Part 1. Income Distribution and The Impact of Trade Deficits

Trade is killing our jobs! We must build a wall! We must abandon international trade agreements!

Introduction

A growing chorus of voices around the world is challenging the traditional view of economists that trade is a win-win proposition. This view can be summarized as follows:

“Everyone gains from increased efficiency stimulated by growing trade. Some people will have to find new jobs, but they will be better jobs. And if they don’t, the winners from growing trade will compensate the losers, and all will be better off.” 

The voices opposing this view are especially loud in the United States, which is in the midst of its most contentious presidential election in years. And they are being joined by people in Britain, particularly those who voted for Brexit, and in countries throughout the European Union, especially in the Mediterranean area where unemployment rates have been at record levels.

What happened? Why isn’t international trade working as it should? 

Should we restore American manufacturing, employment and family incomes by introducing tariffs and other trade barriers? Or should we expand trade to reap the benefits that expanded trade and specialization are supposed to bring to America ? This  post is the first in a series of three that seek to resolve these conflicting views.

• This post shows that, if a country has negative trade balances, expanding trade tends to make income inequality worse.

• The second post will show that countries with more openness to trade – with a higher ratio of imports to GDP –  tend to have higher incomes and less income inequality.

• The final post will conclude that implementing currency-related measures that erase trade deficits by moving the nation’s exchange rates to its trade-balancing equilibrium exchange rates will reduce income inequality and will increase average income levels.

This trilogy of essays, along with footnotes and more technical information, will soon available as a single online document.

Income Inequality and Trade Deficits

In the United States, opposition to international trade comes, not from the urban elite or from agrarian communities, but from middle class men and women who are losing their jobs in manufacturing. Middle-aged workers feel particularly vulnerable. After a lifetime of making good wages doing honest work, they resent their decline into relative poverty and fear what lies ahead.

Statistical analysis as well as micro-level studies of the realities facing these individuals indicate that they are at least partially right in blaming foreign trade for their woes. But they too often assume that their suffering is caused by hostile acts of foreign governments such as currency manipulation by the Chinese.

They fail to realize that the biggest problem may well be America’s currency policies – policies that are more relevant to the world of fifty to one hundred years ago than to today’s world where international trade in capital assets vastly outweighs trade in real goods and services. Furthermore, they tend to blame “trade” in general without focusing on the fact that the problem is not the volume of trade but rather trade imbalances. In fact, as shown in the next post, countries with larger ratios of trade to GDP tend to enjoy a more equitable distribution of income.

External Deficits and Income Inequality – A Cross-Country Overview

A clear correlation exists between external deficits and income inequality throughout the OECD countries. In Figure 1, the average external balances as a share of GDP for 1980-2015 and the Gini coefficients for 2012 for these countries are shown as a scatter plot.

Figure 1

The Gini coefficient reflects the difference between a perfectly equal distribution of income where the bottom 50 percent of the population enjoys 50 percent of total national income, and the actual distribution of income where the bottom 50 percent of the population enjoys only 25 percent of total national income, for example.

The downward slope of the dashed blue line, which reflects the trend line for the plotted data, shows that income inequality increases as the average current account balance declines from surplus to deficit.
  
The correlation is certainly not tight enough to say that external trade imbalances are the sole driver of income inequality. But an important relationship clearly exists. Furthermore, micro-level analysis of the lives of those affected by trade deficits show the causal links between trade imbalances and income distribution.

Causal Links Between Trade Deficits and Income Inequality

The people most at risk of suffering stagnant or falling incomes because of expanding unbalanced trade are those least able to compete with workers in low-wage countries. As indicated in the excellent studies by David Autor and his colleagues, at-risk workers include those who:

1. Have less than a college education.
2. Lack advanced manufacturing skills.
3. Are older and cannot work long enough to repay the cost of additional training.
4. Work in factories producing textiles, apparel, footwear, furniture and other labor-intensive products where low-wage countries have a comparative advantage.
5. Work in regions dominated by plants producing similar at-risk products.
6. Work in single-factory “company towns” where alternative jobs are scarce.
7. Live in areas already suffering high unemployment and low wages.
8. Live in isolated, traditional communities far from alternative sources of employment.
9. Are bound to their present community by poverty, inadequate information about jobs elsewhere, illness, housing costs, family ties, or tradition. 

In short, those most likely to suffer a further relative loss of income from foreign import competition are those already most likely to be relatively poor, thus making overall income inequality even more severe.

If trade were balanced, international competition would drive producers to expand production and jobs, and this expansion would tend to take place in products where America has its greatest comparative advantage. But if the dollar is overvalued, the price signals that would otherwise encourage producers to invest in more competitive production and better jobs are distorted.

An overvalued currency actually discourages production by making made-in-America products too expensive to compete in either the domestic market against imports or in foreign markets as exports. The result – more job losses and more poverty. And as Scott has pointed out, job losses will be particularly high among those with less than a college education.

In contrast, balanced trade is good for growth, employment, income equity, and national economic stability because balance encourages the most efficient use of a nation’s resources –  not only of workers, but also of capital stock, raw material endowments, and infrastructure.

Balanced trade is particularly good for income distribution because, as demand for American goods increases, the domestic demand for American workers will increase, raising worker incomes in two ways. First, wages for existing workers will rise as the labor market becomes tighter. Second, higher wages will draw workers out of joblessness and back into the labor force, producing major increases in family incomes.

Furthermore, by helping to assure maximum possible growth, balanced trade increases the revenues available for the government to finance supporting investments in worker training, research, regional development plans, infrastructure and other productivity-enhancing investments that will further accelerate growth and living standards for all.

Finally, even if tax rates were lowered as part of a major overhaul of the tax system, balanced trade would tend to reduce the government deficit because balanced trade would mean less need for expenditures to bail out failing corporations and out-of-work households.

Conclusion

America’s forty-year history of trade deficits has been a major factor driving increases in income distribution inequality over the period because job losses caused by trade deficits have the most serious impact on those who are already in or relatively close to poverty.

Eliminating U.S. trade deficits would make a major contribution to reducing poverty and improving income distribution.

The next post will show that expanding trade -- if trade is balanced -- would not only improve income distribution, but would also raise average income levels for all Americans.

America Needs a Competitive Dollar - Now!