Don Luskin’s amazing 180° turn on free trade

Last week, a friend forwarded me a link to an opinion piece by Don Luskin in the Wall Street Journal. If you’ve ever watched any of Larry Kudlow’s shows on CNBC, you probably know Don Luskin. He is a frequent guest there, and generally seems to be in full agreement with Kudlow’s views on the economy. Remember Kudlow’s tag line: We believe that free market capitalism is the best path to prosperity.” Kudlow opens every episode of his show with it.

Luskin himself is known as a Republican with libertarian leanings, who has often written for the conservative National Review Online. As such, he has consistently been one of the most emphatic defenders of free trade. This article carries the subtitle The benefits of free trade are settled science. (Although that won’t stop the deniers.)” and summarizes his views. In another piece, he absolutely eviscerates conservative commentator Lou Dobbs’ protectionst view on international trade.

So it was to my utter amazement, that Don Luskin basically did a screeching 180° turn on international trade this week. Everything he believed until now (“Free trade is a human right.”, Trade can make everyone better off.“) was apparently wrong. Free trade is a dumb idea, and Lou Dobbs must have been right all along. Luskin doesn’t tell us what brought about the total reversal of his political and economic beliefs. The argument that he makes now, is substantially the same one he derided years ago, when Dobbs put it it forward. Luskin offers no acknowledgement for his change of heart, nor any apology to Lou Dobbs.

With that out of the way, I want to take a look at some of the facts” that Luskin asserts:

Trump’s Pro-Growth Path to Victory, by Don Luskin, from wsj.com, 6/20/2016Trump’s Pro-Growth Path to Victory, by Don Luskin, from wsj.com, 6/20/2016

Luskin himself has, in his older articles, characterized the beneficial nature of international trade as axiomatic”, a position he now ascribes to the sophisticates” whom he now knows, of course, to be dead wrong. Leaving aside the interesting switch of sides, this just betrays a continued misunderstanding of what that term axiomatic” actually means. Axioms are assertions that are presupposed to be true and foundational within a given theory; they can neither be proven by the model they give rise to, nor can they be disproven, or broken”, by it. But the benefits of free trade obviously can, and must, be tested by empirical investigation. They either exist, or they don’t. Or they exist sometimes, but not at others. Ipso facto, these benefits are not axiomatic. No reasonable economic theory would treat them as such. The reason the sophisticates” view international trade as beneficial is not because it is economic gospel, but because economic practice provides evidence for it.

Next, while not stated explicitly, Luskin creates the impression that China’s acceptance into the WTO represents an American policy mistake, which Mr Trump is getting ready to remedy. But the WTO is an organization with 162 member countries. Accession is governed by complex, multi-national procedures and negotiations, and whether any U.S. government could have kept China from becoming a member is questionable.

In any case, Luskin has us believe that U.S./China trade growth exploded since 2001. And, I admit, it feels right. It’s truthy. It’s also completely false. Since Luskin doesn’t show any data, let me do the honors: The following chart is based on Federal Reserve Bank data accessed through Quandl:

Annual Change in U.S. Imports of Goods from China, Mainland, Customs BasisAnnual Change in U.S. Imports of Goods from China, Mainland, Customs Basis

As the chart illustrates, the growth of Chinese imports to the U.S. has actually declined since China became a WTO member. The average growth rate before was 23%, afterwards it moderated to 13%. In 2015, it actually turned negative, a trend that continued in Q1, 2016. So, while China certainly has a large trade surplus with the U.S., and while it absolutely does engage in selective trade protectionism, and while the legal protections for American investors and businesses in China leave much to be desired, it is nonsense to claim that the WTO has caused an axiom-breaking” acceleration of import growth from China to the United States. If anything, the opposite is true: The engagement of China in WTO sponsored trade negotiations appears to have slowed Chinese export growth.

Trump’s Pro-Growth Path to Victory, by Don Luskin, from wsj.com, 6/20/2016.Trump’s Pro-Growth Path to Victory, by Don Luskin, from wsj.com, 6/20/2016.

China acceded to the WTO in mid-December, 2001. So, in terms of Luskin’s narrative, the last good year” for U.S. GDP growth should really be 2001, not 2000 as Mr. Luskin writes. But this would get in the way of a good story: You see, 2001 was a lousy year, with the dotcom crash and 9/11 weighing on the economy. Per capita GDP growth was slightly negative. Including it in the good old days” prior to the China/WTO hookup would weaken the argument.

But, whether measured from 2000 or from 2001 forward, the primary reason that growth was slow in the last decade and a half, is the simple fact that this period includes the Great Recession. We suffered through the worst economic pull-back in more than 80 years. Growth peaked in 2006, when the real estate boom was still in full swing. In 2007 the real estate market was already past its peak, and per capita GDP growth was below 1%. In 2008 per capita GDP declined by 1.2% and in 2009 it declined by 3.6%. These numbers, by the way, are also retrieved from Quandl, originally compiled by the OECD. Was the Great Recession brought on by China? Of course not. If anything, a Chinese domestic stimulus program kicked off in 2009 helped end the global malaise. 2011 was another bad year in the US: Per capita GDP growth was 0.8%. But I would submit that it had a lot more to do with the threat of a Government shutdown, and the specter of a default by the U.S. treasury as a consequence of a deadlocked Congress, than it did with imports from China.

