Tag Archives: free trade

Is The US Public Debt Sustainable?

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The US public debt is rising $1 trillion every 100 days, headlines say. Is the US public debt sustainable?

Well, the US net international investment position is on an unsustainable path and that reflects on the US public debt. The solution is not fiscal contraction but using policy to address the US balance of payments.

According to the Federal Reserve release Z.1, the US net international investment position was −$19.37 trillion at the end of 2023. (Table B.1, line 24), while the Gross Domestic Product for 2023 was $27.36 trillion. (Table F.2, line 1).

Since government deficit is connected to the current account balance by an identity,

NL = DEF + CAB

where NL is the private sector net lending, DEF is the government deficit, CAB is the current account balance, it suggests a connection between the government deficit and current account balance not just as a static identity but behaviourally and there is a connection between the public debt and the net international investment position. In behavioural stock-flow consistent models, this can be seen more clearly.

The US has had high current account deficits and that has put the US economy on an unsustainable path.

And in general, there is no market mechanism to resolve imbalances. Lots of political discourse in the US has been around trade/tariffs etc. Industrial policy has also appeared. Note that many people define industrial policy as government picking winners, but that is misleading/a deceit. The aim of industrial policy is to improve competitiveness of a country and that has to do with exports and imports.

A lot of people complaining about the path of the US public debt seem to suggest that the way to solve it is via fiscal contraction. But that causes a deflation of the US economy and increases unemployment.

But sadly, the other side denies that there is any problem with sustainability/trade etc. So we have crazy politics. An important problem is the lack of understanding how economic forces operate. Or that people’s self-interests stand in the way of understanding.

Note that “r < g” is not a condition for sustainability.

The resolution of the problem lies in the US asking the rest of the world to increase growth by more fiscal expansion (which would increase US exports and reduce US imports relative to GDP), use protectionist measures and industrial policy and then work toward a system of planned/regulated trade where international trade is generally balanced.

Trump Proposes A Ring Around The Collar

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In a recent interview with Larry Kudlow, Donald J. Trump has proposed a 10% tariff on all goods and services produced by nonresident economic units which he calls “a ring around the collar”.

Trump has a chance to be reelected the President of the United States and it’s noteworthy not just because of that but because there is hardly anyone proposing the same. I think that the US balance of payments and hence its financial position is in an unsustainable path and it has to take such measures.

It is important to realise that Trump was using protectionist measures in his Presidency, he faced ridicule from supposed experts. But soon when Joe Biden became the President, Biden not only continued Trump’s policy but also did more to try to improve the US’s net international investment position.

But instead of acknowledging this, the expert class obviously has its narrative. It’s partly to do with the fact that they don’t want to acknowledge that they were wrong and the rest with the fact that they want to return to the old world order of free trade once the US presumably improves its economic/financial position.

Paul Krugman has a Twitter thread and an article in The New York Times on this. It’s a tribe defense, plus a plan to keep this as it is after a small change, with the assumption that it will succeed.

Economists On US Manufacturing And Trade

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Recently, Paul Krugman wrote two articles in The New York Times on recent surge in US manufacturing: Making Manufacturing Great Again (June 6, 2023) and Making Manufacturing Greater Again (April 20, 2023).

Post-Keynesians stress the importance of manufacturing and exports/international trade. Before the economic and financial crisis which started in 2007, Wynne Godley was worried about all this and proposed to improve exports and take measures such as imposing non-selective protectionism, as he thought—rightly—that a crisis would happen and fiscal policy should be used and would be used but that alone will not be sufficient. In other words, the market mechanism won’t do the trick.

The reason manufacturing is important is because of the potential for expansion of exports.

Economists however have been denying all this. Especially with the rise of Donald Trump when attempts to improve the US balance of payments/international investment position were looked upon as clownish. But now the establishment has accepted that it needs to be addressed. But they don’t want to accept that they were behind. At the same time, Joe Biden has gone beyond measures that Trump has taken.

However, there are many economists who still live with old dogmas. For example, see Adam Posen’s article America’s Zero-Sum Economics Doesn’t Add Up for Foreign Policy.

So we have two types of mainstream economists: a) those who grudgingly accept that they were wrong and b) who are still wedded to dogmas.

