Version 5.0 (7/14/2017)
Can a radical reinterpretation of GDP and trade deficit numbers explain voter rage and the failure of establishment ideology and academic economics? I believe it can. As far as I know this is the first argument of its type.
Since I’ve never been a stickler for precise numbers, I’m going to round down the US GDP to $18 Trillion and focus on a portion of the 2016 trade deficit. In particular, I will round up our trade deficit with China to $400 billion to keep the math simple for the moment. Thus, as the mainstream business editor will point out, our trade deficit amounts to not much more than 2 percent of our GDP. Hard to imagine voter outrage driven by an 2% shift in GDP.
Who would have sleepless nights over this drop in the economic bucket? I would. As an engineer whose new model of economics restores the traditional cost of production based on wages, I take a completely different perspective to adding apples to oranges (foreign wage content vs domestic wage content embedded in an import). Let’s for argument’s sake simply assume the average Chinese factory worker makes $2 per hour and the average American factory worker makes $20 per hour in the hopes of getting a rough sense of the magnitude of the problem. As a result the logic runs as follows:
Labor content of Chinese exports into USA: $463Billion/$4k Chinese yr salary = 115 million man years
Labor content of USA exports into China: $116Billion/$40k American yr salary = 3 million man years
In other words, Chinese imports shell shock not 2% of the GDP, but more in the range of 25% (115 M x $40k = $4.6Trillion/$18T) .
With nearly 50 million Americans near the poverty level, perhaps this is not such a far fetched suggestion to make.
For good measure, lets add Mexico to the equation of economic ruin. Here we assume the same $2/hr wage as was the case with China.
Labor content of USA exports into Mexico: $231Billion/$40K = 6 Million man years
The labor of Mexico has to be adjusted due to the fact that Mexico reexports materials we ship them (metal for a car). Let’s be conservative and assume that this is true of 50% of our exports to Mexico.
Labor content of Mexico exports into USA : $294Billion – $115Billion \ $4K yr salary = 45 million man years.
This, using the same logic above, is roughly another 10% body blow to GDP. Add the two together and you have 35% GDP economic body slam.
Let’s now focus on an EU country that has been in the news lately: Germany. Using the same methodology we see the following and here we assume the German wage is roughly in the same ballpark as an American factory worker.
Labor content of German exports into USA: $114Billion/$40k German yr salary = 2.8 million man years
Labor content of USA exports into Germany: $49Billion/$40k American yr salary = 1.2 million man years .
Thus we have a very rough delta of 1.6 million jobs lost to Germany. A drop in the bucket compared to Mexico and China. The trade deficit with Japan is roughly of the same magnitude ($132B imports from vs $63B exports to). The focus on Germany and Japan is therefore misplaced.
Feel free to be as precise as you desire by taking profits into account, land rent, and anything else you an dream up, but I don’t think it will make any real difference. I’m hoping an astute reader will tell me I’ve put the decimal in the wrong place, because these are very scary numbers. Frankly, I’m stunned by them. As an engineer I view these magnitudes as those of a nation headed for the economic abyss (no industry, no prosperity). Selling more beef and pork to China ain’t going to cut it. Wheeling and dealing won’t work either, because all sectors are impacted (only sky-high tariffs across all sectors can restore proper domestic wage mechanics need for worker mobility and productivity measures). Unlike us, “China gets it.”
There are several additional implications. It means the Mexican worker cannot consume a huge portion of the fruits of his labor. This is the classical school subsistence wage story of the 1700 and 1800s again (plantation economics). It also pulls the rug out of the capital account argument as a panacea (i.e. Chinese return the dollars back to the USA by buying Treasuries, homes, etc). To see this, you simply have to image that the $1 dollar worth of imports that displaced the $10 of American labor cannot undue the damage by returning the $1 dollar and reinvesting it, because it only restores 1/10 of the damage it inflicted.
