Archives: January, 2010

Good News in the Rising Trade Deficit

The U.S. trade deficit jumped to its highest level in 10 months, according to data released by the U.S. Commerce Department this morning. What to make of this?

Every month the Commerce Department publishes data on the value of U.S. exports and imports. And every month, the media do an absolute hatchet job explaining the meaning of those data. As I’ve been arguing for a long time, careless reporting and inaccurate media analyses of imports, exports, the trade balance (exports minus imports), the “Trade Account” and the slightly broader measure of international trade activity called the “Current Account” help explain the growing aversion of Americans to trade and trade agreements during the past decade.

The media’s tendency to describe a rising trade deficit as bad news or imports as a drag on economic growth has reinforced misconceptions that politicians perpetuate all the time: that exports are good; imports are bad; the trade account is the “scoreboard,” and; the large U.S. trade deficit is proof that the United States is losing at trade.

But the fact is that imports are very much pro-cyclical. They increase as the economy grows and decrease when it contracts. One of the more obvious reasons for this is that as personal consumption increases (decreases), consumer demand for imports increases (decreases). But another critical, but less discussed, reason is that U.S. producers rely heavily on imported raw materials, components, and capital equipment. As businesses starts to ramp up output, demand for imported intermediate goods rises. Purchases of intermediate goods have accounted for over half of all U.S. import value in recent years, which would suggest that the rising trade deficit has more to do with business being poised for expansion than with consumers itching to go to the mall.

Yet, media and politicians often characterize imports as a sign of profligacy. They argue that balanced trade or a trade surplus should be an objective of economic policy, and that policies designed to slow import growth can accomplish more balanced trade. But imports and exports are also very much positively correlated. They rise and fall together. Imports are contained in domestic output, and a good chunk of domestic output is exported. Buy more from abroad, and foreigners can afford to buy more from us. Sell more abroad and we can afford to buy more from foreigners. Stymie imports and you get stymied exports.

My colleagues and I have joked in recent years that what we need is a good recession to cause Americans to reexamine their feelings about imports. Maybe that would mark a turning point in public opinion about trade. Well, we may have been onto something. In recent months, as we’ve been emerging from the Great Recession, the media’s reporting of the trade figures has been more circumspect and more balanced.

The opening sentence in Martin Crutsinger’s Associated Press story today is: “The U.S. trade deficit jumped to the highest level in 10 months as an improving U.S. economy pushed up demand for imports (my emphasis).”

There’s nothing like a good reminder of the pro-cyclicality of imports to help Americans reconsider their antipathy toward trade. However, before concluding that we’ve fully turned the corner, there’s this passage from the same report:

“Through the first 11 months of 2009, the overall U.S. trade deficit in 2009 was running at an annual rate of $371.59 billion, down by nearly half from last year’s imbalance of $695.94 billion. That improvement (my emphasis) reflected a deep recession in the United States which cut sharply into consumer demand for foreign products.”

If an “improving” U.S. economy is associated with a trade deficit that “jumped” in 2009 (as described in Crutsinger’s first passage), how can an “improvement” in the trade deficit “reflect a deep recession in the United States,” as reported in his second?

It’s time reporters adopted neutral terminology when describing the trade account. The trade deficit “increased” or the trade deficit “decreased” are not only more objective descriptions, but more accurate ones as well.

Obama’s Health Tax Conundrum

As President Obama is finding out, spending a trillion dollars on health care reform is easy; paying for it is a bit harder. 

Both the House and Senate versions contain huge tax increases.  But they take completely different approaches toward which taxes are hiked and who would pay them.  And, as President Obama discovered in yesterday’s contentious meeting with labor bosses, those differences will not be easy to resolve.

The Senate wants to slap a 40 percent excise tax on so-called “Cadillac” insurance plans, that is plans with an actuarial value of more than $8,500 for an individual and $23,000 for a family.  The tax technically falls on the insurance company that offers the plan, but there’s widespread recognition that insurers will merely pass that tax on to their customers in the form of still-higher premiums. The Congressional Budget Office estimates that initially about 19 percent of insurance plans would be subject to the tax, and union surveys suggest that it could hit as many as 25 percent of union workers.  Moreover, as inflation drives costs higher, more and more plans will be subject to the tax.  That is because the threshold for the tax is indexed to general inflation not medical inflation which runs higher. 

As today’s Washington Post editorial points out, economists and deficit hawks see this measure as one of the few cost-control provisions left in the bill.  Its goal is not just to raise some $150 billion in revenue over 10 years, but to discourage the type of “gold plated” insurance plans that encourage over utilization and drive up costs.  That is why the Obama administration has endorsed this approach.

