Sunday, August 4, 2019

Krugman on Trump and Trade: Not Tariffic

I’m no fan of the Trump tariff tantrum, but weak criticism of it does no one a service.  And while I agree with Paul Krugman on a lot of things, he has a long history of being misguided on trade policy.  Alas, his op-ed in today’s New York Times continues the legacy of the Bad Krugman, not the good one.

Before getting to the theoretical meat, let’s take a moment to observe the holes in his argument that should have been identified and vetted before publication.

1. He cites a graphic from the Peterson Institute for International Economics that claims that Trump’s tariffs on Chinese goods have risen to 21.5% this month from 3.1% under Obama (under the Most Favored Nation provision).  Applied to $500 billion in imports from China, that comes to almost $100 billion more in tariff collections, right?  Not so fast.  He reproduces a FRED chart that shows tariff revenue rising by only about $35 billion during the same period.  He hedges a bit (“the revenue numbers don’t yet include the full range of Trump tariffs”) and then tries to squirm his way out of the evidence that US consumers aren’t really paying $100 billion more for these goods.  We’ll get to the squirm in a moment, but note that some portion of the tariff will be paid by Chinese producers in the form of lower prices to maintain market share, and the evidence suggests that this portion is much too great to simply handwave away.

2. The squirm is Krugman’s assertion that the missing tariff revenue can be partly explained by trade diversion, where some goods formerly supplied by China will now come to us from producers in other countries like Vietnam.  Here there are two problems.  First, trade diversion does not explain the missing tariff revenue, since we are still looking at $500 billion of Chinese exports to the US.  Second, it is wrong to assume, as Krugman apparently does, that the shift from Chinese to Vietnamese suppliers can be interpreted as a hidden tax on US purchasers—“instead of importing from China, we buy stuff from higher-cost sources like Vietnam”—since there a multiple reasons why Vietnam might be a less desired source than China at the same price, such as quality, delivery reliability or Chinese domestic content rules.  Yes, there might be some diminution in the satisfaction we get from substituting non-Chinese goods, but this is not a tax in the macroeconomic sense.

3. Finally, to the extent tariffs function like a tax on domestic consumers—and of course they do insofar as we pay them—they can be offset through fiscal expansion.  Krugman is right to snicker at the Trump tax cut, whose benefits mostly accrued to corporations, which in turn mostly used them to finance stock buybacks.  So far, so good.  But in principle we could institute other, more beneficial types of fiscal expansion; in fact, that’s a central pillar of the Green New Deal.  So the bottom line is that, while there is a modest fiscal drag from unproductive tariffs on Chinese goods, what makes this a macroeconomic problem is that there isn’t a corresponding fiscal lift from environmental and infrastructure spending.

Now on to the theoretical problem, which psychologically if not analytically drives everything else.  Krugman is a high priest of the doctrine that trade balances are caused by capital account balances, which in turn are caused by macroeconomic “fundamentals”.  You can read all about it in the textbook he coauthored with Maurice Obstfeld; it will set you back only $300.  (Not mainly PK’s fault, of course.)  It shows up in his op-ed when he says, “Trade balances are mainly about macroeconomics, not tariff policy. In particular, the persistent weakness of the Japanese and European economies, probably mainly the result of shrinking prime-age work forces, keeps the yen and the euro low and makes the U.S. less competitive.”

The theory that trade balances are determined by macroeconomic aggregates (via impacts on exchange rates) is as close to being objectively wrong as any in economics.  First, the trade balance, or more accurately, the current account balance, is not one thing which can cause or be caused by another thing called the capital account, which expresses differences in national savings and investment.  They are one identical thing, the country’s international position.  We are talking identities here, three little parallel lines (≡), not two (=).  It is essentially what economists call a general equilibrium problem, where what is to be determined is not this component or that but all of them simultaneously, much the way the demand for natural gas can’t be said to “cause” the demand for coal, or vice versa, but both are reflections of underlying factors.  Elsewhere I’ve laid out the evidence that, based on what we know about transmission mechanisms, there is no general dominance of “macro” factors over “micro” ones.

If you want to know why some countries like the US have trade (and current account) deficits year after year, while others, like Germany, China and the Scandinavian countries, have chronic surpluses, the places to turn are international political economy and the varieties of capitalism literature in sociology and political science.  That would give us an entirely different agenda for repositioning the US within the global division of labor and finance, not Trumpian but not Krugmanian either.


Anonymous said...

Thanks for the informative blog. What sociology & polisci would you recommend, that you mentioned at the end?

