Giglio

Free trade doesn’t work for most American workers

Posted on by j.giglio

The aphorism “A rising tide lifts all boats” has become entwined with a basic assumption that free trade results in economic wins for all players in the global economy. Of course this assumes you are lucky enough to have a boat that has not run aground.

The classic case for free trade was made nearly 200 years ago by economist David Ricardo. This static argument relies on the principle of comparative advantage; that trade enables countries to specialize in goods and services they produce more efficiently than do their trading partners. This increases overall productivity and total output.

The conclusion follows from countries having different opportunity costs of producing tradeable goods. The opportunity cost of any good is the other goods that could have been produced by the same resources. Each country focuses on what it does best and everyone gains. This notion of free trade has a hallowed status among the cheerleaders for globalization.

Another way to understand comparative advantage is to consider the opportunity cost of undertaking a certain activity. Let’s assume that Lady Gaga, the famous entertainer, also happens to be a world-class typist. Rather than entertaining and typing, she should specialize in entertaining, where her comparative advantage is greatest and she could maximize her income.

In this example, Lady Gaga has a much higher opportunity cost of typing than does her secretary. If Lady Gaga spent an hour typing while the secretary spent the hour running the business, there would be a loss of overall output.

The real world is much more complex. Free trade has a downside: while its benefits are broadly distributed, costs are often concentrated. Consider the case of American textile workers. In the aggregate, American consumers gain by having access to cheap clothing, but unemployed textile workers bear the loss.

Many free trade cheerleaders confuse it with off shoring jobs, which is simply substituting, cheap foreign labor for more expensive American labor when nothing is in fact being traded. Moving production overseas has nothing to do with comparative advantage; it simply reflects wage and price competition from countries seeking jobs and economic growth.

If a firm shifts production to low-wage countries, its profits improve, driving up share prices and senior management performance bonuses. To paraphrase one-time presidential candidate Ross Perot: If you can build a factory overseas, pay about a dollar an hour, have little or no health care or retirement benefits and no environmental controls, then you are the greatest businessman in the world

But when many firms move overseas, American workers lose their incomes. So when do the costs of lower incomes resulting from job losses and government revenues exceed the benefits to consumers of lower prices? Put differently, do the costs of exporting good-paying American jobs outweigh gains from cheaper imports and contribute to a shrinking middle class.

Free trade advocates contend that the Americans left unemployed have acquired new skills and will find better jobs in “sunrise” industries. In reality, how many steelworkers do you know who have become computer software engineers?

This is one reason why Americans’ real incomes have stopped growing as manufacturing jobs have been moved offshore.

As then-presidential candidate Barack Obama said in 2008, “You go into these small towns in Pennsylvania and like a lot of small towns in the Midwest, the jobs have been gone now for over 25 years and nothing’s replaced them. And it’s not surprising, then they get bitter, they cling to guns, or religion or antipathy to people who aren’t like them or anti-immigrant sentiment or antitrade sentiment to explain their frustrations.”

A former General Motors CEO allegedly said “what is good for GM is good for America.” But offshoring challenges the conventional wisdom that American firms generally advance the nation’s economic interests. When they employ a large foreign workforce but few people within the United States, it certainly is good for the firms, but not for the American worker.

Originally Published: April 16, 2016.

Trump and Sanders may be right: Free trade is costing U.S. too much

Posted on by j.giglio

Opposing so-called free trade deals has been an important part of the rhetoric of presidential candidates in both parties, especially polar opposites Donald Trump and Bernie Sanders. They blame free trade for the loss of American jobs, the decline in workers’ real wages, increased income inequality, and a shrinking middle class.

From their opposing ends of the political spectrum, Sanders and Trump have ignited an important debate about just who benefits from free trade. Sanders criticizes free trade as a proxy for corporate greed, while Trump says such deals serve politicians who put the interests of corporate contributors over those of ordinary Americans. Both candidates roll out the full Monty of free trade criticisms and argue that the U.S. needs to be smarter about sustaining a global trading order that supports America’s workers and economic interests rather than playing the victim for trading partners who steal jobs and play by rules that don’t reflect American social and environmental values.

They are fed up with being out-traded and out-negotiated in deals that are the serial killers of American jobs. They believe other countries engage in managed trade, not free trade, and play the game in a way that produces trade surpluses for them and fewer lost jobs for the U.S .

Opposition to free trade is a major vote getter; a way to leverage voter anger and bond with ordinary Americans. In some parts of the country, it has served as an organizing principle in a deeply divided electorate.

