# Rethinking Trade Imbalances

An episode of [Paul Krugman Podcast](https://invisiblenetwork.ai/podcast/1877144831), 26 Jan 2025, 40 min.

Audio: https://api.substack.com/feed/podcast/155721604/9bc75eaaa8381b587a58f22e36d0450e.mp3

If you want to listen to this, I suggest using headphones. For me the volume comes out too low otherwise. Later this week I’ll be giving a presentation to Markus Brunnermeier’s macroeconomics webinar at Princeton; he asked me to talk about “geoeconomics”, which could mean a lot of things. But I decided to talk about a new view of trade imbalances, associated especially with Michael Pettis, that has been gaining some traction lately. It’s also mostly wrong, and some friends in the international economics community have asked me to take it on. I’ve already prepared a slide show for the presentation, and I thought I’d try talking about that slide show here. This, by the way, is sort of the real me — or at least who I wanted to be: wonkish and relatively apolitical. Alas, the world had other ideas. Get full access to Paul Krugman at paulkrugman.substack.com/subscribe

## Transcript

[0:01] SPEAKER_00: Hi, folks.
[0:03] SPEAKER_00: This is Paul Krugman speaking.
[0:06] I'm going to try an experiment here,
[0:09] which is to record a narration of a slideshow.
[0:16] And if this works right,
[0:18] you'll be able to scroll through this post to see the slides.
[0:23] SPEAKER_00: I thought of trying to make a video narration of slides and all of that.
[0:30] There may be a good way to do that,
[0:32] but this seems to be simpler right now.
[0:34] SPEAKER_00: The occasion is that I am going to be doing a presentation
[0:41] later in the week at a webinar that Marcus Brunermeyer runs at Princeton.
[0:48] SPEAKER_00: He asked me to talk about geoeconomics,
[0:51] SPEAKER_00: which sounds kind of pretentious,
[0:52] SPEAKER_00: but I'm not going to do the whole thing,
[0:56] SPEAKER_00: but I thought I would respond to some ideas that are floating out there.
[1:02] So there is a,
[1:04] and this is very much a sort of wonkish policy,
[1:08] wonk economist thing,
[1:10] not
[1:11] SPEAKER_00: not cutting-edge economic research,
[1:13] SPEAKER_00: but the sort of thing that goes on in think tanks,
[1:17] SPEAKER_00: whatever.
[1:19] SPEAKER_00: And I'm not sure if this stuff even matters in the era of Trump.
[1:25] SPEAKER_00: I think thinking hard about anything is kind of DEI or something.
[1:29] SPEAKER_00: But anyway...
[1:31] SPEAKER_00: It certainly is out there.
[1:32] SPEAKER_00: And I decided to respond.
[1:35] SPEAKER_00: I've had some people requesting,
[1:38] SPEAKER_00: people in the trade macroeconomics community,
[1:41] SPEAKER_00: friends of mine,
[1:42] SPEAKER_00: my other life,
[1:46] who wanted me to respond to some of the kind of new thinking
[1:51] about trade deficits,
[1:55] SPEAKER_00: international capital flows,
[1:58] SPEAKER_00: that...
[1:59] SPEAKER_00: we've been hearing a lot of in these circles lately that is,
[2:04] SPEAKER_00: you know,
[2:05] SPEAKER_00: it's getting people's attention.
[2:07] SPEAKER_00: It's not Trumpy exactly.
[2:09] SPEAKER_00: I don't think the people involved,
[2:11] especially Michael Pettis is a economist who's been very vocal
[2:16] on all of this stuff.
[2:19] SPEAKER_00: I don't think that this is actually MAGA.
[2:22] SPEAKER_00: but it's kind of vaguely,
[2:25] it's more MAGA-friendly than what you usually hear from
[2:28] international economists.
[2:30] SPEAKER_00: It can sound kind of impressive, sounds knowledgeable.
[2:36] SPEAKER_00: Some of the incoming Trump economics people are...
[2:43] SPEAKER_00: not exactly citing Pettis, but saying things that sound kind of like it.
[2:50] SPEAKER_00: So, you know, I believe it's sincere.
[2:54] SPEAKER_00: It's somewhat learned.
[2:58] SPEAKER_00: It's also entirely, no, I shouldn't say it's largely wrong.
[3:01] SPEAKER_00: It's not unadulterated nonsense.
[3:03] SPEAKER_00: It's adulterated nonsense.
[3:05] SPEAKER_00: And it seemed to be worthwhile going through.
[3:11] SPEAKER_00: why I believe that and some of the basics.
[3:16] So I am going to,
[3:19] again,
[3:19] if this works properly,
[3:20] you'll be able to scroll through the slides.
[3:24] This is a draft set of slides for my presentation at the
[3:28] webinar on Thursday.
[3:30] SPEAKER_00: But this will be an indication of the kinds of things I'm going to say.
[3:36] SPEAKER_00: This is me being much more sort of
[3:40] SPEAKER_00: what I wanted to be,
[3:41] a serious economic analyst doing stuff that is not at least
[3:47] intensely political.
[3:48] SPEAKER_00: You know,
[3:50] SPEAKER_00: the world history chose not to agree with that career intention,
[3:55] SPEAKER_00: but once in a while I can indulge it.
[3:57] SPEAKER_00: It is at least somewhat relevant to the policy debates.
[4:01] SPEAKER_00: So without further ado, this is a
[4:07] SPEAKER_00: The title page,
[4:09] first slide here is the title page from an article written by
[4:16] Pettis and Erica
[4:19] SPEAKER_00: Hogan for the Carnegie Endowment,
[4:23] SPEAKER_00: laying out his views.
[4:25] SPEAKER_00: You can see trade intervention for freer trade, a little Orwellian.
