Blogs

  • 11 Oct 2016 6:10 PM | Daniel Mitchell (Administrator)

    Mitchell’s Musings 10-17-16: Most Economists


    Daniel J.B. Mitchell


    I happened to hear a public radio broadcast from NPR recently on the recent depreciation of the British pound and the Brexit vote of last June.[1] The program began with this sentence:


    Since the U.K. voted to leave the European Union last summer, the country's currency - the pound - has lost about 16 percent of its value against the dollar. Most of the damage, according to economists, was self-inflicted.


    It ended with this sentence:


    The pound dropped again this morning trading below $1.23. Most economists think it has yet to hit bottom.


    In between the beginning and the end, there was what you might expect. There were references to the Brexit vote of June, anecdotes on how foreign tourists in Britain were benefiting from reduced costs, etc. But let’s start with the beginning sentence which references the fall in the pound.

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    Source: XE.com as of October 11, 2016.

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    As the chart above shows, relative to the euro, the pound at this writing is about where it was during and in the aftermath of the Great Recession. Until the Brexit vote, it tended to rise relative to the euro. When the vote occurred, it fell. And the pound has generally fallen since.


    The NPR program describes the fall in the pound as “damage” which was “self-inflicted.” There is no doubt that that the Brexit vote was an Act of Man rather than an Act of God. But is it correct to view a currency depreciation as “damage”? Note that if the pound declined relative to the euro, it is also true (by inversion of the pound/euro ratio) that the euro appreciated relative to the pound. So was the euro-zone “helped” by its currency’s appreciation?


    Other things equal, the decline in the pound made British exports more competitive and imports to Britain less competitive. So on that dimension, you could just as well say Britain was helped and the euro-zone was damaged. Suppose you applied the same logic to the U.S. and its dollar that the NPR broadcast applied to Britain and its pound. The chart below shows an index of the U.S. dollar relative to the currencies of its trading partners since 2000.


    If you equate the exchange rate with national welfare, we were never as well off as we were just after the dot-com bust and the related recession. During the recovery from that recession, things got progressively worse if we use the exchange rate as our measure. The Great Recession then gave our welfare a big boost temporarily. But the recovery from that recession made us worse off again. We didn’t see a big improvement until the 2015-16 election cycle made the future of U.S. economic policy uncertain. If nothing in that interpretation makes much sense to you, you now can see the folly of identifying exchange rate trends with national welfare.

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    Source: FRED database of the Federal Reserve Bank of St. Louis.

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    There seems to be an underlying assumption in the NPR broadcast that the fact that Brexit inherently changed some fundamental determinants of the British exchange rate means the pound must be lower than it was. However, the demand for the pound is ultimately a function of the demand for British exports and for British investment assets (British stocks, bonds, real property, etc.); the supply of the pound is ultimately a function of British demand for imports and foreign investment assets. How the demand and supply will balance out once the dust settles, i.e., what the eventual long-term exchange rate will be, is unknown. It will depend on such things as British inflation relative to that of its trading partners and rates of saving at home and abroad. But note that the question of whether or not Brexit was a good idea for Britain in terms of its national economic and political welfare is simply not the same thing as the exchange rate.


    Well, that’s fundamentals. The broadcast closes with the idea that “most economists” think – was there a survey? – that the pound will fall further. That prognosis isn’t accompanied by a time period. Is it by tomorrow? By next week? Whatever the time period may be, it seems to be a short-term prediction. And if it is short term, it should also be the case that most economists are going short on the pound because they know it will soon fall. But is there any evidence that, for example, British economists have been putting their holdings in euros? Are they going further and borrowing pounds and then investing them in euro-denominated assets? If it were evident that the pound would be notably lower in value relative to the euro in the near future, the rush into euros would make it lower relative to the euro today.


    Bottom lines:


    1) Will the pound be lower tomorrow than it was today? If you say “yes,” you have about a 50-50 chance of being right.


    2) Is it a Bad Thing for Britain that the pound exchange rate is lower than it was pre-Brexit? Other things equal, depreciation of the pound stimulates British exports and discourages imports. So let’s just say that the answer is more complicated than assuming that national welfare moves with the exchange rate.


    3) Finally, what should NPR have said in its broadcast? Probably not much more than with the decline in the pound, Americans might want to consider a London holiday.

