From: Robert E. Scott (Economic Policy Institute)

Submitted via email to transition team

For the U.S. economy to “Build Back Better” after the COVID-19 pandemic, the Biden-Harris administration must emphasize job creation in America’s manufacturing and construction sectors. Rebuilding U.S. manufacturing industries, and upgrading domestic infrastructure, can generate millions of high-wage jobs and reduce income inequality while also addressing racial injustice.

There are three key efforts needed to rebuild manufacturing and the U.S. economy:

1. Realign the U.S. dollar and address overseas currency manipulation.
2. Invest in infrastructure and renewable energy.
3. Rebalance U.S. trade.

PRIORITY ONE: Realign the dollar through a competitive currency policy

The single most effective tool for rebalancing trade is the adoption of a competitive dollar policy. The real value of the U.S. dollar—which has gained nearly 21% since mid-2014 alone—needs to fall by 25% to 30% in order to rebalance trade, according recent research.1 Dollar realignment would stimulate rapid export growth, resulting in surging domestic investment and job creation even as it also reduced import growth.

However, there are two reasons the dollar is currently overvalued.

The first is currency manipulation, which is the result of years of foreign central bank purchases of U.S. dollar assets. This has driven up demand for the dollar and helped to keep it overvalued. This currency manipulation can be addressed through government sanctions and intervention.

More recently, however, the extent of currency manipulation has decreased. Instead, during the last five years, excess private demand for U.S. assets from overseas investors has caused the dollar’s value to soar. This second reason, currency misalignment, can be addressed through market interventions.

Implementing a competitive dollar policy will stimulate rapid export growth, resulting in surging domestic investment and job creation, while limiting import growth. Eliminating America’s $864 billion annual goods trade deficit could create between 3.5 million and 6.6 million jobs over the next four years, including at least 1.4 million good manufacturing jobs.

Immediate steps for the new administration

• The next Treasury report on Foreign Exchange Policies of major trading partners (due April 2021) should label all countries meeting the criteria identified by Christopher Collins and Joseph Gagnon of the Peterson Institute for International Economics (PIIE) as currency manipulators. In addition, countries maintaining very large stocks of foreign exchange reserves—which also have a depressive effect on the values of their respective currencies—should also be labeled as currency manipulators (as explained by Dean Baker, senior economist with the Center for Economic and Policy Research). This includes China and Japan.
• In January, the president should immediately announce the suspension of tax waivers on foreign government holdings of U.S. financial assets in the United States, as proposed regarding China by PIIE’s Joseph Gagnon and Gary Hufbauer in 2011. This will also discourage foreign government holdings of U.S. assets and put downward pressure on the dollar. The U.S. should also deliver notice of canceling tax treaties with selected foreign governments. Taxes should then be withheld on income earned on Treasurys and other government assets, at an initial tax rate of roughly 30%. Significantly, other countries that should be subject to this taxation continue to hold huge foreign exchange reserves, most in dollar assets. These countries include China ($3.1 trillion), Japan ($1.4 trillion), Singapore ($500 billion), and South Korea, ($400 billion).
• The president should use his executive authority under the International Emergency Economic Powers Act (IEEPA) to impose a tax on foreign government owned or controlled holdings of U.S. financial assets as soon as possible. Announcing his intent to do so when canceling tax treaties would put currency manipulators on notice that the United States is serious about stopping such practices. The net of these taxes could be widened as needed, since many currency manipulators have stashed large amounts of their reserves in additional Sovereign Wealth Funds, including China ($1.4 trillion), and Singapore ($900 billion).2
• Taxation of foreign government holdings of U.S. assets would discourage currency manipulation. However, government demand for these assets may not be influenced by taxes on the income the assets earned. Therefore, the Commerce Department and the U.S. trade representative should continue to pursue currency countervailing duty (CVD) cases against individual products and countries. Such cases send a “shot across the bow” to currency manipulators in the absence of more comprehensive measures.
• The Biden administration should initiate offsetting purchases of the foreign assets of those countries found to be engaging in currency manipulation, purchases known as countervailing currency intervention (CCI). Overall, such purchases are the most effective tool available to remedy currency manipulation. The use of Exchange Stabilization Fund (ESF) assets by the Treasury and the Federal Reserve to engage in CCI was proposed by Bergsten and Gagnon in 2017. Substantial increases in ESF assets are required to engage in significant CCI intervention, and will require congressional authorization.
• The Biden administration must also address market-driven currency misalignment. It should do so by empowering the Federal Reserve to establish an exchange rate management policy designed to achieve and maintain balanced trade. This can be done by working with Congress to implement the bipartisan legislation proposed by Senators Tammy Baldwin and Josh Hawley in their “Competitive Dollar for Jobs and Prosperity Act” (S. 2357). The measure would impose a “Market Access Charge” on new foreign investor purchases of U.S. assets. It would also authorize a substantial increase in resources for the Treasury Exchange Stabilization Fund, needed to fight government-backed currency manipulation.
• Along these lines, the administration should also impose an initial emergency access charge, exactly as defined in S. 2357, under the IEEPA.

PRIORITY TWO: Rebuild U.S. infrastructure and begin the clean energy transition

The Biden-Harris plan for investments in infrastructure and climate programs, with a full “Buy America” commitment, can supercharge recovery for the U.S. economy. A $2 trillion, four-year plan of investments in these sectors, along the lines of that announced by President-elect Biden in July, would support between 3.4 million and 6.3 million total jobs. Nearly half (45.7%) of the 3.4 million direct and indirect jobs supported would be in good-paying manufacturing and construction sectors.

Immediate steps for the new administration and Congress

• Immediately revive and expand plans for the Moving Forward Act (MFA), an infrastructure bill that was developed by the House Transportation and Infrastructure Committee, and passed by the House on July 1, 2020.
• Develop an expanded plan for renewal of transportation infrastructure legislation, which can attract bipartisan support. To the extent possible, extensions to the MFA should incorporate Biden-plan goals for expanded U.S. auto production, investments in zero-emission public transit, building and housing investments, and research and development.
• Maximize employment and economic impacts as part of the recovery plan by ensuring that the MFA is entirely debt-financed until the economy has fully recovered (with the exception of current revenues in the transportation trust fund).
• Do not raise additional revenues to fund infrastructure investments until and unless we meet two criteria: estimates of total nonfarm employment exceed 152.5 million (the level reached in February 2020) and interest rates on short-term treasury securities exceed 3.5% on a sustained basis. Where possible, user fees should be relied on to fund public investments in infrastructure, as growing reliance on efficient and clean transportation sources will erode transport fuel tax receipts over time.
• To the extent possible, use the infrastructure bill to fund climate-friendly public investment (e.g., electrical grid upgrades, battery development/capacity, R&D for smart grids, etc.).
• Develop separate legislation to support popular incentives:, such as incentives for hybrid cars, e-cars, wind turbines, and solar power to help utilities meet state renewable guidelines; residential and commercial incentives for weatherization; incentives for appliance efficiency upgrades; consumer solar; renewable conversions for schools and public buildings; and, investments in innovation, agriculture, and conservation.

PRIORITY 3: Pursue trade and industrial policies that will rebalance U.S. trade

More than three decades of globalization have devastated U.S. manufacturing and the American working class. Trade-related job losses are just the tip of the iceberg. Globalization has also reduced median wages by roughly $2,000 per year for roughly 100 million working-class Americans. Joe Biden recognized these problems when he promised the United Steelworkers in May that he would not consider any new trade agreements “until we’ve made major investments here at home, in our workers and our communities.”

