Naked Economics (35 page)

The connection between the current account balance and a nation’s savings rate is crucial. Any country that is consuming more than it produces must by definition be running a current account deficit because (1) the stuff you are consuming beyond what you produce must come from somewhere else in the world; and (2) you can’t trade goods and services for the extra stuff that you’re getting from the rest of the world because you’ve consumed everything you have.

As usual, a farming analogy will help. Suppose Farmer America grows corn. He is a highly productive farmer, handsome and smart, who uses only the most modern farming techniques. (These details are irrelevant here, just as they are when describing whether a national economy runs a current account surplus or deficit.) There are only four broad things that Farmer America can do with what he grows: He can eat it (consumption); he can plant it for next year’s crop (investment); he can send it to the government to pay for services (government spending); or he can trade it for other stuff (exports traded for imports). That’s it. So let’s imagine that Farmer America’s year looks like the following:

He grows 100 bushels of corn. He eats 70. He sends 30 to the government. He needs 20 to plant next year. But if you do the math, you’ll see that Farmer America is using 120 bushels a year but growing only 100. He must be a net borrower of corn—20 bushels in this case. That is the equivalent of a current account deficit, and it’s just math—if he uses more corn than he grows, the rest has to come from somewhere else.

Farmer China works across the way. He grows only 65 bushels of corn, because he is new to farming and uses relatively primitive methods. Farmer China consumes 20 bushels, sends 10 to the government, and sets 15 aside to plant next year. Again, some quick math suggests that Farmer China is not using everything he grows. He has an extra 20 bushels. As convenience would have it, these bushels can be traded to Farmer America, who has come up short. Of course, Farmer America doesn’t have any crops to trade, so he offers an IOU instead. Farmer China gives Farmer America the corn (an “export”)—and loans him the money to buy it.

Let’s jump from farm analogies to reality: So far, the United States owes China about a trillion dollars.

Normally these kinds of global imbalances have self-correcting mechanisms. The currency of a country with a large current account deficit will usually begin to depreciate. Assume that New Zealand is running a current account deficit. The rest of the world is steadily accumulating New Zealand dollars because they are selling more goods to New Zealand than they are buying from it; foreign firms will want to trade their accumulated New Zealand dollars for their home currency. On the foreign exchange market, the supply of New Zealand dollars for sale will exceed the demand for them, pushing the value of the New Zealand dollar down relative to the currencies of its trading partners. The falling New Zealand dollar helps to correct the trade imbalance by making New Zealand’s exports more competitive and imports more expensive. For example, if the New Zealand dollar depreciates relative to the yen, then Toyotas become more expensive in New Zealand while New Zealand’s farm products (kiwis?) look cheaper in Japan. Meanwhile, the same thing happens with other countries; New Zealand will begin to import less and export more, narrowing the current account deficit.

The current situation involving China and the United States is different. The two countries are arguably locked in an unhealthy symbiotic relationship that has the potential to come unglued at any time. China has created a very successful development strategy built upon “export-led growth,” meaning that the bulk of job growth and prosperity has been generated by firms making products for export. Many of those exports come to the United States.

China’s export-oriented development strategy depends on keeping the renminbi relatively cheap. To accomplish that, the Chinese government recycles accumulated dollars primarily into U.S. treasury bonds, which are loans to the U.S. federal government. Both parties get what they want (or need), at least in the short run. The Chinese government has used exports to generate jobs and growth. America has funded its dissavings with enormous loans from China. The situation really isn’t much different than Farmer China and Farmer America: The United States gets loans from China to buy its exports.

In the long run, the situation poses serious risks for both parties. The United States has become a large debtor nation. Debtors are always vulnerable to the whims and demands of their creditors. America has a borrowing habit; China feeds it. James Fallows has noted, “Without China’s billion dollars a day, the United States could not keep its economy stable or spare the dollar from collapse.”
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Worse, China could threaten to dump its huge hoard of dollar-denominated assets. That would be a ruinous thing to do. As Fallows points out, “Their years of national savings are held in the same dollars that would be ruined; in a panic, they’d get only a small share out before the value fell.” Still, that’s an awfully powerful weapon to give a nation with which we often disagree.

