Mitchell's Musings

  • 29 Jul 2016 2:00 PM | Daniel Mitchell (Administrator)

    Mitchell’s Musings 8-1-2016: Friedman in Flatland

    Daniel J.B. Mitchell

    With the presidential election in full swing after the two national conventions, there is no shortage of interpretation by opinion leaders floating through the news media. I was struck by a recent column written by Thomas Friedman of the New York Times who is famous for arguing that the world has become “flat.” By flat, Friedman was referring to “globalism.” Now it may seem odd to characterize a round globe as flat. But I don’t write best sellers and he does – so what do I know? Anyway, here is an excerpt from his recent column:

    Yes, we’re having a national election right now. Yes, there are two parties running. But no, they are not the two parties that you think. It’s not “Democrats” versus “Republicans.” This election is really between “Wall People” and “Web People.”

    The primary focus of Wall People is finding a president who will turn off the fan — the violent winds of change that are now buffeting every family — in their workplace, where machines are threatening white-collar and blue-collar jobs; in their neighborhoods, where so many more immigrants of different religions, races and cultures are moving in; and globally, where super-empowered angry people are now killing innocents with disturbing regularity. They want a wall to stop it all.

    Wall People’s desire to stop change may be unrealistic, but, in fairness, it’s not just about race and class. It is also about a yearning for community — about “home” in the deepest sense — a feeling that the things that anchor us in the world and provide meaning are being swept away, and so they are looking for someone to stop that erosion.

    Wall People have two candidates catering to them: Donald Trump, who boasts that he is “The Man” who can stop the winds with a wall, and Bernie Sanders, who promises to stop the winds by ending our big global trade deals and by taking down “The Man” — the millionaires, billionaires and big banks…[1]

    I don’t have to tell you who the web people are. They are, of course, the sophisticated high-tech folks who are sufficiently gifted and wise to understand the world (almost) as well as Friedman. They are smart enough to agree with Friedman. They understand that the wall people are relics. Etc. Etc. Etc.

    The idea of a flat world – rather than being somehow a representation of globalism – is really one that is two-dimensional. In fact, before Friedman appropriated the concept of being flat, a flat world might well have brought to mind the 19th century book Flatland.[2] In that book’s Flatland, the people lived on a plane and could not imagine a third dimension. One character in fact is given the knowledge that there is a third dimension. But, of course, he can’t convince anyone that a third dimension exists since it is impossible for two-dimensional creatures to imagine. So perhaps a flat columnist who believes that the electorate is two-dimensional – wall people vs. web people – can be forgiven for his limited view. He can’t see beyond a world of dichotomy.

    The problem, however, is that the flat view of the election – which is not unique to Friedman – is a major contributor to the Trump and Sanders phenomena which Friedman so dislikes. First, globalism is a term so widely used that it lacks meaning. As we have noted in past musings, there is a difference between trade “protection” as that term is generally used (tariffs, quotas, and other devices designed to limit imports) and changes in exchange rates. When the dollar depreciates relative to other currencies, imports are discouraged (and exports are encouraged). But no one says during times when the dollar falls that the U.S. is becoming protectionist. And no one says when the dollar appreciates that the U.S. is becoming global. Dealing with currency manipulation by trading partners of the U.S. is not normally viewed as “protectionist.”

    If all you know about trade is “comparative advantage” which you learned in Economics 1A, you are in another Flatland. The model – used to demonstrate the idea in basic textbooks – involves two countries trading (bartering, actually) two products. More two-by-two dichotomies! There is a more nuanced view of trade in Economics 1B that notes that trade can affect income distribution. But that takes you out of Flatland and into a third dimension. And still more nuance arises when you get away from barter into a monetary international economy with the possibility of trade deficits and surpluses.

    Moreover the protection (Bad Thing) vs. free trade (Good Thing) is yet another two-dimensional view of the world. Take the word “protection” out of the trade arena and it has no negative connotation. Is Friedman against insurance (whether social insurance or private insurance)? Isn’t the function of insurance to protect those covered from future risks?

    Even in the trade context, there is an important difference between trade in goods and trade in technology. Technology can be traded and transmitted easily, whether a country is “protectionist” in its trade policy or not. So nothing in “protectionist” trade policy inherently deprives “web” people from using the Internet. In fact, when “protection” is applied to information, it often means devices such as patents, copyrights, and other restrictions designed to limit exports, not imports. In the early days of the industrial revolution, Britain sought to ban exports of designs for its valuable new textile machines. But it was hard to prevent folks from memorizing plans for the machinery and then traveling abroad. That’s how early textile machinery made its way from England to New England. (The problem of the difficulty of limiting technology transmission continues today with regard to scientific knowledge deemed to have military significance.)

    In the end, the two-dimensional portrait espoused by Friedman of those “economic” backers of Trump and Sanders is fuel for their sense that there is an elite establishment that is uninterested in their fates. Depicting folks as relics – wall people - is unhelpful. Indeed, it’s hard to know what could be more infuriating than the condescending wall vs. web dichotomy. True, Friedman goes on in his column to say that Hillary Clinton should find some especially compassionate web people to add to her coalition. They presumably would support burial insurance for wall folks, due to their compassion. But in the end, Friedman wants everyone who has not done well in Flatland just to accept his two-dimensional world view and not to consider the possibility of any third way.




  • 23 Jul 2016 3:05 PM | Daniel Mitchell (Administrator)

    Mitchell’s Musings 7-25-16: Old Gold: Bad Ideas Never Die

    Daniel J.B. Mitchell

    If you poke around in the Republican platform that was approved by the Party’s national convention last week, you will find the following somewhat obscure statement:

    Determined to crush the double-digit inflation that was part of the Carter Administration’s economic legacy, President Reagan, shortly after his inauguration, established a commission to consider the feasibility of a metallic basis for U.S. currency. The commission advised against such a move. Now, three decades later, as we face the task of cleaning up the wreckage of the current Administration’s policies, we propose a similar commission to investigate possible ways to set a fixed value for the dollar.[1]

    What does this section mean and why was it included? As you might expect, there is a long history. First, the phrase about “a metallic basis for U.S. currency” is in fact a reference to the gold standard. (Would anyone think it referred to tin or copper or iron?) But most people are nowadays barely aware of the gold standard as a monetary issue. It lives on in popular culture as an idiom. Look up its idiomatic meaning and you will find examples on the web such as:

    Ferrari is the gold standard among automobiles.[2]

    The implication of the idiomatic expression is that the gold standard of something is the best of its kind.  But would the gold standard be best today as a monetary system? In simple terms, the idea of the U.S. going on the gold standard is ridiculous. Setting up a new commission to study the idea of returning to the gold standard would be the gold standard of foolishness.