Immediate steps for the next administration and Congress

• Establish a freeze on negotiating new trade agreements until the dollar is realigned and the U.S. goods trade deficit has been erased.
• Ensure that trade policy does not privilege corporate interests over workers. The proliferation of Investor State Dispute Settlement (ISDS) clauses inserted into international trade and investment agreements has created a global system of special courts exempt from any judicial appeal or review. These courts allow multinational companies to sue governments for any potential infringement on future profits, as documented by Todd Tucker in his book Judge Knot. These agreements have cast a pall over the ability of governments to regulate in their own legal and national interest. The U.S. must negotiate the elimination of ISDS clauses from most or all trade deals.
• Promote welfare-enhancing multilateral agreements negotiated by the USTR in areas such as labor rights and environmental standards while also rejoining the Paris Climate Accord.
• Pursue multilateral rules to address major international challenges, such as greenhouse gas (GHG) emissions. The U.S. should pursue binding agreements to reduce GHG emissions, especially with China—the world’s largest and most rapidly growing GHG emitter—earlier than called for in the current Paris Climate Accord.
• Ensure that the USTR works with the Commerce Department to aggressively combat overcapacity in steel, glass, paper, solar panels, and a host of other industries distorted by massive state subsidies and other illegal trade and industrial policies.
• Maintain Section 232 steel and aluminum tariffs until tariffs can be replaced by more comprehensive, global limits on unfair trade in these products. One model is to negotiate global tariff agreements to “wall off” products from countries with excess capacity. At present, overcapacity is widespread in many exporting countries, including Japan, Korea, Brazil, Turkey, and China.
• Eliminate tax evasion, corporate inversions, and tax havens that allow multinational enterprises to avoid corporate taxation. The Tax Cuts and Jobs Act of 2017 (TCJA) established new, lower tax rates for foreign investment by multinational corporations; this encouraged further offshoring. Consider adopting sales factor apportionment (SFA) to fully tax profits on all corporate sales in the United States, regardless of where production takes place or where corporations are domiciled. SFA techniques have been used for many years by states to fairly allocate taxation of corporate profits.
• Don’t tax U.S. consumers to protect the intellectual property rights of U.S. multinationals in China. This simply encourages more offshoring of U.S. jobs and factories. As Dean Baker has explained, stronger patent and copyright protections have transferred roughly $1 trillion annually from workers and consumers to corporations and the richest 10 percent.
• Strengthen “Buy America” requirements for all federal, state, and local purchases, as supported by the Alliance for American Manufacturing’s industrial policy proposals. Buy America requirements can greatly enhance the job creation and domestic output of public investments. Historically, Buy America preferences have been loosely enforced.
• Develop new standards and methods to maximize domestic job creation associated with any recovery act, clean energy, or infrastructure expenditures. One simple step would be to require bidders for large government contracts to submit job impact assessments, and to document these outcomes in post-project assessments.
• Establish a strong, whole-of-government program to reshore critical materials production. This includes bringing back to the United States the production of everything from pharmaceuticals to medical equipment to rare earth metals.
• Expand job training and workforce development programs, and consider adopting “flexicurity”-style programs—modeled after those developed in Denmark and other European countries—to support growth and renewal of America’s aging industrial workforce.
• Revamp America’s unemployment insurance (UI) system. Effective UI systems are industrial policies. Jobs not destroyed are much cheaper to restart than those that have been entirely eliminated through short-sighted labor policies. The COVID-19 crisis has demonstrated that America’s UI system is broken and in desperate need of repair. In contrast, many European governments have paid firms to keep workers on the payroll, so that when employers emerge from a downturn, they would be intact.
• Greatly expand R&D and Cooperative Extension Services. Fund the proposal by Simon Johnson and Jonathan Gruber in their book Jump Starting America to identify metropolitan areas that could be hubs of science and technology. Designate them to receive large-scale science and tech spending using the tripartite federal/state and local/private sector investment model to create dozens of national centers of manufacturing research and excellence. In addition, the Hollings Manufacturing Extension Partnerships, which have been targeted for extinction in the Trump administration, should be substantially expanded.
• Substantially increase domestic content requirements and require jobs impact statements by the US Export-Import Bank in its Buy America policies, which have been watered down beyond all recognition. These standards must be tightened and reformed.
• Reevaluate the costs and benefits of foreign direct investment in the United States. So-called “insourcing” (foreign investment in the United States) is dominated by foreign acquisition of U.S. companies, such as Lenovo’s purchase of IBM’s PC division in 2005. Such purchases have eliminated millions of U.S. jobs over the past three decades through layoffs, plant closures, and sell-offs. Furthermore, foreign multinational companies (MNCs) often buy domestic firms simply to distribute their own exported products. As a result, foreign MNCs are responsible for a large and growing share of U.S. trade deficits. Adding insult to injury, state and local governments are often involved in a race to the bottom for such investments, competing to offer tax abatements and infrastructure subsidies to attract foreign investors. The United States should consider banning tax abatements and infrastructure and other subsidies to foreign investors unless entities seeking subsidies can prove that they are effectively creating jobs.

Endnotes

1. Fred Bergsten, “Time for a Plaza-II?” in International Monetary Cooperation: Lessons from the Plaza Accord after Thirty Years, eds. (Washington, D.C.: Peterson Institute for International Economics, 2016), Table 14-5. Bergsten estimated that in order to rebalance U.S. trade, the real value of the U.S. dollar must fall by 26.5% on a trade-weighted basis against the currencies of major surplus countries, including the Euro Area countries, China, and Japan. In their 2020 working paper for the Coalition for a Prosperous America (“Modeling the Effect of the Market Access Charge on Exchange Rates, Interest Rates and the U.S. Economy”), Steven Byers and Jeff Ferry, using a macroeconomic model from the Federal Reserve, estimated that the dollar needs to fall by 27% to rebalance U.S. trade.

2. These funds include China Investment Corporation ($1.046 trillion) and the National Council Social Security Fund ($324 billion), and from Singapore, GIC Private Limited ($453 billion) and Temasek Holdings ($417 billion) according to the Sovereign Wealth Fund Institute (data downloaded from SWFI November 22, 2020).

Figure A

Trade deficits and jobs losses with China continued to grow during the first two years of the Trump administration—despite the administration’s heated rhetoric and imposition of tariffs. The U.S. trade deficit with China rose from $347 billion in 2016 to $420 billion in 2018, an increase of 21.0%. U.S. jobs displaced by those China trade deficits increased from nearly 3.0 million jobs lost in 2016 to 3.7 million jobs lost in 2018, an increase of more than 700,000 jobs lost or displaced in the first two years of the Trump administration.

Although the bilateral trade deficit with China has declined in 2019 (through November), the overall U.S. trade deficit in non-oil goods, which is dominated by trade in manufactured and farm products, has continued to increase, suggesting that trade diversion has grown in importance. These are important topics for future research.

While growing exports support some American jobs, growing imports eliminate existing jobs and prevent new job creation—as imports displace goods that otherwise would have been made in the United States by domestic workers. As a result, growing trade deficits result in increasing U.S. job losses. The top half of Table 1 shows just how much the trade deficit has grown: The U.S. trade deficit with China increased from $83.0 billion in 2001 to $420 billion in 2018. While U.S. exports to China increased in this period, growing exports were overwhelmed by the massive growth of imports from China, which increased by $437 billion in this period. 

U.S. trade deficits with China displaced 956,700 jobs in 2001 when China entered the World Trade Organization (WTO) and the number of jobs lost due to the trade deficit increased to 4,661,400 in 2018, leading to a net 3.7 million jobs lost, as shown in the bottom half of Table 1.

Table 1

The single most important cause of growing trade deficits with China is its history of currency manipulation and dollar misalignment that has persisted for more than two decades. And yet, the reported deal will provide extremely unfavorable terms for the United States on exchange rates, essentially locking in the current exchange rate. This deal is a step backwards on currency manipulation and misalignment.

Despite all of the tariffs and other restrictions imposed on China trade by the Trump administration, the bilateral trade deficit continued to grow between 2016 and 2018, resulting in the loss of more than 700,000 U.S. job opportunities. It remains to be seen whether bilateral and global trade balances improve in the wake of the phase one trade agreement with China, and future trade deals to come. But the phase one trade deal does not appear to address the key structural concerns with the long-term imbalance in trade between the United States and China.

I am pleased to enter my comments in support of the proposed modification of CVD regulations to allow Commerce to treat currency undervaluation as a countervailable subsidy subject to CVD regulations, subject to the comments and issues noted below.1

The Economic Policy Institute (EPI) is a nonprofit, nonpartisan think tank located in Washington, D.C. I am a Senior Economist with EPI, and am the Director of Trade and Manufacturing Policy Research. There are a number of issues that arise with respect to the measurement of equilibrium currency values and how they should be assessed that I wish to note, based on my review of the draft regulations.

Currency manipulation and currency misalignment are distinct, but closely related, problems

Currency manipulation consists of government purchases and sales of foreign exchange reserves that are designed to persistently depress the value of the domestic currency for commercial advantage. Currency manipulation by about 20 countries—including China, Japan, and a number of other countries in Asia and Europe—resulted in large, persistent trade and current account surpluses for those countries, especially during the “Decade of Manipulation” from 2003–2013.2 Currency manipulation has distorted global trade and capital flows, to a greater or lesser degree, for much of the past two decades.

Since 2014, the central governments of China and other currency manipulators have begun to reduce their purchases of United States and other foreign exchange reserve securities. But the dollar is still rising, thanks to overseas investors now pouring huge amounts of private capital into bonds, stocks, and controlling interests in American companies, as well as real estate, bank loans, bank deposits, and currency.3 It is important to note that some of these recent, “private” purchases come from quasi-state actors or state-influenced institutions (such as social security trust funds in Japan and Korea, and private insurance funds in Taiwan).

These private purchases have driven up the real value of the dollar by more than 20 percent since mid-2014, continuing the trend of making American-made goods less competitive globally. As a result, the Congressional Budget Office predicts that America’s trade deficit is on track to exceed $700 billion by 2021, a full 3 percent of gross domestic product.4

Thus, the dollar is currently “overvalued” relative to the trade-balancing, equilibrium exchange rate. I assume here that the equilibrium exchange rate is the set of exchange rates that would produce balanced trade for the United States and some or all of its major trading partners.