The Chinese have it worse. Suppose America’s debt burden grows beyond what U.S. taxpayers can (or are willing) to pay back. The U.S. government could default—simply refuse to honor its debts. That is highly unlikely, mostly because there is another irresponsible option that is more subtle: America can “inflate away” much of its debt to China (and other creditors) by printing money. If we recklessly print dollars, the currency will lose value—and so will our dollar-denominated debts. If inflation climbs to 20 percent, then the real value of what we have to pay back will fall by 20 percent. If inflation is 50 percent, then half of our debt to China effectively goes away. Is this a likely outcome? No. But if someone owed me a trillion dollars and also had the authority to print those dollars, I would spend a lot of time worrying about inflation.

This dysfunctional economic relationship will end. The crucial questions are when, why, and how. James Fallows has summarized where we stand now: “In effect, every person in the (rich) United States has over the past 10 years or so borrowed about $4,000 from someone in the (poor) People’s Republic of China. Like so many imbalances in economics, this one can’t go on indefinitely, and therefore won’t. But the way it ends—suddenly versus gradually, for predictable reasons versus during a panic—will make an enormous difference to the U.S. and Chinese economies over the next few years, to say nothing of bystanders in Europe and elsewhere.”
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Given the stakes involved, are any adults supervising all of this? Yes, but they are getting long in the tooth. In the waning days of World War II, representatives of the Allied nations gathered at the Mt. Washington Hotel in Bretton Woods, New Hampshire. (It’s a delightful place in both summer and winter, if you are looking for a New England getaway.) Their mission was to create a stable financial infrastructure for the postwar world. They created two international institutions, or “the two sisters.”

The institution at the center of the global fight against poverty is the Washington-based World Bank. (The first $250 million loan was to France in 1947 for postwar reconstruction.) The World Bank, which is owned by its 183 member countries, raises capital from its members and by borrowing in the capital markets. Those funds are loaned to developing nations for projects likely to promote economic development. The World Bank is at the center of many of the international development issues covered in Chapter 13.

If the World Bank is the world’s welfare agency, then its sister organization, the International Monetary Fund (IMF), is the fire department responsible for dousing international financial crises. Iceland called the IMF. So did Argentina, Mexico, and all the others. The IMF was also conceived at Bretton Woods as a cooperative global institution. Members pay funds into the IMF; in exchange they can borrow in times of difficulty “on condition that they undertake economic reforms to eliminate these difficulties for their own good and that of the entire membership.” No country is ever required to accept loans or advice from either the IMF or the World Bank. Both organizations derive power and influence from the carrots they wield.

Few institutions have attracted as much criticism as the World Bank and the IMF from such a broad swath of the political spectrum.
The Economist
once commented, “If the developing countries had a dollar for every proposal to change the ‘international financial architecture,’ the problem of third-world poverty would be solved.”
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Conservatives charge that the World Bank and the IMF are bureaucratic organizations that squander money on projects that have failed to lead nations out of poverty. They also argue that IMF bailouts make financial crises more likely in the first place; investors make imprudent international loans because they believe the IMF will come to the rescue when a country gets into trouble. In 2000, the Republican-led Congress convened a commission that recommended shrinking and overhauling both the World Bank and the International Monetary Fund.
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At the other end of the political spectrum, the antiglobalization coalition accuses the World Bank and IMF of acting as capitalist lackeys, forcing globalization on the developing world and leaving poor countries saddled with large debts in the process. The organizations’ meetings have become an occasion for violent protest. When the two institutions held their fall meeting in Prague in 2000, the local Kentucky Fried Chicken and Pizza Hut both ordered replacement glass ahead of time.

