Kerry drinks the trade Kool-Aid, but trade agreements do NOT create jobs

Secretary of State John Kerry bought into the hype around trade in a speech this week in Paris when he claimed that the proposed U.S.–EU trade and investment agreement could help Europe emerge from the economic crisis. Kerry claimed that the proposed U.S.–EU trade agreement “may be one of the best ways of helping Europe to break out of this cycle [and] have growth.” As I’ve explained before, trade agreements do not create jobs. This is not some proprietary EPI view on trade – it is a standard view straight out of economics text books.

The issue is simple: it is trade balances—the net of exports and imports—that can affect jobs. Unless trade agreements promise to reduce our too-high trade deficit, they will have no positive effect on jobs. Even worse, past trade agreements have actually been associated with larger trade deficits in their aftermath.

This is mainstream (neo-classical) trade theory, as explained by Paul Krugman in “Trade Does Not Equal Jobs.” Responding (in 2010) specifically to claims that the Korea–U.S. trade agreement could be a driver of recovery, he pointed out that in macroeconomic terms, the United Sates had too little spending on domestically-produced goods and services, with spending defined by:

Y = C + I + G + X –M

Where C is consumer spending, I is investment spending, G is government purchases of goods and services, X is exports and M is imports. He noted that while trade agreements lead to higher X, they also lead to higher M. Exports support demand for domestically produced goods, so higher X increases employment. However, the growth of imports reduces demand for domestically produced goods, which reduces domestic employment. Professor Krugman asserted that “on average, they’re a wash.”

So, a trade and investment agreement between the United States and the European Union is not going to be the salvation for either the U.S. or the EU economy. The roots of the EU’s economic problems, as in the U.S., lie in the global financial crisis and a string of related housing and banking crises that began in 2007. But the similarities end there. The U.S. responded to the crisis with a strong fiscal stimulus in the American Recovery and Reinvestment Act of 2008. Although the initial EU response also involved some stimulus, Europeans have embraced fiscal austerity for the past several years and the results have been shockingly bad. In January, average unemployment in the Euro area reached 11.9 percent, vs. 7.9 percent in the United States (U.S. unemployment declined to 7.7% in February).

There are only three ways out of the crisis in Europe, and none of them involves a trade agreement with the United States. The hardest hit areas in the south of Europe are Greece and Spain, (where unemployment now exceeds 26 percent), Portugal (17.6 percent), Italy (11.7 percent), and Cyprus (14.7 percent), the most recent crisis victim where unemployment could double in the next year. These countries suffer from fundamental competitiveness problems that result from a decade of price and wage growth fueled by capital inflows from Germany and other wealthy, surplus nations. The key question for the Southern countries is how they are going to grow and recover in the medium term—over the next decade. As EPI’s Josh Bivens has explained, “A key barrier to a country like Greece achieving growth in the coming decade is the lack of an independent monetary and exchange-rate policy.” Exit from the Euro would allow Europe’s southern countries to recover much more quickly than if they remained in the Euro area, particular if the EU maintains its commitment to austerity in the face of massive and widespread unemployment.

The other two choices for a sustained recovery in Europe would require substantial and continuing macro-economic stimulus. The first would require Europe to follow the model of the U.S. Federal Reserve Bank and engage in much more expansionary monetary policy. Although the European Central Bank has extended crisis financing to Cyprus, Greece and other countries, it remains committed to very restrictive, overall monetary policies. The other alternative is for Germany and other wealthy countries in the North to pursue expansionary fiscal policy, in effect lifting poorer countries in the south out of recession. However, expansionary monetary and fiscal policies have both been ruled out by the EU, which is thoroughly committed to austerity. Thus, we are left with exit from the Euro as the only viable path to a relatively quick recovery for much of southern Europe. As Paul Krugman has pointed out repeatedly in the past, the Euro model was flawed from the beginning, in part because the Euro area lacks a central government.

Europe’s problems are largely internal, and they cannot be solved by a trade agreement with the U.S.—at least not in a way that would serve the interests of working Americans. To create the millions of jobs Europe needs through trade with the US would require a massive increase in European exports and in the U.S. trade deficit. This would in turn mean the loss of millions of jobs here in the U.S. as imported goods replaced domestically manufactured competitors.

Efforts to negotiate new trade agreements are divisive and divert attention from the core economic problem that confronts both the United States and the European Union: the continuing need for fiscal and monetary stimulus until excess unemployment is eliminated. Premature efforts to reduce deficits in both Europe (through austerity programs) and in the United States (through sequestration and additional deficit cutting now under discussion) simply increase the threat that unemployment will rise in both areas. Secretary Kerry’s claims aside, trade won’t help create jobs in the U.S. or the EU.

  • Michael Flox

    Quite right. Trade agreements with the EU are unlikely to benefit either party. Both are similarly depressed by trade with low wage countries so further trade openness may hinder rather than help.

    I have noticed that the exact mechanism by which globalization may damage an economy is rarely explained. So here is the short version, as I understand it.

    First the scenario: we look at trade between a capital rich country (Home) and a capital poor country (Foreign). Assume that Foreign can produce at near the efficiency of Home, capital is internationally mobile and that the capital/labor ratios are far apart. What does theory tell us will happen?

    Firstly, price signals will drive both economies to restructure. Home will move toward the production of more capital intensive goods and Foreign will focus on labour intensive production. Both economies can expect to benefit from the transition. The move to capital intensive production at Home will lower the nominal wage. However, it is likely that the real wage will rise at Home through the income effect of a fall in prices. So far so good.

    So what is the problem?

    Problem is, this is only part of the story. With capital/labor ratios far apart, trade in goods cannot equalize factor prices. In particular, wages will be higher and rents lower at Home than in Foreign. What will follow is a progressive transfer of productive capital from Home to Foreign by rentiers (the owners of capital) in search of higher rents.

    International capital transfer is not benign. In a static model, as productive capital is transferred from Home to Foreign, the real wage at Home falls as labor has less capital to work with. Meanwhile, rentier real income increases both from the increased rent from Foreign as well as an increase in rents at Home (capital is now more scarce there). This leads to a fall in the labor share of national income and a corresponding increase in the rentier share. Inequality increases as a result. The production possibility frontier (ppf) at Home shrinks (economy contracts) and the ppf of Foreign grows (economy expands). Labor productivity falls in line with the reduction in productive capital.

    In a dynamic model, we see wage stagnation, a reduction in the labor share of national income, slower output growth, reduced labor productivity and growing inequality. Expect also to see high growth in income at the top of the income scale reflecting the higher returns to rentiers – the big winners in this model. Structural unemployment can be expected to rise. Mainly because the constantly shifting capital/labor ratios between Home and Foreign mean that trade cannot find an equilibrium. Consequently, there is continual restructuring via trade.

    Anyone recognize any of this?

    Computer simulations of this scenario are particularly worrying. It appears that capital transfer is a stronger driver of global gains than trade. It follows that most restructuring will occur via damaging capital transfer rather than the relatively benign goods trade.

    At any rate, this is what theory says will happen. It is strongly supported both by mathematical and computer modelling. It is, therefore, somewhat bizarre that so many economists reject their own theory and continue to extol the benefits of globalization with almost religious zeal.