[4:28] SPEAKER_00: We must have tariffs in order to have free trade.
[4:32] SPEAKER_00: But it lays out a worldview.
[4:36] SPEAKER_00: There's a lot of charts, a lot of analytical language.
[4:41] SPEAKER_00: There are no equations in Pettis' presentation.
[4:47] SPEAKER_00: And it looks serious.
[4:51] SPEAKER_00: I believe he is trying to be serious, but I think it's all wrong.
[4:56] SPEAKER_00: It's a hard thing to summarize in a brief way.
[5:01] but i'm hoping that uh this will uh that i'm hoping that that
[5:08] we'll see i'm sure
[5:09] this will get back to him i hope he will agree that my
[5:13] characterization of his
[5:14] position is more or less right i probably won't agree with my
[5:20] reputation of most of
[5:22] SPEAKER_00: the position so here next slide are four points
[5:28] SPEAKER_00: my understanding of what this new view of trade amounts to.
[5:32] SPEAKER_00: The first is that absent distorting policies by governments,
[5:39] SPEAKER_00: countries,
[5:40] SPEAKER_00: every country would have more or less balanced trade.
[5:44] that exports would be roughly equal to imports and that it's a
[5:49] mark of a failed system,
[5:51] SPEAKER_00: a distorted system,
[5:52] that in fact we have large imbalances with the United States
[5:56] running large deficits
[5:57] SPEAKER_00: with China.
[5:58] This has been focused by some other countries like Germany or
[6:02] the Netherlands
[6:03] running large trade surpluses so that the norm should be if we
[6:09] can get rid of these distortions,
[6:10] SPEAKER_00: we would have more or less balanced trade.
[6:14] SPEAKER_00: In which he says,
[6:17] SPEAKER_00: as economists do tend to say,
[6:18] that the purpose of exports is to pay for imports and not to
[6:24] run a surplus.
[6:27] SPEAKER_00: He says,
[6:27] SPEAKER_00: the second point is that these trade imbalances that we see are caused by
[6:32] SPEAKER_00: government policies that distort the system.
[6:35] His third point is that the deficit countries are hurt by these interventions.
[6:44] SPEAKER_00: And the fourth point is that tariffs are an appropriate response.
[6:49] That a tariff serves the purpose of basically making up for the
[6:54] fact that exchange rates,
[6:55] SPEAKER_00: in his view,
[6:56] SPEAKER_00: are not right.
[6:58] SPEAKER_00: So of these,
[7:00] SPEAKER_00: I actually have some sympathy for two,
[7:03] SPEAKER_00: that trade imbalances are caused by,
[7:07] SPEAKER_00: some of them are caused by what you might call distortionary policies.
[7:14] SPEAKER_00: I myself have written that China, the inadequacy of Chinese policy
[7:20] Their failure to respond to the inevitable downshifting of
[7:24] their pace of economic
[7:25] SPEAKER_00: growth is leading to a trade surplus,
[7:29] SPEAKER_00: which is a problem for the rest of the world,
[7:32] although I would view it mostly as a political economy problem
[7:35] rather than straight
[7:36] SPEAKER_00: economics problem.
[7:38] But his view is that anytime you see substantial sustained
[7:44] trade imbalances,
[7:45] SPEAKER_00: that's a sign of distortionary policies.
[7:48] SPEAKER_00: But that's the one place where I have some sympathy.
[7:54] SPEAKER_00: The rest, not so much.
[7:57] SPEAKER_00: So let's first talk about is...
[8:02] SPEAKER_00: a world in which most countries more or less balance their trade,
[8:06] SPEAKER_00: in which exports and imports are about the same for each country.
[8:11] SPEAKER_00: Is that normal?
[8:13] Is that what would happen if we didn't have things like Chinese
[8:19] manipulation of its
[8:20] SPEAKER_00: currency and of its industrial structure?
[8:25] SPEAKER_00: And the answer is clearly from the history, that is not the case.
[8:30] That it's,
[8:33] if we look,
[8:33] so we have a very,
[8:35] very long time series for Britain.
[8:40] SPEAKER_00: Bank of England did a two centuries of,
[8:45] SPEAKER_00: or I guess 250,
[8:46] SPEAKER_00: whatever it was,
[8:48] SPEAKER_00: a very,
[8:48] SPEAKER_00: very long horizon review of British economic history for Parliament.
[8:55] SPEAKER_00: The earlier numbers are a little flaky because,
[9:00] SPEAKER_00: you know,
[9:00] SPEAKER_00: really they weren't collecting the data.
[9:02] So this is kind of inferences from the data that do exist,
[9:05] but the basics are pretty right.
[9:09] SPEAKER_00: Current account, that's the broad definition of the trade balance.
[9:12] SPEAKER_00: Mainly it includes the balance on investment income.
[9:17] SPEAKER_00: interest payments,
[9:18] SPEAKER_00: dividends,
[9:18] as well as earnings from exports of goods and services and
[9:23] payments for imports of
[9:24] SPEAKER_00: goods and services.
[9:26] SPEAKER_00: Not an important distinction right now.
[9:30] What you see from this chart is that Britain had very large
[9:36] current account surpluses in the
[9:41] SPEAKER_00: in the period basically starting,
[9:45] SPEAKER_00: roughly speaking,
[9:47] SPEAKER_00: with the opening of the Suez Canal,
[9:50] SPEAKER_00: the gold standard era,
[9:54] SPEAKER_00: the era of globalization via steamships and telegraphs,
[9:59] SPEAKER_00: was also an era in which a lot of money
[10:03] SPEAKER_00: investment flowed across national boundaries,
[10:06] which meant large trade imbalances because the balance of
[10:09] payments always balances.
