## Study Reveals Unexpected Relationship Between Wages and Trade

December 20, 2010

Low wages in other countries, especially China, is one of the factors often cited as the cause our enormous trade deficit.  If you’ve followed this blog, you’ve heard me often counter that, in fact, low wages have virtually nothing to do with the balance of trade.  After all, if low wages are to blame, how does one explain even larger trade deficits (in per capita terms) with high-income nations like Japan and Germany?

But I was going by gut feel more than anything else.  For some time now, I’ve been promising a complete study on the subject to find out what the truth might really be.  I’ve completed that study and can report to you that both I and the economic experts are wrong about the relationship between wages and balance of trade.  There is, in fact, a relationship, but one you’d not expect.

Methodology: First, some explanation of my methodology is in order.  It’s simply not possible to compare actual wages from one nation to the next for the full range of manufactured products, so I did the next best thing and utilized per capita “Purchasing Power Parity” (or “PPP”) for each nation.  Per capita PPP is roughly the gross domestic product (or GDP) of a given nation divided by its population, and it tends to track pretty closely with average income.  For example, U.S. GDP of about \$14 trillion, divided by a population of 300 million, yields a figure of about \$46,700 per capita – pretty close to the average family income.

On the trade side, I tabulated by SIC code the imports from and exports to each of 163 U.S. trading partner nations.  I then identified each manufactured product by SIC code and totaled them to arrive at a balance of trade in manufactured products.  By dividing that figure by the population of that nation, I arrived at a per capita balance of trade in manufactured products.  It’s important to track only manufactured products, since that’s where jobs are concentrated.

I then constructed “scatter charts” of the data, looking for any relationship that might be evident.  By having the computer generate an equation that describes the relationship (if any), along with a coefficient of correlation, it became easier to determine the existence of any relationship.  A scatter chart that yields a shotgun-like pattern shows that no relationship exists, while a scatter chart that has the data points more or less organized along a line does show a relationship.  It’s important to note that a relationship isn’t necessarily evidence of cause and effect.  For example, just because your alarm clark happens to coincide more or less with the rising of the sun doesn’t mean that the sunrise causes your alarm clock to go off or vice versa.

Summary: When all 163 nations are taken as a whole, there is a relationship between PPP and the U.S. balance of trade.  As PPP increases from a very low level (near zero), the U.S. balance of trade in manufactured products tends toward a surplus that grows larger as the PPP of its trading partners rises.  Lower PPP tends to drive the balance of trade toward zero.

On the one hand, this intuitively seems to be correct.  Higher PPP nations produce more and consume more, creating greater opportunities for trade and thus the potential for greater imbalances.  Lower PPP nations produce and consume little.  Thus, there’s little opportunity for trade, and little chance of running a large surplus or deficit.

However, the fact that higher PPP tends to drive the balance of trade toward a surplus seems counter-intuitive.  How can this be, when the U.S. actually has an enormous trade deficit?  Closer examination of the data points reveals that 116 of the 163 data points fall on the trade surplus side of the chart, while only 47 fall on the trade deficit side.  Regardless of whether one looks at only the trade surplus nations or the trade deficit nations, PPP has the same effect – it tends to amplify an imbalance in trade.  Among the trade surplus nations, the surplus tends to grow with rising PPP.  The same is true among the trade deficit nations.  The deficit tends to grow larger with rising PPP.

There is only one possible explanation for the seeming contradiction between the fact that the U.S. has a trade surplus with 71% of nations but overall has an enormous trade deficit in manufactured goods:  the latter category of nations represents a far higher proportion of the world’s population.  Those 47 trade deficit nations, while representing only 20% of the earth’s populated land surface area (Antarctica is excluded), represent 65% of the world’s population.  The average population density of the 116 nations with whom the U.S. has a surplus of trade in manufactured goods is 58 people per square mile.  The average population density of the 47 nations with whom the U.S. has a trade deficit is almost eight times greater at 440 people per square mile.

Analysis: The following scatter chart plots the PPP for each of 163 nations vs. the per capita U.S. balance of trade in manufactured goods (the balance of trade divided by the population of each nation).  Tiny island nations were excluded from the analysis for the sake of simplicity and because their economies are almost universally based upon tourism.  Tiny city-states like Singapore, Luxembourg, Vatican City, Monaco, etc. are also excluded.

