It is no accident that US president Barack Obama asked for fast track trade promotion authority after he had faced his last election. Free trade is good for economic growth. Economic theory predicts that the value to consumers, workers and owners of firms gained from free trade outweighs the value lost. So why do so many politicians see free trade as toxic politically?
One reason rightfully given for the political toxicity of free trade is that the concentrated losers from free trade are more obvious, more vocal, and better organized than the widely dispersed winners from free trade. During recessions, another factor in the opposition to free trade is that people blame trade for what is primarily a failure of monetary policy or a failure of financial stability policy. When the poor in other countries are out of mind, a concern about the effect of free trade on the poor in one’s own country can be a reason to oppose free trade. And one can cogently worry that free trade might adversely affect sectors of the economy that start out being stunted by product market and labor market distortions more than the sectors of the economy that would be helped by free trade (one of the few things that can overturn they theoretical prediction that the value gained from free trade outweighs the value lost).
Yet despite all these factors, I wonder if many who think of themselves as opposing free trade are really opposed to trade deficits. Let me speak as if the home country at issue is the US, but a similar question can be asked for many countries. How many people would be against free trade if it were balanced trade in which people and firms in other countries buy just as much from Americans as Americans buy from them?
If trade were balanced, it would mean that every dollar of imports would be balanced by a dollar of exports. Intuitively, freer trade means that people in the US can do more of what they are best at and less of what they are worst at—but with this subtlety: in producing goods and services people in the US are better at almost everything than people in other countries. So to have balanced trade, out of all the things people in the US are better at, some at the bottom of the list of US advantage (whether in ability to produce quantity or to produce quality) have to be imported in order to give people in other countries the US dollars they need to buy the things near the top of the list of US absolute advantage.
All of this gets thrown off when trade is not balanced. How can that happen? To simplify, when Americans buy Chinese goods with borrowed Chinese yuan, while the Chinese people and the Chinese government save the US dollars they get instead of spending them on American goods, and follow the same pattern with many other countries, then the US will run a trade deficit. Running a chronic trade deficit results in less employment in a way that goes beyond the business cycle.
What is the remedy for unbalanced trade? It isn’t trade restrictions. Regardless of trade restrictions, as long as Americans are borrowing more from other countries than they are borrowing from us, the simple fact that they are directly or indirectly (when doing the foreign exchange transaction) handing Americans their currency when they lend guarantees that one way or another Americans will end up spending more on foreign goods and services than the other way around. Thus, the equation is that if you borrow from foreigners, you will buy more from foreigners than they will from you. (I explain this principle more on my blog.)
For a country running a trade deficit as the US is, given open financial markets, the only way to get to more balanced trade is for the American people, American firms or the US government to save more, or for Americans to shift their net financial investments toward lending to foreigners.
It might seem that it would be hard to raise the US saving rate given the limited success of past attempts. But the conjunction of psychology and economics has identified a powerful and underappreciated lever for raising saving, waiting to be used. In remarkable research initiated by Brigitte Madrian (now a professor at Harvard’s Kennedy school) and continued with the help of many coauthors, it has been found that when people are automatically enrolled in 401(k)’s, they save a lot more than when they have to actively set up 401(k) contributions themselves. Some people opt out of doing that extra saving, but many don’t.
One of the biggest benefits would be helping people arrive at retirement well prepared financially. But it would also have a major effect on the US trade balance. I talked to Madrian and David Laibson, the incoming chair of Harvard’s Economics Department (who has worked with her on studying the effects of automatic enrollment) on the sidelines of a Consumer Financial Protection Bureau research conference last week. Using back-of-the-envelope calculations based on the effects estimated in this research, they agreed that requiring all firms to automatically enroll all employees in a 401(k) with a default contribution rate of 8% could increase the national saving rate on the order of 2 or 3 percent of GDP.
The regulation I am talking about would not require any change to the rate at which firms match their employee’s contributions. One of the biggest benefits would be helping people arrive at retirement well prepared financially. But it would also have a major effect on the US trade balance. If the US ran smaller trade deficits, employment would go up beyond any particular business cycle. If Americans were saving too much and had too many available jobs tempting them to work too much, that wouldn’t be a good thing for them. But right now, in this economy, more jobs and more savings are appropriate, so it would help them.
Automatic enrollment in retirement savings plans is so powerful that some economists will worry that its spread will help exacerbate a global glut of saving. But if paper currency policy gets out of the way of the appropriate interest rate adjustments, financial markets will find the appropriate equilibrium. They will balance the supply and demand for saving, and companies will realize the extent to which an abundance of saving makes available the funds they need to dream big by creating new markets and technologies that the future of America depends on.
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