There’s of course a limit to this, so the solution to the problems lie in disbanding the system of free trade and move toward a system of balance-of-payments targets.

Mainstream Economics On A Better Globalisation

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The United States policies and maintains the “liberal international order”, a totally unfair game built on laissez-faire/anti-Keynesian ideas. That was advantageous for the United States because its corporations are highly competitive because of historical reasons and who don’t need protection at home. Of course the US has still been using protectionist measures, so there’s hypocrisy there too. But the general system is the removal of protection from countries whose producers need it. Free trade in general. Low tariffs, no import quotas and industrial policy is shooed away.

There’s a good Noam Chomsky video on What Is The WTO? (with transcripts on that page).

Post-Keynesians have argued how the system of free trade has a deflationary bias and causes polarisation in the fortunes of nations.

The solution is, as proposed by Nicholas Kaldor in his book Causes Of Growth And Stagnation In The World Economy, page 87:

… coordinated fiscal action including a set of consistent balance of payments targets and “full employment” budgets.

Anyway, China has gamed this too well to cause troubles to the United States. The US balance of payments and international investment position is on an unsustainable path now because of this. Slower growth for the US also implies slower growth for the world as a whole because the United States is a spender of the last resort (or more like the first resort). High imbalance also means that many countries can’t expand fiscal policy.

So there is a need to change the rules of globalisation, which is more than about free trade but free trade is an important part of it.

Dani Rodrik has two interesting recent articles on this. He is different from the establishment but unfortunately falls short. In his article US-China Rivalry: Geopolitics Is Ruining The Chance To Shape A Better Globalisation, he talks of how the US has taken measures which are more than just tariffs raised by Trump:

US President Joe Biden has added to these challenges by launching what Edward Luce of the Financial Times has called “a full-blown economic war on China”. Just before the party congress, the United States announced a vast array of new restrictions on the sale of advanced technologies to Chinese firms.

As Luce notes, Biden has gone much further than his predecessor Donald Trump, who targeted individual companies such as Huawei. The new measures are astounding in their ambition, aiming at nothing less than preventing China’s rise as a hi-tech power.

In Trump’s four years, economists led by Paul Krugman dismissed Trump’s actions on China but the current Biden administration for which Krugman—acts as a lackey—have gone way beyond.

It’s such a blot on the economics profession that almost nobody saw all this coming. The exception of course was Wynne Godley who was recommending import controls and policies to expand exports in the 2000s. The bigger solution of course is one in which trade is overall balanced. Wynne Godley mentions in his article The United States And Her Creditors — Can The Symbiosis Last? written in 2005:

A resolution of the strategic problems now facing the U.S. and world economies can probably be achieved only via an international agreement that would change the international pattern of aggregate demand, combined with a change in relative prices. Together, these measures would ensure that trade is generally balanced at full employment.

The other Dani Rodrik article How To Build A Better Order although interesting doesn’t go much far than proposing some changes. And Rodrik is a kind of dissenter from mainstream economics from within the establishment, so the profession doesn’t have a clue!

Mainstream Economics Vs. PKE On Manufacturing

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Post-Keynesian growth theory (based on the work of Nicholas Kaldor) highlights the importance of manufacturing.

Mainstream theory denies it.

That’s because once you start talking along those lines, the idea of free trade appears even more dubious than at first sight. Mainstream economists don’t want that to happen as they represent the interests of Western corporations which have an interest in finding more markets for their products and services, at the expense of local producers abroad.

A recent denial of the importance of manufacturing came from Adam Posen who uses what’s called woke language. It also highlights how the woke ideology/identity politics is simply class politics disguised as concerns for identity.

Here’s what Adam Posen said in a talk at the CATO Institute:

I’m sure I’m gonna piss off both left and right, so I apologize. The fetish for manufacturing is part of the general fetish for keeping white males with low education outside the cities in the powerful positions they are in in the U.S., and that is really what’s going on here, because when you look at the costs of manufacturing and Susan Houseman and her co-authors have done a lot not of manufacturing but of trade and job displacement and community. Susan Houseman and her co-authors have done a lot of work on this and I’m sure she’ll have a different view than I do but when I look at the so-called cost of the China shock or the cost of the decline of manufacturing, I always think ‘compared to what’?

