Saturday, April 1, 2017

Must Capitalist Economies Grow?

I ran across a claim that a "capitalist" economy must grow.

I believe that one of the key benefits of a market economy is creative destruction.   Entrepreneurship leads to innovation and growth. Profit and loss incentives motivate each firm to introduce new products and methods of production that create a system where larger amounts of better goods and services are produced.  Successful innovation generates greater profit.   Perhaps more important,  innovation by competitors can result in reduced profits and perhaps losses and even bankruptcy.   This creates a powerful incentive to innovate in order to "keep up with the competition."

A somewhat different consequence of profit and loss incentives is to allocate resources to produce whatever goods and services for which people are willing to pay the most.   Competition for resources results in resource prices that communicate opportunity costs--the value of the most important goods and services sacrificed by the use of those resources in production.   If buyers are willing to pay more for products than the opportunity cost of the resources used to produce them, then a firm profits.   If, on the other hand, people are willing to pay less for a product than the opportunity cost, any firm producing that product suffers losses--motivating it to produce less.  Profit and loss creates an incentive to produce more important things and avoid "wasting" resources in producing less important things.

But does any of this mean than capitalist economies must grow?

One "micro" argument would be that larger firms are always more efficient.  This would seem to imply that only one firm can survive competition.   During the competitive process, then, each firm is racing to be the biggest, and so most efficient, which will allow it to increase its lead and eventually "win" the competition by becoming a monopoly.  

I am not sure how seriously to take such an argument.   If a new production technique is introduced that exhibits economies of scale, and there were many firms using some prior approach with fewer such economies of scale, then something like the above process would occur.   Depending on the economies of scale and the demand for the product, it could be that the result is a natural monopoly--a single firm can produce the amount of the product demanded at the lowest cost.   But this is not necessarily true.     It is not always most efficient to produce output in a single giant plant.  It is more common to have many factories or plants even if they are all owned by a single firm.   Having many factories managed by a single firm is not necessarily more efficient than having multiple independent firms in competition.   Organizations have many problems, which generally are described as the cost of bureaucracy.  One key benefit of the market system is that it allows for large scale cooperation without a single massive bureaucracy.   There can instead be many, somewhat smaller, more manageable bureaucracies.

A second argument is "macro."   Here there is a behavioral assumption that is supposed to be a defining characteristic of capitalism.   Firms make profit.   While the owners of the firms consume something, this can be ignored as a practical matter.   The profits are all reinvested making the firm grow.   "Capital," understood as the value of the firm, increases.   "Capitalism" is an economic system that maximizes the growth of capital by maximizing profit.  The greater capital is intended to result in greater profit and so greater increases in capital.   Critics of capitalism claim that this system must eventually collapse.   I read Marx as making an argument along these lines.

I think there are some advocates of the market system who defend it with something like the first part of the argument.   They justify profit based upon how it is used.   Profit is justified because it is reinvested and that creates more growth (and maybe even "more jobs.")    I suppose for a leftist critic of capitalism, reading such claims by their opponents, gives them the impression that everyone agrees that capitalism entails constant growth in capital.   And if these advocates of capitalism focus on the benefits of more capital and justify profit on that ground, then this explains their opposition to policies that reduce profit--such as higher wages.

I think that most economists, including those who are very sympathetic to the market, really don't focus on how profits might be used.   As I mentioned in my first two paragraphs, the profits and losses both motivate innovation and also the allocation of resources to produce what particular goods and services people want to buy the most.   If anything, the assumption is that the entrepreneurs use this source of income to enjoy greater consumption of goods and services.   That is the reward they obtain for their successful innovation or reallocation of resources.    I think allowing entrepreneurs to obtain profit and suffer losses is desirable because the prospect of profit and losses motivates them to do desirable things--innovate and reallocate resources to produce what people want to buy most.

Of course, entrepreneurs may well save part of the income they earn.  Perhaps they will save a substantial portion of it.   Still, any identification of profit with saving and capital accumulation is simply not a key element of modern economics.   Instead, it is common to identify "capitalism" with a "market economy."   My basic framing of the economic problem includes consumption being the purpose of production.   So, as I consider capitalism, I don't start with profit and capital accumulation, must less with a "goal" of maximum aggregate profit and maximum accumulation of capital.  Rather, it is about people achieving their goals, with an emphasis on producing the goods and services they most want to consume.     Perhaps I have some slight idiosyncratic twist to my thinking on this, but I think it is pretty much consistent with mainstream economics.  In my view, this is just a restatement of the centrality of scarcity in economic thinking.