[10:10] SPEAKER_00: So if some countries are importing lots of capital,
[10:13] SPEAKER_00: they must also be running large trade deficits.
[10:15] Countries are exporting lots of capital,
[10:17] they must be running large trade surpluses.
[10:21] SPEAKER_00: The
[10:24] SPEAKER_00: This was, if you ask where was this money going?
[10:27] SPEAKER_00: So Britain was a huge exporter of capital during this era.
[10:32] Sometimes you see people say it was going to developing countries,
[10:35] which is not really right.
[10:38] SPEAKER_00: Some of it was going to places like Argentina.
[10:42] SPEAKER_00: Some of it was going to the United States and Canada.
[10:45] SPEAKER_00: Some of it was going to Australia.
[10:48] SPEAKER_00: Very little to India, despite it being part of the British Empire.
[10:53] SPEAKER_00: if you look at histories of international capital flows,
[10:57] they basically say that capital was flowing from Europe to what
[11:03] they call zones of
[11:04] SPEAKER_00: recent settlement,
[11:06] SPEAKER_00: which really meant,
[11:08] SPEAKER_00: you know,
[11:08] SPEAKER_00: let's be blunt.
[11:09] SPEAKER_00: These were basically places where white people were moving in,
[11:13] SPEAKER_00: wiping out the native population and
[11:15] SPEAKER_00: setting up economies to export agricultural products back to Europe.
[11:21] SPEAKER_00: So that included the US, Canada, Argentina, southern Brazil, Australia.
[11:29] SPEAKER_00: That stuff came to an end.
[11:32] Britain ran a massive current account deficit during World War II,
[11:36] but that was sui generis.
[11:37] SPEAKER_00: That was massive U.S.
[11:39] SPEAKER_00: lending to Britain for the purposes of the war.
[11:45] SPEAKER_00: Then we had a period,
[11:47] SPEAKER_00: but in general,
[11:47] SPEAKER_00: capital flows were much,
[11:49] SPEAKER_00: much smaller between World War I and the 1970s.
[11:55] SPEAKER_00: And then they opened up again.
[12:01] If you look at the very end of this chart,
[12:04] you can see that Britain has in recent years
[12:09] SPEAKER_00: run pretty large current account deficits.
[12:12] Anyone who says that the United States is unique in its ability
[12:16] to run persistent
[12:18] deficits in trade hasn't looked at Britain or Canada or
[12:23] Australia above all.
[12:25] SPEAKER_00: That simply isn't true.
[12:27] SPEAKER_00: But anyway,
[12:28] SPEAKER_00: you see that this period,
[12:30] SPEAKER_00: the period when trade was roughly balanced country by country,
[12:35] SPEAKER_00: did span a period of something like
[12:41] SPEAKER_00: 60 years or maybe a bit less.
[12:45] SPEAKER_00: But that was not a state of nature.
[12:47] That was because in the interwar period and for a number of
[12:52] years thereafter,
[12:53] SPEAKER_00: there were extensive government controls on the movement of capital.
[12:57] So those were the era that people like Pettis think of as
[13:02] representing the state of
[13:04] SPEAKER_00: nature actually reflected the opposite.
[13:06] They reflected very much government controlled international
[13:10] capital movement and
[13:11] SPEAKER_00: hence roughly balanced trade.
[13:13] And what happened after around 1970 is that we started to
[13:16] return to the historical
[13:18] SPEAKER_00: norm in which capital flows quite a lot.
[13:22] SPEAKER_00: And as a result, trade is widely imbalanced.
[13:26] SPEAKER_00: My next slide is there's a survey from some years ago,
[13:32] SPEAKER_00: but not that far back,
[13:34] by Alan Taylor and Maury Opsfeld on international capital
[13:39] movement in the long term.
[13:43] SPEAKER_00: And the data are scrappy, but they have an interpretation.
[13:48] SPEAKER_00: If you look at the source note on this one,
[13:50] SPEAKER_00: it's,
[13:50] SPEAKER_00: I've got to say,
[13:52] SPEAKER_00: some of my fellow economists do at least have a dawnish sense of humor.
[13:56] SPEAKER_00: This is from introspection, but it is almost certainly right.
[14:01] There was a really big increase in the mobility of capital
[14:05] across national
[14:06] SPEAKER_00: boundaries starting in basically post-1860,
[14:15] SPEAKER_00: post-Suez Canal,
[14:18] SPEAKER_00: submarine telegraphs altogether.
[14:21] SPEAKER_00: The world got pretty integrated in there.
[14:26] SPEAKER_00: side point.
[14:26] SPEAKER_00: People moved back and forth, actually, more so than they do today.
[14:31] Despite all the talk about immigration,
[14:32] it's nothing compared with the flows back then.
[14:35] SPEAKER_00: And people moved back and forth.
[14:37] SPEAKER_00: Hitler's economic czar,
[14:40] SPEAKER_00: Hjalmar Schacht,
[14:42] was actually named Hjalmar Hares Grierlingsacht because his
[14:46] father had lived in
[14:47] SPEAKER_00: Chicago for a while before moving back to Germany.
[14:50] SPEAKER_00: Anyway,
[14:52] what we're seeing now is in some ways that the world today is
[14:56] actually in many ways
[14:58] SPEAKER_00: like the world as it was.
[15:03] SPEAKER_00: It's like the world before there were a lot of government interventions,
[15:07] SPEAKER_00: not a departure from a state of nature in which trade is mostly balanced.
[15:14] SPEAKER_00: The United States...
[15:15] SPEAKER_00: In particular,
[15:16] SPEAKER_00: so this is my next slide,
[15:17] and this time I can actually just give you net exports so it's
[15:23] not including things
[15:24] SPEAKER_00: like interest payments.