The trade-balancing, equilibrium exchange rate concept is completely distinct from that of “currency manipulation,” as defined by Treasury, the IMF, and other agencies. Currency manipulation refers to government intervention in foreign exchange markets for the purpose of gaining commercial advantage. The CVD regulations as published, and under discussion here, refer only to the concept of a “subsidy in the form of currency undervaluation,” without direct reference to currency manipulation as a cause of that undervaluation. Thus, my remarks will focus only on the concept and estimation of equilibrium exchange rates.

Currency undervaluation can result from currency manipulation, from excess private capital inflows, or both. These comments are concerned only with addressing the consequences of undervaluation.

The definition and determination of equilibrium exchange rates should be reconsidered

The draft regulations refer to various definitions of the equilibrium “real effective exchange rate” (REER), including estimates from the IMF and from the Peterson Institute. The particular Peterson paper—referred to in footnote 28 of the Commerce Department notice of proceeding5—is a 2017 estimate of “fundamental equilibrium exchange rates” by William R. Cline.6 In these comments, I will distinguish between the particular results that Cline obtained in his 2017 paper using the model that he developed, in a series of related papers, with his Peterson Institute colleague John Williamson.7 That model (hereinafter referred to as the “Cline model”) has been used to estimate equilibrium exchange rates under a number of different assumptions about data inputs and parameter values.

None of the methods cited in the draft regulations will generate reliable estimates of trade-balancing exchange rates. The Cline estimate cited in the draft regulations, in particular, allows for current account deficits and surpluses equal to plus or minus 3 percent of GDP, which are far from trade-balancing exchange rates.

The Cline model has been used by Bergsten to estimate a set of true trade-balancing exchange rates, based on generating zero current account balances for Japan, China, and the European Union, which are responsible for the vast majority of global current account imbalances at the present time.8 These three countries/unions are responsible for the development of large and persistent global trade imbalances over the past 10 to 20 years.9

For purposes of illustration, Bergsten estimates (using 2016 data, and projected to 2019) that the euro, the Chinese yuan, and the Japanese yen must rise by 40.9 percent, 37.1 percent, and 50.2 percent, respectively, in order to eliminate the persistent current account surpluses of these countries. In this scenario, the real dollar would depreciate by 26.5 percent, while the real (price-adjusted, trade-weighted) value of the euro, yuan, and yen would rise by 15.0 percent, 9.9 percent, and 22.6 percent, respectively. The U.S. current account deficit would be eliminated as well, as a product of these realignments.10

Data quality issues must be considered in the estimation of equilibrium exchange rates

The results of the Bergsten model illustrate the fact that estimates of trade-balancing equilibrium exchange rates (which should be used to determine the extent to which a currency is “undervalued” in the proposed CVD proceedings) depend critically on model parameter values used in the Cline model, or any other, alternative model used to estimate equilibrium exchange rates.11

The quality of data used to estimate equilibrium exchange rates is also critical to the determination of the degree of undervaluation of any particular bilateral exchange rate. The Cline and Bergsten models are both based on estimates of each country’s total current account balance as a share of GDP. The current account is the broadest measure of the total flows of trade in goods, services, and income. Having accurate estimates of each country’s trade and income flows is thus essential to the development of reliable estimates of equilibrium exchange rates.

There are substantial problems with the quality of data used to compute equilibrium exchange rates. Such calculations typically depend on estimates of current account flows as reported by the International Monetary Fund.12 The IMF typically relies on self-reported trade data in its reports. There are substantial and well-known problems with self-reported trade data. For example, recent research by the Federal Reserve has shown that China is overstating its tourism trade deficit by roughly 1 percent of GDP (roughly $145 billion in 2018).13 Thus, current Chinese self-reported trade data understate that country’s current account surplus by at least that amount. Use of underestimated parameter values for China’s current account balance will lead to underestimates of the equilibrium dollar–yuan exchange rates needed to achieve current account realignment.

Likewise, it is well known that U.S. estimates of the bilateral U.S.–China goods trade deficit are substantially larger than those reported by China. Since China’s own self-reported current account estimates are based on China’s own self-reported goods trade flows, the goods trade account is also likewise underestimated. Further research is needed on this issue.

Who should be responsible for estimating equilibrium exchange rates?

These questions lead naturally to the issue of which agency or agencies should be responsible for estimating the equilibrium exchange rates that are used to determine the “benefit resulting from a subsidy in the form of currency undervaluation” in the proposed modifications to CVD regulations. The proposed regulations state that Commerce “intend[s] to seek and defer to the Department of Treasury’s (Treasury’s) evaluation and conclusion as to whether government action on the exchange rate has resulted in currency undervaluation.”14

It would be a mistake to assign the job of determining trade-balancing equilibrium exchange rates to Treasury. Although that agency has legislative responsibility for producing the semi-annual reports on the macroeconomic and foreign exchange policies of major trading partners of the United States,15 it has failed miserably in carrying out this responsibility for the past two decades.16 In particular, during the “Decade of Manipulation,”17 China and about 20 other countries engaged in massive, unprecedented currency manipulation that decimated U.S. manufacturing, resulting in the loss of roughly 5 million manufacturing jobs and 90,000 manufacturing plants.18 Yet Treasury did not once find any of these countries guilty of currency manipulation. This despite widespread agreement among professional economists that China and these other countries were acting in clear violation of IMF and WTO norms regarding prohibitions against currency actions taken “to gain unfair competitive advantage over other members.”19

In plain English, there are clear reasons why Treasury has refused to call out currency manipulators or intervene in currency markets. Simply put, Wall Street loves a strong dollar, and Treasury has historically been run by and for U.S. financial markets.20 The strong dollar has made imports artificially cheap (and U.S. exports less competitive on world markets), resulting in large and growing trade deficits. The resulting flood of cheap imports has driven huge profits for the companies that sell them, especially firms like Walmart, Amazon, Nike, and Apple. It has also led to reductions in wages for 80 million American workers competing with millions of workers in countries where labor has been cheapened by these undervalued currencies.21 All of this has filled the coffers of multinationals who outsource production, as well as the pockets of financiers on Wall Street who brokered these investments and the hedge fund managers who presided over the dismemberment of domestic manufacturing firms. It is no mistake that the current Secretary of the Treasury came from Wall Street, just as it is no mistake that most of his predecessors over the past three decades also came from Wall Street—and returned there when their time in government “service” was done.

The Federal Reserve should be charged with estimating equilibrium exchange rates for the purposes of determining the effects of currency undervaluation in CVD proceedings

As these comments have illustrated, there are serious technical issues involved both in modeling equilibrium exchange rates and in identifying the most accurate trade data and underlying parameter values. In addition, there are serious conflicts of interest that would arise if Treasury were tasked with making these assessments, for reasons outlined above. Furthermore, the Federal Reserve Board of Governors retains perhaps the most extensive team of economists and statisticians familiar with international data and modeling issues: These economists are intimately familiar with the functioning of international trade and financial markets, and they are best qualified to perform the objective analysis called for by these regulations.

I am well aware of the historic role played by Treasury as the lead agency for the U.S. government for international financial issues. However, those are policy issues largely having to do with the United States’ relationships with the International Monetary Fund, the World Bank, and other international financial institutions. The question at issue with respect to the determination of equilibrium exchange rates is a technical matter better suited to the expertise of the professional staff of the Federal Reserve.

Furthermore, historic roles and tradition must be subject to periodic evaluation and reconsideration as goals and policy environments change. For the past 46 years, since the end of the gold standard and the Bretton Woods Agreement in 1973, the United States has both adhered to and advocated for a system of market-determined, flexible exchange rates. This slavish adherence to financial market forces, come what may, has come at tremendous cost to communities across the United States. It is time to consider new ways to manage exchange rates, and these new approaches to managing currencies may require new institutional arrangements as well.

The Commerce Department’s proposed regulations to consider currency undervaluation as a part of countervailing duty determinations are an important step in this direction, and they should proceed in implementing these regulations, after due consideration of the issues raised here.

Endnotes

1. Modification of Regulations Regarding Benefit and Specificity in Countervailing Duty Proceedings, 84 Fed. Reg. 24406 (May 28, 2019).

2. C. Fred Bergsten and Joseph. E. Gagnon, Currency Conflict and Trade Policy: A New Strategy for the United States. (Washington, D.C.: Peterson Institute for International Economics, June 2017). See especially chapter 4, “The ‘Decade of Manipulation’ (2003–13).”

3. Robert E. Scott, “Elizabeth Warren’s Radical Plan to Fix the Dollar,” New York Times, June 16, 2019.

4. Congressional Budget Office, The Budget and Economic Outlook: 2019 to 2029, January 2019. Excel spreadsheet (data underlying figures in the report) downloaded February 2019.

5. Modification of Regulations Regarding Benefit and Specificity in Countervailing Duty Proceedings, 84 Fed. Reg. 24406 (May 28, 2019).

6. William R. Cline, “Estimates of Fundamental Equilibrium Exchange Rates, November 2017,” Peterson Institute for International Economics, November 2017.

7. William R. Cline and John Williamson, “New Estimates of Fundamental Equilibrium Exchange Rates,” Peterson Institute for International Economics, July 2008.