Total Chart

As you can see, the data points hug the zero point at the low end of the PPP scale, but steadily fan out as PPP increases.  There is a very strong correlation coefficient (0.57) with the trend line equation describing the relationship.  (“0” is no correlation while 1.0 is perfect correlation.)  And, as you can see, the trend line lies on the surplus side of the chart.  That’s because there are more data points (116 vs. 47) that fall on that side of the chart.  But aside from the number of points, the trade deficit side of the chart is virtually a mirror image of the surplus side.  Trade deficits tend to increase with rising PPP, just as trade surpluses tend to do.

I then split the data into two groups – trade surplus nations and trade deficit nations – to try to understand this dichotomy.  The following is a scatter chart for the trade deficit nations:

For those nations with whom the U.S. runs a trade deficit, there is a definite relationship between PPP and the size of the trade deficit, but it’s exactly the opposite of what you’d expect.  The trade deficit in per capita terms tends to grow with rising PPP, and trends toward zero as PPP declines.  This flies in the face of what is said by those who blame our trade deficit on low wages.  Consider China.  In per capita terms, our trade deficit with China is relatively low, falling right in line with other trade deficit nations with similar PPP.  But the overall deficit with China is large, not because of low wages but because it’s such an enormous country.  Take Thailand as another example.  Their PPP is very similar to that of China’s, as is our per capita trade deficit in manufactured products with Thailand.  If Thailand were twenty times larger (like China), our trade deficit with them would be the same.  Yet no one cares about Thailand.  In per capita terms, our trade deficit with wealthy, high-wage countries like Japan, Germany, Switzerland and others is significantly worse than our deficit with China.

On all of these charts, I had to turn off the data labels to make them more legible.  But I’ve identified a few of the more notable data points on this chart – nations that are significant trade partners with the U.S.  As I scanned down the list of 47 nations that appear on this trade deficit side of the scatter chart, one common characteristic quickly stood out:  these are very densely populated nations.  In fact, of the 47 trade deficit nations, only four are less densely populated than the U.S.:  Armenia, Laos, Finland and Sweden.  In addition to those data points I’ve identified on the chart, also included in this group are Bangladesh, El Salvador, Hungary, India, Italy, Malaysia, Mexico, Pakistan, the Philippines, South Korea, Taiwan, the U.K. and Vietnam among others – all far more densely populated than the U.S.  This group of 47 nations represents 65% of the world’s population, but only 20% of its land surface area (uninhabited Antarctica excluded from the calculation).  The population density of this group of nations as a whole is 440 people per square mile.

Now let’s take a look at the trade surplus nations and see what common characteristics they might share.  The following is a scatter chart of those 116 nations with whom the U.S. had a surplus of trade in manufactured goods in 2009.

Once again, we see that as PPP increases, the trade surplus tends to grow.  The surplus trends toward zero as PPP declines.  The correlation to a linear, upward-trending equation is very strong at 0.61.

I’ve identified some of the more significant trading partners in this group – some very large countries like Canada, Australia and Brazil.  This group of 116 nations represents 80% of the world’s land surface area, but only 35% of its population.  The population density of these 116 nations taken as a whole is only 58 people per square mile.

Conclusions:

Low wages do not cause large trade deficits.  Low wages tend to result in small trade imbalances when expressed in per capita terms.  High wages tend to result in large trade imbalances – both surpluses and deficits.  China is no exception.  With a relatively low per capita PPP, the trade deficit with China expressed in per capita terms is relatively low – exactly as the chart would predict.  Our trade deficit with China is large because of its sheer size.  If China were a cluster of many small nations, our deficit with each would be relatively small.

Population density is clearly the overriding factor in determining whether the U.S. will experience a surplus or deficit in trade with any particular nation.

The reason for the relationship between PPP and balance of trade being similar (but opposite) for surplus vs. deficit nations is a matter of speculation.  It is my belief that, among the surplus nations, higher PPP tends to produce a greater surplus of trade for the U.S. because these nations are wealthy in natural resources and they trade those resources for manufactured products.  Thus, their wealth is the cause of the U.S. trade surplus.  Conversely, among the deficit nations, higher PPP produces a larger trade deficit for the U.S. because these nations use manufacturing for export to generate their wealth.  Thus, their wealth is the result of the U.S. trade deficit and a surplus with the rest of the world as well.