This is ridiculous as it sort of implies that people of other races somehow don’t want a position in manufacturing, are okay with offshoring work abroad or are okay with closing down of factories due to competition from abroad.

In reality this kind of analysis is just cover for class politics favouring the upper class and the super-rich.

Compare Post-Keynesians:

Here’s a quote from Wynne Godley from 1995 from the article, A Critical Imbalance In U.S. Trade, The U.S. Balance Of Payments, International Indebtedness, And Economic Policy:

It is sometimes said that manufacturing has lost its importance and that countries in balance of payments difficulties should look to trade in services to put things right. However, while it is still true that manufacturing output has declined substantially as a share of GDP, the figures quoted above show that the share of manufacturing imports has risen substantially. The importance of manufacturing does not reside in the quantity of domestic output and employment it generates, still less in any intrinsic superiority that production of goods has over provision of services; it resides, rather, in the potential that manufactures have for expansion in international trade.

Edward Nell On Managed Trade

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Edward Nell in Free Market Conservatism: A Theory Of Critique And Practice, 1984:

… The second set of controls needed would prevent the flight of capital overseas. Some capital mobility would be permitted; the point would be to regulate it in the national interest, rather than permitting capital flows to follow anticipated profits (profits that may never be realized, as in the loans to some ‘developing’ countries, which went into the pockets, and Swiss bank accounts, of corrupt officials). Along with these controls, a policy of managed trade will be needed; countries must not be required to generate recessions in order to bring imports down to the level of their exports. Selective import controls must be permitted and balance of payments deficits must be financed without requiring ‘austerity’. Again, it is not technically impossible to see how to do this; instead of penalizing the weak—those who run deficits—penalties could be assessed against the strong—the surplus countries—who would be required to promote the loans to finance the deficits. Instead of cutting back imports through austerity, deficit-running countries could be encouraged to modernize their export industries

Some Wynne Godley Quotes On Planned Trade

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There’s an interesting review of Jagdish Bhagwati’s book Protectionism published in the year 1988 by Wynne Godley in the journal Economica, year 1993. Without going into the review, I wanted to highlight how Wynne Godley’s views were quite similar to Nicholas Kaldor’s and Godley proposals such as planned trade and international cooperation of a new kind:

… Kaldor’s chapter, ‘The Foundations of Free Trade Theory and Their Implications for the Current World Recession’ (in E. Malinvaud and J. P. Fitoussi (eds.), Unemployment in Western Countries, 1980), which, in the context of a fundamental critique of the abstract theory of international trade, suggests that, because of the scope for dynamic economies of scale, free trade in manufactured goods leads to the concentration of manufacturing production in certain areas, what Kaldor called ‘a polarisation process’. ‘In principle such trade is of great practical benefit since specialisation between industries of different areas should enable the benefits of the economies of scale to be realised more fully. However … this … depends on the trade being balanced in both directions … But as past experience … has shown this does not come about naturally.’

These ideas were further developed in Kaldor’s 1981 article in Economie Appliquee, ‘The Role of Increasing Returns, Technical Progress and Cumulative Causation in the Theory of International Trade and Economic Growth’, where he related his concern about dynamic imbalances in trade to the ideas of Roy Harrod (himself a strong advocate of protection as a way of improving Britain’s economic performance throughout the postwar period), who had put forward the theory of the foreign trade multiplier in his International Economics (1933). As the trade imbalances constituted a growing threat to the continued expansion of the world economy, Kaldor concluded that we should not ‘stick to free trade (whatever the cost) but introduce a system of planned trade between the industrially developed countries on a multilateral basis’.

Also in an interview to the magazine Marxism Today in 1981, Wynne Godley says how he is openly opposed to free trade and the destructive aspect of it:

Let’s turn to some international questions. How do the problems of the UK economy — and your solutions to them — tie in with problems in the world economy?

Well, the general answer is that I don’t think that free trade is the best way of organising international trade. The classical theory of international trade, which appears in text books and which is extremely influential in peoples’ minds, is based on a postulate of full employment. If you assume full employment you can easily prove that free trade is mutually advantageous. But if you think, as I do, that full employment cannot be assumed, then it’s easy to make out a realistic case that free trade is extremely destructive to economies that are relatively unsuccessful. Instead of making them more prosperous and better-off, it destroys them. I think this is a general proposition; it applies to the United Kingdom at the moment because it’s a relatively unsuccessful country, and I think it is beginning to apply to the United States, which is also becoming a relatively unsuccessful country.