As the global recession of 2007 unfolded, the United States criticized several European nations for not doing more to stimulate their economies. The specific criticism is debatable, but it makes a crucial point nonetheless. For the American economy to recover, the European economies needed to recover, too. And Japan. And China. And every other major economy. Nations are not competitors in the traditional sense of the word. After all, the Red Sox would never complain that the Yankees were not doing enough in the off-season to improve their team. Baseball is a zero-sum game. Only one team can win the World Series. International economics is the opposite. All countries can become richer over time, even as individual firms within those countries compete for profits and resources. Global GDP has grown steadily for centuries. We’re richer collectively than we were in 1500. Who got poorer to make that possible? No one. The goal of global economic policy should be to make it easier for nations to cooperate with one another. The better we do it, the richer and more secure we will all be.

I
magine a spectacular invention: a machine that can convert corn into stereo equipment. When running at full capacity, this machine can turn fifty bushels of corn into a DVD player. Or with one switch of the dial, it will convert fifteen hundred bushels of soybeans into a four-door sedan. But this machine is even more versatile than that; when properly programmed, it can turn Windows software into the finest French wines. Or a Boeing 777 into enough fresh fruits and vegetables to feed a city for months. Indeed, the most amazing thing about this invention is that it can be set up anywhere in the world and programmed to turn whatever is grown or produced there into things that are usually much harder to come by.

Remarkably, it works for poor countries, too. Developing nations can put the things they manage to produce—commodities, cheap textiles, basic manufactured goods—into the machine and obtain goods that might otherwise be denied them: food, medicine, more advanced manufactured goods. Obviously, poor countries that have access to this machine would grow faster than countries that did not. We would expect that making this machine accessible to poor countries would be part of our strategy for lifting billions of people around the globe out of dire poverty.

Amazingly, this invention already exists. It is called trade.

If I write books for a living and use my income to buy a car made in Detroit, there is nothing particularly controversial about the transaction. It makes me better off, and it makes the car company better off, too. That’s Chapter 1 kind of stuff. A modern economy is built on trade. We pay others to do or make things that we can’t—everything from manufacturing a car to removing an appendix. As significant, we pay people to do all kinds of things that we could do but choose not to, usually because we have something better to do with our time. We pay others to brew coffee, make sandwiches, change the oil, clean the house, even walk the dog. Starbucks was not built on any great technological breakthrough. The company simply recognized that busy people will regularly pay several dollars for a cup of coffee rather than make their own or drink the lousy stuff that has been sitting around the office for six hours.

The easiest way to appreciate the gains from trade is to imagine life without it. You would wake up early in a small, drafty house that you had built yourself. You would put on clothes that you wove yourself after shearing the two sheep that graze in your backyard. Then you would pluck a few coffee beans off the scraggly tree that does not grow particularly well in Minneapolis—all the while hoping that your chicken had laid an egg overnight so that you might have something to eat for breakfast. The bottom line is that our standard of living is high because we are able to focus on the tasks that we do best and trade for everything else.