However, as labor leaders made clear in yesterday’s meeting with the president, this middle-class tax hike is unacceptable.  AFL-CIO president Richard Trumka has even threatened to retaliate at the polls against Democrats who vote for it.  In addition, 124 House Democrats have signed a letter opposing the “Cadillac tax.”  With just a three vote margin, House Speaker Nancy Pelosi cannot afford to have any defections from tax opponents. 

The House, on the other hand, has gone with a “soak the rich” strategy, calling for a surtax on incomes of $500,000 or more a year.  But Democrats already plan to allow the Bush tax cuts to expire next year, raising income taxes for millions of Americans.  An income tax surtax on top of that would mean marginal tax rates of more than 50 percent in many states with devastating consequences for economic growth.  Moderate Democratic Senators like Ben Nelson (Neb.) and even liberals from states with high cost of living like Chuck Schumer (NY) are unlikely to go along with this tax.  And, in the Senate, Democrats can’t afford even a single “no” vote. 

The conventional wisdom in Washington is that a health care bill is inevitable.  But if the growing fight over taxes is any indication, inevitability is overrated.

Pepsi Throwback and the Sugar Racket

This weekend while watching a football game with a friend, I saw a commercial for Pepsi “Throwback.” This is a new product containing real sugar instead of high-fructose corn syrup. My friend was incredulous when I explained that soft drinks manufactured for sale domestically generally don’t contain sugar because government protection of the U.S. sugar industry from imports make its use cost-prohibitive.

I am intrigued that Pepsi would market a sugar-based product. In perusing the Internet for news about it, I found countless stories applauding the product but blaming Pepsi and Coke for continuing to use inferior-tasting high-fructose corn syrup. For example, Pepsi Throwback’s Wikipedia page states that soft drink manufacturers switched to high-fructose corn syrup decades ago because of rising sugar prices, but it doesn’t mention that government policy was behind the price increases.

A Cato essay on agricultural regulations and trade barriers explains the government’s sugar racket and its destructive effects. Here are the key points:

  • The federal government guarantees a minimum price for sugar in the domestic market by maintaining a system of preferential loan agreements, domestic marketing quotas, and import barriers.
  • USDA data show that U.S. sugar prices have been more than twice world market prices.
  • The Government Accountability Office estimates that U.S. sugar policies cost American consumers about $1.9 billion annually.
  • U.S. food industries that buy sugar are harmed by current sugar policies. The employment in U.S. sugar growing is 61,000, which compares to employment in U.S. businesses that use sugar of 988,000.
  • According to a U.S. Department of Commerce report, for each sugar growing and harvesting job saved through high U.S. sugar prices, nearly three confectionary manufacturing jobs are lost.
  • Numerous U.S. food manufacturers have relocated to Canada where sugar prices are less than half of U.S. prices and to Mexico where prices are two-thirds of U.S. levels.

Chicago has been particularly hard hit, with many candy companies moving production abroad. One might think that our president, a Chicagoan, would be willing to take on the powerful domestic sugar lobby. But as Dan Griswold discussed in October, Obama’s USDA ignored a plea from domestic sugar-using industries and kept quotas at their current restrictive level.

What about high-fructose corn syrup? Government policy artificially increases the price of sugar, but its corn subsidies artificially reduce the price of corn, which helps make high-fructose corn syrup more cost-effective in products like soft drinks. Major high-fructose corn syrup manufacturers, such as Archer Daniels Midland, benefit from federal programs and they spend lots of money lobbying policymakers to keep them going.

In his classic 1995 Cato policy analysis, “Archer Daniels Midland: A Case Study in Corporate Welfare,” James Bovard recounts ADM’s long-standing influence behind the government’s sugar racket:

Although ADM does not directly produce sugar, Congress and the USDA have created a price umbrella under which ADM’s production of high-fructose corn syrup – a sugar syrup – has become immensely profitable. ADM got into corn fructose production very heavily around 1974, just as sugar prices peaked on world markets. After ADM invested heavily to increase its capacity to produce high-fructose corn syrup ninefold, sugar prices plummeted from 65 cents to 8 cents per pound.

[ADM Chairman Dwayne] Andreas told Business Week in 1976, “If it was a mistake, I’d say it was my mistake.” Business Week noted, “One industry source suggests that ‘Dwayne looks at this as sort of a waiting game, basing his unflappability on the predicted passage of a new sugar bill.’ Such a bill is expected to provide an ‘umbrella’ – that is, to put supports under sugar at a level where high-fructose corn syrup will be at least reasonably profitable. Andreas contributed heavily to the 1968 and 1972 campaigns of Humphrey, Jackson and Nixon. With both parties covered, ADM may reasonably anticipate some legislative help.” That help came in the form of a new sugar bill in 1981.