8. C. Fred Bergsten, “Time for a Plaza II?,” in International Monetary Cooperation: Lessons from the Plaza Accord After Thirty Years, ed. C. Fred Bergsten and Russel Green (Washington, D.C.: Peterson Institute for International Economics, 2016).

9. Brad Setser, The Return of the East Asian Savings Glut, Council on Foreign Relations, October 2016.

10. C. Fred Bergsten, “Time for a Plaza II?,” in International Monetary Cooperation: Lessons from the Plaza Accord After Thirty Years, ed. C. Fred Bergsten and Russel Green (Washington, D.C.: Peterson Institute for International Economics, 2016), Table 14-5.

11. C. Fred Bergsten, “Time for a Plaza II?,” in International Monetary Cooperation: Lessons from the Plaza Accord After Thirty Years, ed. C. Fred Bergsten and Russel Green (Washington, D.C.: Peterson Institute for International Economics, 2016).

12. International Monetary Fund, World Economic Outlook Database, April 2019: By Countries (Country-Level Data).

13. Ana Wong, “China’s Current Account: External Rebalancing or Capital Flight?,” Federal Reserve Board of Governors, International Finance Discussion Papers no. 1208, June 2017.

14. Modification of Regulations Regarding Benefit and Specificity in Countervailing Duty Proceedings, 84 Fed. Reg. 24406 (May 28, 2019).

15. U.S. Department of the Treasury, Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States, May 2019.

16. U.S. Department of the Treasury, Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States, May 2019.

17. C. Fred Bergsten and Joseph. E. Gagnon, “The ‘Decade of Manipulation’ (2003–13),” in Currency Conflict and Trade Policy: A New Strategy for the United States (Washington, D.C.: Peterson Institute for International Economics, June 2017).

18. Robert E. Scott, “What’s Good for Wall Street is Often Bad for American Workers and Manufacturing: The Overvalued Dollar,” Working Economics Blog (Economic Policy Institute), June 27, 2019.

19. Jonathan E. Sanford, Currency Manipulation: The IMF and WTO, Congressional Research Service, January 2011.

20. Robert E. Scott, “What’s Good for Wall Street Is Often Bad for American Workers and Manufacturing: The Overvalued Dollar,” Working Economics Blog (Economic Policy Institute), June 27, 2019.

21. Robert E. Scott, “Elizabeth Warren’s Radical Plan to Fix the Dollar,” New York Times, June 16, 2019.

In order to rebalance U.S. trade, the dollar needs to fall 25–30 percent, especially against the currencies of countries with large, persistent trade surpluses such as China, Japan, and the European Union. This would help to address the trade deficits that have eliminated nearly 5 million good-paying American manufacturing jobs over the past two decades and some 90,000 factories. In fact, trade with low-wage countries has pulled down the incomes of 100 million non-college educated workers by roughly $2,000 per year.

This week, Ruchir Sharma of Morgan Stanley trotted out a bunch of very shaggy dogs in defense of a strong currency. But he never mentioned the real reason Wall Street loves a strong dollar. An overvalued greenback has enabled the cheap imports that fuel the massive profits of American giants ranging from Apple and Amazon to Costco and Walmart. And multinational corporations have used offshoring, and the threat of moving more plants abroad, to drive down U.S. wages and benefits, and to weaken domestic labor unions.

Sharma claims growing trade deficits bring great benefits to the United States. And he praises the financing of our budget deficits through the sale of Treasury securities to foolish foreigners who are willing to hold them—with Wall Street bond traders brokering all of those sales for hefty fees. However, there are vast amounts of excess savings available in the United States and around the world, and there are no signs of a capital shortage, as evidenced by short- and long-term interest rates that are at historic lows across developed countries. The real issue, therefore, isn’t attracting capital, but rather the loss of American jobs and productive capacity that comes from growing trade deficits.

Sharma also claims that America’s ability to sell Treasury bills abroad depends, in part, on the dollar’s status as a “reserve currency …a perk of imperial might,” as though America were some powerful kingdom, with a throne in New York. In fact, as Dean Baker points out, the “dollar is not ‘the’ reserve currency,” it is simply one among many. Baker notes that central banks also hold euros, yen, British pounds, and Swiss francs, and can easily switch from one to another. And in today’s modern global economy, there is very little need to hold costly currency reserves. For example, in January 2019, the United States held only $115 billion in total foreign exchange reserves, which was equal to less than two weeks worth of total goods and services imports.

Sharma admits that dollar realignment would boost exports and jobs, but claims that it would provide only a temporary benefit for “fading manufacturing industries.” This is a particularly troubling argument. First, as noted above manufacturing jobs (along with construction) provide excellent wages and benefits, especially for U.S. workers without a bachelor’s degree (as demonstrated in the chart below). Unfortunately, there are still 900,000 fewer jobs in these sectors than at the start of the Great Recession.

“Growing industries” such as hospitality, health care, and temporary help services—which have gained jobs since the beginning of the recession—pay substantially less than construction and manufacturing industries. Hourly pay in these job-gaining industries was $26.19 on average, versus $28.88 in in manufacturing and $31.29 construction, as shown in the figure below. Total compensation (which includes both wages and benefits) in job-gaining industries is 33.39, while compensation in manufacturing and construction is $39.53 and 39.55 respectively, 18.4 percent more than in job-gaining industries.

Economic snapshot

Prolonged stagnation in manufacturing and construction employment have contributed to the slow growth of wages for non-college educated workers over the past decade. Rebalancing the dollar could lead to strong growth in these sectors. And that would provide a much-needed boost to wages for working Americans.

The second flaw in Sharma’s “fading” manufacturing industries argument is that this is not an inevitable—or desirable—trend. The steady loss of U.S. manufacturing jobs is the result of a policy choice. Germany, for example has held onto manufacturing jobs over the past 20 years, despite having higher wages for comparable workers than in the United States, as shown in the chart below. Manufacturing’s share of total employment has been stable in Germany, at about 17 percent of total employment (versus less than 10 percent in the United States), as shown in the second figure below.

China, which has been running massive trade surpluses for two decades has seen its manufacturing employment share rise. Germany held onto manufacturing jobs, in part by devaluing within the euro and the EU, via the Hartz reforms, which lowered wages relative to the rest of the EU. China manipulated its currency for more than a decade, and continues to maintain an undervalued yuan by carefully managing private capital outflows. Maintaining a strong manufacturing sector and stable manufacturing employment are policy choices. And contrary to Sharma’s dismissal, it is a key driver for income generation in advanced economies.

While Germany and China have managed their economies to maintain and expand manufacturing employment, the United States has favored a strong dollar policy that has decimated U.S. manufacturing. But that path has also generated massive profits for Wall Street, along with rising incomes only for those at the top, including finance executives. Germany and China have invested in building up strong manufacturing sectors. In contrast, the U.S. poured massive subsidies into Wall Street (with nearly a decade of unlimited access to discount-window borrowing from the Federal Reserve at near-zero percent interest rates), with no payback or quid pro quo. Meanwhile, not a single banker went to jail in the wake of a financial crisis that rocked the global economy.

Sharma has the temerity to conclude that dollar realignment will “damage the economy.” But who benefits from this type of economy?

He has it exactly backwards. A lower dollar stimulates exports, job creation, and the growth of a strong economy with high and rising wages. The dollar was realigned by President Nixon in December 1971, and again in 1985, during the Reagan administration, following the Plaza Accord. There is no evidence that the economy slowed after either one of those events, as shown in the chart below, which tracks U.S. quarterly GDP growth since 1969 (each currency realignment is marked with dotted lines).

The time has come for a serious discussion of permanent currency realignment to rebalance global trade and capital flows. And it is time to put an end to sacrificing the national interest simply for the narrow benefit of Wall Street.

Figure A

The IMF predicts that the U.S. current account deficit—the broadest measure of U.S. trade in goods, services, and income—will nearly double between 2016 and 2022. Unless these trends are offset by a rapid decline in the value of the U.S. dollar, rapidly rising trade deficits could be devastating for U.S. manufacturing, likely giving rise to massive job loss on the scale experienced in the 2000–2007 period, when 3.5 million U.S. manufacturing jobs were lost.

The U.S. goods trade deficit with China reached a new record of $419.2 billion in 2018, up from $375.6 billion in 2017, an increase of $43.6 billion (11.6 percent). United States trade with China is dominated by the deficit in manufactured products. Although the United States has imposed tariffs of 10 to 25 percent on $250 billion in imports from China (about half of total U.S. imports from that country), China has played its ‘ace-in-the-hole’ by allowing it’s currency to fall by roughly 10 percent against the dollar. As a result, the U.S. trade deficit with China increased faster (11.6 percent) than the U.S. deficit with the world as a whole (10.4 percent). While the United States and China are poised to negotiate a deal to end their trade dispute, the proposed deal amounts “much ado about nothing much,” as Paul Krugman puts it. It will do little to reduce the massive imbalance in U.S.–China trade flows.