Further discussion of the evolution of the trade deficit with China and the implications for U.S. trade policy will be covered in subsequent posts.

## “Evening in America”

December 14, 2010

http://www.amconmag.com/blog/evening-in-america/

Thanks to reader Ken for bringing the above-linked article from The American Conservative, “Evening in America,” to my attention.  It’s a great review of two books – The Betrayal of American Prosperity  by Clyde Prestowitz and How The Economy Was Lost by Paul Craig Roberts – both former members of the Reagan administration, expressing alarm about the direction of U.S. trade policy.  I encourage you to take 5 minutes to read the article.  What’s interesting to me is that such thinking is creeping into conservative thought, since free trade has long been a conservative mantra.

The only place where I take exception to the article is the analysis of Japan’s “lost decade,” in which the article claims that Japanese GDP growth was actually better than it appears, and would be even better were it not for the lag in Japanese population growth.  In other words, the author is an advocate of using population growth to stoke GDP growth.  Not surprising.  Another conservative mantra.  (Though I’m not being fair, since liberals rely even more heavily upon this failed strategy.)  Clearly, the author has no clue about the relationship between population density and per capita consumption.

Nevertheless, it’s encouraging to see current U.S. trade policy being viewed with growing skepticism, even among conservatives.

## Dip in Oil Imports and Rise in Oil and Food Exports Combine to Cut October Trade Deficit

December 11, 2010

As reported by the Foreign Trade division of the U.S. Census Bureau this morning (link to the report provided above), the October trade deficit fell unexpectedly from \$44.6 billion in September to \$38.7 billion.  Exports were up \$4.9 billion while imports were down \$0.9 billion.

Of the \$4.9 billion jump in exports, \$3.3 billion is due to “industrial supplies and materials” (\$2.6 billion) and “foods, feeds and beverages” (\$0.7 billion).  Most of the former category is due to a jump in exports of natural gas, fuel oil and other petroleum products and chemicals.

Crude oil imports fell by \$2.3 billion.  Otherwise, imports actually rose by \$1.4 billion.

In other words, virtually all of the improvement in the October trade deficit can be attributed to swings in oil imports and exports and a jump in food exports.  Consequently, this puts exports closer to being on track for meeting Obama’s goal of doubling exports in five years but, until the October report, exports were lagging this goal badly.  Goosing the export total with a one-month gush of petroleum and food products (neither of which contributes anything to job growth) isn’t a very convincing step in meeting the president’s goal.  I expect to see a reversal in November’s report when it’s released next month.

It’s also interesting that imports seem to have hit a ceiling in the last few months, not rising above \$200 billion per month.  I also expect that barrier to be broken.  Time will tell.

Here’s an update of my charts:

## President’s Debt Commission: Thinking Inside the Box

December 8, 2010

http://www.fiscalcommission.gov/sites/fiscalcommission.gov/files/documents/TheMomentoftruth12_1_2010.pdf

The report issued last week by the President’s “National Commission on Fiscal Responsibility and Reform” (link provided above), while laudable for emphasizing the seriousness of the problem of our runaway debt and the urgency of addressing it, the report never identifies the root cause of our economic problems.  The commission clearly boxed itself into examining only taxation and spending.  It seems that never once did they stop to consider what may have prompted the use of deficit spending to prop up the illusion of economic growth and prosperity in the first place.

If the commission had gone back in time, tracked the growth in deficit spending and made an attempt to correlate it with other things going on in the economy, they could easily have identified trade policy and the erosion in our balance of trade as the root cause of our debt problems.  If you’ve read my book and followed my blog, you’ve heard me claim many times that it is no mere coincidence that, since our last trade surplus in 1975, the growth in our national debt almost exactly matches our cumulative trade deficit.  If you’re still skeptical, the following chart of the data should erase all doubts:

National Debt vs. Cumulative Trade Deficit

Notice that 32 years after our last trade surplus in 1975 (in 2007), the growth in the national debt and the cumulative trade deficit were exactly the same!!  In the three years since then, a gusher of deficit spending to brake the slide in the economy has the debt racing ahead of the cumulative trade deficit.  We can expect another lame attempt to slow the rise in the national debt, just as we saw in the late ’90s.  But without a change in trade policy it will be impossible to stop.  Deficit spending is the only mechanism available to plow trade deficit dollars back into the economy.  Without deficit spending, our banks would soon be drained of their reserves by an arterial bleed of over 500 billion trade deficit dollars per year.  Yet, this simple fact has completely eluded the president’s debt commission – probably not surprising, given that the commission was staffed and led by people who have perpetuated this trade regime.

