Thursday, September 29, 2016

Navarro’s Nonsense on Net Exports

Paul Krugman and Scott Sumner focus on the trade balance discussion by Peter Navarro. After all – this part of his nonsensical writing was the big enchilada. Scott leads with:
This is a very basic error. International economists almost universally agree that a VAT is neutral with respect to trade. An across the board 10% import tax, combined with a 10% export subsidy, offset each other, leaving no net impact on trade. Instead they convert the tax from a production tax to a consumption tax. But it's a consumption tax that applies equally to all goods, whether made domestically, or imported. This is not even a tiny bit controversial.
Paul agrees:
nobody thinks that sales taxes are an unfair trade practice. New York has fairly high sales taxes; Delaware has no such tax. Does anyone think that this gives New York an unfair advantage in interstate competition?
AS I noted here, the medical device giants argued against their excise tax on precisely opposite reasoning, which was also absurd. I think the point here is that the WTO rightfully does not see sales taxes as interfering with free trade. Of course Team Trump likely cares little about the WTO. So why not put tariffs on Mexican goods. Of course our bilateral trade deficit with Mexico was only $58 billion in 2015 as compared to the $102 billion trade deficit with the EU (mostly) Germany. Europe does VAT so why did Trump not go after Merkel? Is he afraid of this woman? Of course our largest bilateral trade deficit is with China. Scott goes after the alleged Chinese manipulation of exchange rates with:
China is not intervening to lower the value of the yuan; they are intervening to raise its value. And no, textbook theory does not say that exchange rates should adjust in the long run to balance trade in goods and services, unless long run means 1,000,000,000 years, in present value terms. But in that case the current US deficit presents no puzzle; it hasn't lasted for a billion years. Textbooks say that exchange rates should adjust in the short run to balance trade in goods, services and assets. Trade deficits (actually current account deficits) are caused by imbalances between domestic saving and domestic investment. Those can persist indefinitely. And currency "manipulation" (which is a meaningless concept) is completely beside the point. A country can have a laissez faire policy towards its currency, and still run deficits or surpluses for centuries. Now let's think about the broader Trump economic plan, how would that impact the saving/investment relationship? To make my point more clearly, I'll compare his plan to Reagan's, which has some similarities:
There is a lot of good reasoning here that I would like to expand upon. My concern was that Navarro was all Keynesian with no consideration of where output was relative to potential GDP or the impacts on potential GDP. Navarro proposed using some sort of trade protection to raise net exports by $500 billion per year. That might have a big aggregate demand impact under the assumptions of fixed exchange rates and fixed interest rates, which of course is the most basic Keynesian model that Navarro both mocks and uses. One can wonder whether the output gap now is really that large. Of course, I have suggested that perhaps the output gap may indeed be as much as 5 percent but other economists suggest it is smaller. Scott is noting, however, the Trump wants to increase defense spending and massively cut taxes which push aggregate demand so high that the Federal Reserve would have to raise interest rates. We should also note how various policy positions work in a standard Mundell-Fleming model. Take monetary policy for example:
An expansionary monetary policy will shift the LM curve to LM’, which makes the equilibrium go from point E0 to E1. However, since now exchange rates are flexible, the balance of payments deficit will depreciate the domestic currency. This will increase net exports, shifting the IS curve to IS’. Also, since domestic assets are less expensive, the BP curve will shift to the right (to either BP’+ or BP’-). Therefore, with high capital mobility, final equilibrium will be at point E2. Monetary policy works well under these assumptions. It’s actually the more efficient the higher capital mobility is.
Of course this is what the ECB has recently done. The US Federal Reserve alas has allowed our interest rates to drift up relative to interest rates in Europe which is why the US$ has appreciated lowering net exports. And yet Trump has criticized the Federal Reserve for allegedly pursuing too much monetary stimulus. Go figure. Another key implication of this Mundell-Fleming model is trade protection under floating exchange rates will only serve to further appreciate the US$ with no net impact on net exports or the economy.


Unknown said...

In an open economy with a current account deficit -- or a domestic savings investment gap --the equilibrium or market clearing interest rate is the one that attracts sufficient foreign capital to finance the twin deficits with a stable currency.
If the currency is rising domestic rates are too high and if the currency is falling
rates are too low.

reason said...

are you suggesting that the central bank should target the exchange rate? Doesn't this really mean letting foreigners decide our inflation rate?

ProGrowthLiberal said...

Reason - Spencer does not appear to be advocating a fixed exchange regime. Precisely the opposite - he is describing how a floating exchange rate regime reacts. It is all well explained by that Mundell-Fleming model. Alas Navarro has no idea about how this model or any other model works.

Cinclow20 said...

PGL - Isn't it rue that, while a country can I fact run a current accounts deficit ad infinitum, it would depend on what the incoming capital was used for? If it were used for investment, the additional production would offset the carry on the incoming capital; whereas, if it were used to finance additional consumption, as it has in the U.S. over the past several decades, absent external interventions, it should negatively impact the value of that nation's currency. And wasn't this the concept behind Keynes's proposal for an international currency (the bancor), against which all nations would peg their currencies, with the individual currencies' values being regularly adjusted to react to their trade flows?

Anonymous said...

Navarro was discussing VAT rebates on exports.

Have you even been to Japan? Did you not think it odd that there were no non-Japanese cars?

American economists are taking the West off a cliff. Why does anyone believe this people? Watch Dr. Charles Ferguson's Inside Job for an excellent expose of the corruption of the shills posing as economists

ProGrowthLiberal said...

Cinclow20 - all excellent questions and points. All of which is above Navarro's pay level.