    There is in fact a long history of the contentious development of the U.S. currency and the role of the gold standard in that development. Given all the latest discussion of “American exceptionalism,” it’s worth noting that the U.S. seems to be unique in its history of there being major political controversy around currency issues. Other countries seem to be content to have the authorities deal with monetary matters. They don’t see grand conspiracies surrounding the issue. They don’t see central banks as centers of evil.[3] But monetary conspiracy theories have always been part of U.S. politics.

    Back in the late 1990s, through some odd circumstances, I became president of a professional academic organization then called the North American Economics and Finance Association. One duty of the organization’s president was to write and deliver a presidential address. I decided to write about the gold standard in the American context. Part of the reason was that although (Republican) president Richard Nixon had essentially killed the remains of the gold standard in the early 1970s, segments within the GOP seemed unable to give it up. Such figures from Republican politics of the 1990s as Ron Paul, Jack Kemp, and Steve Forbes favored a return to the gold standard. And as the quote from the 2016 platform suggests, the idea lingers even now.

    U.S. history of monetary controversy goes back to the early days of the country as I noted in my presidential address. But a good starting point for this musing is the 1896 presidential election in which the Democrats were taken over by the populist free silver movement in the form of the candidacy of William Jennings Bryan.[4] Bryan won himself the nomination with his famous “Cross of Gold” speech which attacked the gold standard using religious imagery. Republicans ran (and won) in 1896 with William McKinley and his support of the then-existing gold standard.

    In my presidential address, I looked at the political situation a century later:

    The ultimate triumph of William Jennings Bryan’s battle against gold could be seen 100 years after the defeat of his first campaign for the presidency. Whereas incumbent Bill Clinton spoke of a “bridge to the 21st century” in the 1996 presidential campaign, candidates such as Steve Forbes and Jack Kemp tried to interest the public in returning to the gold standard. But such a monetary bridge to the 19th century simply did not resonate with the electorate. It just sounded odd. A candidate might as well have campaigned for a return to the bustle and the buggy. By the 2000 campaign, Kemp had dropped out of presidential politics. And Steve Forbes’ gold position had been condensed into single sentence in his campaign book, easily lost in a sea of other agenda items.[5]

    In the modern view, the old gold standard was one version of a fixed exchange rate system. If all currencies are pegged to gold, then they are also fixed in relation to one another. But you don’t need gold to have fixed exchange rates. For example, before the euro-zone was fully created with its own single currency, it went through a stage in which the various currencies that were to be replaced (marks, francs, lire, etc.) were fixed relative to one another. No gold was involved in the fixing nor was gold needed to create such a system.

    The odd platform plank envisions pegging the dollar to gold despite the fact that no other countries have any interest in doing so. So it wouldn’t be a fixed exchange rate system. It would instead create a system in which volatile gold price swings relative to currencies other than the dollar would cause the dollar to appreciate and depreciate. The chart below shows fluctuations in euros per ounce of gold over the past ten years. Do you think it would be helpful to the U.S. economy if the dollar moved up and down depending on the vagaries of the volatile and speculative gold market depicted on the chart?

    Now there could be value in at least considering a return to fixed exchange rates. But the point is that pegging the dollar to gold when no other currency does so is not fixed exchange rates. It would be flexible rates on steroids. The current flexible exchange rate system obviously has some volatility, maybe too much. For example, over the same ten year period, comparing the dollar’s lowest point relative to the euro to its later high is an appreciation of the dollar in the 50% range (euros per dollar). But peak to trough of the gold price (euros per ounce) is about three fold.

    It’s hard to find the once-popular brand of Old Gold cigarettes nowadays, but some folks can’t quit the habit, just as others can’t quit longing for the gold standard. Bad ideas never die. They apparently don’t even fade away.


    [1]  [page 4] 


    [3] Indeed, sometimes not questioning monetary affairs abroad can be a failing. So when experts in the EU proposed a monetary union and a super-national currency, it did not become a political issue. Of course now, the ready acceptance of the euro in place of national currencies within a subset of EU member states is a matter at least some folks in those countries now regret.  

    [4] Bryan remained a popular figure and folks liked to hear him give the address many years later. He made a phonograph record with excerpts from the speech which can be heard at:

    [5] Daniel J.B. Mitchell. (2000). “Dismantling the cross of gold: economic crises and U.S. monetary policy.” North American Journal of Economics and Finance, 11 (2000) 77-104. Available at:

  • 17 Jul 2016 3:13 PM | Daniel Mitchell (Administrator)

    Mitchell’s Musings 7-18-16: Cash on hand

    Daniel J.B. Mitchell

    At the moment, unemployment is low. We can debate about the state of the economy and whether unemployment or non-employment (or non-participation) is the best indicator of labor market slack. What we can say, however, is that when the Great Recession hit, one of the major casualties was the budgetary condition of state and local governments. And currently, with some exceptions, a calm in the state and local fiscal situation prevails. So it’s a good time to look back and see what can be said about how such budgets get into trouble. There will someday be another downturn so now is a good time to learn about their fiscal implications.

    Of course, in the simplest terms, the trouble for state and local budgets during recession results from a reduction in tax revenue; as the economy declines, taxes – which are largely based on economic activity – also decline. Budgets are pushed into the “red.” But deficit budgets by themselves are not crises. If sufficient reserves are available, temporary deficits can occur without a crisis, at least until the reserves are exhausted.

    The State of California was particularly hard hit by the Great Recession. It had a disproportionate share of the flaky mortgage bubble and bust. Its revenue base was (and is) heavily tilted toward the personal income tax. And its personal income tax is highly progressive, with a large share of revenue coming from a narrow stratum of high income tax payers whose taxable income reflects capital gains and losses. In the immediate aftermath of the Great Recession, California had one of the highest unemployment rates of any state in the nation.

    California state government by the summer of 2009 was unable to pay all its bills and instead began to issue registered warrants (IOUs) to some suppliers and taxpayers owed refunds. Most of the focus in the news media was on the General Fund budget, the operating budget of the state. In principle, the state is supposed to produce a “balanced” General Fund budget by July 1 of each year. But, at the time, budgetary rules in the state’s constitution required a two-thirds vote for a budget enactment and the result was lengthy delays beyond July 1.[1]

    The General Fund is operated as a kind of household checking account. So it may have a positive working balance which is a kind of reserve just as the balance in your checking account is available to cover checks.[2] But beyond what is in the official reserve is a hidden reserve of cash possessed by the state. That hidden reserve results from the fact that there are “special funds” outside the General Fund, which are typically earmarked with particular revenue sources to be used for designated purposes. The largest of these funds deal with transportation and receive revenue from the gasoline tax and other motor vehicle-related sources. But there are many other special funds created by the legislature, some quite small.