[15:26] SPEAKER_00: The United States had roughly balanced trade.
[15:30] We had surpluses right after World War II because we were
[15:33] lending countries or
[15:34] SPEAKER_00: giving them a lot of aid.
[15:36] SPEAKER_00: But after that,
[15:37] SPEAKER_00: we had roughly balanced trade for a long stretch,
[15:40] SPEAKER_00: but then moved into serious deficit during the Reagan years.
[15:45] I wrote a Substack post about that and kind of moved back
[15:51] towards balance briefly,
[15:53] SPEAKER_00: but then moved deep.
[15:55] SPEAKER_00: into deficit,
[15:57] SPEAKER_00: especially after 1995,
[16:00] SPEAKER_00: which is kind of interesting because this was a period,
[16:05] SPEAKER_00: actually that will be my next slide,
[16:09] SPEAKER_00: it was a period when actually we were doing well.
[16:12] That trade deficit was a sign of US economic strength,
[16:16] not US economic weakness.
[16:18] SPEAKER_00: And deficits are down some actually from their peak as a share of GDP,
[16:24] SPEAKER_00: but have remained quite high.
[16:27] SPEAKER_00: And this is what has Trump all worked up.
[16:34] SPEAKER_00: It is certainly true that the U.S.
[16:35] SPEAKER_00: sells less to foreigners than we buy from them.
[16:39] SPEAKER_00: And whether that's a problem or not is more of a question,
[16:46] SPEAKER_00: and it's not at all clear that it is.
[16:49] SPEAKER_00: Just about sources of the trade deficit.
[16:53] Next slide shows rates of productivity change in the United States,
[16:59] so output per worker hour.
[17:02] SPEAKER_00: You can also do total factor productivity,
[17:05] SPEAKER_00: which tries to take into account the contribution of capital as well.
[17:10] SPEAKER_00: But let's just stick with this.
[17:12] SPEAKER_00: It's good enough.
[17:15] The dates on this,
[17:16] I've written this,
[17:17] but this is from the Bureau of Labor Statistics.
[17:20] SPEAKER_00: The dates are based on comparing business cycle peaks.
[17:27] SPEAKER_00: And the reason for that is, as I say, is the Anna Karenina Principle.
[17:31] SPEAKER_00: All happy economies are alike.
[17:34] SPEAKER_00: Each unhappy economy is unhappy in its own way.
[17:38] SPEAKER_00: So when the economy is booming, it tends to get pretty close to capacity.
[17:43] SPEAKER_00: And that's a fair measure.
[17:45] SPEAKER_00: When the economy slumps, slumps differ a lot in their depth.
[17:48] So you get a better sense of what the sort of underlying trend
[17:53] is by going from
[17:54] SPEAKER_00: business cycle peak to business cycle peak.
[17:57] That is slightly unfortunate if there's a kind of a big change
[18:01] that takes place
[18:02] SPEAKER_00: between business cycle peaks,
[18:05] SPEAKER_00: which is a little bit of a problem here.
[18:07] SPEAKER_00: But basic story is from World War II up until the early 1970s,
[18:13] SPEAKER_00: the US economy was a productivity monster.
[18:17] SPEAKER_00: we achieved really, really high rates of productivity growth.
[18:20] SPEAKER_00: Interestingly,
[18:21] not so much from drastically new technologies as from figuring
[18:26] out how to use
[18:27] SPEAKER_00: existing technologies,
[18:28] SPEAKER_00: electrification,
[18:30] SPEAKER_00: the internal combustion engine,
[18:32] SPEAKER_00: but
[18:32] SPEAKER_00: We did really, really well.
[18:34] Then productivity slowed down drastically in the early 1970s
[18:40] and didn't really
[18:42] SPEAKER_00: accelerate much,
[18:44] SPEAKER_00: even during the Reagan years.
[18:50] SPEAKER_00: Nobody's quite sure why that happened.
[18:53] SPEAKER_00: That's a whole other story.
[18:54] SPEAKER_00: But whatever it was,
[18:55] SPEAKER_00: what was interesting there is that there was a lot of fancy,
[18:59] SPEAKER_00: a lot of innovation and information technology,
[19:02] SPEAKER_00: but it appeared as if business didn't quite know what to do with it.
[19:06] SPEAKER_00: So we had the old line from Robert Solo.
[19:11] SPEAKER_00: I won't quote it verbatim,
[19:13] but it's roughly that you can see the computer everywhere but
[19:16] in the statistics.
[19:18] SPEAKER_00: Then circa 1995,
[19:22] SPEAKER_00: businesses did figure out what to do with IT.
[19:25] SPEAKER_00: Some of that was the internet,
[19:26] though at that point it was mostly local area networks and just
[19:29] plain computers,
[19:33] SPEAKER_00: using computers to process data.
[19:36] SPEAKER_00: Some of it came in unanticipated places.
[19:40] SPEAKER_00: One of the big things there was actually
[19:42] SPEAKER_00: inventory management.
[19:44] SPEAKER_00: So,
[19:44] SPEAKER_00: you know,
[19:45] SPEAKER_00: high tech is all very glamorous,
[19:46] but what really paid off for the economy was Walmart being able
[19:50] to run its stores
[19:52] with less inventory because they could keep constant track of
[19:55] what was being,
[19:56] SPEAKER_00: what was on the shelves and what had left them.
[19:59] SPEAKER_00: So we had a period of
[20:01] of rapid productivity growth,
[20:04] and it really starts in 1995 and kind of fades out around 2005.
[20:11] SPEAKER_00: There's a little bit of inexactness here,
[20:15] SPEAKER_00: but we had roughly a decade of good productivity growth,
[20:19] SPEAKER_00: kind of post-war normal.