Starting with this notion that the purpose of production is consumption helps make sense of the view that saving is about reducing consumption in the present and increasing it in the future.   For an individual in a market system, to save is to spend less on consumer goods and services now than the income earned now, so that  more can be spent on consumer goods and services later than the income earned later.   Suppose someone works for many years and spends just part of their wage income on consumer goods and services.   The saving each year is income less  consumption.   This person's wealth, or net worth, grows with that saving over the years.   Eventually, this individual retires from work and no longer has any wage income.   However, they continue to purchase consumer goods and services out of their accumulated wealth.   Each year, wealth decreases due to dissaving.   That is, consumption greater than income.

Entrepreneurs earn profit, which is a form of income.   Unless they have some other source of income, they must use some of it to purchase consumer goods and services.  If they earn a very high income, then they can purchase lots of consumer goods and services.   However, like anyone else, they certainly can save.   Still, the basic framing here is that they save by spending less income from profit on consumer goods and services now in order to spend more than their income in the future.

Under most circumstances, both the worker saving for retirement or the entrepreneur saving profit and building a fortune can earn capital income on their wealth.   The worker might put savings in a bank and earn interest.   The entrepreneur might reinvest his saving in his own firm, purchase additional capital equipment, and earn additional profit.   This capital income reduces the amount the worker must save while working to have sufficient consumption when retired.   The already luxurious consumption an entrepreneur could afford now is compounded in the future by the additional income earned on accumulated wealth.

However, this doesn't mean that there is some kind of "system" that has the goal of maximizing aggregate profit with all of it being saved to accumulate as much wealth as possible to increase profit as much as possible.

In my view, the fundamental reason for capital income is productivity.   If fewer resources are used to produce consumer goods and services now, then those current resources can be used in ways that allow for additional production of consumer goods and services in the future that not only replace those sacrificed now, and but exceed them.   Generally these techniques involve the use of various sorts of durable tools--machinery, equipment and the like.   More elaborate--more expensive and productive--tools can be used if more resources are available to produce them.

The capital income earned by the worker putting money in a bank for retirement or the entrepreneur reinvesting profit into his or her own enterprise captures part of this additional output as added income.   That it is desirable that people earn capital income is not based on some notion that they will always reinvest such income and accumulate even more wealth which also implies that more valuable and productive capital equipment will be produced an utilized.  Or rather, I don't think of it that way.   It is rather that the prospect of earning such income in the first place motivates people to save more than they otherwise would, resulting in more total output and income than would otherwise exist.

To me, and most all economists, growth is about increases in the production of goods and services.   It isn't about increases in aggregate profit or wealth or the capital stock.   Profit and loss generates powerful incentives for growth, however, nothing in the market system, that is  "capitalism," requires such growth.   If no one was interested in any new good or service or there were no better ways to produce the existing ones, then there would be no more innovation.   One of the key reasons why profit is desirable would no longer exist, though there would still be the second reason--producing the proper mix of existing goods and services in the already discovered most efficient ways.

Most economics is done in the context of a growing population.   This requires some net saving and investment so that a growing work force can utilize the same types and amounts of capital equipment and that there will be more consumer goods and services for the additional people to enjoy.   Such growth could occur with each person and generation enjoying unchanging consumption per capita.   A market system could coordinate that scenario.

If the population were to be constant or even shrink, the market system could coordinate that scenario too.  With a constant population, constant consumption and sufficient capital (tools and the like for each worker) could be maintained with no net saving or investment.   With a shrinking population, the market system could coordinate a shrinking capital stock through negative saving and investment-net dissaving and net disinvestment.   The output of consumer goods and services would shrink over time, reflecting the reality that there would be fewer people to enjoy them.

Or suppose people wanted to enjoy more leisure.  They might prefer shorter workdays, work weeks, longer annual vacations, or perhaps start work later or retire earlier.   If they valued this more than the goods and services that they would not be producing and could no longer afford, then the market system could coordinate that.   Better yet, in the context of creative destruction and growing productivity it is perfectly possible to take the benefits in reduced work time.   Further, a market system could coordinate a mixed result where more consumer goods and services are produced for people to enjoy along with additional leisure time to enjoy them.