    California’s constitution forbids borrowing for current operations, but there are two exceptions. Court decisions have allowed short term borrowing within a fiscal year on the grounds that such borrowing is really just a technique for handling the seasonal ups and downs of revenue. (Examples: Income taxes are due in April. Sales taxes bump up during Christmas sales.) So the state can issue Revenue Anticipation Notes (RANS) – external borrowing - within a fiscal year to cover short periods while awaiting for taxes to arrive. But it can also engage in internal borrowing, effectively putting IOUs into the special funds and taking the cash there to cover expenses in the General Fund.

    As the chart above shows, California issues monthly reports on a concept known as “unused borrowable reserves."[3] Borrowable reserves are essentially the cash available from special funds from which the state controller is allowed to borrow for General Fund purposes. Unused reserves are those which either haven’t been directly borrowed or which are covering short-term external borrowing from financial markets. The chart depicts unused borrowable reserves in 2009-10, the worst of the budget years that followed the Great Recession, and the just completed 2015-16 fiscal year.

    In 2009-10 – the crisis year – the ratio of unused borrowable reserves fell twice below 5% of the level of disbursements (spending) for that year. The first time was in July, the month in which IOUs began to be issued. Essentially, despite the ability to dip into special funds to cover General Fund operating expenses, there just wasn’t enough cash around to cover all bills which had to be paid. In contrast, in 2015-16 even the biggest dips left the ratio above the peaks of the crisis year.

    Using the special funds as an ersatz reserve for operating spending has drawbacks, of course. If the special funds are loaded up with internal IOUs rather than cash, their ability to fulfill their earmarked purposes is constrained. Presumably, the legislature viewed carrying out those purposes was necessary or it wouldn’t have created those funds. But if you are looking at sources of cash to deal with immediate budget crises, the special funds are part of the picture, even if potentially interfering with their designated purposes is a Bad Thing to do.

    It’s also important to note that although there was a tendency to view California’s issuance of IOUs to external creditors as a kind of bankruptcy, as a technical matter states have no legal ability to declare bankruptcy. And if you think of de facto bankruptcy as an inability to cover contracted bond-related debt service, there was little danger of that kind of default occurring, even at the peak of the post-Great Recession crisis. At present, the ratio of General Fund debt service to revenue is around 7% and it wasn’t much different in the crisis year of 2009-10.  So there is always enough revenue around to cover debt service; you can always divert seven percent of revenue to cover debt service.

    Other states will have different revenue bases, different institutions, and different spending priorities and politics. But one suspects in broad terms the stories will be similar. The use of a General Fund for operating expenses and special funds for designated purposes is common to state and local governments. If you are looking at how state and local entities manage their finances during recessions and budget crises, you have to look beyond their general funds to see what sources and cash reserves are available.


    [1]Partly as a result of the problems caused by budget delays, voters have since amended the constitution to require only a simple majority, and delays no longer occur. We are leaving aside troublesome problems related to budgetary language and accounting methodology.

    [2]California now operates with a separate “rainy day” reserve, separate from the General Fund, so the two reserves must be summed together to evaluate the state of the official budget.

    [3]The monthly reports are available from the state controller:

  • 08 Jul 2016 5:33 PM | Daniel Mitchell (Administrator)

    Mitchell’s Musings 7-11-16: Brexit keeps on giving

    Daniel J.B. Mitchell

    The Brexit event keeps on giving, at least to this blog, since I have been writing about it in the past few weeks. But let’s put aside the political ramifications of Brexit, which are big in Britain and – some think – within the larger EU. Let’s put aside analysis of why a (slim) majority of British voters favored Brexit. And let’s put aside the question of whether, in the long run, Britain would be better off inside or outside the EU. Apart from those important issues, there are lessons about exchange rates embedded in the aftermath of Brexit.

    Let’s start with the observation, as the three charts below illustrate, that immediately after the Brexit shock, the pound fell in value relative to the US dollar, the euro, and the yen, all of them major world currencies.

    In effect, there was an immediate shock to financial markets at the time of the election. You can argue about the market reaction. Was it “justified” in depreciating the pound as much as it did? Was it an overreaction? Whatever it was, it led to a flight from the pound towards other currencies once the result of the election was known. So the pound fell in value in response.

    Now consider two scenarios. First, suppose the British had attempted to hold the exchange rate to the level that it was before the shock. The British authorities would have had to buy up the unwanted pounds – as investors shed them – using Britain’s foreign currency reserves to do it. Since they could not create US dollars, euros, or yen, they would have had to run down their reserves and possibly work out deals with foreign central banks to borrow needed currency. Those central banks might have demanded sharp increases in British interest rates to attract demand back to the pound. Even if they didn’t, Britain might have raised interest rates to make the pound more attractive and reduce the shift away from the pound.

    Such interest rate hikes might have caused a recession or slowed the economy. Recessions or slowdowns, by cutting imports, do tend to add to net demand for a currency. But they are painful. In short, under this scenario, Britain, given a Brexit-type crisis, would have had the kind of “balance of payments crisis” that was common when the world was on fixed exchange rates until the early 1970s.

    Second, suppose the British had in the past become part of the euro-zone and then experienced a negative shock of the Brexit magnitude. For reasons dealt with in prior musings, we say “Brexit magnitude” rather than Brexit because pulling out of the EU for a country that was also part of the euro-zone would mean pulling out of that zone, which really is not feasible.[1]

    To stimulate their economy, the British authorities might have wanted to provide a domestic demand boost to offset the shock. But they could not have used monetary policy since – under this hypothetical scenario - they had previously given up their national currency. They might have tried a fiscal stimulus. But that would likely have entailed running a budget deficit. And as any state or local government official within the “US dollar zone” could point out, borrowing in a currency you can’t create leads to budget crises and rising interest rates on government debt.

    So the first lesson is that having a floating exchange rate, as Britain does, acts as a kind of macro cushion. The exchange rate absorbs some of the shock. And it also allows more freedom in domestic macroeconomic policy. While Brexit brought out all the clichés about living in a global economy, the presence of a flexible exchange rate in fact acted as a partial insulation against globalism for Britain. If you like, Britain was already less global than those countries within the euro-zone.

    There is another lesson. The ultimate in a fixed exchange rate is not having a national currency at all, as characterizes countries within the euro-zone. They have the least latitude in dealing with negative shocks. Countries with separate currencies, but some kind of target exchange rate, have more latitude. They can always, as a last resort, abandon their target. Countries with floating rates have the most flexibility – but represent the least global of the three options:  1) having no national currency, 2) having a separate currency but fixed exchange rate, and 3) having a floating exchange rate.