Peter Dorman said...

Good question. The problem is that I don't know of a particular book or article that would serve as a proper entry point. Beginning with the original Varieties of Capitalism book (Soskice & Hall), the extent of trade surplus dependence is a major theme, but it runs through all of it. Mainstream IPE people, like Barry Eichengreen and Jeff Frieden, frequently discuss the characteristics that consign countries to chronic surplus or deficit status, but to my knowledge there is no single piece of writing that sums up what they have to say about it. More progressive/radical types like Eric Helleiner (a personal favorite) make reference as well, again with no canonical text. Bottom line: there is a screaming need for someone to write the sort of thing you're asking for.

ps: I have a few pages in my macro text that introduce the topic, but at a very basic level.

Anonymous said...

I am grateful for this post, and have read it carefully a couple of times but fail to understand what model you are using to explain say the German trade surplus. Where is your model? I need to have a model in mind to understand this important post.

Thank you so much.

Anonymous said...

Thanks! I figured Friedan, and there was all that 1980s political economy (Kazenstein)--good institutional and structural comparisons, but we're talking 25-30 years ago. said...


Mixes reactions to this post, Peter. Yes, Krugman often oversimplifies things, and maybe he got messed up exactly what is going on with the tariff revenues (not a big deal for me one way oor the other), but you have yourself kind of misled on some points.

So, yes, many of the nations with regular trade surpluses have more cooperative labor management relations (Germany, Nordic nations) than the US. But I do not think this explains the situation in the US. A major factor, which I think Krugman occasionally mentions, is US dollar reserve currency role and wisespread use in trade, which reflects US hegemonic position, but also tends to push value of dollar up. As it is, we have not had a trade surplus since the mid-70s, soon after floating started with the end of Bretton Woods, which was a super US-hegemonic system.

No, savings does not totally determine things, but your claim it has nothing to do with this is also simply wrong. After all, pretty much all those nations with regular trade surpluses do have higher savings rates than does the US. Where did you get the idea this is false?

This also carries over to including "government saving," which iis negative most of the time. So Reagan's budget deficit led to enlarged trade deficits as the dollar soared in value (and the personal savings rate declined, proving Robert Barro wrong). Likewise, Trump's enlarged budget deficit, combined with his tariffs, have pushed the dollar up along with the trade deficits.

More fundamentally, and Krugman tends not to report this, modeling forx markets is a mess, with stock models not coherent with flow ones, except in a nowhere existing super general equilibrium. An example of stock and flow being off for the US is that while the US is a massive net debtor, US still has a small positive net inflow of capital income internationally. As it is few models beat a random walk for forecasting, and those that do, do so very weakly.

I note that Econbrowser is a good place to track this stuff as major poster there, Menzie Chinn posts a lot on forex modeling and currently is a coeditor of the Journal of International Money and Finance. said...

BTW, I know you like them because of their super focus on labor-management relations and their focus on Germany, but as a oomparative economist I find Soskice and Hall to be simplistic and wildly overrated.

Peter Dorman said...

Bark, I like and respect you a lot, but sometimes you read quickly and react to something that isn't there. I never said savings don't matter; that would be silly. What I do say is that net savings at the aggregate level is not something different from the trade balance that can cause it; it's the same thing, and we have to look at latent factors to determine the cause of the international position, which can be observed either as the capital account or the current account. It's a bit like saying of a baseball game that the high strikeout pitching of one team caused the high number of strikeouts of the other. No. Latent factors, like ball movement on the part of the pitchers or the hitting form of the hitters has to be examined to determine which aspect of the game is primarily responsible for the outcome. (And responsibility is likely to be shared.) Similarly with trade flows and capital flows, where propensities to consume domestically and externally, ability to identify and exploit market niches, fiscal policy, access to credit, and all the other relevant factors need to be examined -- and responsibility is likely to be shared.

I agree entirely about the inability to forecast forex markets, which plays a role in the analysis I link to in the post (my Challenge article of years long gone). The chain of reasoning PK invokes requires a robotic response in xrates, and as you and I know, that response is not generally forthcoming.

Finally, I don't invoke the VoC literature out of a love for Germany, or collaborative labor relations, or fandom of Soskice and Hall. It's now a very large literature with fuzzy boundaries, as it gets admixed with other perspectives. (See, for instance, the work of Servaas Storm, who draws on VoC and Post Keynesian macro.) I think Storm and others do a decent job of identifying the complex of institutions, policies, hermeneutic narratives, etc. that drive countries to the surplus or deficit side of the ledger. As for your cooperative labor relations, they are as much a consequence as a cause of export dependence, since wage restraint in the interest of expanding or maintaining external markets is central to how such countries operate, much the way chronic deficit countries require very robust internal demand (and higher wage growth or some functional equivalent). I don't understand why you would argue with this.