The typical American family saw its wealth decline significantly in the wake of the Great Recession and many voters have begun to question the fairness and adequacy of past trade policies. Deals such as the 1994 North America Free Trade Agreement (NAFTA) have been blamed for massive job losses.

Barack Obama repeatedly criticized NAFTA during the 2008 Democratic primary battle, noting that “we can’t keep passing unfair trade deals like NAFTA that put special interests over workers’ interests.” Trump and Sanders, hoping to win support from working class voters who are not fans of globalization, fervently oppose the ambitious 12-member Trans-Pacific Partnership pact the president supports.

Manufacturing’s contribution to U.S. employment has fallen steadily for more than half a century. Over the last 20 years, tens of thousands of factories have closed and many have moved to lower wage countries like Mexico, China and Vietnam. The sword of additional plant closings hangs over the heads of workers as companies pursue the classic go-to move of chasing cheaper labor.

Both Trump and Sanders cite the Carrier Corp.’s recent announcement that it will close its Indianapolis manufacturing plant and move all 1,400 jobs to Mexico. The move comes after the company was awarded $5.1 million in taxpayer money in 2013 under the Clean Energy Tax Credit Program. The funds were supposed to be used to “expand production at its Indianapolis facility to meet increasing demand for its eco-friendly condensing gas furnace product line.” Carrier says it has not received the money and will not claim it despite having been awarded the funds.

Carrier is another example of how low-wage countries can raise their living standards and impoverish American workers by importing American jobs and industries. You could argue that Carrier and other firms are really engaging in the exploitation of cheap labor, a form of economic arbitrage rather than trade, but this would not accrue to the political advantage politicians pursue.

While Carrier’s move will in theory reduce the cost of its products in the U.S., who will compensate the 1,400 workers losing their jobs or the community’s tax base? Is it any wonder that large numbers of voters prefer protecting domestic jobs from low-wage countries over lower prices for consumer goods?

To hold the line, Trump and Sanders contend it is time to rethink free trade and advocate for quotas and tariffs that protect and defend American interests and values rather than those of special interests such as multi-national corporations. On that issue they may have a point.

Originally Published: April 2, 2016

Why ‘good’ job numbers leave us feeling mad, sad and worried

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Earlier this month the Bureau of Labor Statistics released its February jobs report. The unemployment rate of 4.9 percent is the lowest since February 2008 and suggests nearly full employment, but the real picture is far more mixed.

The report finds that the country created 242,000 new jobs last month, well ahead of the Wall Street forecast of 190,000. It also revised its December and January reports to add a total of 30,000 more jobs. The numbers suggest that even in the face of financial market turmoil and slowing global demand, the

U.S. has averaged about 228,000 new jobs over each of the last three months.

Still, many of the jobs were concentrated in low-wage sectors. Retailers added 54,900 jobs last month and restaurants and drinking establishments another 40,200. Manufacturers cut their payrolls by 16,000 jobs as slow growth in key markets around the world and the rising value of the dollar reduced demand for U.S. products. By far the weakest sector for job growth was the mining sector, which includes oil and gas producers. It cut jobs for the 17th straight month, losing 19,000 in February.

Hiring by employers directly associated with consumers has more than offset layoffs by manufacturers and fossil fuel companies, the two sectors squeezed by declining oil prices and a strong dollar.

An increase in the labor force participation rate was an encouraging sign. The rate of 62.9 percent is the highest in over a year as more than half-a-million people joined the labor force. Fewer and fewer people appear to be sitting on the sidelines.

But there is more to the story. The headline unemployment number does not account for the underemployed, such as those who are involuntary working part time. And even though labor participation rose, there are still many long-term unemployed and discouraged workers who have stopped looking because they believe no jobs are available for them. When these groups are included, the February unemployment rate rises to 9.7 percent, which suggests that the labor market is far from overheating.

Other downbeat notes were that the average length of the workweek declined by 0.2 hours, aggregate hours worked fell 0.4 percent, and average wages fell by 3 cents to $25.35 an hour. This put the yearly wage growth at 2.2 percent, just slightly ahead of core inflation rate. That makes it difficult for the average American to keep up with the staples of a middle class life. Indeed, real wages for most American workers have been flat lining since the 1970s.

A 4.9 percent unemployment rate masks the fact that things are not going very well for a large share of American workers. Jobs may be plentiful, but they are not paying much. It may be good news that the economy is growing at 2 percent, but ordinary Americans are not reaping the benefits of that growth.