Finally, free trade throws a wrench into the gears of a sound government taxation model. To see this, imagine a highly simplified economy consisting of bakers, cheese producers, and a government sector building the roads between bread and cheese factories. Each sector makes up 1/3 of the economy. The bread and cheese output is sufficient to feed everyone. Thus the government can tax away 1/3 of the bread and cheese to feed themselves and provide the roads in exchange. Eventually, the politicians fall under the spell of a free trade economist and allow very cheap bread and cheese to be imported, putting the domestic industries out of business. Two thirds of the economy is unemployed. The government in order to “stay in business” and feed itself floats bonds (creates debt) which it uses to buy the imported bread and cheese for itself. The cheese and bread importer buys these bonds to maintain the currency manipulation which gave it the price advantage in the first place. Since the government does not tax the importer (this is the definition of free trade) and no longer has a healthy tax base (2/3 of the economy is unemployed), it has no means to pay the bonds off. Nor will the rich have anywhere to hide their financial assets from this Weimar hyper inflation scenario waiting to happen (print money to pay off the bonds). Game over.
So how does one manage to inflict such damage against a superpower? You simply carry a bigger stick. Consider China’s GDP from another perspective. China had roughly 100 million workers in manufacturing 2009 (a quick search). Let’s fudge the number in the hopes to be conservative in our estimate: Say 60% are at the level of the hinterland (i.e. blacksmiths). This leaves 40 million using modern technology, and thereby achieving modern productivity levels. That’s roughly 3 to 4 times the USA number. As an engineer I would argue that means China’s GDP is 3 to 4 time the size of ours. If that sounds crazy, simply look at raw industrial output in terms of quantity of steel, chemicals, concrete, or anything else you can think of if you doubt this. The academics suggest China’s GDP is just barely bigger than ours. If that is true, how then do they explain this story:
UPDATE (7/8/2016): One of my heroes in this struggle to save American prosperity is Richard McCormack and his excellent website. Serendipitously he posted the following excellent analysis of China’s manufacturing #’s after I posted this essay: http://www.manufacturingnews.com/news/2016/China-Manufacturing-Employment-0630161.html
If this analysis is anywhere close to being accurate, then I suspect America is heading for an economic train wreck of epic proportions. With federal, state, and local spending in the ball park of $50K per full time American worker, it is government spending, not industrial wealth production, holding our duct-taped economy together. When that party comes to an end, watch out.
Nor is history is on the side of the academics. Daniel Webster argued the primary purpose behind the creation of the Constitution was to stop free trade (tariffs could not be laid under the Articles of Confederation). Lincoln and his party were protectionists (nationalists), while the big dollar cotton plantation owners were the party of free trade (globalists).
This analysis also implies that even my “balanced-trade-friends” who have been raising the red flag over the damage done by free trade for years, are not really on the same sheet of music as I am. I am singing this song by myself, because as I attempt to show with a simple example in the link below, even balanced trade can cause great damage. Thus protectionism (sky high tariffs) becomes a matter of necessity.
How did we end up in such a fantastic mess? The answer: There has never been a sound theory of economics (see “Just Measures” tab). As an engineer, this is the root cause analysis. Superpowers have risen on the backs of its industries which they historically have protected. A nation’s wealth and prosperity stems from 200 years of genius hidden behind the industrial, chemical, and electronic revolutions. The blue collar worker becomes a member of a middle class by leveraging fruits of this rare genius in the form of productivity gains in a closed economy. In other words, a waitress who dropped out of high school is able to enjoy the comforts of a car built on cutting edge science and technology.
Let’s take that first step down that road, and begin with an analysis found in traditional macroeconomics text book GDP equation measured in dollar amounts:
Y(GDP) = C (Consumption) + I (Investment) + G (Government Spending) + X (Exports) – M (Imports)
This equation is a bit trickier than it appears. The Consumption component includes purchases of imports. So the net impact of a trade deficit amounts to zero. I’ve cited a mainstream analysis of this detail at the end of the article.