If everyone wanted to consume all of their income, so that there was no net saving and no net investment, then wealth would not grow nor would the capital stock.   However, if creative destruction continued, the capital equipment might well improve, and substantially change as old capital goods wear out and are replaced.   Consumption could grow or leisure could expand without any increase in wealth or capital.   (The scenario of no net saving or investment and a growing population is more challenging.)

Nothing in a market system requires constant growth in output.  Nor does capitalism require that profits be saved and used to increase net worth and increase the capital stock.

A separate question is whether a practice of entrepreneurs always saving their profit so that profit always adds to net worth and the capital stock is harmful the market system.   It is not necessary for capitalism to exist, though it is plainly consistent with capitalism if people behave this way.  What happens?  Does that practice, which some seem to think is an essential defining characteristic of capitalism, have some calamitous consequence?

More later.

Tuesday, March 14, 2017

The Trade Deficit, National Income Accounting and Aggregate Demand

Peter Navarro has been using the national income accounting identity to argue that policies that reduce the trade deficit must increase the production of goods and services in the U.S.   There have been various efforts to dismiss his claim as absurd.   Interestingly, he appears to be following in Keynes' footsteps by being a little confused about the relationship between identities and equilibrium conditions.   But the best way to interpret Navarro's claim is to see it as a very simple Keynesian approach.   On this view, aggregate real output in the U.S. is driven by aggregate demand for goods and services produced in the U.S.

U.S. GDP is a measure of the production of goods and services in the U.S.   The textbook accounting identity is Y = C+I+G+X where Y is GDP, C is consumption, I is investment, G is government spending, and X is net exports.   Net exports are exports minus imports.   If there is a trade deficit, then X is negative, so it subtracts from C+I+G.   The bigger the trade deficit, then, the smaller is GDP.   A smaller trade deficit, or better yet, a larger trade surplus, implies a larger GDP.    Navarro claims that this means that policies that encourage exports or discourage imports will raise GDP.

The argument that this is just an identity points out that the C, I, and G refer to goods and services categorized as consumption, investment, and government in the U.S. regardless of where produced.   Imports are subtracted to get the goods and services produced in the U.S.   Exports are added to account for the goods produced in the U.S. that are not categorized as U.S. consumption, investment, or government because they are accounted for as C, I or G in some other country.

However, I think this is an unfair characterization of Navarro's view.   Navarro's point is that GDP is equal to spending by U.S. residents on domestically produced  U.S. output plus foreign spending on domestically produced output.   The process for calculating GDP is to add up all spending by U.S. residents on different categories of goods and services and then subtracting off spending on foreign produced goods.  This provides spending by U.S. residents on goods and services produced in the U.S. Spending by foreigners on all types of U.S. output is added back.   The result is total spending on U.S. goods and services.   This is nominal aggregate demand.

Navarro's theory is the simple Keynesian one that the various categories of spending are determined, and if it becomes more costly to purchase foreign goods, then spending will be shifted to purchase domestically produced output.   For example, if total spending on consumer goods and services by U.S. residents is $12 trillion, and $2 trillion of that would be spent on foreign consumer goods and services with relatively open markets, a policy of banning all imports would result in U.S. consumers spending $2 trillion more on consumer goods or services produced in the U.S.    The same would be true for investment--purchases of newly-produced capital goods by U.S. firms as well as purchases by various levels of government.   Therefore, a smaller trade deficit (or larger surplus) would be associated with more aggregate demand in the U.S.

Navarro emphasized the possibility of an increase in exports.   Trump's threats to impose higher taxes on imports from Mexico would result in Mexico agreeing to purchase more U.S. products in order to be allowed to continue to export to the U.S...Assuming that spending by U.S. residents on consumer goods, capital goods, and government in aggregate is unchanged, this increase in the demand for U.S. goods by Mexicans increases total spending on domestically produced U.S. goods and services.   Again, the trade deficit is lower and aggregate demand is higher.

In the simplest Keynesian model, output is solely determined by aggregate demand.   If trade policy can expand exports and reduce imports, these "deals" that reduce the trade deficit (or expand a surplus) will increase aggregate demand and so production in the U.S.