Things are tough on Wall Street, too. Average bonuses paid out in the financial services sector tumbled 9 percent last year to the lowest level in three years, according to new figures from the New York State comptroller. Of course, that average $146,200 bonus is still nearly three times the median annual U.S. household income of about $52,000.

In light of these disparities and glass-half-empty job numbers, is it any wonder that average working class Americans are seething with anger, are anxious about the future, and are feeling betrayed? Stalled incomes may be fueling the hard line positions on illegal immigration and opposition to job-destroying trade deals that spur the rise of both Donald J. Trump and Bernie Sanders, the yin and yang of America’s season of political discontent and economic stagnation.

If that continues, voters might find themselves liking the cure even less than they like the illness.

originally published: March 19, 2016

Remembering a day that was too big to forget

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This month marks the anniversary of the collapse of Bear Stearns, once Wall Street’s fifth-largest investment bank. The demise of the 85-year old institution signaled the real start of the 2008-2009 financial crisis. Eight years later, we can only hope our leaders learned something from the experience.

The collapse and Bear’s subsequent bailout by the Federal Reserve, with the support of the Treasury Department and JPMorgan Chase sent shockwaves throughout the financial system. Bear’s incredibly rapid demise raised serious questions about the banking industry’s use of leverage, inadequate oversight of commercial and investment banks, and the role of the Fed and other regulators in preventing the failure of major financial institutions.

Late on Sunday afternoon, March 16, 2008, Bear’s board of directors accepted JPMorgan Chase’s offer to purchase the company. Less than 18 months after its stock was trading at an all-time high of $172.61 a share, Bear Stearns had little choice but to accept the humiliating offer of $2 a share.

JPMorgan Chase later raised the bid to $10 per share and the Fed provided $30 billion in collateral guarantees to facilitate the deal. The Fed considered Bear too large and too interconnected to fail and saw no choice but to arrange a bailout to prevent a global market crisis. It was hoped that the Bear rescue would nip the problem in the bud and avoid the damage to the larger financial world that many policymakers thought would result from the failure of a major investment bank.

The precise nature of the transaction seemed unclear, but the Fed appeared to be accepting responsibility for the toxic, illiquid assets on Bear’s balance sheet if their eventual liquidation resulted in a loss. In this sense, it appeared that the Fed became the residual owner of these securities and put the federal taxpayer on the hook for Bear’s reckless risk taking activities. Some believe that this action exceeded the Fed’s power.

The first sign of trouble at Bear was the July 2007 collapse of two of its hedge funds. The funds had invested heavily in collateralized debt obligations backed by subprime mortgages, and their failure alerted the rest of the financial system to this contagion.

The hedge funds’ collapse also raised concerns about the firm’s own exposure to mortgage-related securities. It damaged the firm’s reputation, weakened its finances and served as the precursor to Bear’s ultimate collapse. Within a year “the plumbing had stopped working” and credit ceased to flow through the financial system.

Hopes that a global financial crisis could be averted proved misplaced just six months later when Lehman Brothers, another bank that was heavily involved in the mortgage business and was even larger than Bear filed for Chapter 11 bankruptcy on September 15, 2008. The public backlash against the Bear bailout made rescuing the 158 year-old Lehman Brothers politically untenable, especially just weeks before a hotly contested presidential election.

The 2008-2009 financial crisis proved to be the most expensive in history. On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd­ Frank), one of the most sweeping financial reforms in U.S. history.

The law’s stated aim is to “promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail,’ to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.” Essentially, Congress’s intent was to reduce system-wide risk and to prevent another financial collapse.

Let’s hope policy makers actually learned enough about how the economy and the financial system fit together from the 2008-2009 financial crisis to avoid future learning experiences. They would be well advised to recall the words of that prolific author, anonymous, who said, “The past is prologue: but which past?”

originally published: March 5, 2016

Negative interest rates are on the table

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Just two months ago the Federal Reserve (the Fed) hiked the short-term interest rate it controls. The quarter-point increase was the first in nine years after efforts to pump up economic growth by keeping the rate close to zero. Now several members of the Fed are talking about reversing themselves and moving interest rates into negative territory.

It’s not such a far-fetched idea. Sweden, Denmark, Switzerland, Japan and the European Central Bank have introduced negative interest rates. It’s the latest toy in the world of monetary policy, where the economy is seen as an automobile and interest rates are the gas pedal.