While Mr. Luskin’s article fails to uncover any evidence of a jobs crisis in the U.S., it’s an indisputable fact that GDP growth has been muted, recently. Excluding 2008 and 2009 (the Great Recession), per capita GDP rose by 1.5% on average since 2002, vs. 2.3% during the 10 years prior. That’s not as dramatic a fall-off as Mr. Luskin makes it out to be, but it’s nontheless significant. But there’s no evidence presented in the Luskin article to convince me that China (or Mexico) is to blame for this. In fact I have another take on that, and I will get to it in the next section:

Trump’s Pro-Growth Path to Victory, by Don Luskin, from wsj.com, 6/20/2016Trump’s Pro-Growth Path to Victory, by Don Luskin, from wsj.com, 6/20/2016

This image of the displaced, disillusioned cast-off ex-employee who can’t find a new job and eventually gives up is so pervasive in the media, it’s impossible to ignore. And yet, I don’t believe that it reflects the reality of the overall US job market.

First, all labor market statistics simply point in a different direction. During the Great Recession, the number of employed people in the U.S. fell by about 8 million. Since then, however, the economy brought about 13 million people back into jobs. The jobless rate is now at 4.7%, the lowest level since November, 2007, and less than half of its recession peak. While it was briefly lower during the dotcom boom and again during the real estate mania of the early 2000s, it is below any level achieved between 1973 and 1997. The number of job openings has been rising in tandem with the new positions. The number of unemployed people per job opening is at cycle lows. All of this is simply inconsistent with the desperate picture Luskin paints.

As for the labor force participation rate, it dropped most significantly among the 16-24 year-old age group. This is consistent with the fact that during the 20 year period ending in 2014 the college enrollment rate for that age group has increased by more than 5 percentage points. If the stereotype of a severaly distressed job market were true, then the labor participation rate should be lowest/dropping among the groups most vulnerable to permanent job loss, namely aging employees. Aging job seekers offer the shortest payback period for any job training, they are more likely to suffer health issues, more likely to lack important computer skills, and given that they are eligible to enter retirement, some of them are bound to choose it over accepting a new job at lower pay. And yet, none of this is happening. Labor force participation is actually rising for all age groups above 50. The statistics are here.

In fact, the trend of people stretching their work years may have a different reason, which has nothing to do with China, but is actually troubling and may explain the subpar growth over the past few years: As Gen-X’ers and Baby Boomers age, they are finding that their savings are insufficient to allow them to retire at the age they otherwise would have chosen to do so. The phenomenon was described a while back in the Atlantic: Real estate ownership among people aged 35-44 hit a peak in 2005, as they were the 1st time buyers getting sucked in by easy credit to subprime borrowers and record low interest rates at the time. Consequently, the real estate collapse of the following years hit them disproportionally. Their home ownership rates have dropped far below historical levels, as their savings were wiped out by declining home prices and their credit was destroyed.

Home ownership rates over the past 20 years, from theAtlantic.comHome ownership rates over the past 20 years, from theAtlantic.com

This is the group that is now in their mid-40s to mid-50s. It is not surprising that they are participating in the labor force at higher than normal rates, as they are still rebuilding their finances. This is a group that would normally be in their prime spending years, but instead they are deleveraging their finances (see chart, below). And it is the reason why the Federal Reserve Bank’s low/zero interest rate policy was not working as intended. People are not interested in adding to their debt, if their finances are already too stretched to meet their retirement needs. What they would really need, is an investment alternative that combines an acceptable risk profile with a significant return, to allow them to (re)build their wealth. But that’s what the so-called accommodative Federal Reserve policy took away. It pushed savers to either accept a lot more risk than they wanted, or to save a much higher percentage of their income. Given past experience risk tolerance was low, and that meant the deleveraging went on longer than expected. This increase in household savings has, I believe, more to do with the low per capita GDP growth since the Great Recession, than all the imports from China.

Household Debt Service Ratio, from fred.stlouisfed.orgHousehold Debt Service Ratio, from fred.stlouisfed.org

Fortunately, it appears that the household deleveraging has finally reached a trough, and if I am right, we will see higher per capita GDP growth in the future.

Trump’s Pro-Growth Path to Victory, by Don Luskin, from wsj.com, 6/20/2016Trump’s Pro-Growth Path to Victory, by Don Luskin, from wsj.com, 6/20/2016

The paper that Mr. Luskin links to in his article is protected by a paywall and I wasn’t in a spending mood. But I googled Mr. Autor, and found this page on MITs web site, offering a Q&A with Mr. Autor on just the topic at hand. Asked directly, what policies can combat [income] inequality, Mr. Autor mentions

Revoking trade deals with China or Mexico didn’t make the list.