    In its history within the EU and its predecessor agreements, Britain has moved from having a separate currency and a floating rate, to trying to maintain a target exchange rate relative to its partners, then back to having a floating rate in 1992 and after, and now to Brexit.[2] Viewed that way, Brexit was a further step toward autonomy within a British history of trying to balance autonomy and connection, rather than something totally new. There seems to be a need in the news media to see the eve of destruction in the Brexit vote. The latest such overheated prognostication is that the world is about to have a currency war due to Brexit.[3] In reality, there is a long history of Britain varying its economic linkage to continental Europe. So keep calm.


    [1] Yes, during the Greek crisis, there were many discussions of a “Grexit” involving giving up the euro and creating a new drachma. But no one ever laid out how that could be done.

    [2] Britain joined the European Economic Community (EEC) in 1973 as the post-World War II regime of fixed exchange rates was collapsing. At around that time, there was an attempt by various member countries – but not the UK - to maintain target exchange rates between them, an effort known as the “snake in the tunnel.” When that failed, other target rate systems were tried. Britain for a time was part of those efforts but pulled out in 1992.


  • 01 Jul 2016 5:10 PM | Daniel Mitchell (Administrator)

    Mitchell’s Musings 7-4-16: Downgrading the Graders

    Daniel J.B. Mitchell

    The decision of British voters on June 23rd to select the “Brexit” option was, shall we say, not carefully thought out, as noted in prior musings on this blog. It was followed –as I indicated in last week’s musing - by silly statements by various continental politicians in the EU that, given the vote, Britain should exit quickly. Now the foolishness has spread to the rating agencies:

    The UK has lost its top AAA credit rating from ratings agency S&P following the country's Brexit vote. S&P said that the referendum result could lead to "a deterioration of the UK's economic performance, including its large financial services sector." Rival agency Fitch lowered its rating from AA+ to AA, forecasting an "abrupt slowdown" in growth in the short-term.

    S&P had been the only major agency to maintain a (sic)AAA rating for the UK. It has now cut its rating by two notches to AA. On Friday, Moody's cut the UK's credit rating outlook to negative. A rating downgrade can affect how much it costs governments to borrow money in the international financial markets. In theory, a high credit rating means a lower interest rate (and vice versa). S&P said that the leave result would "weaken the predictability, stability, and effectiveness of policymaking in the UK."[1]

    Readers may recall similar downgrades regarding American federal securities when there were U.S. crises over lifting the debt ceiling by Congress.[2] Then as now, there is a problem with such downgrades when it comes to countries such as the U.S. and U.K. What people look to rating agencies to provide is an assessment of the risk of default. What is the chance that the IOU, whatever it is, won’t be paid off according to its terms? When it comes to private-sector entities or public-sector entities below the national government level, such judgments are made based largely on financials. You look at such things as the size of the debts outstanding relative to cash on hand or to other available resources. You look at the tax base. You look at budgets. You look at overall liabilities.

    But if a country borrows in its own currency – as the U.S. and the U.K. do – its national government can potentially create whatever money it needs to meet any obligation. So its ratio of cash on hand to debt is effectively infinite. Of course, there is a political risk that for one reason or another, the country will default anyway. If the central bank is constrained by some legal arrangement, then the needed money creation might not occur unless there is legislative action to undo the constraints. So political inertia or gridlock could conceivably lead to default – not because the country can’t pay it obligations – but because it won’t. However, not paying in such situations has nothing directly to do with “a deterioration of… economic performance” as it might for subnational political entities (whose tax receipts might be reduced) or for a private-sector firm (whose sales and profits might be harmed). Money creation by the national government to meet debt obligations does not depend on tax receipts or economic performance.

    It might be noted in this regard that the kind of gridlock seen in the U.S. when you have divided government is unlikely to occur in the U.K. with its parliamentary system. In the U.K., you can’t have a situation in which the Parliament is in the hands of one party and the prime minister belongs to another. So even if there were some grounds for the U.S. downgrade, the case for a U.K. downgrade is even less.

    Really, the agencies shouldn’t even be rating the sovereign debt of countries that borrow in their own currencies. At the subnational and private level, you can analyze such “financials” as the cash-to-debt ratio, and perhaps make judgments that “add value” for investors. But when the cash-to-debt ratios are potentially infinite, all you are doing is basing ratings in what is in the headlines. Obviously, when a British prime minister steps down and it is uncertain who will succeed him, you might say that event would "weaken the predictability, stability, and effectiveness of policymaking in the UK."  But the headlines – that there was a Brexit vote, that there is uncertainty in both British political parties concerning leadership, that EU politicians are mouthing off – are available to anyone. S&P and the other agencies are no better than anyone else in making such nonfinancial assessments based on such headlines. And the link to default on sovereign debt of those headlines is questionable.

    Indeed, we have a nice empirical test available in this case. If investors thought that the probability that Britain would default had risen, as the rating agencies are telling us, then British Treasury bonds should have fallen in price after the Brexit vote and so bond yields should have risen. But what actually happened? The British Treasury publishes an index of long-term Treasury bond yields as shown below for the month of June:[3]

    06/01/16              2.36%

    06/02/16              2.32

    06/03/16              2.24

    06/06/16              2.27

    06/07/16              2.25

    06/08/16              2.23

    06/09/16              2.20

    06/10/16              2.16

    06/13/16              2.15

    06/14/16              2.15

    06/15/16              2.14

    06/16/16              2.10

    06/17/16              2.14

    06/20/16              2.18

    06/21/16              2.22

    06/22/16              2.21

    06/23/16              2.27

    -- Post-Brexit vote --

    06/24/16              2.12

    06/27/16              1.99

    06/28/16              1.98

    06/29/16              2.01


    Yields fell (bond prices rose) after the Brexit vote. The ratings downgrades were thus seen by the market as irrelevant if not flat wrong. Put another way, the market implicitly downgraded the opinions of the rating agencies. And rightly so. When the rating agencies were caught giving high ratings to flaky mortgage securities as the 2008 financial crisis unfolded, it was said that their erroneous ratings were the product of greed. They were telling their paymasters what they wanted to hear. But this time, the only plausible explanation is that they were caught by the wider contagion of foolishness surrounding the entire Brexit affair.



    [2] and

    [3] (as of June 30). 

  • 25 Jun 2016 3:02 PM | Daniel Mitchell (Administrator)

    Mitchell’s Musings 6-27-16: Lessons from Labor Negotiations for Brexit

    Daniel J.B. Mitchell

    Last week’s musing, written before the “Brexit” vote, noted that while Brexit was a Big Deal for Britain (and not a particularly wise choice), it was not likely to be a big deal for U.S. economic performance. I noted that the really big choice for countries entering the EU or within the EU was being part of the euro-zone (or not), because of the euro’s compromising effect on national economic sovereignty. But Britain never joined the euro-zone. So why have a Brexit?