When Fed Chair Janet Yellen delivered her semiannual testimony before Congress last week, she said the Fed has not fully researched the issue of charging banks to hold their excess reserves. But the plot took a sinister twist when it was disclosed that the Fed asked banks to consider the impact of negative interest rates during the latest round of bank stress tests.

Under a negative interest rate policy, banks are charged to park their cash with the central bank. The hope is that this will encourage banks to stop hoarding money and instead lend to consumers and businesses to accelerate economic growth.

No one knows if negative interest rates would work in the U.S.; the Fed has never tried them. Fully identifying their impact is very complicated, but we know how the story will play out for the average Joe. If the Fed charges banks for excess deposits, the banks will in turn charge customers for depositing money.

Still further, just because the interest rate is negative does not mean a bank will pay you interest (rather than the other way around) when you pay back a loan. The average customer will not get paid to take out a loan, not now, not ever, never.

Negative interest rates effectively charge the customer for deposits, discourage saving and encourage spending. Forget about saving for retirement and a child’s education; this policy is designed to grow the economy by coercing people to spend. Of course, the customer can at least be held harmless by holding cash and earning a zero percent nominal return.

The Fed has effectively punished the millions of American who rely on their savings to get by. Safe options such as savings accounts, certificates of deposit and treasury bonds offer pitiful returns forcing many people to dig into their principle to make ends meet. Under negative interest rates, the longer funds are on deposit the less money is available for withdrawal as banks charge to hold the money. Also, if people are unable to retire, many will either remain in or re-enter the labor force, thereby competing with younger workers for jobs or risk their savings by putting money in risky investments.

Crazy as it sounds, this may be the new normal. Remember that when the Fed thought they could not cut the interest rate any more, they engaged in quantitative easing: basically creating money out of thin air and releasing it into the economy, mainly by buying bank debt securities.

Bargain-basement interest rates and flooding the system with trillions of dollars in cheap money has produced sharp stock market gains -though even that has ended in recent months – and enabled corporations to buy back their own shares and pursue mergers and acquisitions instead of expanding production and creating jobs. It’s time for the public to ask what we have to show for these aggressive and addictive monetary policies that are a misallocation of resources and contribute to income inequality by shifting wealth to asset owners.

Monetary policy does not make for good presidential debate sound bites, but the time is long overdue for candidates to engage on the issue of federal monetary policy and how it has contributed to income inequality.

originally published: February 20, 2016

Middle East violence is a reminder of the Thirty Years War

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Mark Twain’s reputed quip that “history doesn’t repeat itself, but it does rhyme” reminds us that historical analogies can sometimes provide a useful perspective on current events and even inform the future. The sectarian violence and bloodletting raging all over the Middle East have given rise to several historical comparisons, not least the hellish Thirty Years’ War that ravaged Europe in the first half of the 17th century.

With apologies to Dickens, it was the worst of times in Europe. This conflict among the Catholics, Calvinists, Lutherans, and Huguenots, involving multiple great powers, became a bloody, protracted struggle over the continent’s political and religious order.

Across the modern Middle East, Western foreign policy blunders have largely, though not entirely, contributed to a growing sense of instability. Many argue that the turmoil currently engulfing the region was born out of the catastrophic American invasion of Iraq in 2003 and its failure to reconstitute an Iraqi state.6

The turmoil is fueled by the hatred between the Shia and Sunni branches of Islam that has existed for centuries. Toppling Saddam Hussein unleashed the Shia in Iraq and strengthened Iran’s bid to be the region’s most important actor.

Just as with the Thirty Years’ War, the religious conflict is overlaid by a great rivalry between Iran, leading a Shiite coalition, and Saudi Arabia, which is Sunni central. Add to that the presence of the United States and Russia, which are fighting proxy wars in the region, and you have a precarious and highly flammable mix.

In 16th and 17th century Europe, the Protestant Reformation opened a Pandora’s Box of international and civil conflict culminating in the Thirty Years’ War, the greatest of the so-called wars of religion. Although the struggles that led to it erupted many years earlier, the war is conventionally held to start in 1618. It lasted through 1648, a seemingly endless and devastating conflict in which millions of

Europeans were killed, a scale unimaginable during the medieval era. It is estimated that more than 25 to 40 percent of the German population perished during the war.

The roots of both the Middle Eastern and European conflicts stretched back centuries and centered on unresolved questions of religious freedom and power politics. Not unlike the geopolitical and religious contest of will between Sunni and Shia, the Thirty Years’ war began as a conflict between Protestant nobles in Germany fighting to preserve their autonomy and faith against the Catholic Hapsburg Dynasty (the Holy Roman Empire).