The vast bulk of the U.S. goods trade deficit in 2018 was explained by trade in non-petroleum products, which are dominated by manufactured goods. The trade deficit in non-petroleum products reached $825.4 billion in 2018, an increase of $91 billion (12.4 percent). The United States had a small trade surplus of 26.5 billion in agricultural products in 2018 (this sector is part of trade in non-petroleum products). The agricultural trade surplus declined by $2.4 billion in 2018 (8.3 percent), as a consequence of trade restraints in China and elsewhere, and the rising dollar. The United States had a trade surplus in services which increased from $255.2 billion in 2017 to $270.2 billion in 2018, an increase of $15.0 billion (5.9 percent). However, the growth in the services surplus was more than offset by the $83.8 billion increase in the goods trade deficit; thus the overall goods and services deficit increased by $68.8 billion (12.5 percent) in 2018.

The most important cause of large and growing U.S. trade deficits is persistent currency undervaluation by countries such as China, Japan, and Korea, which have run large, persistent trade surpluses, as well as large structural surpluses accumulated by the European Union, including especially Germany and the Netherlands. The real, trade-weighted value of the U.S. dollar increased 21.8 percent between December 2013 and December 2018, and including 6.7 percent in 2018 alone, as shown below. The Trump tax cuts will add more than $1 trillion to U.S. fiscal deficits over the next decade, putting upward pressure on interest rates and the U.S. dollar, as reflected in the chart, below. Absent aggressive efforts to reduce its value, the rising dollar will put continuing upward pressure on the trade deficit, and downward pressure on employment and output in U.S. manufacturing.

Figure A

Last month, General Motors announced plant closures in the U.S. that could lead to roughly 14,700 layoffs by the end of 2019. The shutdowns will have the biggest impact in industrial states like Ohio and Michigan, where key plants in Detroit-Hamtramck, Lordstown, and Warren are being closed. But the closures also have wider implications for American industry—and not just the machine shops and fabricators that produce rubber, steel, and glass components for auto assembly. America’s manufacturers are all struggling with the same issue—an overvalued dollar that puts them at risk from rising trade deficits. And it all derives from flawed Trump administration economic policies.

Trump’s tax cuts and increased government spending for defense and nondefense needs are widening the U.S. budget deficit, which will top $1 trillion in 2020 (5 percent of GDP). On top of that, Trump’s tariffs on China have backfired. China has reduced the value of the yuan 10 percent this year, and its trade surplus with the United States has increased 10 percent over the same period last year—even faster than the overall U.S. goods trade deficit, which is up 9.4 percent in the same period. The IMF projects that the overall U.S. current account deficit (the broadest measure of trade in goods, services and income) will nearly double over the next four years.

As a result of the rising dollar and increasing current account deficit, the U.S. goods trade deficit will increase to between $1.2 trillion and $2 trillion by 2020, an increase of $400 billion to $1.2 trillion above the $807 billion U.S. goods trade deficit in 2017, as shown below. This will directly eliminate between 2.5 and 7.5 million U.S. jobs, mostly in manufacturing (because 85 percent of U.S. goods trade consists of manufactured products). The collapse in output, especially in the capital intensive manufacturing sector, will decimate investment—and taken together, both will result in large additional job losses as income and spending collapse, resulting in a steep recession if nothing is done to reduce the over-valued dollar. The dollar must fall by at least 25 to 30 percent (on a real, trade-weighted basis) to rebalance U.S. trade and avert the coming trade tsunami that’s baked into the economy as a result of the rising trade deficit.

To see why the GM announcement is the canary in the coal mine, consider its position. Why is the company taking such a drastic step? CEO Mary Barra says the company is trying to make itself leaner, and shifting resources toward newer electric vehicles and self-driving cars.

But that’s not the entire issue. The U.S. dollar is now substantially overvalued—which keeps making imports cheaper and U.S. exports more expensive. GM is clearly trying to protect itself against a future economic downturn. It’s well known in the business community that the prospects for a recession in the next few years are quite high. This is the chickens coming home to roost on the broader Trump economic policies.

The dollar’s overvaluation stems from a rather grievous irony. The United States is the epicenter of the world’s financial markets, with overseas investors continually purchasing dollar-denominated assets and securities. That’s certainly good for Wall Street. But it invites a downside.

A continuing influx of foreign capital is driving up demand for the dollar. Trump appointees Jay Powell (Chair) and Randy Quarles (Vice Chair) at the Fed also bear substantial responsibility for recent increases in the dollar, due rapid interest rate increases within the past year, which have made U.S. investments more attractive to foreign investors.

And the resulting rise in the dollar is making America’s exports—including the cars built by General Motors—more expensive for overseas consumers. It also makes imported goods cheaper in the U.S. market. These low-cost imports deliver growing profits for multinational operations like Apple—and yield a triple-whammy for U.S. manufacturers competing against imports that keep getting cheaper.

The situation has gotten worse of late because President Trump’s economic policies have actually reinforced the dollar’s rise. Last year’s tax cuts and 2018’s spending increases are swelling a budget deficit projected to exceed $1 trillion by 2020. Just as textbooks predict, increased federal borrowing (along with Fed policy) is driving up short- and long-term interest rates, attracting even more foreign capital—and further strengthening the dollar.

The president’s policies are now backfiring on GM and domestic manufacturers because the dollar has increased 5.4 percent in value in the past year alone. And China has devalued its currency, the yuan by 10 percent this year—more than offsetting the impact of the president’s tariffs. Thus the irony that President Trump’s tax cuts and increased defense spending have short-changed working Americans even as they’ve swelled corporate coffers. The administration believes tax cuts will stimulate investment and job creation. But companies—including GM—have used the proceeds to increase dividend payments, buybacks, and CEO compensation—not worker wages.

Figure A

Figure B

Because the dollar keeps rising, the International Monetary Fund (IMF) foresees a perfect storm. Rising imports will drive America’s current account deficit up from $449 billion in 2017 to more than $800 billion in 2022. Concurrently, the U.S. goods trade deficit could double in the next four years, rising from $807 billion in 2017 to between $1.2 and $2.0 trillion. Such a massive increase could potentially tip the nation into a new recession.

Figure C

Growing gap between current account and goods trade deficits bodes ill for U.S. manufacturing

Historically, and especially between 2000 and 2006, the U.S. current account and goods trade balances tended to track one-another nearly dollar for dollar. However, since 2007, there has been a growing gap between these two measures, with the goods trade deficit rapidly increasing relative to the current account deficit, as shown below. There are three reasons for this. First, since the mid-2000s, the United States has begun to run a sizeable surplus in “services” trade (not shown), which reached $243 billion (1.3 percent of U.S. GDP) in 2017. To some, this sounds like the desirable symbol of a “modern” economy. But in fact, over half of the U.S. services surplus is in three categories: financial services (banks, brokers, and credit card companies, 23 percent); professional and management consulting (15 percent); and charges for intellectual property (13 percent). These “services” are simply rents, or profits accruing to investors, and high-wage industries in finance and business consulting. They generate few good jobs for non-college educated workers, of the type supported by manufacturing, in the domestic economy. Of the rest, “travel” is the largest single category, which is dominated by education (another high-wage sector, 13 percent) and other personal travel (18 percent), but the later primarily supports low wage jobs in industries such as accommodations and food services.

The second major, growing component of trade is growth of “primary” income, including investment income and payments to employees (such as foreign executives), which generated $217 billion of net income (1.3 percent of GDP) in 2017. The dangerous irony of the modern global economy is that outsourcing, which has shifted production to foreign countries, has generated rapidly growing flows of foreign profits and rents (royalties, profits, and wages paid in banking and consulting services) to U.S. and foreign multinationals. These flows of capital income have directly offset the growing U.S. deficits in goods trade, which have displaced millions of manufacturing jobs. In total the United States has lost 5 million manufacturing jobs since 1998, most due to growing trade deficits with China and other large exporters. The troubling irony is that outsourcing is generating a flow of profits and services income that is offsetting growing goods trade deficits in the broadest trade measure (the current account deficit), effectively disguising the negative impacts of globalization on the domestic economy.

The third major component shift in U.S. trade patterns has occurred in petroleum products. A decade ago, in the mid-2000s, the United States ran a trade deficit in crude and refined petroleum which reached 2.1 percent of GDP in 2006 (peaking at 2.8 percent of GDP in 2008). However, the rise of fracking in the United States, combined with a decline in world oil prices and rising U.S. exports of refined petroleum products, has reduced the U.S. trade deficit in crude and refined petroleum to only 0.3 percent of GDP. The U.S. trade deficit in non-oil goods (which is dominated by trade in manufactured products) reached near-peak levels of $732 billion in 2017 (3.8 percent of GDP). This is much larger than the previous peak of $520 billion in 2006, which was also 3.8 percent of GDP. Thus, the rise in U.S. oil production has also tended to obscure the impacts of the rapid growth in the U.S. non-oil goods trade deficit, over the past decade. The non-oil goods trade deficit is poised to explode as a direct result of the failure of Trump’s trade and economic policies.