Why would these kinds of transactions be different if a product or service originated in Germany or India? They’re not, really. We’ve crossed a political boundary, but the economics have not changed in any significant way. Individuals and firms do business with one another because it makes them both better off. That is true for a worker at a Nike factory in Vietnam, an autoworker in Detroit, a Frenchman eating a McDonald’s hamburger in Bordeaux, or an American drinking a fine Burgundy in Chicago. Any rational discussion of trade must begin with the idea that people in Chad or Togo or South Korea are no different from you or me; they do things that they hope will make their lives better. Trade is one of those things. Paul Krugman has noted, “You could say—and I would—that globalization, driven not by human goodness but by the profit motive, has done far more good for far more people than all the foreign aid and soft loans ever provided by well-intentioned governments and international agencies.” Then he adds wistfully, “But in saying this, I know from experience that I have guaranteed myself a barrage of hate mail.”
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Such is the nature of “globalization,” the term that has come to represent the increase in the international flow of goods and services. Americans and most others on the planet are more likely than ever to buy goods or services from another nation and to sell goods and services abroad in return. In the late 1980s, I was traveling through Asia while writing a series of articles for a daily newspaper in New Hampshire. In a relatively remote part of Bali, I was so surprised to find a Kentucky Fried Chicken that I wrote a story about it. “Colonel Sanders has succeeded in putting fast-food restaurants in the most remote areas of the world,” I wrote. Had I realized that the idea of “cultural homogenization” would become a flashpoint for civil unrest a decade later, I might have become rich and famous as one of the earliest commentators on globalization. Instead, I merely noted, “In this relatively undisturbed environment, Kentucky Fried Chicken seems out of place.”
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That KFC restaurant was more than the curiosity that I made it out to be. It was a tangible sign of what the statistics clearly show: The world is growing more economically interdependent. The world’s exports as a share of global GDP have climbed from 8 percent in 1950 to around 25 percent today.
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U.S. exports as a fraction of GDP grew from 5 percent to nearly 10 percent over the same stretch. It is worth noting that the bulk of the American economy still consists of goods and services produced for domestic consumption. At the same time, because of the sheer size of that economy, America is one of the world’s largest exporters, behind only China and Germany in total value. The United States has much to gain from an open, international trading system. Then again, so does the rest of the world.

Having made that case in many different venues, now I get hate mail, too. Sometimes it’s actually kind of clever. My favorite is an e-mail that came in response to a column arguing that a richer, rapidly growing India is good for the United States. After the usual introduction arguing that my job should be outsourced to some low wage country as soon as possible, the e-mail concluded, “Why don’t you and Tom Friedman [author of the pro-globalization book
The World Is Flat
] get a room together? The world isn’t flat, it’s just your head!” Others tend to be less subtle, such as the e-mail with the subject line: YOU SUCK!!!!!!!!!!!!!!!!!!!!!!!! (Yes, that is the exact number of exclamation points.)

All those exclamation points notwithstanding, nearly all theory and evidence suggest that the benefits of international trade far exceed the costs. The topic is worthy of an entire book; some good ones wade into everything from the administrative structure of the WTO to the fate of sea turtles caught in shrimp nets. Yet the basic ideas underlying the costs and benefits of globalization are simple and straightforward. Indeed, no modern issue has elicited so much sloppy thinking. The case for international trade is built on the most basic ideas in economics.

Trade makes us richer.
Trade has the distinction of being one of the most important ideas in economics and also one of the least intuitive. Abraham Lincoln was once advised to buy cheap iron rails from Britain to finish the transcontinental railroad. He replied, “It seems to me that if we buy the rails from England, then we’ve got the rails and they’ve got the money. But if we build the rails here, we’ve got our rails and we’ve got our money.”
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To understand the benefits of trade, we must find the fallacy in Mr. Lincoln’s economics. Let me paraphrase his point and see if the logical flaw becomes clear: If I buy meat from the butcher, then I get the meat and he gets my money. But if I raise a cow in my backyard for three years and slaughter it myself, then I’ve got the meat and I’ve got my money. Why don’t I keep a cow in my backyard? Because it would be a tremendous waste of time—time that I could have used to do something else far more productive.
We trade with others because it frees up time and resources to do things that we are better at.

Saudi Arabia can produce oil more cheaply than the United States can. In turn, the United States can produce corn and soybeans more cheaply than Saudi Arabia. The corn-for-oil trade is an example of absolute advantage. When different countries are better at producing different things, they can both consume more by specializing at what they do best and then trading. People in Seattle should not grow their own rice. Instead, they should build airplanes (Boeing), write software (Microsoft), and sell books (Amazon)—and leave the rice-growing to farmers in Thailand or Indonesia. Meanwhile, those farmers can enjoy the benefits of Microsoft Word even though they do not have the technology or skills necessary to produce such software. Countries, like individuals, have different natural advantages. It does not make any more sense for Saudi Arabia to grow vegetables that it does for Tiger Woods to do his own auto repairs.