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    [1] “Brexit Results Prove Increasingly Costly to Britons,” Morning Edition, October 11, 2016. Available at: http://www.npr.org/2016/10/11/497487391/brexit-results-prove-increasingly-costly-to-britons

  • 08 Oct 2016 1:43 PM | Daniel Mitchell (Administrator)

    Mitchell’s Musings 10-10-16: Makes Sense to Me


    Daniel J.B. Mitchell


    I came across an article in the Los Angeles Times business section recently with the print-version headline “Trade is seen as harmful.”[1] The article noted that a Pew Research Center poll found that “eight out of ten adults regarded outsourcing of jobs overseas and the growth of imports of foreign-made goods as harmful to U.S. workers. By comparison only half of the people surveyed saw automation as hurtful – even though many economists believe that new technologies and the mechanization of work have led to as many job losses as imbalanced trade.” The article went on to relate the trade concerns to the current presidential election campaign.


    Above are the actual poll results from the underlying Pew study.[2] Although the LA Times article seems to imply that respondents have misdiagnosed the relative importance of trade vs. automation, there may be an explanation. Unfortunately, Pew does not provide the precise wording of the questions asked. So exactly how respondents interpreted words such as “outsourcing” and “automation” is not clear. Were they given definitions? The hurt vs. help contrast also raises some questions. Do the words mean destroy jobs vs. create jobs? Or do the terms suggest making jobs more difficult to do vs. assisting workers to do their jobs? Or do the terms suggest some kind of good jobs vs. bad jobs distinction?[3] The LA Times article implicitly assumes the destruction/creation interpretation.


    Despite the ambiguities, let’s limit the interpretation to destruction vs. creation when thinking about the trade issue and how survey respondents reacted. Other things equal, the large trade imbalance (deficit) that has characterized the U.S. for decades has to be a source of net destruction. There are caveats, of course. Important among them is the fact that workers whose jobs are lost may end up in the non-trade sector (such as retail).[4] That is, imbalanced trade may shift the mix of jobs towards the non-trade sector without changing the total number of jobs.


    What about automation as a concern? Note that the LA Times article seems to use automation and technology interchangeably. If that is also how respondents reacted, at least some of them may have been thinking about the way technology provides an assist to workers in doing jobs. Thanks to computer technology, for example, it is easier to access information needed on the job than it used to be. Medical records are now available readily without going through paper files. There are many such examples.


    Finally, what about immigration? Respondents are roughly split on whether immigration hurts or helps American workers. The LA Times article notes that ten years ago, the result was much more anti-immigrant than it is now. Although the pace of illegal immigration is hard to measure precisely, another report from Pew suggests that during the past decade, net illegal immigration has halted.[5] That is, the absolute of number of illegal immigrants residing within the U.S. has stayed about constant, as shown on the chart below. Presumably, the Great Recession and its aftermath had an impact in discouraging a net inflow; up until the Great Recession occurred, the number had been rising. That shift to a net of zero may explain the attitudinal change.[6]


    In short, the Pew survey results do not seem to be counter-intuitive. They seem to go with the election narrative. Reflected in the outcome, you have the followers of Bernie Sanders who think trade is a problem but not immigration vs. the followers of Donald Trump who think both are a problem.  You have automation-technology seen as good and bad, perhaps because the question is posed ambiguously. It makes sense to me.

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    [1] The online version of the article had a different headline focused on immigration, not trade: “Americans are feeling better about immigrants' economic effect — but Republicans aren't, survey shows.” See http://www.latimes.com/business/la-fi-pew-study-jobs-20161006-snap-story.html.  

    [2] The full report is at http://assets.pewresearch.org/wp-content/uploads/sites/3/2016/10/ST_2016.10.06_Future-of-Work_FINAL4.pdf. A summary is at http://www.pewsocialtrends.org/2016/10/06/the-state-of-american-jobs/.   

    [3] The fact that decline of unions is seen as more hurtful than helpful in the survey suggests that respondents may have been thinking – at least in part – about job characteristics such as pay and benefits.

    [4] Exports and imports may differ in their labor-using characteristics. At least in theory, however, U.S. imports should be more labor-intensive than exports which would intensify the net destruction effect. That is, even with balanced trade, there might be net displacement.

    [5] http://www.pewresearch.org/fact-tank/2016/09/20/5-facts-about-illegal-immigration-in-the-u-s/. Even when the stock of illegal immigrants is constant, there may be gross flows into and out of the U.S. But the inflows and outflows must be balanced, i.e., a net of zero, for the total stock to stay the same.

    [6] Immigration has had a U-shape in terms of skill with a concentration of unskilled immigrants and a lesser concentration of highly-skilled immigrants. Since this pattern is not a replica of the existing U.S. workforce, there may be both competition among substitutes (e.g., low-skilled natives vs. low-skilled immigrants) as well as complements, e.g., natives for whom demand for their labor is enhanced by the presence of immigrants. For example, native supervisors in southern poultry packing plants may benefit from the influx of low-skilled production workers. It seems unlikely, however, that this nuanced view of the impact of immigration across different groups within the workforce is driving the survey results.

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