This Keynesian model is most plausible when there is unemployment of labor and excess capacity in most sectors of the economy.    The increase in demand both results in more production and more employment.

In a world with near universal price floors, and a quantity of money such that equilibrium prices are below those fixed prices, this Keynesian approach would apply.    If the floors instead apply to wages, the result would be similar.    Of course, rather than hoping for "better" trade deals to raise aggregate demand, it would be possible to repeal the price floors or else increase the quantity of money.

Fortunately, the U.S. does not have anything like universal price floors.   However, in the short run at least, it seems that prices and wages do not immediately adjust so that real aggregate demand equals productive capacity.   In fact, they appear to have some perverse momentum that is only gradually dissipated.   Prices and wages continue to rise even when market conditions suggest they should fall.   Only very gradually does the rate of increase of prices and wages slow.

It is possible then, that during a recession, tough trade negotiations would boost aggregate demand and hasten a recovery.    This is not an argument that reduced imports and expanded exports will permanently increase output and employment.   In other words, Trump's approach might have made sense in 2008 and 2009, but no longer.    The Fed has already started raising interest rates to restrain the growth of spending on U.S. output.   Policy that reduces imports and expands exports would reduce the trade deficit, but it would it would have no impact on aggregate demand or employment.  It would instead just result in higher interest rates.

Even in recession, restrictions on imports can easily backfire.   That is because exports are not fixed.  For a "small" country, this might not be a problem.   But if the U.S. restricts imports, the result could easily be a recession in other countries, which will result in fewer U.S. exports.  The foreigners demand fewer U.S. goods when their economy suffers recession.   This results in reducing income to those producing the exports, which likely would result in reduced demand for both domestically-produced goods and services, and imported goods.    Casual empiricism suggests that triggering a recession in the U.S. is the best way to reduce U.S. imports and so the trade deficit!

For a small country, the amount that it imports from the rest of the word is small, and so reductions have little impact on the world economy.   For such a country, the only problem is "retaliation," where foreign governments restrict imports from the small country and so reduce its exports.  

As a Market Monetarist, I believe that the monetary regime can and should target a stable growth path for nominal GDP--spending on domestically produced output.   What I think is the most reasonable interpretation of Navarro, that trade policy can reduce trade deficits and increase aggregate demand which might hasten the recovery of output and employment in a recession and avoid the need for disinflation, is unnecessary and inappropriate.    Under the current monetary regime, better monetary policy by the Fed would make this unnecessary.

Regardless, thinking of our current situation, and the long run across many business cycles, it is not sensible to have a trade policy that is about expanding aggregate demand to hasten recover from a recession.   The long run analysis must take into account that a trade deficit is matched by a net capital inflow.   The result is a lower natural interest rate and more investment.    That is, the demand for capital goods, including domestically produced capital goods, is higher than it would be if the trade deficit was lower.

If some policy does manage to reduce the trade deficit, the result may well be more domestic production of goods and services that would have been imported and more goods produced for export, but there would be fewer capital goods produced.   The result is a change in the composition of demand and the allocation of resources, but there is no increase in aggregate demand.

Worse, the long run effect of any restriction in the production of capital goods is a lower growth path of productive capacity and so future real GDP will be lower than it otherwise would have been.

And that points to the fundamental determination of trade deficits--the relationship of domestic saving and investment to world saving and investment.   It would be great if foreign governments would reduce barriers to trade and this allowed for increases in U.S. exports.   However, this could easily result in more U.S. imports, leaving the U.S. trade deficit the same.   Americans would earn more from exports and use the extra income to purchase more imported goods.  That is the key reason to export goods and services--getting imports in exchange.    But that also ignores international investment.

If the world interest rate is below the interest rate that would coordinate U.S. national saving with U.S. domestic investment, then foreigners will be motivated to invest in the U.S. to obtain higher returns.   The amount of this net capital inflow must be matched by a trade deficit.  Foreigners will export goods and services to the U.S., not to buy U.S. goods and services and take them home with them, but rather to buy capital goods in the U.S. or else claims to capital goods--like stocks or bonds.

It is important to understand that this is not foreigners buying up a fixed quantity of assets. The U.S. can and does produce additional capital goods to sell to foreigners.   U.S. workers and firms are building a plant for Volvo in the South Carolina lowcountry.   These new capital goods increase future production in the U.S.  A reduction in the trade deficit, then, means that increase in future production does not occur.   That doesn't mean that production doesn't grow over time.   It probably would grow, but its level at any future time would be lower than if there had been a larger trade deficit, net capital inflow, and investment.