When you say that you think that the free trade system is a bad system, how do you think it should be changed? It’s easy enough to say Britain should have import controls, but how do you see this in international terms?

Well, the logical answer to the question which, as an academic, is what I am primarily called on to give, is quite clear to me. If all relatively unsuccessful countries protect in the way we suggest — using import controls to raise domestic output and not to strengthen their balance of payments — the system of protection can be generalised advantageously. But that assumes a high degree of international co-operation, and international co-operation of a new kind.

Gunnar Myrdal And Circular, Cumulative Causation

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The practical triumph of the free trade doctrine is the fact that even the severest critics of the general policy line of noninterference usually find it difficult to free themselves from its fascination.

– Gunnar Myrdal

I was reading this book The Dynamics Of Poverty: Circular, Cumulative Causation, Value Judgments, Institutions And Social Engineering In The World Of Gunnar Myrdal by Mats Lundahl, which is a sort of an intellectual biography published in 2021.

Gunnar Myrdal was the first to apply his own idea of circular, cumulative causation to international trade and success and failure of nations. Roughly it means: success breeds further success and failure begets more failure, in the words of Nicholas Kaldor.

Although the idea was original to Myrdal, the detailed mechanism was first formulated by Nicholas Kaldor in 1970 in his paper The Case For Regional Policies.

According to Lundahl’s book Myrdal’s genius can be found in the following works (page 82):

Gunnar Myrdal also spent much of the 1950s working on problems related to poverty and inequality on the international level and on the relation between polarization between regions within a country and polarization between countries. This resulted in a ‘trilogy’: An International Economy, Development and Under-Development: A Note on the Mechanism of National and International Economic Inequality, usually referred to as his Cairo lectures, and Economic Theory and Under-Developed Regions (or Rich Lands and Poor).18

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18Myrdal (1956a, 1956b, 1957a, 1957b).

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References

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  • Myrdal, Gunnar (1956a), An International Economy: Problems and Prospects. New York: Harper & Brothers Publishers
  • Myrdal, Gunnar (1956b), Development and Under-Development: A Note on the Mechanism of National and International Economic Inequality. Cairo: National Bank of Egypt
  • Myrdal, Gunnar (1957a), Economic Theory and Under-Developed Regions. London: Gerald Duckworth & Co
  • Myrdal, Gunnar (1957b), Rich Lands and Poor: The Road to World Prosperity. New York: Harper & Brothers

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You can find the first and the third/fourth book (which are the same but just different names in the UK and the US) at Internet Archive in this link. “Cairo Lectures”, seems difficult to obtain, but the important part Trade As A Mechanism Of International Equality can be found in Gerald M. Meier’s book Leading Issues In Economic Development.

A Concise History Of “Circular And Cumulative Causation” From Anthony Thirlwall

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In Anthony Thirlwall’s essay Nicholas Kaldor: A Biography, 1908–1986, (first published in 1987 and republished in 2015, [note: he has a full biography too]), there’s a para which has both the history of Kaldor’s thoughts on circular and cumulative causation and a short explanation:

