March 16th, 2016 | By Nick Sargen
Throughout the post-World War II era, a guiding principle of the U.S. Government under both Democratic and Republican Administrations has been support for free trade and international capital flows. This commitment is a legacy from the Great Depression, when countries turned inward and pursued “beggar my neighbor policies” that included passage of high tariff barriers, imposition of capital controls and widespread currency devaluations.
For roughly 25 years after the war ended, the international monetary system was governed by a set of arrangements that western governments adopted at the Bretton Woods Conference in 1944. The overriding objectives were (1) to establish an exchange rate system that would foster low inflation and free trade, and (2) to ensure that the system was also sufficiently flexible to promote long-term economic growth and development.
When the Bretton Woods system broke down in the early 1970s and was replaced by floating exchange rates, economists who favored fixed-exchange rates worried that increased currency volatility would hinder growth of international trade. However, this outcome did not materialize. In fact, over the past four decades international trade grew at roughly twice the rate of global economic growth, partly in response to a series of agreements to lower barriers to trade under the auspices of the General Agreement on Trade and Tariffs (GATT) and a series of bilateral trade arrangements.
Along the way, there were contentious disputes that had to be reconciled. During the 1980s and 1990s, tensions between the U.S. and Japan increased over a rising bilateral trade deficit. U.S. officials accused Japan of manipulating the yen to gain a competitive advantage, while Japan’s policymakers contended persistent large U.S. budget deficits were at fault. In the end, Japan agreed to curb exports to the United States voluntarily, and the yen appreciated by 70% versus the dollar over a ten-year period. Yet large trade imbalances persisted.
Trade tensions resurfaced in the past decade, when China’s current account surplus reached a peak of 10% of GDP after it gained access to the World Trade Organization (WTO). Officials from the U.S. and Europe pressed the Chinese authorities to allow the RMB to appreciate materially, or face trade sanctions. The outcome was a 35% appreciation of the RMB versus the U.S. dollar over a ten year period, while China’s current account surplus declined to 2%-3% of GDP.
While trade tensions with Japan and China contributed to large currency movements, they did not loom large in U.S. elections. The controversy over the North American Free Trade Association (NAFTA) in the 1990s, however, emerged as a key issue when Ross Perot ran as a third party candidate for President. President Clinton and other supporters viewed NAFTA as a way for the United States to form a free-trade zone with Canada and Mexico that could compete more effectively with the European Union (EU). Perot and U.S. labor unions claimed it contributed to job losses in the United States. Following President Clinton’s reelection in 1996, the controversy subsequently died down.
Meanwhile, opposition to globalization has been brewing since the 2008-09 Global Financial Crisis, as critics have blamed it for the loss of two million manufacturing jobs in the United States. Thus far, no candidate has stepped forth to defend free trade. On the Democratic side, Bernie Sanders has attacked globalization for hurting the working class, and Hillary Clinton has withdrawn her support for the TPP in an attempt to appeal to labor unions. On the Republican side, Donald Trump has threatened high tariff barriers on China and renegotiating trade agreements with Mexico and other countries.
Thus far, the election has not been a focal point for investors, and it will probably not be until the campaign gets into full swing after Labor Day. Should Trump and Clinton become nominees, Trump is likely to step up his attacks and accuse the Clintons of having backed NAFTA and China’s inclusion in the WTO. As the rhetoric heats up, it could add to uncertainty about the global economy at a time when growth in world trade has stagnated and overseas economies are in a precarious state.
While Trump and others have accused China of manipulating its exchange rate to gain a competitive advantage, the Chinese authorities in fact have been intervening in foreign exchange markets to support the yuan against the dollar (see February 9th post “Currency Wars Revisited”) The reason: They do not want to encourage capital flight from the country when there is concern about an economic slowdown. Nonetheless, this has not stopped Trump from claiming the yuan is undervalued by 15%-40%, when many market participants believe it needs to weaken by 15%-20%. Even if this is nothing but bluster on his part, such rhetoric during the campaign could unsettle markets on a much grander scale than what occurred during the U.S. budget ceiling fiasco several years ago: China not only is the world’s second largest economy; it also is the largest holder of U.S. Treasuries at $1.2 trillion.
Amid this, it is hard to find a U.S. politician today who will come out in support of free trade. Even Rob Portman, who had been a strong supporter when he was U.S. Trade Representative, has come out against the TPP as he seeks re-election to the Senate. This illustrates how challenging it is for politicians to counter arguments that globalization is responsible for job losses in manufacturing.
Paul Krugman, a former supporter of free trade turned skeptic, contends that both sides have exaggerated the impact that trade agreements have had on jobs (March 11 edition of the New York Times): “What the models of international trade used by real experts say is that, in general, agreements that lead to more trade neither create nor destroy jobs…” In his view the main reason the United States pursued trade agreements is foreign policy: “Global trade agreements from the 1940s to the 1980s were used to bind democratic nations together during the Cold War. NAFTA was used to reward and encourage Mexican reformers, and so on.”
While there is some merit to Krugman’s argument, he omits the most important consideration – namely, the role international competition plays in improving economic efficiency and productivity, which holds the key to improving living standards. In my view the success Asian economies have enjoyed is a tribute to their ability to compete internationally, whereas Latin American economies lagged behind because they pursued import-substitution policies that shielded domestic producers from competition. In the case of the United States, businesses had become complacent during the environment of high inflation and a chronic weak dollar in the 1970s, but they were compelled to become more efficient in the 1980s when record high interest rates propelled the dollar to record highs.
Looking to the future, some experts have contended that the biggest challenge on the employment front will be from increased automation. In a recent article (March 10, 2016), James Pethokoukis of AEI cites findings of two Oxford University researchers who contend that 47 percent of U.S. jobs are at “high risk” of automation in the next two decades, as well as a 2013 McKinsey study that concludes:
“By 2025, technologies that raise productivity by automating jobs that are not practical to automate today could be on their way to widespread adoption. Historically, when labor-saving technologies were introduced, new and higher value-adding jobs were created. This usually happens over the long term.”
Viewed from this perspective, our politicians should be focusing on policies to make sure the U.S. labor force has the necessary education, skills and training to compete in a world where technological advances will render existing production techniques outmoded. That’s the honest message the electorate should be hearing rather than diatribes about how America is the victim of globalization.