    Undoubtedly, now that the pro-Brexit vote has occurred, you’ll find economic forecasters who will predict – down ­to the tenth of a percentage point – what the effect of Brexit-related “uncertainty” will be on the American GDP growth rate. (If the problem created by Brexit is uncertainty, how can you be certain?) But let’s put aside the U.S. effect and look in this musing at the negotiations that must now ensue between Britain and the EU. And let’s note at the outset that the vote in favor of Brexit was 52% to 48%, hardly an overwhelming endorsement. Basically, the British electorate was split down the middle. Some random event or perhaps a better campaign by the anti-Brexit group could have reversed the totals.

    I saw a headline on the Boston Globe website the day after the vote – “Britain exits the EU, and the world shudders” – which was totally misleading.[1] Britain hasn’t already left the EU and couldn’t do so under the most accelerated possible timetable for a couple of years. Rather, there has been a referendum to start negotiations on the terms of a divorce. So let’s focus on the word “negotiations.” Is there anything that can be said about these Brexit negotiations from the study of labor relations? I think there is.

    Defined Goals

    In labor negotiations, while the parties can’t be sure of the outcome, they usually start with some defined goals of what they would like to achieve. In the Brexit case, the current prime minister of Britain – who opposed Brexit but promised to have a vote on it – is stepping down for obvious reasons. Who his successor will be in the Conservative Party is as yet unknown. The Party remains split between pro- and anti-Brexit forces. So the immediate leadership of the country is unknown. The opposition Labour Party largely opposed Brexit and there is pressure on its current leader to step down. Given its state of political flux, Britain doesn’t have defined goals for the eventual negotiations with the EU. And it can’t have defined goals until its political process determines who will lead the country.

    What about the other side? Does the EU have defined goals? Hasty and ill-considered statements from various EU officials made immediately after the vote indicated that they want the process to be over with quickly. But it takes two to tango and the British aren’t ready to dance. The outgoing prime minister would be foolish to rush into talks and start making deals which his successor might void. And why would the EU want to start with a lame duck prime minister and then be confronted with someone else who might insist on starting over?

    Anyway, the day before the election, the EU’s goal was that there should be no Brexit. Suddenly, after the vote, the goal became to divorce “fast.” But “fast” is not a goal; terms and conditions are goals. If you view the negotiations as being about divorce, there are complicated areas to be considered such as the status of EU and British nationals now residing in the two areas, trade relations such as tariffs, etc. But what if the EU goal were to remain not having a divorce, i.e., no Brexit despite the vote? We’ll come back to that possibility later.

    Defined Chief Negotiators

    In traditional labor negotiations, someone on each side ultimately has to call the shots. Even though there are negotiating teams, someone must ultimately be in charge who can make and accept offers. Usually, in the private sector, the management side is inherently the more disciplined party since the union is a representation organization. But in public sector labor relations – with elected officials and designated professional negotiators on the management side – unity on that side is not always present.

    As noted, Britain’s political process will eventually produce a new leader. But that process has just started to operate. And the initial response of the EU was statements being made by various officials without any clear lines of authority. In short, there are no defined chief negotiators in place on either side of the negotiations. The parties aren’t ready.

    Never Say Never (and Never Say Must) Unless You’re Sure

    Labor negotiations are what economists call repeat games. Contracts are agreed upon, signed, ratified, and then expire on a specified date and have to be re-negotiated. If, in today’s negotiation, you say you will never accept something and then accept it, you lose credibility in future negotiations. If you say there is something you absolutely must have, and then accept a deal without it, again you lose future credibility. When you say never or must in the future, why should the other side believe you?

    Presumably, in the Brexit case, there will be only one EU negotiation with Britain. But the EU is said to be concerned that other countries might want whatever deal Britain gets at some point in the future. So saying never to something Britain wants (or saying the EU must have some provision from Britain) and then conceding could undermine EU credibility with another country in the future.

    Does the EU really know at this point what its “nevers” and “musts” are, especially since there doesn’t seem to be a defined negotiating leader? It doesn’t seem to have its nevers and musts, and – if that’s the case – the EU isn’t yet ready for negotiations. And neither is Britain.

    Silence is Golden

    There is a false idea that the solution to all ills - whenever official institutions are involved - is “transparency.” But transparency is not consistent with meaningful negotiations. That’s why negotiations are held in private in the labor relations realm. If they are not kept private, the negotiators are forced to play to various outside constituents and cannot be frank with each other.

    Sometimes, external news media statements are used to put pressure on the other side. But such use of outside pressure involves having a strategy. Right now, the EU – due to its lack of a defined leader – features officials mouthing off without any strategy. In short, the EU is not ready to negotiate until it has a strategy, has a designated leader, and can maintain discipline (no mouthing off) within its officialdom.

    Deadlines Can Be Helpful But Only If They Are Real

    In a labor negotiation, there typically is a date at which a contract expires that serves as a real deadline, real in the sense that there are consequences of not reaching a settlement by that time. Generally, contracts have no-strike clauses. So once the expiration date is past, the union is free to strike (although it doesn’t have to do so). After contract expiration, management is free to change terms and conditions once it has bargained to an “impasse” (although it doesn’t have to do so). For these reasons, labor agreements are often reached shortly before the de facto deadline of the expiration date.

    Of course, parties to any negotiation can always set some arbitrary deadline for themselves. But if nothing real happens when that deadline passes, there will be no pressure to reach a deal at that point. There is talk of a two-year deadline for a Brexit divorce. But would anything happen if the deadline passes and a deal hasn’t been reached? There has never been a divorce of an EU country before. So in practice, it’s unlikely anything would happen if the deadline came and went without a deal. That fact is yet another reason for not rushing into negotiations. Starting early doesn’t prevent finishing late.

    Third Parties Can Help

    Although we have pointed out that “nevers” and “musts” can be dangerous, parties to negotiation sometimes stumble into taking positions that are hard to change. As labor negotiations illustrate, points of inflexibility are when mediation can be helpful. A mediator can help the parties reformat their positions so that they seem to be – or can be said to be - within the parameters set by their previous nevers and musts. Mediators, in short, can often induce flexibility when positions have hardened.

    One way to settle disputes if the parties become stuck and mediation fails is arbitration. In the labor relations case, there are well known individuals who can play the role of neutral third parties. Surely, in the international field, there are prominent former diplomats and officials who could play such a role for the EU and Britain. (Barack Obama will be around after January 2017 – but the EU might regard him as too Anglophile.)