There are absolutely people in the U.S. whose lives are impacted by the declining value of low-skilled labor. Many have lost their jobs, and many more have had to accept substantial pay cuts to remain competitive in the new environment. I don’t want to minimize their plight. They bear the burden of adjusting to the new environment and this burden needs to be distributed. And by that, I don’t just mean offering unemployment assistance. People don’t want handouts instead of work, they need meaningful jobs in their lives. The true political failure of the past decades was not to embrace free trade, but the failure to raise the competitiveness of the American workforce through adequate investments in science, education, and infrastructure.

The last person standing in low-skilled repetitive assembly jobs will likely not be American, or Chinese, or Mexican. It will not be a person at all. Machines will win this race. Robots will assemble cars, furniture and iPhones faster and more reliably than any human ever could. They will do it 24 hours per day, without taking breaks. Their performance will keep improving and their cost will keep coming down. Along the way, the marginal value of low-skilled labor will keep decreasing. As a society, the way to win this race, is by not running it. Trying to wrest the baton from the Chinese makes no sense.

As an aside, I absolutely do agree with Mr. Luskin’s point on the deleterious effects of polarization of Congress. The more ideologically rigid our representatives are, the less room there is for productive compromise, and gridlock can become dangerous, as we saw in 2011. However, unlike Mr Luskin, I don’t blame regions most affected by trade with China” for this polarization. I blame gerrymandering. A decade of this practice has rendered the overwhelming majority of Congressional seats largely uncontested in general elections. This leaves incumbents to worry more about potential primary election challengers, than about challengers from the other party. And the way to defeat primary challengers, is obviously to appeal to the base” by pandering to the most extreme views. Take a look at this disturbing article in the Washington Post, and you will see how gerrymandering works, why it’s unfair, and that it’s a fact of politics.

Trump’s Pro-Growth Path to Victory, by Don Luskin, from wsj.com, 6/20/2016Trump’s Pro-Growth Path to Victory, by Don Luskin, from wsj.com, 6/20/2016

It’s true that the US statutory corporate income tax rate is the highest in the developed world, when looking at this table from the OECD. But the notion that the lack of business investment in the US economy is due to offshore funds being unavailable in the US, is laughable: The companies that have large sums of offshore funds, Google, Apple, Facebook and the like, also have access to billions of dollars in onshore liquidity. The Fed has been pushing US businesses for years to invest more with zero-interest rate policy. Lack of liquidity is simply not a problem, right now. The real reason why companies are not investing more in the U.S. is that they don’t see enough investment opportunities which clear their internal hurdle rates.

But that’s not even the worst of it. The bigger issue with Trump’s corporate tax argument is its confusion of statutory tax rates (the published official headline rate) with effective tax rates (those actually paid by businesses after taking full advantage of R&D tax credits, bonus depreciations, and other tax minimizations available to them). So how high is the effective rate? Well, for about two thirds of American corporations, it’s zero. You read that right. Two thirds of American corporations don’t have any federal income tax liability. Let’s leave those aside, since it’s really hard to argue that $0 of taxes is too much to pay. Focusing instead purely on those corporations that are both large and profitable (“Joe the Plumber” doesn’t use the Double Irish, Dutch Sandwich strategy to dodge the IRS, anyway) the effective tax rate is still only 14%, i.e. 1% less than the rate called for under the Trump plan and less than the statutory rate in every OECD country, with the exception of Ireland. This is based on a study by the congressional watchdog GAO.

That said, I’d still be in favor of bringing the statutory and effective tax rates into closer agreement by simplifying the tax code and plugging the available loopholes. I doubt that this would do much for job growth, but more transparency and less bureaucracy are always a good thing, all else being equal. I am not holding my breath, though. Bipartisan efforts have been made in that direction, but nothing ever seems to come of them. And even if one day such a simplified tax regime were enacted, the former beneficiaries would without question launch a massive lobbying effort to reinstate their favorite loopholes.

The reason I am pointing out Don Luskin’s tortured 180° logical turn, is that he represents a trend toward political populism that troubles me. Both on the left and on the right, there is a lot of derision aimed at the elites”, the sophisticates”, fat cats”, or Wall Street”. Those are dog-whistle terms. They mean nothing, except to tell a discontent audience: You’re not happy with the way your life is going, and you don’t know what went wrong. But you’re angry, and you need to blame someone. We get it! We’re on your side!” What’s lost in the debate, are the facts. It’s always easier to pander to base instincts of the poorly informed, than to illuminate complex issues and to present real solutions.

I don’t want to seem like a social darwinist, who advocates for a policy that may have a positive effect in the aggregate, but leaves

June 25, 2016 at 8:12pm · random thought · politics · economics · Luskin


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