Though there is nothing wrong with a clean textbook analysis of the equation, I feel the equation itself suffers from a serious problem. In prior essays, I’ve wrestled with what I perceived as serious logic problems with the Investment portion of the equation (in short, the possibility that all investment is ultimately consumed and should not appear in the equation). Here I will focus on the imports variable M in the equation and reintroduce my interpretation of China’s GDP.
Before we look at the numbers, let me try to illustrate my key point of concern. Let’s use a very simple model of a nation that is a closed economy (no imports or exports) and has a GDP of $4Trillion. We will take Government and Investment out of the discussion to keep it simple for the moment.
GDP = Consumption=$4T
In short, this closed economy consumes what it produces as one would expect.
Now let’s allow a low cost foreign competitor into the equation so to speak. Say the foreign competitor produces half of everything the nation produced ($2T) at a half of the cost ($1T). What would the new equation look like?
GDP=Consumption ($2T domestic remains + $1T Imports) – Imports $1T = $2T
The effect of these imports is not zero in my opinion as a textbook leads you to believe, because imports generally speaking displace the domestic competitor , thus we went from $4T to $2T. Half the GDP vanished as a result. But if the textbook interpretation is to believed, the sky is the limit in terms of imports. We could have something like this:
GDP=Consumption ($4T domestic goods + $10T imported goods) – Imports ($10T) = $4T
In other words, a $10T deficit has no impact on the economy. I reject this logic, because the equation implies the domestic and imported goods are non-competitive (e.g. geographically limited goods). In reality, the whole point of cheap imports is to put your apparently inefficient neighbor out of work.
If this is really a model of unemployment, then where will these unemployed workers migrate too? One place might be government jobs which could mask the industrial decline.
GDP = Consumption $3T-Imports $1T+Government $2T = $4T
In this case, real industrial wealth production is vanishing (shifting to government services) and all still seems fine with the GDP. What response would a trained economist offer us? He would remind us that his textbook recognizes there will be winners and losers in the game of free trade, and that the winners gains will exceed the losers losses. The winner will have to compensate the loser in some form or another. Unfortunately, without an industrial base producing real wealth there are no winners left. And even if there were some winners holding on for dear life, the magnitude of 100 million man years of damage is beyond any compensation scheme imaginable.
Nor can the populist approach of “deal making” stop the ruin in my opinion; only sky high tariffs across all sectors can save us. The reasoning behind this position is described in detail in my “Just Measures” essay, but for brevity sake one can imagine the entire economy as a rotating kaleidoscope consists of 10s of thousands of pieces of colored glass. The changing image represents the endless sector size adjustments taking place to meet the constant churn of consumer demand, along with shifts due to competition. In simplistic terms, the pieces of glass (industry sectors) can only tumble properly in a closed economy because industry productivity gains and resulting short term unemployment rely on measures of domestic wages reflected in cost of production and worker mobility to function properly. The populist approach of fixing a few pieces of glass will fail if my analysis is sound, because all sector size adjustment are intertwined–as one grows another shrinks as consumer spending is redirected from one to another. In addition, the populist goal of balanced trade does not undo the damage done by 10 to 1 wage differential.
How many manufacturing jobs (direct and indirect) might we create by closing the economy? I’ll take a shot from the hip and suggest 15 million (simply divide man years by 10 again since purchasing power dictates the limit). Keep in mind, these are not “ordinary” jobs. They are the core foundation of a national economy. All other sectors are spawned from manufacturing. Recall the impact of the farm tractor on subsistence farming to grasp the basic idea. The farm tractor (industrial jobs that create productivity gains) freed up farmers to move to new sectors (e.g. book publishing, etc).
It’s time to get your head out of your textbook (and your ideology), before it destroys our country.
As always, critique welcome.
Noah Smith’s textbook interpretation:
It is also not obvious how debt enters here, but again Noah Smith does a nice job introducing this issue in the following link
The Establisment is not the party of Lincoln:
Why balanced trade is not a panacea:
A new model of economics to make sense of the historical success of protectionism:
Is modern capital theory flawed (money and machines; saving and investment myth)?
See my Kindle Book: Just Measures by Van Geldstone.