The foreign investors expect a return, and the reduction in the growth path of real GDP would not be entirely a decrease in the growth path of real GNP.   Less will be produced in the U.S. in the future than otherwise, but less income will be paid out to foreign investors.   Still, this is unlikely to benefit U.S. workers--even foreign owned capital goods are a complementary factor of production which would tend to raise their incomes.

It is incomes that foreigners earn from U.S. investments that leads some to describe a net capital inflow as an increase in U.S. indebtedness to the rest of the world.   While foreigners could hold deposits in U.S. banks or purchase corporate bonds or U.S. government bonds or even accumulate paper currency, they in fact also purchase equity--stocks--or make direct investments.   If everything goes as planned they can earn income from all of these investments and even repatriate the money they invested at some future time.  But foreign equity investments in the U.S. are not debts of any U.S. resident.

Now, I favor a reduction in the U.S. budget deficit, shifting it to a modest surplus.   This would result in an increase in U.S. national saving.   The result should be a slightly lower trade deficit in the U.S.   Further, I favor social security privatization, shifting from a pay-as-you go system to a fully funded system.   That will increase U.S. private saving.   This also would tend to reduce the trade deficit.    I favor ending excessive regulation of business in the U.S. (A goal I share with Trump.)  This should increase domestic investment in the U.S., which would tend to raise the U.S. trade deficit.

So, I think Navarro isn't just confusing an identity with an equilibrium condition.  He may seem to.   And maybe he is a little confused.   But I think the best way to understand his view is that he is making a simplistic Keynesian argument--acting as if production is always constrained by demand while ignoring key role of productive capacity.   My Economics 201 back in the day emphasized the simple Keynesian Cross.  Advanced Macroeconomics (first year graduate school) was a bit more sophisticated.   Perhaps it was different at Harvard in Navarro's day.  But I suspect he is using a very simplistic approach that most economists understand quite well.

Tuesday, January 31, 2017

Trump's Ban

     When Trump ran for President he proposed a total ban on Muslim's entering the U.S. until our representatives figure out what is happening.   The last part was foolish and the first part was evil.  That he would propose such a thing was something that made him unacceptable.

    Before long, he came up with a different proposal.   This time, it was not Muslims that would be banned but rather people from countries that are sources of terrorism and rather than the ban lasting until we figure out what was going on, people from those countries will be subject to "extreme vetting."   
     Trump's executive order appears more consistent with this second approach, which I think is sensible.   The administrative incompetence was incredible.  There was no need for a rush.   How hard would be to slow down new visas?   How difficult is it to devote more resources to investigation?

     Of course, this would not involve some dramatic "action" by Trump.   It just would have modestly improved security.  

     It is just difficult not to see Trump and his advisors as being both incompetent and cruel.

Saturday, January 21, 2017

Tariffs and Exports

    If the Trump administration imposes a tariff on imports, it will result in a contraction of trade--both imports and exports.   Frequently, it is claimed that this will only occur if foreign governments retaliate to tariffs on their exports to the U.S. with tariffs on U.S. exports to their countries.    However, that is not correct.   There is a market process that brings this about even without "retaliation."

     The most direct process occurs with floating exchange rates, which is at least approximately the U.S. regime.   The tariff reduces the amount of dollars paid for imported goods.   This reduces the supply of dollars on foreign exchange markets and so requires an increase in the value of the dollar for the market to clear.  This partly offsets the tariff by making the dollar prices of imported goods less, but it also makes U.S. exports more expensive for the foreign buyers.   This results in a decrease in exports.

      The U.S. currently has a trade deficit, and the stronger dollar will tend to reduce it.   While an expectation of an increased value of the dollar will encourage foreigners to invest in U.S. financial assets, once the dollar is higher, U.S. real assets will be more expensive for foreigners.   So, the result will tend to be a lower trade deficit as well as reduced exports.

       The U.S. could use monetary policy to prevent the dollar from rising in value.   This is done by increasing the quantity of money.   The equilibrium consequence of this policy is higher inflation in the U.S.  The higher prices in the U.S. will make foreign imports more attractive, partially offsetting the effect of the tariff, but will also make U.S. exports more expensive for foreigners, causing them to purchase less.   Similarly, U.S. assets will be more expensive for foreigners to purchase, so that the trade deficit will be smaller.