As Kaldor grew older (and perhaps wiser?), he lost interest in theoretical growth models and turned his attention instead to the applied economics of growth. Two things particularly interested him: first, the search for empirical regularities associated with ‘interregional’ (country) growth rate differences, and secondly, the limits to growth in a closed economy (including the world economy). The distinctive feature of all his writing in this field was his insistence on the importance of taking a sectoral approach, distinguishing particularly between increasing returns activities on the one hand, largely a characteristic of manufacturing, and diminishing returns activities on the other (namely agriculture and many service activities). Kaldor’s name is associated with three growth ‘laws’ which have become the subject of extensive debate.73 The first ‘law’ is that manufacturing industry is the engine of growth. The second ‘law’ is that manufacturing growth induces productivity growth in manufacturing through static and dynamic returns to scale (also known as Verdoorn’s Law). The third ‘law’ states that manufacturing growth induces productivity growth outside manufacturing, by absorbing idle or low productivity resources in other sectors. The growth of manufacturing itself is determined by the growth of demand, which must come from agriculture in the early stages of development, and from exports in the later stages. Kaldor’s original view74 was that Britain’s growth rate was constrained by a shortage of labour, but he soon changed his mind in favour of the dynamic Harrod trade multiplier hypothesis of a slow rate of growth of exports in relation to the income elasticity of demand for imports, the ratio of which determines a country’s balance of payments constrained growth rate. Because fast growing ‘regions’ automatically become more competitive vis á vis slow growing regions, through the operation of the second ‘law’, Kaldor believed that growth will tend to be a cumulative disequilibrium process—or what Myrdal once called a ‘process of circular and cumulative causation’,—in which success breeds success and failure breeds failure. He articulated these ideas in several places, most notably in two lectures: his Inaugural Lecture at Cambridge in 1966,75 and in the Frank Pierce Memorial Lectures at Cornell University in the same year.76 Most of the debate concerning Kaldor’s growth laws has centred on Verdoorn’s Law and the existence of increasing returns. Kaldor drew inspiration for the theory from his early teacher, Allyn Young, and his neglected paper ‘Increasing Returns and Economic Progress’.77 Young, in turn, derived his inspiration from Adam Smith’s famous dictum that productivity depends on the division of labour, and the division of labour depends on the size of the market. As the market expands, productivity increases, which in turn enlarges the size of the market. As Young wrote ‘change becomes progressive and propagates itself in a cumulative way’, provided demand and supply are elastic. Hence increasing returns is as much a macroeconomic phenomenon as a micro-phenomenon, which is related to the interaction between activities, and cannot be adequately discerned or measured by the observation of individual industries or plants. Kaldor was convinced by theoretical considerations and by his own research, and that of others, that manufacturing is different from agriculture and most service activities in its ability to generate increasing returns in the Young sense.

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Notes

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  1. See A. P. Thirlwall (ed.), ‘Symposium on Kaldor’s Growth Laws’, Journal of Post-Keynesian Economics, Spring 1983.
  2. See Causes of the Slow Rate of Economic Growth of the United Kingdom (CUP, 1966).
  3. As note 74
  4. Strategic Factors in Economic Development (Cornell University, Ithaca, New York, 1967).
  5. Economic Journal, December 1928.

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I don’t see much reference to short book Strategic Factors In Economic Development anywhere and I wasn’t even aware of the book till I reread this passage again recently. Must get it. Although according to this review, there’s nothing much in addition to Causes Of The Slow Rate Of Economic Growth Of The United Kingdom.

I have never been able to appreciate Kaldor’s earlier models, perhaps he tried to unsuccessfully build a stock-flow coherent model.

Also, in recent times, Post-Keynesians have come to the realisation that trade elasticities are endogenous not fixed parameters. To me that the most crucial aspect of circular and cumulative causation, although the Verdoorn Law plays a role too.

Joan Robinson On The Importance Of International Trade For Economic Dynamics

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A few important things to understand macroeconomics/political economy are: national accounts/flow of funds, fiscal policy, endogeneity of money—the financial system in general, the role of demand (or the reverse Say’s Law), behaviour of firms such as pricing, decisions to produce, decisions to hire labour, and international trade and globalisation.

After the economic and financial crisis which started in 2007, economists have conceded to some extent that they have been wrong and accepted some heterodox positions except the most important one: international trade.

Joan Robinson was in my opinion the first economist to truly understand all the issues need to make someone an economist of rank one.

Here’s the opening of a 1973 article:

Joan Robinson on international trade

In this article she tells the reader about how this problem leads to polarisation in the fortunes of nations:

We are now in the era of modern capitalism when every industrial country has a national economic policy of near-full employment and growth of GNP. Every industrial country wants a surplus on income account. ‘Export lead growth’ is the most convenient way of running modem capitalism. Who succeeds at any moment is accidental, largely depending upon historical circumstances and political and psychological influences. Success leads to success and failure engenders failure.

The most important point is that market mechanisms fail to resolve imbalances and this leads to divergence instead of convergence and causes a deflationary bias to the whole world. So in the absence of a market mechanism, an official mechanism is needed.