[20:24] SPEAKER_00: But it didn't last,
[20:25] SPEAKER_00: which is another interesting point,
[20:30] SPEAKER_00: certainly relevant for the discussion of AI now.
[20:35] SPEAKER_00: We really have no idea what the payoff to AI is going to be,
[20:38] SPEAKER_00: and we certainly have no idea of the duration.
[20:41] If you had to make a guess,
[20:43] you'd use that IT surge as a model and say that
[20:48] SPEAKER_00: that we'll get a period of higher productivity, but not forever.
[20:55] SPEAKER_00: Remains to be seen.
[20:57] SPEAKER_00: But in terms of my discussion here,
[21:01] what's striking is that this was a time when the US was doing
[21:05] really well.
[21:06] We had a surge in productivity that really wasn't matched in
[21:11] the rest of the advanced world.
[21:14] SPEAKER_00: and lots of discussions about why that might have been the case.
[21:19] SPEAKER_00: But there was definitely a period of a decade or so when the U.S.
[21:23] SPEAKER_00: was really
[21:25] SPEAKER_00: figuring out what to do with IT and the rest of the world was not.
[21:30] SPEAKER_00: And so the U.S.
[21:31] SPEAKER_00: pulled ahead and is still ahead,
[21:33] although a lot of the divergence took place during this
[21:36] relatively brief period.
[21:39] SPEAKER_00: Now,
[21:40] SPEAKER_00: if you had a kind of naive,
[21:43] SPEAKER_00: a country is like a company view of the world,
[21:46] SPEAKER_00: you would say,
[21:47] SPEAKER_00: well,
[21:47] SPEAKER_00: the U.S.
[21:47] is getting a lot more productive,
[21:48] so that must mean we're getting lots more competitive.
[21:51] SPEAKER_00: So surely we must have been running big trade surpluses.
[21:55] SPEAKER_00: In fact, it was the opposite.
[21:56] SPEAKER_00: So if you go back to the previous slide,
[21:59] you'll see that that's exactly when the United States began
[22:02] running big trade deficits.
[22:03] SPEAKER_00: And the reason is that because the US economy was doing well,
[22:07] SPEAKER_00: it was attracting a lot of inflows of foreign investment.
[22:11] SPEAKER_00: And the balance of payments balances.
[22:15] SPEAKER_00: The trade balance plus net inflows of foreign investment equals zero.
[22:21] So if we're getting a lot of money coming to America to take
[22:24] advantage of the opportunities,
[22:26] SPEAKER_00: we run a big trade deficit.
[22:31] SPEAKER_00: Hard to see how any of this is objectionable or a problem.
[22:35] SPEAKER_00: This is international macroeconomics working the way it's supposed to.
[22:43] SPEAKER_00: Capital flowing to areas that offer high returns to investment,
[22:47] SPEAKER_00: which for a while there was the United States.
[22:51] Okay,
[22:52] now the reason people think it's a problem is that we have
[22:56] definitely de-industrialized.
[23:00] If you look at manufacturing as a share of GDP,
[23:03] which is my next slide here,
[23:06] it is way down.
[23:09] SPEAKER_00: We used to be more than a quarter of the economy.
[23:12] SPEAKER_00: It was still pretty big as late as 1980.
[23:17] SPEAKER_00: It's now around 10% of GDP.
[23:22] And although I don't show it,
[23:26] it's even a bit less as a share of employment.
[23:31] SPEAKER_00: About 8% of employment now is in manufacturing.
[23:34] SPEAKER_00: We are a service economy.
[23:37] SPEAKER_00: I had a paid post saying that that's not going to change.
[23:40] SPEAKER_00: And as some regular readers can tell,
[23:45] SPEAKER_00: some though not all of the material here is stuff that I'm picking up,
[23:49] SPEAKER_00: you know,
[23:49] SPEAKER_00: the research that I did for previous posts,
[23:52] SPEAKER_00: but here putting it together in a slightly different way.
[23:59] SPEAKER_00: strong temptation to attribute deindustrialization to globalization,
[24:05] to say that it's because of all of these foreign imports that
[24:11] we've stopped being a
[24:13] SPEAKER_00: manufacturing nation.
[24:15] And of course,
[24:15] Trump promising that he can make us a manufacturing nation again.
[24:21] SPEAKER_00: There's not zero truth to that.
[24:24] When we import more manufactured goods than we export,
[24:28] then that means other things equal.
[24:30] There are going to be less value added in manufacturing in the
[24:35] United States.
[24:36] There are going to be fewer people employed in manufacturing in
[24:39] the United States
[24:40] SPEAKER_00: than if that trade deficit wasn't happening.
[24:44] SPEAKER_00: But it is not the major,
[24:47] SPEAKER_00: it's not the dominant force in deindustrialization,
[24:52] SPEAKER_00: and it's not something that any conceivable set of policies can reverse.
[24:58] SPEAKER_00: Lots of ways of doing that.
[25:01] SPEAKER_00: I like,
[25:02] SPEAKER_00: I mean,
[25:03] SPEAKER_00: comparing with China,
[25:05] SPEAKER_00: lots of reasons to think that China is kind of a bad model.
[25:09] SPEAKER_00: For one thing, they're much poorer.
[25:11] They're just kind of in a lot of ways at an earlier stage of
[25:14] development than we are,
[25:15] SPEAKER_00: despite being very effective in some sectors.
[25:19] SPEAKER_00: But I like as a
[25:22] SPEAKER_00: kind of test case to look at Germany.
[25:26] SPEAKER_00: Germany runs an enormous surplus in manufactured goods.
[25:31] That's partly because Germany runs an enormous current account
[25:35] surplus overall.
