage growth before 1973 but not since. The fact that real wage growth has nonetheless lagged behind productivity growth since 1973 is the result of two often overlooked factors:
- The measure of wage growth does not include fringe benefits, notably health care and pension costs, which employers increasingly have paid to workers in lieu of increasing cash wages. With fringe benefits factored in, figure 2 illustrates a much closer connection between the growth of overall compensation and productivity.
- Conventional measures of real wages use the consumer price index to correct for inflation. But to producers, the real output of their workers is measured by output in current dollars deflated or corrected by the growth in the prices of the goods they sell (not the prices of all goods and services consumers buy).
Some critics argue that a major reason for growing wage inequality is that trade and the threat of American firms’ moving offshore to low-wage countries have eroded the bargaining power of workers. If this argument is correct, then we should expect the relative wages of less skilled workers to fall more rapidly in trade-sensitive sectors than elsewhere in the economy. But figure 3 clearly shows that this is not the case. Less-skilled workers have been falling behind because employers have had less need for them, a circumstance that figure 4 shows has affected industries that are most and least affected by trade alike. A recent study by three Harvard economists and published by Brookings confirms that trade with developing countries contributes only minimally to growing worker inequality: it accounts for only between 4 and 7 percent of the increase between 1980 and 1995 in the premium earned by college graduates relative to those who have a high school education.
Since skills are the ultimate driving force behind wage differentials—both within and across industries—those who are concerned about rising inequality must look for a solution to improvements in and widened accessibility to education and training at all levels: K-12, vocational, and college. Restricting trade is not the answer.
Why More Trade?
The case for negotiating even lower trade barriers will not be won by playing only defense—that is, answering the claims of the globaphobics. Political leaders and their constituents must be given positive reasons to support further trade liberalization.
In the past, the positive case has traditionally been made by attempting to convince voters that freer trade—and enhanced export opportunities in particular—means more jobs. Implicit in this argument is that imports are an evil necessity we have to live with; we trade in order to export so that we can create more jobs.
From an economic point of view, both these arguments are sheer nonsense. As we have already noted, domestic demand, not how much we trade, determines total employment. In addition, the level of trade barriers abroad has very little to do with our trade balance, which, like total employment, is determined by macroeconomic factors—specifically, the balance (or imbalance) between saving and investment. Nations that invest more than they save (as we do) must attract foreign capital to finance their saving; the foreign capital is then used to buy imported goods. Trade barriers abroad are important, but only because, by reducing our exports and the demand for dollars on international markets, they depress our exchange rate and lower the prices on what we sell abroad.
Meanwhile, the notion that exports are good, imports are bad is long overdue for correction. Our living standards—what we can buy for the work we do—depend on our productivity as workers. We can improve living standards by concentrating on producing the things we do relatively best, selling some of them at a good price, and using the proceeds to buy from abroad the things we are least efficient at producing. In short, we export in order to import.
Understood this way, reducing barriers to trade both abroad and at home delivers four broad benefits:
- Lower trade barriers abroad mean better jobs (not more total jobs) for American workers because jobs in export industries (being more productive than average) pay 15 percent more than the average wage.
- Lower trade barriers promote faster growth in the standard of living for Americans. Broader export markets enable U.S. companies to reap larger returns on their innovations. Lower trade barriers here, meanwhile, enhance competitive pressure on our firms to innovate. In addition, U.S. firms increasingly rely on imported high-tech capital equipment and know-how, which accelerate the growth of productivity and living standards here.
- Lower U.S. trade barriers provide the equivalent of a tax cut for American consumers because they lead to lower prices—not just on the imported items, but also on the domestically produced goods and services with which those imports compete. According to the World Bank, consumers around the world are expected to gain between $100 billion and $200 billion every year in additional purchasing power as a result of the Uruguay agreement, with two-thirds of the benefits to be reaped by rich countries like ours. Once barriers to full competition in telecommunications are dropped, in an agreement reached under the auspices of the WTO earlier this year, consumers around the world stand to enjoy more than $1 trillion in savings over a fourteen-year period. In short, broader trade is a win-win rather than a zero-sum game.
- Finally, freer trade expands the variety of goods and services available to American consumers. Think of a world in which Americans had to make do without fax machines or video recorders, which are overwhelmingly or exclusively made abroad—or consumers abroad could not buy the products of Silicon Valley.
To date, most political leaders and those who advise them have not sold freer trade using these arguments. It is time they start. The jobs argument was the way NAFTA proponents argued their case. Yet, as events turned out, the peso crisis made a mockery in the popular media of the jobs argument and, in the process, soured much of the public on freer trade in general, a legacy that supporters of fast-track legislation are now fighting to overcome
Smoothing the Way for Trade Liberalization
The advantages of trade liberalization are not without costs. While the U.S. economy as a whole, and the vast proportion of its citizens, will be better off with more liberalized trade, some Americans will be worse off. The typical reply to this conundrum is to advise politicians to channel some of the winnings from freer trade to compensate the losers.
To a very limited extent, policymakers have responded by authorizing adjustment assistance for workers dislocated by trade—but the program has never been very big and has been criticized. The original program did not require recipients to undergo training and basically involved extending unemployment benefits. While the special NAFTA trade adjustment program did require recipients to undergo training, it has not been used intensively—not just because the total job losses have not been as great as many feared, but because only about 10,000 of the 120,000 workers found to be eligible for assistance have actually claimed benefits. One reason workers are reluctant is that if they want to obtain benefits, they may not take an alternative job. Thus the current NAFTA program might better be described as nonadjustment assistance.
In our view training programs or benefits targeting trade-displaced workers should be complemented with an explicit compensation mechanism. The best indicator of the losses suffered by workers, and thus the basis for compensation, is the difference between what workers earn in their new jobs and what they earned previously. We would favor a wage insurance scheme in which dislocated workers who were in their job for some minimum period (say, two years) would be compensated for half the loss of earnings they may experience after gaining a new job. This would also strongly encourage them to locate new employment quickly. The compensation would last for a limited period, perhaps for another two or three years. Time is running short. While policymakers debate whether to negotiate further reductions in trade barriers, other countries may strike their own deals, while others may be tempted to backtrack on deals already made. The United States has invested too much in the cause of trade liberalization to sacrifice its leadership on the issue now.
[On the ongoing trade negotiations] If we’re serious about resolving the core issues that the U.S. has with China, then this is going to be a way station that’s going to require a lot more continued focus by the administration for a number of months if not years.