       Like most market monetarists, I think that prices are sticky, and that includes wages.   The inflationary process would not be instantaneous or smooth.   The increase in demand though out the economy would likely result in increases in output and employment.   Wages are also very sticky, even in an upwards direction, so real wages would be depressed which should help employment.   That effect would be especially strong in weak areas of the economy--including import competing manufacturing.   Only in "the long run" would higher prices and wages result in a return to equilibrium.

       It would be possible for the central bank to keep keep the dollar from rising while avoiding inflation by sterilization.   The Federal Reserve would need to sell off dollar assets it holds while purchasing foreign exchange--foreign assets.    This can last as long as the Fed has U.S. assets to sell.   The result should be a reduction in imports and a reduced trade deficit.   Unfortunately, the expansion in demand for the products of U.S. import competing industries will be offset by a reduction in the demand for the products of interest-sensitive industries--construction and capital goods.   Once the Fed runs out of U.S. assets, allowing the dollar to rise would result in financial losses to the Fed.   Perhaps this would lock in the inflationary equilibrium.

       It would also be possible to blame the increase in the value of the dollar on currency manipulations by foreigners.   A higher dollar is at the same time a lower pound, euro, yen, and renminbi.   How dare they devalue their currencies to offset the effects of the tariffs?
       Foreign nations could prevent their currencies from losing value by contracting their quantities of money.   In the long run, this would result in them having lower prices and wages, and so U.S. buyers would find their imported goods cheap and they would find U.S. exports expensive.   While that process would likely be long and painful, the effect on U.S. exports would be prompt.   The recession induced by their monetary contraction would result in reduced U.S. sales in their markets.

       Finally, they could keep their currencies from losing value by selling off any U.S. assets they hold and instead accumulating other sorts of foreign exchange or else each their own domestic assets.   This would tend to shrink the U.S. trade deficit by reducing the amount of foreign funding of U.S. investment.   This could last until they run out of U.S. foreign exchange.   Again, any expansion in the demand for import competing industries will be offset by a reduction in demand in interest sensitive industries in the U.S.--construction and capital goods.

      Changes in the composition of the Fed's balance sheet or the balance sheets of foreign central banks could shield U.S. exports from the decrease in imports for a time.   It is only if such adjustments are made that a contraction in U.S. exports would only occur due to retaliation of increased tariffs.