On the political side, the Hapsburg Dynasty wanted to preserve its European hegemony. This triggered a conflict among a conga line of great powers such as France, Denmark and Sweden that was not unlike the modern power struggle between Iran and Saudi Arabia.

The Thirty Years’ War ended with the Peace of Westphalia in 1648, referred to by contemporaries as the Peace of Exhaustion. It established a new political order that irrevocably changed the map of Europe. The Netherlands gained independence from Spain, Sweden gained control of the Baltic, the German Protestant nobles were able to determine the religion of their lands, France was acknowledged as the preeminent Western power ,  the Holy Roman Empire continued as an empty shell until it was dissolved 150  years later and the principle of state sovereignty emerged, creating the basis for the modern system of nation states.                  ·                                              ·

In the long run, mitigating the Middle East’s sectarian and geopolitical conflicts may partially center on implementing the Westphalian nation state concept. Some semblance of stability in the Middle East may be restored with the reestablishment of a state-based order. For starters, that may mean a three-state arrangement, redrawing the existing national boundaries to accommodate separate states for the Sunnis, the Shias, and Kurds.

But history teaches us that the West must best be prepared to wait a very long time for the latest conflict in the Middle East to subside and for anything that approaches a solution to take hold.

originally published: January 19, 2016

Political rhetoric and the jihadists

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Every terrorist attack on a Western target presents the self-styled saints in Washington and other western capitals with an opportunity to engage in perfectly staged grandiose rhetoric. Employing borrowed words, identical sound bites, and first-cousin cliches designed to curate their images, conceal their ignorance and ignore realities on the ground, world leaders’ pontificate about destroying ISIS.

But there is precious little explanation of what defeating ISIS really means or how it will be accomplished.

Our leaders’ mandarin rhetoric is reminiscent of Queen Gertrude’s admonition to Polonius in Hamlet: “More matter with less art.” In contemporary parlance, this is translated as more substance with less style. More content without the rhetorical ornamentation and digressions. The political classes in God’s menagerie talk until their mouths bleed and reassure the public that they will defeat the terrorists without a hitch like an Ocean’s Eleven heist.

Best to recall the truth of George Orwell’s comment that “…if thought corrupts language, language can also corrupt thought” blurring the boundaries between the fake and the real. It is a reminder that the moment to be wariest of political rhetoric is precisely when elite opinion is lined up on one side of the boat.

Those politicians talk about destroying ISIS, but what about other radical Islamic terrorist groups such as al Qaeda, Hezbollah, Hamas, Jabhat al-Nustra, and Boko Haram, that have proliferated all over the globe partially facilitated by the information revolution?

Does victory over ISIS mean taking the fight to their doorstep in Iraq and Syria? If it means beating them militarily, that is a silly question. If the American public has the stomach to support boots on the ground with the collateral damage to civilians, the world’s mightiest military could go through ISIS in Syria and Iraq to take a phrase from General Patton, “like excrement through a goose.” But the American people will not touch this approach with a barge pole.

The U.S. military did not start bombing ISIS’ oil infrastructure and their fleet of tanker trucks because the Obama administration was worried about civilian casualties and environmental damage. You have to wonder whether the allies would have won World War II if they had to submit their bombing targets to the White House for approval.

Is defeating ISIS militarily, stopping its propaganda machine, blocking its revenue sources sufficient to eliminate radical Islamic terrorism? ISIS and other jihadists ‘ initial goal is to create a caliphate in Iraq, Syria, Lebanon, Jordan, Yemen, Libya and the Palestinian territories. After that, they want to recreate the caliphate of old and then spread Islam over the entire planet. A global caliphate achieved through a global war. Other than that, they have modest ambitions.

Does it mean making their ideas go away? Does a grand strategy have to deal with the challenge of overthrowing a religion, a belief system? Even if we defeat the extremist militarily, we are still going to be dealing with the sons and daughters of jihadists 20 years from now. The fight against terrorism could become like the endless war on crime, or poverty or cancer.

To reduce and manage the terrorist threat, mainstream Muslims themselves must come out forcefully against the jihadis who are trying to hijack their religion. Political rhetoric comes with the speed of light, while developing and executing a successful strategy to deal with the scourge of radical Islamic terrorism comes with that of sound.

originally published: January 2, 2016