    Negotiations Might End in No Brexit

    We hinted at the possibility that the EU’s former goal, no Brexit, could be revived. Why shouldn’t no Brexit still be the EU’s goal? In fact, there is already a petition drive in Britain for holding another referendum. However, just repeating the previous referendum seems unlikely and might alienate voters. But it certainly sometimes occurs in labor negotiations that a deal is reach, is rejected by workers in a close vote, and then is cosmetically redesigned and re-voted (and accepted). As noted, 52% vs. 48% was not an overwhelming margin of victory for Brexit. As problems for Britain begin to arise – calls for Scottish independence, Northern Ireland issues, volatile stock markets, etc. – there could be a change in public opinion. A small shift could turn the decision around.

    As noted, an identical repeat referendum with the same choice as before might be a hard sell. But what if there were to be a second referendum after a divorce deal was tentatively concluded, whenever that turns out to be? There could be a referendum on the terms of divorce. It wouldn’t technically be a repeat of the Brexit vote. It would instead be a vote to accept the yet-to-be-negotiated divorce terms, yes or no? And if voters rejected the terms of the negotiated divorce, they would automatically be voting for no divorce, i.e., no Brexit. That’s the kind of reformatting that occurs in creative labor relations and which could be applied in the Britain-EU case.

    Bottom line: Everyone should take a deep breath and stay calm. Learn from labor negotiations. Goals need to be set. Leadership needs to be arranged. Mouthing off by unauthorized officials needs to be discouraged. The parties should avoid inflexible nevers and musts. Use of neutral third parties should be considered. And the possibility of no Brexit should remain on the table. There will be negotiations, but what’s the rush?



  • 18 Jun 2016 12:25 PM | Daniel Mitchell (Administrator)

    Mitchell’s Musings 6-20-16: If it ain’t broke, don’t Brexit (but it’s not a big deal for the U.S.)

    Daniel J.B. Mitchell

    Obviously, the possibility of Britain leaving the European Union (“Brexit”) is a Big Deal – over there. But let’s put things in perspective from the vantage point of someone on the U.S. side of the Atlantic. It is perfectly possible for a country to be in close geographic proximity with the EU (as is the UK), to have substantial trading and investment relations with it, and yet not to be a member state. Switzerland does it. Norway does it. Both are prosperous countries and would be prosperous countries, whether in or out of the EU. Switzerland in fact considered becoming an EU member but recently withdrew its application to join. Both countries, it might be noted, have independent currencies.

    This logic has not limited the hyperbole in the campaign leading up to the Brexit vote. Here’s an example from a recent British headline:

    Britain will become an isolated trading post “with the significance of GUERNSEY” if we vote for Brexit says French minister[1]

    Britain has long been an EU member.[2] But, like Switzerland and Norway, it has an independent currency and long ago dropped plans to abandon its pound for the euro.[3] So it’s important to distinguish EU membership from being in a monetary union. The latter is a far more significant policy decision – as Greece found out in the last few years. Membership (or not) in a trade group with an umbrella of social and other regulatory arrangements – which is what the EU is – is a lesser decision, particularly since nonmembers can negotiate trade deals with the EU (as Switzerland and Norway have).

    Giving up your currency, in contrast, means giving up setting your own monetary policy. It’s a substantial loss of economic sovereignty that also compromises domestic fiscal policy. But, as noted, staying in the EU for the UK doesn’t mean a full-blown monetary union. Indeed, as we pointed out in the case of Greece in prior musings, once you give up your currency, there is no simple way to get it back. Despite the endless talk during the Greek debt crisis that Greece would somehow leave the euro and go back to the drachma (“Grexit”), no one ever specified exactly how that could be done.[4] Indeed, if Britain had joined the euro and given up the pound, there would be no realistic way for it now to consider a Brexit. A dropping of membership in the EU would imply dropping the euro for any euro-zone countries that might consider such a move.[5]

    Now it’s true that there is a difference between being in the EU and then pulling out and never having joined it in the first place - as is the case for Norway and Switzerland. Exactly what kind of new relationship might be negotiated with the EU by Britain is unclear. There might be some turmoil in financial markets due to uncertainty. The transitional costs might be appreciable – hence the title of this musing. But what about the implications for the U.S.?

    For the U.S., there has been a tendency to attribute domestic monetary policy decisions to a possible Brexit that really have no logical connection to it. Indeed, just about any event can be linked to a possible Brexit if you don’t worry about causality or if you want to invent a story. Drops in the American stock market have been attributed to a possible Brexit in the business news media on the grounds that uncertainty makes investors nervous. But with only a little cleverness, you could easily come up with a hypothetical scenario in which Brexit could boost financial asset prices in the U.S. Example: Turmoil in financial markets abroad leads to a rush by international investors to dollar assets as a “safe haven.” The rush of international liquidity into the U.S. lowers bond yields and boosts the stock market.

    The Fed recently decided not to raise interest rates and the Brexit possibility was mentioned in the news media as one factor in the decision. But in fact, the Fed itself did not mention Brexit in its official explanation and referred only vaguely to “financial and international developments.”[6] Fed Chair Janet Yellen, when asked, did say Brexit was a factor in the decision.[7] But as a practical matter, U.S. interest rates are still pretty close to zero as they have been since the Great Recession. What practical difference would it have made – even assuming some financial turmoil due to a Brexit – if the Fed had slightly raised interest rates at its last meeting? It could simply have reversed the increase if that were subsequently deemed appropriate.

    Fact is, there was no particular domestic reason to raise interest rates at the last meeting. Inflation is still not apparent. True believers in the quantity theory of money have long ago gone into hiding after years of incorrect inflation-is-just-around-the-corner predictions. The Brexit possibility was more of an excuse than a cause for leaving U.S. monetary policy unchanged. A recent UCLA forecast suggests that the labor market still has some room to expand before full employment constraints become an issue.

    In short, we wish our British friends good luck with their upcoming Brexit election on June 23.[8] The case for getting out of the EU is not especially strong since Britain will retain its independent currency, in or out. In the short term, a Brexit might have some negative effects in the UK as folks try to figure out what’s next. There would likely be political fallout since the British prime minister favors continued membership in the EU and has campaigned for it.

    In the longer run, a Brexit vote might simply mean some new trading arrangements with the EU. Perhaps a new arrangement might be negotiated for the UK to remain within the EU and a new vote could be held. Or perhaps Britain might stay outside and have a Swiss/Norwegian-type relationship with the EU. Either way, the effect on the U.S. economy - once the dust settles - should be slight and not a driver of macro policy.



    [2] British membership in the predecessor European Economic Community was initially blocked by French President Charles de Gaulle. The headline above suggests French attitudes have changed.  