Anonymous said...

Thanks to Barkley Rosser. said...


I think we mostly agree, but you are saying some odd things. An example in this latest comment is " savings at the aggregate level is not something different from the trade balance that can cause it, it's the same thing..." No it isn't, not sure what you were intending to say with this.

So something neither you nor Krugman talked about but Krugman's major prof at MIT, the late Rudiger Dornbusch, explained, is the completely conventional phenomenon in forex markets of overshoot, first identified by Gustav Cassel in the 1920s when the fall of the French franc from 7 to 1 USD to 52 to 1 by 1925 played a major role in all those Lost Generation Americans moveably feasting in Paris on practically no USDs. The J-curve is a major reason for that, and the plunge of the Chinese rmb Trump is currently declaring to be "currency manipulation" looks an awful lot like this.

The more important point is that there is no single relationship driving all this, with it not even the case that the capital account perfectly offsets the current account, quite a few nations quite off on that one, and things from either side can be driving forex changes.

Fair enough that you do not take Soskice and Hall too seriously with their emphasixing German "corrdination" againt American "laissez -faire" as the central axis of "Varieities of Capitalism." Again, they do not mention the US position as global economic hegemon with the uSD as reserve currency as playing a role in US chronic trade deficits. Krugman knows that, but he too seems to have put that aside for the moment.

Anonymous said...

Mr. Dorman,

Having looked at the matter carefully, in preparing a fall seminar, as far as I can tell Paul Krugman is entirely right. Krugman has a transparent model that works and writes with clarity and cogency.

I really do wish you would have set down your model, and I still do not understand your argument.

I appreciate the post, however.

Peter Dorman said...

Mr. Anonymous,

If you are comparing a blog post to longer form writing like books and journal articles, I'm not surprised you find the shorter stuff lacking. And it's also true that I haven't published more than a sliver of what PK has. If you would like to see a more worked out but entry level version of my argument, do look at Ch 4 of my macro textbook.

In the past I've toyed with a Kaleckian model for embedding trade balances, but I wasn't satisfied. Unlike PK, I haven't found what I regard to be a satisfactory framework for modeling the global economy. What I've written in the past is that the ideal approach would look rather like an ecological model, an immense set of differential equations, so everything would be happening in real rather than logical time. Constructing such a model is many levels beyond my personal competence and resources. Bottom line: no, I can't produce a global model as comprehensive as PK's, but that doesn't mean I can't point out what I regard as the defects of his. You do what you can do.

Incidentally, if you can identify how PK's fuller treatment renders him immune from my criticisms, that would be a useful contribution.

Peter Dorman said...

Barkley, I was treating the net trade balance as equivalent to the current account balance, which is of course incorrect, but it's common and convenient to do this. For most countries they aren't going to be very far apart. The statistical discrepancies between current and capital accounts are presumably due to measurement issues, especially off the books transactions. Reserve balances in the international accounting sense (actual currencies and not currency-denominated financial assets) don't fluctuate that much.

Of course the role of the dollar as the predominate reserve currency is central to the whole discussion. That does put the US in a different situation than any other country; at the same time, the extent of its current account deficit also depends on other factors, since it has hardly been constant during the post-BW period. And I am not claiming that latent factors, like age structure, that affect savings are insignificant, only that PK and other mainstream international macro types simply rule out latent factors on the micro side by fiat, when the preponderance of evidence (including what you have to say about xrates) contradicts this.

Anonymous said...

If you are comparing a blog post to longer form writing like books and journal articles, I'm not surprised you find the shorter stuff lacking. And it's also true that I haven't published more than a sliver of what PK has. If you would like to see a more worked out but entry level version of my argument, do look at Ch 4 of my macro textbook....

[ I have the text in my office, and will read Chapter 4 carefully tomorrow. What I want in your work is to find a thread running from say Sweden to Japan.

As for criticizing Paul Krugman, that is always welcome for me since I am forced to reconsider Krugman on such criticism. Do continue, then.

As for a Krugman criticism I am going to now consider, there is what I take as a disdain for China that worries me. ]

Anonymous said...

Robert Dorman:

Finished reading the chapter, with which I am well pleased and would like to read more on the matter from you. Excellent argument here.