On the other hand, The U.S. current account deficit—the broadest measure of our trade in goods, services and income—was widely viewed as relatively stable in 2017 at only 2.4 percent of GDP (versus an all-time peak of 5.8 percent of GDP in 2006). Thus, today’s current account trade deficit is viewed as manageable by most economists. However, in manufacturing and other traded goods sectors (such as farming), the goods trade deficit (and especially in non-oil goods) is reaching crisis levels. This explains why it is so important to focus on future trends in goods trade, as shown in the bottom two lines of Figure D, below.

Figure D

The U.S. goods trade balance forecasts (for the 2018 through 2023) shown in Figure D are based on two alternative projections. The first projection (shown in red) is based on IMF World Economic Outlook (WEO) projections of trends in the volume of goods exports and imports. However, these are overly conservative because they fail to reflect changes in import and export prices. The second “alternate goods trade balance estimate” is based on the trend growth in the ration of the goods trade to the current account balance (this ratio increased 3.4 percent per year in the 2018-2023 period).

Both scenarios lead to goods trade deficits well of at least $1.2 trillion by 2023, and possibly as much as $2.0 trillion. Given the rapid decline in U.S. trade deficits in petroleum projects, these deficits will be devastating for the U.S. manufacturing sector, likely giving rise to massive job loss on the scale experience in the 2000-2007 period, when 3.5 million U.S. manufacturing jobs were lost.

There’s still time to sort through the mess, however. Washington can take coordinated action to lower the value of the dollar by at least 25 to 30 percent. The last time the United States intentionally engineered a major currency realignment was with the Reagan administration in 1985. Treasury Secretary James Baker negotiated the Plaza Accord with Japan, France, Germany, and the United Kingdom—achieving a 30 percent depreciation in the U.S. dollar. The U.S. goods and service trade deficit subsequently fell from $122 billion in 1985, and a peak of $152 billion in 1987, to $31 billion in 1991(the trade deficit usually worsens for two years after the dollar depreciates, and then improves rapidly, in what is known as the j-curve effect).

Notably, House Democrats played a key role in the Plaza Accord. The threat of Rostenkowski-Gephardt trade legislation—which would have imposed a 25 percent surcharge on imports from Japan, Brazil, Korea, Taiwan, and others—motivated finance ministers to work with Baker on a currency deal. The threat of high, permanent tariffs lead foreign officials to seek out alternatives that would rebalance trade without introducing new trade barriers.

With GM and other manufacturers now struggling, Democrats should see an opportunity to focus on middle class jobs—starting with a revaluation of the U.S. dollar. They can force the president’s hand by threatening to impose broad, across the board tariffs on all countries with large, persistent, global trade surpluses, including China, Japan, Korea and Germany and other big surplus countries in Europe (Netherlands, Sweden, Switzerland) or the entire E.U. There are also other tools to rebalance the dollar, such as taxing foreign capital inflows. But it is perhaps best to confront a man such as Trump in a language the he understands: with the threat of higher, across-the-board tariffs. The \president campaigned on rebuilding American manufacturing, and delivering more jobs and higher wages. Instead, it could be the newly Democratic House that actually achieves this—by pressing 1980s-style trade legislation as the impetus to revalue the dollar in the same way the Reagan administration wisely did, 30 years ago.

Seventeen years after China acceded to the World Trade Organization (WTO), the bilateral economic relationship between our two countries is enormously lopsided and problematic. The U.S. ran a goods trade deficit with China of $375 billion in 2017—up from $83 billion in 2001. This is the largest single bilateral trade deficit between any two countries in the history of the world—and it continues to trend upward, despite 20 U.S. challenges to China at the WTO, despite earnest annual bilateral talks and commitments, and despite all the “reform” commitments China made upon accession.

Furthermore, it is not just the sheer size of the U.S. trade imbalance with China that is of concern. It is the composition.

As recently as 2001, the U.S. ran a global trade surplus in advanced technology products (ATP). ATP includes advanced elements of computers and electronics, as well as biotechnology, life sciences, aerospace, and nuclear technology, among others. ATP should be a strong suit for a wealthy, technologically savvy, high-skilled, capital-intensive country like the United States. However, roughly coincident with China’s entry into the WTO, the surplus turned to deficit and grew rapidly, hitting $136 billion in 2017. The U.S. ATP deficit with China is more than our entire global ATP trade deficit, which was $110 billion. This means that, excluding China, we actually have a trade surplus in ATP with the rest of the world. This statistic alone should be a signal that there are significant anomalies in the U.S. trade relationship with China that cannot be explained by market forces.

Meanwhile, top U.S. exports to China include raw materials, agricultural products, and waste materials. Between 2001 and 2015, we saw the fastest growth in imports over exports with China in computers, electronics, miscellaneous manufactured commodities, and apparel. We saw the fastest growth in exports over imports in agriculture and aerospace (where significant technology is being transferred over time). This is not the profile of imports and exports that would be expected between countries at the respective economic development levels of China and the U.S.

WTO promises

In 2000, politicians from both the Democratic and Republican parties and business leaders argued that WTO accession would create a “win-win result for both countries”—the U.S. would gain access to Chinese markets, “reformers” in China would ascend in the political/economic hierarchy, workers’ rights would improve, and both countries would prosper.

The actual outcomes have been decidedly different.

According to USTR, China is still not fully compliant with the commitments it made during the WTO accession process. American companies trying to do business in China face theft of trade secrets, counterfeiting, inadequate protection of intellectual property, online piracy, industrial policies that promote domestic goods at the expense of U.S. products, subsidies, discriminatory product standards, the dumping of excess capacity, and restricted access for American services. Seventeen years after accession, China has not even listed all of its restricted export subsidies, let alone eliminated them, as promised.

In addition, China has used currency policy to gain an unfair competitive advantage over American business and labor. During the crucial decade after China’s accession, the Chinese government intervened systematically and in one direction in currency markets to thwart an exchange rate adjustment that could have helped to rebalance trade with the U.S. The legacy of that currency intervention remains an important factor in the current imbalance. While in principle both the WTO and the IMF have mechanisms and rules to address currency manipulation, in practice no U.S. administration has yet been willing to use those mechanisms or U.S. unilateral measures to address this problem.

Impact on jobs and wages

This litany of unfair trade practices and currency manipulation has had a serious and pervasive negative impact on American jobs and wages. As my colleague, Rob Scott, demonstrated in a 2017 report, Growth in U.S.–China Trade Deficit between 2001 and 2015 Cost 3.4 Million Jobs [ https://www.epi.org/publication/growth-in-u-s-china-trade-deficit-between-2001-and-2015-cost-3-4-million-jobs-heres-how-to-rebalance-trade-and-rebuild-american-manufacturing ], the deficit cost jobs in all 50 states and the District of Columbia. Between 2001 and 2011, the growing trade deficit cost directly impacted workers $37 billion a year, while also putting downward pressure on the wages of all non-college graduates by $180 billion a year.

American businesses have also suffered from closed markets and unfair practices in China, but they are often reluctant to initiate trade complaints or protest, as they fear any public outcry will bring more unfavorable treatment on their company.

It is no secret that the Chinese government has a long-term economic strategy to build certain sectors through subsidies, as well as through purchasing, tax, and regulatory policies. These strategies are announced publicly at regular intervals—pillar industries, strategic emerging industries, Made with China, Made in China 2025. These strategic plans are variations on the theme of “picking winners,” also known as industrial policy, something American politicians of both parties tend to scorn. These plans set targets for indigenous production, use of technology, favorable treatment for state-owned enterprises, and discriminatory treatment of foreign brands and companies, among other things. These practices are deep and pervasive.

Of course, the Chinese government has a right to set its own strategic goals, and the U.S. can certainly be faulted for failing to articulate, let alone implement, any coherent, long-term economic strategy.

But there are two problems here, and we should be careful to distinguish them. On the one hand, many of the Chinese government’s practices are inconsistent with international rules and norms—not just WTO rules on prohibited subsidies and dumping, but also international conventions on workers’ rights, public health, human rights, environmental protections, intellectual property rights, and consumer safety. The U.S. touts the importance of a rules-based system, but if some players—like China—flout the rules with impunity over decades, then the rules-based system becomes a trap for those who comply. The U.S. failure to adequately enforce existing rules is why there is so much pent-up frustration among workers and domestic producers over trade with China. The U.S. government’s piecemeal and scattershot enforcement strategy has been time-consuming and ineffective.

The U.S. government has not ever raised, in any systematic or meaningful way, China’s failure to comply with its obligations as a member of the International Labor Organization (ILO) to “respect, promote, and realize” the core international workers’ rights outlined in the ILO Declaration on Fundamental Principles and Rights at Work: freedom of association, right to organize and bargain collectively, and freedom from child labor, forced labor, and discrimination. This means that American workers and businesses are competing on a tilted playing field, since Chinese workers cannot exercise their rights to form independent and democratic unions.