    [3] In 1992, Britain dropped out of a prior European monetary arrangement that was a predecessor to the creation of the euro. Essentially, when it became difficult to maintain the value of the pound relative to the value of a basket of other key EU currencies, Britain abandoned the effort.

    [4] Would you print up a bunch of new drachmas and throw them in the street, hoping everyone would pick them up and throw away their euros? If that sounds ridiculous, then what alternative would be the process? During the Greek crisis, did you ever hear anyone propose an actual, workable mechanism for Greece to exit the euro?

    [5] Technically, several mini-states such as Monaco use the euro without being official members of the EU. If a major euro-zone country dropped out of the EU but wanted to continue with the euro, some arrangement such as a currency board would be required. A country with a sophisticated financial sector (as the UK possesses), would essentially need an agreement with the EU. But, of course, the UK is not part of the euro-zone.



    [8] British opinion polls at this writing are indicating a close vote. The murder of a Labour Party MP who favored membership may have some effect.

  • 11 Jun 2016 1:16 PM | Daniel Mitchell (Administrator)

    Mitchell’s Musings 6-13-16: It’s not true that nostalgia ain’t what it used to be

    Daniel J.B. Mitchell

    Nostalgia is pretty much what it used to be. There has been much criticism of the Donald Trump campaign slogan – “Make America Great Again” – essentially on the grounds that it neglects those things in the past that weren’t so good. But the tendency to romanticize the past, and to ignore its nasty bits, is near-universal and has long existed. Think of the continued popularity of Gone with the Wind and its romantic view of the anti-bellum Old South and slavery.

    The latest example I have come across in the past-was-great school of thought was an op ed in the Los Angeles Times entitled “You’re reading the Bible wrong.”[1] The theme of the piece is that the Bible is really “humanity’s diary.” Let’s put aside the fact that much of humanity has other religious traditions. The scholarly authors of the op ed argue that the Bible really is an attempt to codify behavior as humanity switched from being hunter gatherers to participants in complex agrarian societies. Evolution didn’t make us good citizens of such complex societies, according to the op ed’s authors. We are really hunter gatherers by nature.

    …If many of us today feel a sense of longing for paradise, it is because we live in a world for which we were not really made. Our innate psychology prepares us to live in small groups of mobile hunter-gatherers, virtually without property, where brothers are each other’s best allies, where the need to share everything cuts down on competition and conflict as we struggle to survive against nature, where men and women are nearly equals, and where we do not have to rely on abstract laws to sort out conflicts. The Bible therefore reflects enduring human concerns hailing back to our days as hunter-gatherers: We hate injustice, despotism and excessive wealth and yearn for belonging, for community and for a peaceful life...

    It is perhaps unkind to note that the view of the authors’ of the op ed of hunter-gatherer societies is an updated Biblical Garden of Eden in which none of today’s problems – money grubbing, conflict, sexual and wealth inequality – exist. Never mind that in such societies you died at an early age of various diseases, or maybe were eaten by some wild animal, or maybe were killed by some other tribe in the forest primeval.[2] The op ed’s utopian view of human nature back in the day as inherently peaceful is a twenty-first century fantasy version of the old Noble Savage. defines that ideal for those not familiar with it:

    Noble savage: In literature, an idealized concept of uncivilized man, who symbolizes the innate goodness of one not exposed to the corrupting influences of civilization.[3]

    You can also find the Noble Savage idea in the Marxist view that the human race in the distant past lived under “primitive communism.” In the long run, according to that view – and with a little push from those cognoscenti who understand the “scientific” laws of history – we will get back to a utopian modern version of our original state of nature. In the meantime, of course, there may have to be some pain and sacrifices. Millions were killed in the name of that idea. Many others died for it.

    In short, it isn’t just old white males without college educations who are, or who will be, attracted to slogans such as “Make America Great Again.” Academics and scholars are prone to it, too, if the idea is put in the right terms. There is a broad appeal to a return to a wonderful past across the political spectrum. The more realistic idea of voting for candidates who will - more likely than not and despite their faults - incrementally push things in the direction of improvement is just not so catchy.

    So don’t expect Hillary Clinton to have a cakewalk into the White House. And for Gone with the Wind fans longing for the past, here’s some background on cakewalks:

    The cakewalk was a pre-Civil War dance originally performed by slaves on plantation grounds. The uniquely American dance was first known as the "prize walk"; the prize was an elaborately decorated cake… Plantation owners served as judges for these contests…[4]

    Ah, those Good Old Days.



    [2]UCLA Prof. Jared Diamond: “Traditional nomadic tribes often end up abandoning their elderly during their unrelenting travels. The choice for the healthy and young is to do this or carry the old and infirm on their backs — along with children, weapons and necessities — through perilous territory. Also prone to sacrificing their elderly are societies that suffer periodic famines. Citing a dramatic example, Diamond said Paraguay’s Aché Indians assign certain young men the task of killing old people with an ax or spear, or burying them alive. ‘We react with horror at these stories, but upon reflection, what else could they do?” Diamond asked. “The people in these societies are faced with a cruel choice.’” Source: [Underline added.]



  • 03 Jun 2016 12:34 PM | Daniel Mitchell (Administrator)

    Mitchell’s Musings 6-6-16: In the Long Run…

    Daniel J.B. Mitchell

    John Maynard Keynes is often quoted as saying that in the long run, we’re all dead. His famous statement was meant as a critique of economic reasoning concerning processes that would eventually lead to a desirable stable outcome, while neglecting the difficult transition on the way to that outcome. But the issue of getting to the long run arises in other contexts as well. Consider the following news item:

    Demand for long-term care is expected to increase as the nation ages, but the majority of Americans 40 and older lack confidence in their ability to pay for it. The annual cost of long-term care expenses range from $17,680 for adult day care to more than $92,000 for a private room in a nursing home, according to Genworth Financial. Yet an Associated Press-NORC Center for Public Affairs Research survey finds that a third of Americans 40 and older have done no planning for their own long term care needs, such as setting aside money to pay for a home aide or to help with daily activities or a room in a nursing home…[1]

    The article excerpted above is not unique. Think of the number of articles you have read in recent years about people – especially aging baby boomers - not saving enough. Usually, the thrust of such articles is to urge readers to plan ahead “better” than they otherwise might. But there is another message implicit in such pieces. It is that folks don’t generally do a very good job about planning for the future and the private market doesn’t do a great job in helping them. If such planning was well handled privately, you wouldn’t be seeing such news items.

    In the long run, the baby boomers will pass on as will everyone reading this musing. However, the transition will be difficult in the absence of some provision dealing with the possibility of needing expensive long term care or just outliving one’s savings. And, as noted, there are problems in private provision of protection against such risks.