Sunday, January 15, 2017

Border Adjustment Tax

     Congress has proposed several reforms of the corporate income tax.   One reform is a border adjustment tax.   This means that corporate "profit" will be calculated with no deduction for the cost of imported goods and with a deduction of revenues from exports.
      This has been characterized as a tax on imports and a subsidy for exports.   Of course, it isn't actually the payment of a bounty for exported goods, but rather a relief from corporate income tax on profit generated from exports.   Still, the economic impact  should be similar to a more transparent tax and subsidy scheme.
       However, a tariff on all imports and subsidy for all exports has approximately no effect on trade.   A tariff on a single import tends to restrict demand for that imported good, but the resulting appreciation of the dollar expands the demand for other imports while reducing exports.  Trade shrinks.
       A subsidy for a particular export will tend to expand the production of that export, while the appreciation of the dollar will slightly contract other exports and expand imports.   Trade expands.
       But if you tax all imports and subsidize all exports the same, there is no reallocation between various imports or various exports nor is there any expansion or contraction of trade.    The dollar rises, leaving the allocation of resources unchanged.
       The result is not a reduction in the trade deficit or increase in the trade surplus unless the tax impacts saving or investment.   For a trade deficit country, either investment must decrease or saving increase for the trade deficit to decrease.   While possible, this is a second order effect.
        The rationale for the border adjustment tax is to shift from taxing profits from production in the U.S. to instead taxing profits from selling in the U.S.   The result should make the tax system neutral regarding location decisions for firms seeking to sell products in the U.S.
          The tax proposal has other characteristics that also are inconsistent with a tax on profit.   All capital expenditures are to be expensed rather than depreciated.   That means that if a corporation invests its profit in capital equipment, it pays no tax on the profit.  Also, interest expense is not deductible.  That means that corporations will be paying tax on the income they pay out to bondholders, so that all investors, whether stockholders and bondholders will be taxed the same.   This should make the tax neutral regarding the financing of corporations by the issue of stocks or bonds, taking away the existing artificial encouragement of leverage (borrowing.)
         And the corporate tax rate is to be reduced to 20% rather than the unusually high 35% that exists today.
         A true value added tax is a tax on income.   However, the typical value added tax allows expensing of investment, which makes it a tax on consumption.  Border adjustment taxes are typically applied, so that the consumption of imports is taxed just like the consumption of domestically-produced goods.   Exports are exempt, because there is no intention of taxing foreign consumption.
         A national sales tax is more transparent, and would involve the taxation of final sales of consumer goods and services.   (A tax on the sale of all final goods and services would be an income tax.)   Consumption of imported goods would be taxed the same as domestic products, and there would be no taxation of exports.
        The proposed reform of the corporate income tax, then, moves it in the direction of a consumption tax, but the process is not complete because payroll expense will still be deductible.   It would seem, then, that the proposal is a tax on consumption of capital income from sales in the U.S.
         While the tendency for the dollar to rise could occur through a prompt adjustment of the nominal exchange rate with the inflation rate unchanged, this could be prevented by open market purchases of foreign exchange. This resulting money creation would raise the inflation rate.   In the long run, equilibrium would return with prices and wages higher in the U.S.   As U.S. prices rise, imports would expand and exports shrink,  returning imports, exports and the trade deficit to its initial value.
          The use of sterilized foreign exchange transactions would be possible.   Here, the Fed would sell off its holdings of U.S. assets and purchase foreign exchange.   This would tend to reduce the U.S. trade deficit by reducing foreign funding of U.S. investment.   It could last until the Fed runs out of dollar assets.   This policy could be introduced at any time, though it would usually generate a decrease in the U.S. nominal exchange rate.  That would tend to shrink imports and expand exports consistent with the reduction in foreign funded investment in the U.S.   This might be more politically acceptable if it limits and restrains what otherwise would be an increase in the nominal exchange rate.
        Foreign exchange operations are the responsibility of the U.S. Treasury, so I suppose this could be implemented regardless of what the Federal Reserve wants to do.   The Fed could either sterilize to keep to its inflation target or allow inflation to rise until the real exchange rate increases the necessary amount.
        My preference, of course, would be to allow the nominal exchange rate to increase enough.  While I do not favor inflation targeting, nominal GDP targeting would be qualitatively similar in this situation.