[25:37] SPEAKER_00: And as in the case of China,
[25:40] SPEAKER_00: it's a big surplus country because that's really a sign of weakness,
[25:45] SPEAKER_00: not strength.
[25:46] Germany has somewhat high savings,
[25:49] but mostly it's kind of lacking in investment opportunities.
[25:52] SPEAKER_00: Their technology has been relatively stagnant.
[25:56] SPEAKER_00: Their demographic situation is not good, very low fertility.
[26:03] SPEAKER_00: And while they've had some immigration,
[26:05] it's not enough to prevent them from having a real problem of
[26:08] labor force growth,
[26:10] SPEAKER_00: which means limited opportunities for investment.
[26:13] SPEAKER_00: And so German money
[26:14] SPEAKER_00: flows abroad.
[26:15] SPEAKER_00: A lot of it, for a while, was flowing to other parts of the euro area.
[26:22] The euro crisis really began with massive flows of Germany to
[26:29] southern Europe.
[26:31] SPEAKER_00: If you like, we did fancy financial instruments that nobody understood.
[26:37] SPEAKER_00: The Germans had Landesbanken, local banks,
[26:43] SPEAKER_00: lending money wholesale to Spanish cajas,
[26:46] SPEAKER_00: more or less savings and loans,
[26:49] SPEAKER_00: with very little understanding of the risks involved.
[26:54] SPEAKER_00: But in any case, Germany runs a big surplus.
[26:58] And oh,
[26:58] and Germany,
[26:59] you know,
[26:59] they aren't a big agricultural exporter the way we are.
[27:04] SPEAKER_00: They are a big energy importer in the way we are not.
[27:08] So they would need to run a substantial manufacturing trade
[27:11] surplus just to have balanced trade.
[27:14] SPEAKER_00: And in fact, they run a large overall surplus.
[27:16] SPEAKER_00: So they run a simply huge manufacturing surplus, more than 8% of GDP.
[27:24] SPEAKER_00: Does this mean that Germany has avoided deindustrialization?
[27:30] SPEAKER_00: Well, no.
[27:31] SPEAKER_00: And so this chart here that follows the one on U.S.
[27:37] SPEAKER_00: manufacturing shows that,
[27:40] SPEAKER_00: by the way,
[27:40] SPEAKER_00: Germany starts in 1991 because Germany as we know it,
[27:44] SPEAKER_00: unified Germany starts in 1991.
[27:48] Germany does have a bigger manufacturing sector relative to the
[27:51] economy than we do.
[27:54] SPEAKER_00: But it is substantially smaller than it used to be.
[27:58] SPEAKER_00: And in fact, it's smaller than the U.S.
[28:02] SPEAKER_00: manufacturing sector was in the 1960s.
[28:04] SPEAKER_00: They have not escaped a downturn in China.
[28:14] SPEAKER_00: manufacturing,
[28:15] despite having an extraordinarily favorable trade environment
[28:19] for manufacturing in
[28:20] SPEAKER_00: the form of those massive trade surpluses.
[28:24] SPEAKER_00: And yeah, why has manufacturing declined everywhere?
[28:31] There's a lot of detail,
[28:34] and as always,
[28:34] there's academic papers that try to
[28:37] SPEAKER_00: I cast doubt on the conventional wisdom,
[28:39] but basically productivity in manufacturing has gone up faster
[28:44] than productivity in services.
[28:46] That means that we can satisfy the demand for manufactured
[28:49] goods with a smaller
[28:51] SPEAKER_00: share of the workforce,
[28:53] SPEAKER_00: a smaller share of the economy in manufacturing.
[28:57] SPEAKER_00: It's the same thing that happened to farmers.
[28:59] SPEAKER_00: The U.S.
[29:00] SPEAKER_00: is a massive agricultural producer, a huge agricultural exporter.
[29:06] And we have almost no farmers because we're so good at farming
[29:09] that we don't need a
[29:10] SPEAKER_00: lot of farmers.
[29:15] SPEAKER_00: Now, you might be tempted to say that, hey,
[29:19] okay but what happens when service productivity rises which is
[29:23] done to some extent
[29:24] already and now with ai maybe that makes the service sector a
[29:28] lot more productive
[29:29] doesn't this mean that finally we get the mass unemployment
[29:32] from automation that
[29:33] SPEAKER_00: people have been predicting for
[29:35] SPEAKER_00: about 75 years.
[29:37] SPEAKER_00: Well, the answer is no, because that's a misunderstanding.
[29:40] SPEAKER_00: It's relative productivity change that leads to changes in employment.
[29:48] SPEAKER_00: And I wrote a piece,
[29:50] SPEAKER_00: which is actually,
[29:52] SPEAKER_00: I think,
[29:53] SPEAKER_00: one of the best things I ever wrote for Slate back in 1997.
[29:58] which used a hypothetical economy that produces hot dogs and
[30:01] buns to illustrate
[30:03] SPEAKER_00: that you can't say that because manufacturing lost jobs,
[30:08] SPEAKER_00: because of productivity growth,
[30:09] SPEAKER_00: that the economy as a whole will lose jobs.
[30:13] I won't go into all of that just to say that that's not a valid conclusion.
[30:18] SPEAKER_00: How much
[30:20] SPEAKER_00: How do we think?
[30:21] SPEAKER_00: What do we learn from the German experience?
[30:23] SPEAKER_00: So the next slide,
[30:25] SPEAKER_00: it's a bar chart,
[30:27] compares the size of the manufacturing sector as a share of the
[30:33] economy in the US
[30:35] SPEAKER_00: and in Germany,
[30:37] SPEAKER_00: and the manufacturing trade balance of the two countries,
[30:41] SPEAKER_00: also as a share of GDP.