On the other hand, the U.S. has its own responsibility to develop and implement a coherent long-term economic strategy with respect to both manufacturing and services, both trade-related and domestic. The U.S. government has failed to invest adequately in infrastructure and skills for decades, and business has not filled the void. We have a tax system that rewards capital over labor and outsourcing over domestic production. It remains riddled with unproductive loopholes, and—especially after last year’s changes—it fails to raise adequate revenue to fund needed investments.

Our trade policy is geared toward boosting the profits and mobility of multinational corporations, but not creating and supporting good jobs at home. Our government spends a lot of time and energy negotiating new trade agreements, but has failed to act to stem currency manipulation, which undermines the market-opening measures negotiated with so much fanfare.

Forced technology transfer, IPR transgressions, and the loss of domestic capacity in key sectors can all contribute to the undermining of American innovation and technological leadership. This has consequences not just for the current labor market, but for our future trajectory.

The Chinese government is clearly playing a long game, while the U.S. is egregiously shortsighted. Our trade policies in the past have been so inadequate in scale and slow in implementation that by the time we take action, it is often a decade too late, with the result that our trade actions are ineffective, if not counterproductive.

We need to reform our domestic trade laws so we can act expeditiously—as soon as the Chinese government announces its strategic priorities, not a decade later, after we’ve lost market share and the technological edge. Going forward, we must address new barriers to trade in services and e-commerce. We need to make sure that we have—and are willing to use—measures to address currency misalignment. Our trade enforcement measures should prioritize good jobs, workers’ rights, democracy, environmental compliance, and consumer safety over outsourcing and short-term profits.

In summary, the U.S. government needs to develop and articulate its own long-term economic development strategy. It needs to use domestic tax, infrastructure, and workforce development policies to ensure that American workers and businesses have the tools and skills they need to compete successfully. But the government also needs to strengthen our trade compliance and enforcement measures and be willing to use them aggressively and consistently and in a timely manner to ensure that our trade relationship with China is reciprocal and fair.

Thank you for your attention. I look forward to any questions you may have.

While any attempt to secure a transformative deal on a new NAFTA will certainly face formidable obstacles, it is nonetheless important to lay out a progressive roadmap for the ongoing talks. Instead of allowing multinational corporations to dominate the agenda, we should instead address the root causes of our ballooning trade deficits, such as currency manipulation and misalignments. We also need to use these high-level talks to end the systematic and egregious repression of workers’ rights that disempowers workers and exacerbates inequality in all three North American countries.

NAFTA renegotiation efforts aiming to put workers first would pursue the priorities listed below. These priorities can be used to judge whether or not the NAFTA renegotiation is being done for multinational corporations or for workers in all three countries.

1. Put labor standards with strong enforcement tools into NAFTA.

NAFTA must include specific provisions protecting workers’ rights and wages, including the right to form unions and bargain collectively, and establish an enforcement body that can penalize those who infringe on those rights, including threats to free and independent labor organizations. NAFTA could mandate that all signatories respect the labor standards identified as fundamental worker rights by the International Labour Organization (ILO). Canada even recently requested ending right-to-work (RTW) laws in U.S. states as part of NAFTA renegotiations because they suppress American wages and threaten Canadian jobs—a potentially game-changing provision to include.

2. Eliminate investor–state dispute settlement (ISDS) provisions.

ISDS provisions create special legal privileges for foreign investors, notably the right to sue host governments in private arbitration tribunals (“corporate courts,” as the AFL-CIO calls them) for failing to meet certain standards that cause the investor economic harm. In practice this means that investors can challenge any law or policy change they claim will cut profits. For example, ISDS provisions have been used by American companies to attack basic, sensible labor and environmental safeguards. ISDS provisions have a chilling effect on regulatory safeguards, infringe on our trading partners’ democratic rights to manage their own domestic economies, and encourage American firms to locate abroad and leave American workers behind, harming jobs and wages in the United States.

3. Revise intellectual property (IP) provisions that inflate prices in areas such as health care.

The current IP provisions in NAFTA have extended private monopolies that generate massive profits for drug, software, entertainment, and other industries. In particular, the high cost of prescription drugs is becoming prohibitive for many working families. NAFTA renegotiations should move toward innovation systems that support technological progress but also reduce costs for families in all three countries, while ensuring fair compensation for artists, writers, and innovators.

4. Revise rules of origin provisions.

Rules of origin, which are the criteria used to define where a product was made, are a critical component of trade agreements because they determine which products can benefit from tariff concessions. Rules of origin should be renegotiated to maximize the benefit to workers, farmers, and firms, and to ensure that NAFTA is not turned into a back door through which products from nonsignatory countries flood the North American market.

5. Eliminate procurement requirements that undermine “Buy American” policies.

If policymakers really want to support the “Buy American” principle, the procurement requirements in Chapter 10 of NAFTA should go. Because they require that foreign bidders have equal access to U.S. government contracts, the current procurement provisions have resulted in the loss of U.S. jobs.

6. Include enforceable currency rules that include penalties for violations.

A NAFTA that helps workers would include enforceable currency rules. Currency manipulation and misalignment are the least understood yet most important causes of manufacturing job loss. Both make U.S.-made products less competitive and increase our trade deficits.

While neither Canada nor Mexico currently engages in active currency manipulation or misalignment, including currency rules with enforcement in a major trade agreement would create a standard that should be incorporated into all present and future trade and investment agreements. For example, this is a major issue to consider in reforms of the U.S.–Korea Free Trade Agreement.

References

AFL-CIO. 2017. A NAFTA That Works Must Empower Working People, Not Corporations. June 12.

Bivens, Josh. 2017a. Adding Insult to Injury: How Bad Policy Decisions Have Amplified Globalization’s Costs for American Workers. Economic Policy Institute, July 11.

Bivens, Josh. 2017b. “A NAFTA Renegotiation Game-Changer, until the Trump Administration Squanders It.” Working Economics (Economic Policy Institute blog), September 7.

Brotherton-Bunch, Elizabeth. 2017. “The Procurement System Puts U.S. Companies at a Disadvantage. Buy America Can Help.” Manufacture This (Alliance for American Manufacturing blog), March 15.

Economic Policy Institute. Various years. Currency Policies. Collection of publications available at epi.org/research/currency-policies.

International Labour Organization. 2010 (1998). ILO Declaration on Fundamental Principles and Rights at Work and Its Follow-Up. Second edition with Annex revised 2010. First published 1998.

Scott, Robert E. 2011. Heading South: U.S.–Mexico Trade and Job Displacement after NAFTA. Economic Policy Institute, May 3.

Scott, Robert E. 2015. Unfair Trade Deals Lower the Wages of U.S. Workers. Economic Policy Institute, March 13.

Scott, Robert E. 2016. Currency Manipulation and Manufacturing Job Loss: Why Negotiating “Great Trade Deals” Is Not the Answer. Economic Policy Institute, July 21.

Scott, Robert E. 2017a. “Comments Regarding Causes of Significant Trade Deficit for 2016.” Testimony before the U.S. Department of Commerce, May 18.

Scott, Robert E. 2017b. Growth in U.S.–China Trade Deficit between 2001 and 2015 Cost 3.4 Million Jobs: Here’s How to Rebalance Trade and Rebuild American Manufacturing. Economic Policy Institute, January 31.

Scott, Robert E. 2017c. “Renegotiating NAFTA Is Putting Lipstick on a Pig.” Working Economics (Economic Policy Institute blog), August 21.

Stiglitz, Joseph E., Dean Baker, and Arjun Jayadev. 2017. “Intellectual Property for the Twenty-First-Century Economy.” Project Syndicate, October 17.

Tucker, Todd. 2015. “The TPP Has a Provision Many Will Love to Hate: ISDS. What Is It, and Why Does It Matter?” Washington Post, October 6.

U.S. Government Accountability Office. 2017. Government Procurement: United States Reported Opening More Opportunities to Foreign Firms Than Other Countries, but Better Data Are Needed. Published February 9. Publicly released March 13.

]]> https://www.epi.org/blog/withdrawing-korus-good-impulse-bad-reasons/ Tue, 05 Sep 2017 20:20:53 +0000 http://www.epi.org/?post_type=blog&p=134025 The saying goes that even a stopped clock tells the correct time twice a day. This is a pretty good description of the Trump administration’s approach to trade policy: their analysis and motivations are almost never right, yet they occasionally hit on a decent idea. But then they move quickly off of it. This is illustrated perfectly in their recent moves regarding the Korea-U.S. Free Trade Agreement (KORUS).

News reports suggest that the Trump administration is preparing to withdraw from KORUS. The motivation for this seems more driven by Trump pique that the South Korean government is not rubber-stamping his preferred policy stance on the current tensions in the Korean peninsula, rather than on any coherent economic analysis.

Yet, it’s true that on pure economics, KORUS should be seen as a failure. The KORUS deal, approved in 2011, was supposed to result in rising U.S. exports. However, U.S. exports to Korea actually fell $1.2 billion between 2011 and 2016, while imports from South Korea soared—increasing the bilateral trade deficit by $14.4 billion and eliminating more than 95,000 jobs in the first three years alone.