    First, folks are not good at planning for unpleasant long term outcomes. Second, commercial remedies such as long term care insurance and annuities are not all that effective in solving the problem. Let’s take long term care insurance. Presumably, like any insurance, it can only be offered in such a way as to minimize adverse selection. So commercial providers can’t offer it in a form that let’s purchasers wait until they know they need long term care. It has to be offered well in advance of potential need to get a large and representative risk pool.

    But if it is offered well in advance, purchasers are trusting that some insurance company in the distant future (when it may have been merged, acquired, or possibly gone out of business) will treat them fairly at a time when they are likely to be unable to fend for themselves. That’s a lot to expect. And even setting aside that issue, what will the premiums be over time? Will they remain “affordable”? CalPERS – the giant state pension and health care system for California public employees – offered long term care insurance to participants, but later jacked up the premiums. Participants had to choose among the options of paying the much higher rates, accepting a cut-down policy going forward, or simply dropping the coverage for which they had been paying. So even a state-level public entity had difficulty providing subscribers with the coverage they originally thought they were buying.

    As for simple saving, there is always the issue of outliving the amount put away. And what is put away will vary in future real value with unknown rates of return and with the rate of inflation in the future. Annuities can be bought in commercial markets but they are often expressed in nominal terms, i.e., not adjusted for inflation or only partly adjusted. And they tend to be expensive. There is an adverse selection issue inherent in annuities in that folks who have expectations of being Methuselahs are the likely buyers. Some of the tendency to believe you will be a Methuselah may be unrealistic expectations. But individuals do have relevant knowledge – based on family background and their own prior health history – as to how long they are likely to live.

    Defined benefit pension plans are effectively savings plans with default annuities attached. But as is well known, such have been disappearing from the private sector and have been under attack in the public sector for underfunding. Defined contribution plans, 401k-type plans, and IRAs are not particularly good substitutes. So what remains is Social Security and Medicare, i.e., federal compulsory social insurance arrangements that spread risk. It’s fine to encourage folks to save more. Urging them to take out long term care insurance – given the problems of commercial provision – may not be so fine. Ultimately, what is needed at this juncture is a strengthening of social insurance, particularly to deal with health-related concerns such as long term care.

    There is an unrealistic libertarian assumption that if we just leave such matters to the private market – and let folks suffer the consequences if they do the wrong thing – the role of government in elderly support can be limited. The ants will retire in style and the grasshoppers… Well, too bad for them. In fact, the political process and past history suggests that if there are lots of elderly folks (who are also voters) that find themselves in distress - or if there are lots of younger folks (who are also voters) finding themselves in distress due to a need to support their parents - there will be pressure for government to do “something.” Such pressures are what led to the creation of Social Security and Medicare in the first place.



  • 29 May 2016 8:03 AM | Daniel Mitchell (Administrator)

    Mitchell’s Musings 5-30-16: What Was Missing

    Daniel J.B. Mitchell

    I recently attended the LERA (Labor and Employment Relations Association) meetings in Minneapolis. LERA is the organization that sponsors the EPRN website on which this column appears. Confession: I was on the program committee that helped develop the meeting’s agenda. But as I attended sessions and heard speakers, there was a missing element. Maybe that is my fault.

    There was some mention of the current presidential campaign. However, back when the program was being planned, no one – except maybe Donald Trump and Bernie Sanders (neither of which was on the program committee – could have foreseen how the campaign would evolve. And one way in which it did in fact evolve was candidate discussion of the loss of “good” American manufacturing jobs due to globalization.

    I attended one session on the auto industry – domestic and transplant/foreign - and its shift of facilities to Mexico. However, that session was mainly descriptive (but very interesting). Another interesting panel discussed the incorporation of labor standards into trade agreements such as the currently-pending TPP. Some of the sessions were run simultaneously so I can’t say what happened in all of them pertaining to trade and jobs. And I wasn’t at the last two days of the conference so maybe the omission I am alluding to - exchange rates – was somewhere on the later program after all.



    Let’s have some background. The chart above provides a summary, from the perspective of national income accounting, of the long-term slide of manufacturing relative to overall U.S. economic activity. Back in the 1950s, manufacturing accounted for 30+ percent of American total activity, as depicted on the chart. Nowadays, the share is 10+ percent. That’s a big slide. What caused it?[1]

    The two main causes of choice for the slide in the literature have been technology (rising productivity so fewer workers are needed) and globalization (jobs being outsourced abroad via imports plus competition with U.S. exports). As a quick experiment, I rewrote history on the chart below by assuming that the goods trade balance had been zero (rather than negative over much of the period) and further assumed that all the extra activity generated came from U.S. manufacturing. (Not all goods by any means are manufactured so the latter assumption in particular is extreme.) Making those assumptions reduced the relative decline of manufacturing. Instead of going from 30+ percent to 10+ percent, it went from 30+ to 15+. That’s not nothing in terms of a reduction, but it does suggest that a lot of the reduction was due to some combination of technology and change in demand toward non-manufacturing (including services).



    On the other hand, the shift in the current endpoint from 10+ to 15+ isn’t negligible. That’s roughly a one third increase in manufacturing activity (and presumably jobs) from what we have today. Of course, I made extreme assumptions to get to that third. Nonetheless, it does suggest that different trade arrangements could have a significant impact on the number of manufacturing jobs and the size of that sector.

    It’s hard, however, to see how a revision of labor standards clauses in trade agreements would have much effect. The LERA panel on standards previously mentioned concluded as much. And as long as there are no effective limits on exchange rate manipulation, it’s hard to see that trade agreements that ostensibly reduce foreign trade barriers to American exports will have much effect. Such arrangements are more likely to increase both exports and imports and leave the balance between the two largely unchanged.

    Exchange rates are tough to negotiate about because the definition of “manipulation” is bound to be unclear in practice. Were the U.S. to take unilateral action on exchange rates (as the Nixon administration did in 1971 and 1973 when then-existing fixed rates were abandoned), such defensive responses might be ruled by some tribunal to be manipulation. Put another way, if the U.S. were to take such actions, having treaties with provisions ostensibly dealing with the topic might be a hindrance.

    Addressing the exchange rate issue, if it were done by the U.S., won’t change the advance of technology and the shift in demand toward non-manufacturing activities. We are not going back to the 1950s with 30+ percent of activity in manufacturing. But it could have a significant effect in creating more manufacturing jobs. And it would surely have more effect than the indirect remedies that are often suggested such as providing better training and education. Such provision may be important in its own right. But it is a palliative when it comes to jobs-trade-exchange rates.


    [1] As the chart shows, the switch from the SIC definition of manufacturing to the NAICS definition knocks about a percentage point from the total.


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