[30:43] SPEAKER_00: The U.S.
[30:44] SPEAKER_00: runs a manufacturing deficit of more than 4% of GDP.
[30:50] Germany runs a surplus of more than 8% of GDP,
[30:54] roughly a 13-point difference there.
[30:57] The German manufacturing sector is about eight points higher as
[31:00] a share of GDP.
[31:01] SPEAKER_00: You might ask, why not 13 points higher?
[31:04] SPEAKER_00: The answer is that when you spend a dollar on manufactured goods,
[31:09] SPEAKER_00: not all of that ends up as manufacturing value added.
[31:13] SPEAKER_00: The manufacturing firm spends a lot of money on inputs,
[31:19] SPEAKER_00: some of which come from other manufacturing firms,
[31:22] SPEAKER_00: but some of which are services.
[31:24] SPEAKER_00: The firms buy services.
[31:25] So the dollar spent on manufacturers only adds up to 60 to 70
[31:31] cents manufacturing value added.
[31:33] SPEAKER_00: And that's kind of what you see here,
[31:35] SPEAKER_00: that the German manufacturing sector is a lot bigger than ours,
[31:38] SPEAKER_00: but not as much bigger.
[31:40] SPEAKER_00: as you would have expected given the size of their trade ballots.
[31:48] Germany does show on the one hand that nothing is going to get
[31:53] you back to
[31:53] SPEAKER_00: manufacturing playing the role that once did.
[31:56] SPEAKER_00: On the other hand,
[31:57] it shows that running a big trade surplus in manufacturing can
[32:00] make you have a
[32:01] SPEAKER_00: somewhat bigger manufacturing sector.
[32:05] SPEAKER_00: we are not going to run a German size manufacturing trade surplus,
[32:10] SPEAKER_00: not as a share of the economy.
[32:13] SPEAKER_00: Even if we had policies that would do that,
[32:17] SPEAKER_00: that would,
[32:18] SPEAKER_00: sorry,
[32:18] SPEAKER_00: that would reduce the manufacturing trade deficit,
[32:21] SPEAKER_00: a swing of that scale is simply not going to happen.
[32:25] SPEAKER_00: The U S is just too big an economy.
[32:28] SPEAKER_00: Germany is a far, a far smaller economy.
[32:30] SPEAKER_00: So in absolute terms, their surplus isn't all that big.
[32:34] SPEAKER_00: And the world,
[32:36] SPEAKER_00: is not gonna take.
[32:38] The markets probably aren't even there for US manufacturing
[32:41] exports on that scale.
[32:42] SPEAKER_00: And in any case,
[32:43] SPEAKER_00: we would face a protectionist backlash,
[32:45] SPEAKER_00: just as China is facing a protectionist backlash now.
[32:49] SPEAKER_00: This is just, we are not gonna do that.
[32:51] SPEAKER_00: I think realistically,
[32:53] SPEAKER_00: the most you could possibly hope for,
[32:54] SPEAKER_00: even if we had intelligent policies,
[32:56] SPEAKER_00: which we don't,
[32:58] um would be for the u.s to have balanced trade in manufacturers
[33:02] which might add
[33:04] three points of gdp to our manufacturing sector um and
[33:09] something similar to the
[33:11] share of manufacturing and employment which would still leave
[33:14] us as kind of a a far
[33:17] SPEAKER_00: less uh far less uh uh
[33:22] industrialized country in terms of where the center of gravity
[33:26] is than than we used
[33:27] to be which is okay uh there's nothing that says that
[33:32] manufacturing is the only
[33:35] sort of uh good sector that is the only source of good jobs in
[33:40] fact at this point
[33:41] manufacturing jobs aren't especially good their hourly average
[33:45] hourly compensation
[33:46] SPEAKER_00: is a bit less than the average in the rest of the economy
[33:50] SPEAKER_00: If you take into account,
[33:53] SPEAKER_00: you can do various adjustments,
[33:55] and maybe manufacturing jobs are still marginally better for a
[33:59] given set of skills
[34:01] SPEAKER_00: than jobs elsewhere,
[34:03] SPEAKER_00: but nothing.
[34:03] SPEAKER_00: It's basically not a wash.
[34:07] The reason that we think of manufacturing jobs as good jobs is
[34:10] that once upon a time,
[34:11] SPEAKER_00: manufacturing was unionized.
[34:14] uh and uh and the unions were able to demand high wages uh
[34:19] those unions have
[34:20] largely been broken uh and if you wanted to go back to a world
[34:25] where uh what we
[34:27] used to call blue collar workers but anyway workers without a
[34:30] college degree um can
[34:32] earn a middle class salary uh well the way to do that is to
[34:36] restore unionization to
[34:38] SPEAKER_00: and particularly there is no fundamental reason why
[34:43] giant service sector companies like Amazon and Walmart couldn't
[34:46] be unionized.
[34:48] SPEAKER_00: But in any case, it's not about manufacturing.
[34:50] And the idea that what we need to do is to get back the
[34:55] middle-class society we
[34:56] used to have is to make manufacturing great again is a complete misdirection.
[35:01] SPEAKER_00: It's getting it all wrong.
[35:03] SPEAKER_00: That said, Trump's policies are not going to get us there.
[35:09] SPEAKER_00: We are...
[35:13] I mean,
[35:14] lots we don't know,
[35:15] but what we do know pretty surely is that,
[35:19] uh,
[35:21] Trump is going to blow up the budget deficit with tax cuts and
[35:25] no tariffs are not
[35:26] SPEAKER_00: going to make up for the revenue loss to tax cuts.
[35:29] SPEAKER_00: Uh, he's going to, uh, add inflation, uh, by with, with his tariffs.