The glaring omission in KORUS was failure to include enforceable provisions on currency policy. Korea is a well-known currency manipulator, and it also has the fourth largest current account trade surplus (the broadest measure of trade in goods, services, and income) in the world. Ending Korean currency manipulation and revaluing the won is the surest way to increase U.S. exports and stop the surge in Korean imports in the United States, demonstrating the value of this strategy for rebalance overall U.S. trade and helping to rebuild U.S. manufacturing. Recent estimates suggest that rebalancing U.S. trade will require Korea to revalue the won by at least 32.7 percent.

Figure A

This omission of currency provisions and the resulting U.S.-Korea trade imbalance has been true all throughout the Trump administration and yet it’s only now, in the midst of a foreign policy crisis on the Korean peninsula that has President Trump frustrated with South Korea’s independent stance, that the threats to withdraw from KORUS are being made. It is unfortunate that the president has chosen to use trade policy as an element of his ham-handed geopolitical maneuvering. In the past, this linkage between trade and foreign policy has usually meant trading away our manufacturing base in order encourage our trading partners to cooperate on foreign policy objectives, as Trump did earlier this year when offered China better terms on a trade deal “if they solve the North Korea problem.” Does it matter that the Trump administration’s reasons for withdrawing from KORUS are based on personal pique and bad foreign policy considerations? Isn’t withdrawing from a flawed trade treaty good enough?

Not really. Withdrawing from KORUS will do little-to-nothing to address the U.S.-Korea trade deficit that the Trump administration claims to care about. Genuine policy attention to currency misalignment would—but there is little to no sign that the administration knows or cares about this.

Withdrawing from KORUS simply to inflict political pain on a trading partner whose government is not being compliant on other foreign policy issues is a classic stopped-clock problem. The correct impulse to withdraw from the treaty will soon be left behind, and the correct actions to make trade work better for working Americans will be forgotten.

Over its first 20 years, growing trade deficits with Mexico and Canada from the North American Free Trade Agreement (NAFTA) eliminated 850,000 U.S. jobs, most of them in manufacturing. (American workers suffered far more after China entered the World Trade Organization in 2001, including 3.4 million jobs lost through 2015 alone, due to growing trade deficits with that country.) And trade deficits and job losses are just the tip of the iceberg of the devastation wreaked by bad trade deals, which have also driven down the wages of all 100 million American workers without a college degree, who have suffered losses of just under $2,000 per year for each median wage, full-time worker. Roughly $200 billion per year is being taken from the pockets of working people and middle class families, because the super-rich and huge corporations have been able to game the system at their expense.

NAFTA has created the economic equivalent of a 14-lane freeway to Mexico, paving the way for the outsourcing of jobs and factories to Mexico. In the past twenty years, the U.S. has lost more than 87,000 factories (manufacturing establishments), wiping out nearly one-third of U.S. manufacturing production capacity. Tweaking NAFTA around the edges is not going to change those dynamics. As EPI founder Jeff Faux recently explained, NAFTA created “radical new rules for trade…that shifted the benefits of expanding trade to investors and the costs to workers.” The system that created this deal to benefit rich executives and multinational companies is still in place and, if anything, tilts even further in their interest in an administration led by former Goldman Sachs executives Gary Cohn (Trump’s chief economic advisor) and Treasury Secretary Steve Mnuchin.

Trade and investment deals like NAFTA provide U.S. corporations with privileged access to the labor markets of poor countries like Mexico and China, with special rules providing extended intellectual property rights—opening markets to private investors in service activities ranging from banking and telecommunications to water and public education, enforced by investor-state dispute resolution panels that operate entirely outside of national court systems.

U.S. Trade Representative Robert E. Lighthizer has put forth negotiating objectives that are designed to expand benefits of trade for foreign investors, strengthen intellectual property rights, and update NAFTA rules to facilitate digital trade in goods and services, small business access, and government procurement. Far from the administration’s stated goal of bringing jobs back to the United States, these moves will, if anything, make it easier for companies to send jobs abroad. The administration also seeks to incorporate labor and environmental standards in the core of the agreement. But NAFTA is and will remain an agreement designed to encourage firms to outsource production to Mexico, and to shift income from wages to profits.

Improving labor and environmental standards in Mexico is not likely to shrink the gap between wages in the United States and Mexico to any appreciable extent, nor will it eliminate the U.S. trade deficit with Mexico or Canada. According to The Conference Board, hourly manufacturing compensation costs in the United States exceeded those in Mexico by more than 6-to-1 in 1997, and by roughly the same margin in 2015—there has been no significant change in the wage gap in the NAFTA era. Even if wages in Mexico were doubled through implementation of more effective labor standards (and assuming U.S. wages were unchanged), there would still be a wage gap of more than 3-to-1—providing huge incentives for firms to maintain and increase outsourcing of U.S. manufacturing to Mexico. The only public policy that could support balanced trade with Mexico is a European-style, European Community expansion policy mix (employed when Greece, Spain, and Portugal entered the EC in the 1980s) which provided greatly increased development funds designed to bring about a fundamental increase in wages and incomes in those countries prior to their joining the EC (which subsequently became the European Union). The United States can and should invest heavily in economic development in Mexico, which would be good for workers in both countries, but that is a development policy proposal designed to narrow incentives to offshore production to Mexico while raising demand in Mexico for exports of U.S. consumer goods. Trade policy alone cannot achieve these goals.

For these reasons, the costs of renegotiating NAFTA are likely to exceed its benefits. If patents and copyrights are more tightly enforced, for example, then the profits of big-pharma, software giants, and Hollywood will rise, but this will leave workers in Mexico poorer and will likely result in a decline in U.S. exports of manufactured goods to Mexico. So, even if the trade balance with NAFTA improves, these policies will likely harm U.S. manufacturing, costing more jobs and putting more pressure on workers’ wages.

On the other hand, NAFTA has fundamentally changed the structure of the North American economy. Multinational companies have built complex, integrated supply chains in sectors like automotive production. Parts often cross borders between the United States, Mexico, and Canada multiple times before a final product rolls off the assembly line. President Trump threatened to tear up the agreement in April, but was convinced by his own cabinet members that ending NAFTA would be too costly to the economy. Hence, negotiators are more likely to end up “tweaking a few provisions and … chapters” of the agreement, precisely what Lighthizer said “he is not interested in” doing [emphasis added].

What should be done on trade?

The most pressing trade problem facing the United States today is currency misalignment and dollar overvaluation. Rather than renegotiating NAFTA, the United States should implement policies that are designed to rebalance trade with China, the EU, Japan and other currency manipulators, which have the largest global trade surpluses in the world, as shown in the figure below. It is important to note that both Mexico and Canada have global trade deficits, and are not contributing to global trade imbalances. Currency misalignment is a measure of how much the dollar must adjust in order to rebalance U.S. trade. The best estimates are that the value of the dollar must fall at least 25 to 30 percent. This must include a substantial revaluation in the value of the currencies of leading surplus countries of 28.6 percent to 47.5 percent (based on Bergsten, C. Fred (2016), Tables 14.4 and 14.5, adjusted for recent dollar appreciation).

Figure A

There are several broad, powerful tools that could be used to realign the U.S. dollar and rebalance global trade including Countervailing Currency Intervention (CCI), where the United States purchases foreign assets to offset any foreign government purchases of U.S. assets, and Market Access Charges (MAC), which would tax inflows of foreign capital that bid up the value of the U.S. dollar.

The threat of large tariff increases can also be used to encourage countries to participate in major currency realignments. The United States has engaged in two major currency realignments within the past fifty years, and in both cases, realignment was achieved when large tariffs were threatened or actually imposed (temporarily). In August 1971, President Nixon abandoned the gold standard and imposed a 10 percent across the board import surcharge. His administration subsequently convinced major trade partners to revalue their currencies and remove trade barriers, and the import surcharge was removed four months later.

In 1985, in response to a major surge in imports and widespread manufacturing job losses, the House of Representatives on two occasions passed a bill that would have imposed a 25 percent surcharge on imports from countries such as Japan, Brazil, Korea, and Taiwan that maintained large trade surpluses with the United States. The Gephardt-Rostenkowski “Trade Emergency and Export Promotion Act” (H.R. 3035) passed the House twice in late summer and fall of 1985. On September 22, 1985, Treasury Secretary James Baker announced that the United States had reached a “Plaza Accord” with other members of the G-5 finance ministers, which resulted in a 29 percent decline in the value of the U.S. dollar between 1985 and 1991.

Congress and the president should strongly consider adopting (or threatening to adopt) large, across the board tariffs on countries with large global trade surpluses in order to persuade them to engage in a coordinated effort to reduce the value of dollar by revaluing their currencies, in order to rebalance global trade. The administration should also implement other policies, including CCI and MAC, to maintain the dollar at a level that is consistent with balanced global trade. These policies are needed to make good on the president’s commitments to rebalance trade and rebuild manufacturing.