Wednesday, January 4, 2017

Deindustrialization and Unionization

      The long run trend for U.S. employment is up.   The unemployment rate fluctuates with the business cycle, but any trend is at best minimal.   Still, there are constant complaints that imported goods are destroying jobs.   Or perhaps it is just the "good jobs."   And what are these good jobs?   They are factory jobs were men of modest education can earn high wages and benefits.   These jobs are supposed to allow those workers to be part of the middle class.
       Surely, this is why the loss of manufacturing employment is counted as a major concern.   These middle-class jobs disappear and some of those losing the jobs, or perhaps just their children and grandchildren, must accept low paying jobs in the service sector.   Of  course, some that are more ambitious may accept more responsibility and risk, or at the very least, seek more formal education, allowing for more skilled work.   Even so, people who are little different in terms of skills and attitudes from those who had "good jobs" in the past  must now take substantially worse jobs.
        A simple model of unionization has the union increasing wages in the union sector.   The quantity of labor demanded by the firms in that sector is lower, reducing employment.   The workers who would have worked in the unionized sector seek employment in the nonunion sector.  The increase in supply in the nonunion sector lowers wages in that sector.   In the simplest model, the workers are identical, so the result is that identical workers earn differential wages depending on their industry.   Wages are above the competitive level in the union sector and below the competitive level in the nonunion sector.
       In the nonunion sector, the labor market clears.   In the union sector, there is a surplus of labor.   Workers from the nonunion sector would prefer "good jobs" in the union sector.    If the union sector is "manufacturing" and the nonunion sector is "services," then this would explain why manufacturing is identified with "good jobs" that are "scarce" and the service sector are "bad jobs."
        Unions took off in the U.S. during the Great Depression.   In my view, this was mostly due to money illusion.   There was massive deflation during the first part of the thirties, and substantial decreases in nominal wages.   While real wages actually increased, workers became very interested in joining unions in order to fight the unfair pay cuts.  Federal government policy changed to strongly support unionization, but the workers supported unionization to fight nominal pay cuts despite growing real wages.
          As time passed, the unionized workforce became less significant, mostly because the growth of unionization failed to keep up with the growth of the labor force.   However, many years ago, someone from "management" once explained that there is little benefit for workers to join a union because employers provide pay and benefits for nonunion jobs that are competitive with union pay and benefits.  There appears to be substantial truth to this notion, most obviously in industries and even firms that have both union and nonunion operations.    Keeping pay and benefits low in the nonunion shop is just asking for an organization drive and the loss of the election.
         This suggests that the proper division in the simple model is not between the union and nonunion sectors, but rather between the "easy to unionize" and "difficult to unionize" sectors.   If manufacturing is on the whole easy to unionize and the service sector is difficult to unionize, then manufacturing will provide "good jobs" that pay more than the competitive amount and the service sector will have poor jobs that pay less than the competitive amount.
         It is certainly plausible that manufacturing is easy to unionize because of economies of scale.  There are also substantial sunk costs, which makes exit difficult, which in turn makes entry risky.  In the rest of this post, I will assume manufacturing is easy to unionize and the result is higher than competitive wages in manufacturing.   The service sector is difficult to unionize and so results in lower wages.  
         This ties to trade because it is a way to bypass the inefficiency created by unionization.   The reduced employment in manufacturing results in too low output and too high prices.   The shift of labor to the nonunion sector results in too high output and too low prices.
          By importing manufactured goods, those in the service sector obtain products at lower prices.   This raises their real income.   The domestic manufacturing industry, which is already too small, reduces output further.   However, the need to meet foreign competition lowers their too high prices.   The reduction in employment in the manufacturing sector increases the supply of labor to the service sector, resulting in lower wages.
          Trade must balance, but it is possible to export services.   Tourism is an obvious example, and there are various sorts of financial services that can be provided to foreigners.   It is also possible that a net capital inflow could fund imports of manufactured goods.   Foreign investment funding an expansion of the service sector would fit in well with this account.  
          Certainly, this story does not account for all of the U.S. experience in the late twentieth century.   The simple model ignores sorting in a labor market where workers are not all the same.   Sectors with excessive wages and and a surplus of labor will tend to hire what they perceive to be higher quality workers.   To some degree, workers left in the low wage sector may be less productive.   Manufacturing output has generally increased in the U.S. and not disappeared.  However, the "problem" of a lack of high paying jobs for workers with little education is not solved by a demand for highly-skilled workers in manufacturing.
          Still, I think it does tell us something about the "problem" of the loss of "good jobs."   That just doesn't make much sense in a competitive labor market.   We can image shifts in the share of income going to labor and capital due to changes in trade or technology.  These changes could tend to depress real wages.  These changes simultaneously expand real output so that the net result is ambiguous.   But these processes do not appear to create the phenomenon of the loss of "good jobs" in import competing industries.  
           If a single industry were unionized or were simply subject to unionization, those working in that sector would almost certainly benefit.   They would receive a larger share of a very slightly smaller pie.   When all manufacturing is unionized or even subject to unionization, the loss in total efficiency is more substantial.   The unionized autoworker pays more for shoes produced by union labor.   The expansion of imports similarly has ambiguous effects.   The union shoe maker can buy a cheaper Korean car, while the union autoworker can buy cheaper Mexican shoes.   Still, the analysis treating "manufacturing" as an aggregate provides some element of truth.   Those keeping the unionized or unionizable jobs get cheaper haircuts and the barber pays more for cars and shoes.   An expansion of imports allows the barber to get cheaper cars and shoes, even if there are more former autoworkers and shoemakers who want to set up barber shops.
           Globally, a pattern of international trade that develops because of unionization is inefficient.   World output and income may be higher than without the trade, but it would be higher still if wages in the unionized and unionizable sector were competitive with wages in the service sector.   That is, if workers in the service sector did not covet "good jobs" in manufacturing, and workers in manufacturing did not see service sector jobs as undesirable.   To the degree this makes the domestic production of manufactured goods more profitable and expands the manufacturing sector at the expense of the service sector, the result would be improved global efficiency.