Okay, but what about countries that don’t do anything particularly well? After all, countries are poor because they are not productive. What can Bangladesh offer to the United States? A great deal, it turns out, because of a concept called comparative advantage. Workers in Bangladesh do not have to be better than American workers at producing anything for there to be gains from trade. Rather, they provide goods to us so that we can spend our time specializing at whatever we do best. Here is an example. Many engineers live in Seattle. These men and women have doctorates in mechanical engineering and probably know more about manufacturing shoes and shirts than nearly anyone in Bangladesh. So why would we buy imported shirts and shoes made by poorly educated workers in Bangladesh? Because our Seattle engineers also know how to design and manufacture commercial airplanes. Indeed, that is what they do
best,
meaning that making jets creates the most value for their time. Importing shirts from Bangladesh frees them up to do this, and the world is better off for it.

Productivity is what makes us rich. Specialization is what makes us productive. Trade allows us to specialize. Our Seattle engineers are more productive at making planes than they are at sewing shirts;
and
the textile workers in Bangladesh are more productive at making shirts and shoes than they are at whatever else they might do (or else they would not be willing to work in a textile factory). I am writing at the moment. My wife is running a software consulting firm. A wonderful woman named Clementine is looking after our children. We do not employ Clemen because she is better than we are at raising our children (though there are moments when I believe that to be true). We employ Clemen because she enables us to work during the day at the jobs we do well, and that is the best possible arrangement for our family—not to mention for Clemen, for the readers of this book, and for my wife’s clients.

Trade makes the most efficient use of the world’s scarce resources.

Trade creates losers.
If trade transports the benefits of competition to the far corners of the earth, then the wreckage of creative destruction cannot be far behind. Try explaining the benefits of globalization to shoe workers in Maine who have lost jobs because their plant moved to Vietnam. (Remember, I was the speechwriter for the governor of Maine;
I have tried to explain that.
) Trade, like technology, can destroy jobs, particularly low-skilled jobs. If a worker in Maine earns $14 an hour for something that can be done in Vietnam for $1 an hour, then he had better be 14 times as productive. If not, a profit-maximizing firm will choose Vietnam. Poor countries lose jobs, too. Industries that have been shielded from international competition for decades, and have therefore adopted all the bad habits that come from not having to compete, can be crushed by ruthlessly efficient competition from abroad. How would you like to have been the producer of Thumbs-Up Cola in India when Coca-Cola entered the market in 1994?

In the long run, trade facilitates growth and a growing economy can absorb displaced workers. Exports rise and consumers are made richer by cheap imports; both of those things create demand for new workers elsewhere in the economy. Trade-related job losses in America tend to be small relative to the economy’s capacity to produce new jobs. One post-NAFTA study concluded that an average of 37,000 jobs per year were lost from 1990 to 1997 because of free trade with Mexico, while over the same period the economy was creating 200,000 jobs per month.
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Still, “in the long run” is one of those heartless phrases—along with “transition costs” or “short-term displacement”—that overly minimize the human pain and disruption.

Maine shoe workers are expected to pay their mortgages
in the short run.
The sad reality is that they may not be better off in the long run, either. Displaced workers often have a skills problem. (Far more workers are made redundant by new technology than by trade.) If an industry is concentrated in a geographic area, as they often are, laidoff workers may watch their communities and way of life fade away.

The
New York Times
documented the case of Newton Falls, a community in upstate New York that grew up around a paper mill that opened in 1894. A century later, that mill closed, in part because of growing foreign competition. It’s not pretty:

Yes, the economic gains from trade outweigh the losses, but the winners rarely write checks to the losers. And the losers often lose badly. What consolation is it to a Maine shoe worker that trade with Vietnam will make the country as a whole richer?
He’s poorer and probably always will be.
I’ve gotten those e-mails, too.