For ADM, cheaper inputs (corn) plus a more expensive substitute (sugar) equals nice profits at U.S. taxpayer and consumer expense.

Pepsi Throwback will only be available for U.S. consumers to enjoy until February 22nd.  After that, Americans looking for Pepsi or Coke with real sugar in it will have to go to Mexico. Hopefully, Mexican politicians won’t put up a wall along the border to stop Americans from sneaking into the country and taking all their good soft drinks.

Update: Several readers have pointed out that “Passover Coke,” which contains sugar instead of high-fructose corn syrup, can be found in certain metropolitan areas around Passover. Coke with sugar manufactured in Mexico can also be found in some Latin American grocery stores.

A Nice Little Reminder

There hasn’t been much in the news about education over the last several weeks, so there haven’t been many education entries here on Cato@Liberty. That should be changing soon, though, with the first round of state “Race-to-the-Top” applications due to the feds on January 19, and the Common Core State Standards Initiative expected to release draft grade-by-grade mathematics and language-arts standards sometime this month.

To tide you over until those two monumental happenings occur, the New York Times today offers a little piece about supposedly tough state “exit examinations” that illustrates why you shouldn’t expect either R to the T or national standards to produce any meaningful improvement in academic outcomes. Quite simply, no matter how good or tough “standards” and “accountability” sound, in government schooling they will almost always end up evaded. After all, what incentive does anyone have to set and meet high standards when they’re going to get paid no matter what?

The Real Meaning of China’s Export Primacy

The Washington Post reports today that China surpassed Germany to become the world’s largest exporter in 2009, adding yet another economic feat to its expanding trophy case. Undoubtedly, U.S. trade skeptics and globophobes will consider this “accolade” the latest evidence of American decline and Chinese ascendancy. But more than it is any refection of China’s economic might, the milestone is testament to the successful erosion of economic, political, physical and technological barriers that had previously constrained human possibilities.

Widespread liberalization of trade and investment rules beginning in earnest after World War II; China’s opening to the West beginning with reforms in 1978; the fall of the Berlin Wall in 1989 and the Soviet Union two years later; the collapse of communism as a viable choice for developing countries; the advent and proliferation of containerized shipping, GPS technology, just-in-time supply chain management techniques, and other marvels of the information, transportation, and communications revolutions have spawned a global division of labor and way of doing things that defy traditional trade policy considerations, and render trade flow accounting rather meaningless.

To borrow the theme and some phrases from my recent paper, “Made on Earth,” global economics is no longer a competition between “Us and Them.” It is no longer “Our” producers against “Their” producers. Instead, because of cross-border investment and transnational production and supply chains, the factory floor has broken though its walls and now spans oceans and borders, rendering U.S. workers and foreign workers collaborative, even complementary, in so many endeavors. There is, of course, competition, but that competition is often between production/supply chains or brands that defy any meaningful national identification because the final products are composed of value-added from multiple countries. Thus, there is cooperation within production/supply chains before there is competition between them.

So, what does all of this have to do with China’s status as the world’s biggest exporter? It means that we should avoid the temptation to attach the wrong meaning to the title. China has become the world’s largest exporter primarily because the global division of labor that has helped reduce the burdens of poverty and create greater wealth still prescribes for China the role of lower-value-added production and final assembly operations in global production/supply chains.

While intermediate goods—components and raw materials—are shipped to China from countries such as Japan, Taiwan, Singapore, Australia, and America, those inputs are often “snapped together” or perhaps subject to slightly higher Chinese valued-added operations before being exported as final goods. For the purpose of trade flow accounting, the entire value of the merchandise is registered as Chinese export value, even when a very small percentage is actually Chinese labor, material and overhead.

That accounting methodology helps explain why China’s exports—to the world and the United States—have surged over the decades (as the division of labor evolved and supply chains proliferated), and why policy focus on the U.S. bilateral trade deficit with China is misplaced. As aptly put in the conclusion of this now-famous study about who captures value in the iPod supply chain:

“[T]rade statistics can mislead as much as inform. For every $300 iPod sold in the U.S., the politically volatile U.S. trade deficit with China increased by about $150 (the factory cost). Yet, the value added to the product through assembly in China is probably a few dollars at most.”

Chinese value-added is very low in higher technology and more sophisticated electronics exports. It is higher in other products that Americans import from China. According to the findings in a recent NBER paper titled “How Much of Chinese Exports is Really Made in China,” about 50 percent of the value of a typical cargo container imported into the United States from China is Chinese value-added, which comports roughly with estimates undertaken by others.

So, as we consider the meaning of China’s new status as global export leader, it is important to understand the value and limitations of the trade data.  Those data speak much more convincingly to the virtues of economic interdependence than to China’s stand-alone export prowess.