Economics 101

John Konop asks:

Do you think the trade deals are working with soaring trade debt and falling wages?

Here is my response:

First, a trade deficit is merely a capital surplus. For example, if we export lumber and steel to Brazil for the production of a factory, this is a trade surplus. However, if we import the lumber and steel from Brazil to build a factory in the U.S. and then it is bought by Brazilian investors, we say that we have a trade deficit. What is the difference? A Brazilian-owned factory was built. Does it matter where it was built? Why is it better for the Brazilians to build factories in their own country?

When exports fall, investment in the United States rises. We pay for goods from China with U.S. dollars. These dollars must be used to buy U.S. goods or assets.

A trade deficit does not create debt. If I buy a good that was made in China and the maker of that toy purchases a factory in the United States or shares of a publicly traded company, a trade deficit exists. But where is the debt?

If I purchase a good that was made in the U.S. and the company uses the money to purchase a factory or shares of stock, is debt created? Why is it any different if I buy the good from a foreign company?

Second, it is insufficient to look at earnings in terms of wages. Earnings must be looked at in terms of total compensation because workers are not paid wages alone. So while real wages may have declined, total compensation has not. You still may consider it a bad thing to see wages fall, but it is merely a reflection of the preferences of U.S. workers.

Konop responds:

Josh, tell how we compete with $723 a year wages in China? Tell me why real wages are flat to down for 80% of Americans? Tell me why the national savings rate is negative 1 % for the average American Family?

BTW you missed the concept of wages. If wages drop faster than price break you have a problem. So we do funky interest only and arm loans to make up for the wage shortfull. But hey the banks do not like the latest debt to equity ratio, so interest rates go up. And when the new loan is due Sally has no money!!!! Am I missing something? This is the real world!

First of all, let’s keep the debate confined to economics. “This is the real world!” is not an argument.

Second, why should we pay Americans thousands of dollars to produce goods that the Chinese can produce for a couple hundred dollars per year? The lower labor costs lead to lower prices and is better for consumers. Further, by having the Chinese produce the goods, the United States has additional resources to produce goods in which it has a competitive advantage.

Third, the national saving rate is worthless. It considers saving to be:

Saving (S) = Income (Y) – Consumption (C)

However, they classify things like tuition as being consumption. Tuition is an investment in human capital and is clearly different from purchasing cans of peaches. The government makes no such differentiation.

Additionally, saving is a stock, which means it is a value at a specific point in time. We are much more concerned with savings (with an “s”) because it is a flow — something that occurs over time. Thus, what is important to look at with respect to savings is the marginal propensity to consume. This the the change in consumption due to a change in income. The marginal propensity to consume is less than one which means that when income increases, we spend only a fraction of the new income (albeit a large portion).

Fourth, since NAFTA was enacted in January 1994, wages have risen over 50% (seasonally adjusted). And while real wages have fallen recently, total compensation has increased. Also, when programs like NAFTA are the ones being criticized, it would be helpful to look at the data for wages since the change rather than cherry-picking data. Selective data may make for great conversation in Washington and other political circles, but isn’t useful for those with about five minutes and an internet connection.

Finally, I do not live in a world where when my income falls I take out an interest only or ARM loan. Blaming free trade for individual choices to take out adjustable rate mortgages and interest only loans is wreckless, baseless, and utterly incorrect. If you want to blame someone for the prevalence of these types of loans, blame the bankers.

Additionally, the amount owed to the bank declines in real terms when inflation rises (just like the real wage) if one is smart enough to lock in a fixed rate. Therefore, inflation does not make it harder to pay for loans. Deflation — a negative rate of inflation — makes it harder to pay for loans because it pushes nominal wages down while the amount of the loan increases in real terms.

Class dismissed!