[35:38] SPEAKER_00: Uh,
[35:38] SPEAKER_00: and no,
[35:38] SPEAKER_00: he's not going to bring down the price of eggs or,
[35:41] SPEAKER_00: uh,
[35:42] SPEAKER_00: has no,
[35:43] SPEAKER_00: no mechanism for,
[35:44] SPEAKER_00: um,
[35:45] SPEAKER_00: uh,
[35:46] SPEAKER_00: really bringing prices down.
[35:48] And in fact,
[35:49] almost all estimates say that inflation is going to be higher.
[35:53] And the combination of bigger budget deficits and tariffs means
[35:58] that the Federal
[35:59] SPEAKER_00: Reserve is going to have to lean against it.
[36:02] SPEAKER_00: They're going to have to probably,
[36:06] SPEAKER_00: I think at this point,
[36:07] SPEAKER_00: we've probably done with the cutting cycle or at most one more.
[36:11] SPEAKER_00: And it's quite possible that depending on how things play out,
[36:15] SPEAKER_00: that we'll actually see the Fed starting to hike again.
[36:17] And one place there where people really believe that is the
[36:23] foreign exchange market.
[36:24] SPEAKER_00: And so this is my last slide.
[36:27] SPEAKER_00: The dollar has gone up substantially.
[36:30] uh since a little bit before the election uh reflecting the
[36:35] expectation that we're
[36:35] going to have a combination of that we're going to have loose
[36:39] fiscal policy uh and
[36:41] it will probably be offset by tight monetary policy which is by
[36:46] the way exactly
[36:47] what happened during the reagan years when the us first moved
[36:50] into major trade
[36:51] SPEAKER_00: deficit
[36:52] And that strong dollar is going to,
[36:56] if anything,
[36:57] make our manufacturing trade deficit bigger.
[37:01] SPEAKER_00: And so we're probably going to have a smaller manufacturing sector.
[37:07] SPEAKER_00: Tariffs really won't help.
[37:11] SPEAKER_00: They certainly won't help manufacturing in the aggregate very much.
[37:14] For one thing,
[37:15] tariffs will,
[37:18] other things equal,
[37:19] tend to push the dollar even higher.
[37:21] SPEAKER_00: Because if we import less, the balance of payments always balances.
[37:23] SPEAKER_00: If we import less, something will have to give.
[37:27] And most likely what happens is that a rising dollar causes us
[37:31] to lose exports at
[37:33] SPEAKER_00: more or less the same rate that we reduce imports.
[37:37] SPEAKER_00: And on top of that, we're likely to face retaliation.
[37:43] SPEAKER_00: On the contrary,
[37:44] Americans tend to believe that the rest of the world doesn't
[37:47] exist and has no agency,
[37:49] SPEAKER_00: but it does and it will act.
[37:53] SPEAKER_00: And so that's going to cut, hit US exports.
[37:56] SPEAKER_00: And this final complicating feature,
[37:58] SPEAKER_00: which makes it worse,
[37:59] is that modern manufacturing involves very complex supply
[38:03] chains that span
[38:04] SPEAKER_00: international borders,
[38:05] SPEAKER_00: especially our northern and southern borders.
[38:08] SPEAKER_00: And so we're going to be seeing
[38:12] SPEAKER_00: a lot of disruption to U.S.
[38:14] SPEAKER_00: manufacturing,
[38:15] SPEAKER_00: which will,
[38:16] SPEAKER_00: among other things,
[38:16] SPEAKER_00: make it less competitive against Europe and Japan.
[38:20] SPEAKER_00: So we're not going to re-industrialize.
[38:26] SPEAKER_00: All of this coming back to the new view of trade,
[38:30] SPEAKER_00: new view of imbalances and is,
[38:36] SPEAKER_00: should we throw out the book on the case for free trade?
[38:41] SPEAKER_00: Should we adopt tariffs?
[38:43] Should we make it a priority of policy to get back to a world
[38:47] of balanced trade for everybody?
[38:51] SPEAKER_00: No, this is all a misunderstanding.
[38:54] SPEAKER_00: we should certainly say to the Chinese, hey, get your house in order.
[38:58] You are trying to export your way out of a failure to deal with
[39:04] the reality that
[39:04] SPEAKER_00: you can't grow the way you used to.
[39:07] SPEAKER_00: But as a general principle,
[39:09] SPEAKER_00: this is a misunderstanding of the way the world works,
[39:13] SPEAKER_00: of the way the world should work.
[39:15] SPEAKER_00: And the
[39:18] The idea that tariffs are the answer,
[39:23] really that they're the answer to anything.
[39:27] SPEAKER_00: I understand that they are unavoidable in some cases,
[39:32] SPEAKER_00: mostly,
[39:32] SPEAKER_00: I think,
[39:32] SPEAKER_00: because of the political economy.
[39:34] The fact of the matter is saying to communities that find
[39:38] themselves in the path of
[39:41] SPEAKER_00: an import surge,
[39:42] SPEAKER_00: well,
[39:43] SPEAKER_00: look,
[39:43] SPEAKER_00: there's a lot of dynamism in the economy,
[39:45] SPEAKER_00: and somebody's always going to get hurt,
[39:47] SPEAKER_00: and that's you this time,
[39:49] SPEAKER_00: is really not a sustainable political position.
[39:53] SPEAKER_00: But it is, really.
[39:54] SPEAKER_00: Yeah.
[39:57] We can acknowledge some political realities here without losing
[40:02] our sense of what
[40:05] SPEAKER_00: trade and capital flows are all about.
[40:08] SPEAKER_00: And so no to this new view on international trade balances.
[40:17] And with that,
[40:18] I'm going to try calling a halt and see if this whole thing works.

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