A change in trade policy back to the use of tariffs to assure a balance of trade would easily boost revenues by \$500 billion to \$1 trillion per year, paid mostly by foreign exporters but also boosting tax revenues through a \$1 trillion boost in GDP.  This dwarfs anything included in the debt commission’s report, and does so not just painlessly, but by actually improving the economy.

There are two simple truths about the economy:  (a) taking money out of the economy, regardless of whether it’s done by taxation or by a trade deficit, is bad news for the economy; and (b) putting money back into the economy, whether done through government spending or through the reversal of a trade deficit, is good news.  But regardless of how it’s done, the income must balance the outflow over the long haul.  The problem with ignoring trade is that it leaves the taxation/spending side of the equation permanently out of balance, or assures a slide into depression if balance is attempted.  By boxing trade policy out of their thinking, the president’s debt commission assures us of only one thing – failure.

## Obama’s South Korea Trade Deal Lacks Mechanism to Assure Balance

December 6, 2010

http://www.reuters.com/article/idUSTRE6B25GJ20101204

As reported this weekend, Obama has concluded a trade deal with South Korea.  This is the deal that left him empty-handed when he returned from his recent Asian trip, with the South Koreans refusing to allow more American autos to enter their market than what had been negotiated by the Bush administration.  To his credit, the deal quadruples the number of American cars allowed from what the Bush administration had negotiated.  It also allows the U.S. to keep in place a token 2.5% tariff on Korean autos for a longer period of time.  And it opens the door to more beef exports.  According to Obama, this deal will create 70,000 additional jobs supplying these exports.

Or will it?  While limiting U.S. auto exports to 25,000 per American automaker, there is no corresponding limit on Korean exports to the U.S.  In addition, what little tariff the U.S. imposes on Korean autos will eventually be eliminated, along with the significant tariff it currently has in place on Korean trucks.   And there is no definition of what constitutes an “American” car.  There is a good likelihood that the quotas will be met by Hyundais assembled in the U.S. from imported Korean parts, greatly diminishing any impact on improving the balance of trade with Korea.

The biggest problem with the deal is that it fails to account for the huge disparity in per capita consumption of autos between the U.S. and South Korea.  By combining the U.S. and Korean auto markets into one free trade market, the Koreans get to share equally in the work of manufacturing those autos.  But with the huge disparity in consumption, American auto makers don’t get access to an equivalent market.  Without some mechanism to assure a balance, the net result is sure to be a net loss of jobs in auto manufacturing.  It is precisely this kind of export-focused trade deal, blind to the conseqences of imports that drown out the effect of the imports, that has exploded our trade deficit and driven the U.S. into financial ruin.

Our last hope of avoiding these consequences lies with Congress, who now must ratify the deal.  Republican Senator Mitch McConnell yesterday, on Meet the Press, was already eagerly endorsing the deal  and predicted that his Republican colleagues would do the same.  No doubt.  They’d have just as eagerly ratified the deal struck by Bush, even though it was even worse.  Our only hope lies with the Democrats who fear a backlash from voters over yet another job-killing trade deal.

Obama has said that this will improve our balance of trade with Korea by \$11 billion per year by opening the door to more auto exports (and some beef exports).  Korea will now allow up to 25,000 cars to be imported from each American automaker.  Let’s do some math.  Giving Korea the benefit of the doubt and assuming that they’ll import Fords, GMs and Chryslers, this means that they’ll allow up to 75,000 vehicles.   Assuming an average vehicle value of \$20,000, that many vehicles would account for \$1.5 billion in exports – a far cry from \$11 billion.  Also, assuming that two thirds of that value is labor and assuming that an average job is worth \$50,000, that’s only 20,000 jobs.  There’s no way that beef exports will make up the difference.

Besides, we already export the equivalent of about 40,000 vehicles per year to Korea.  (While that may sound like a lot, it pales in comparison to imports of about 560,000 cars cars from Korea per year.)  So we’re really only gaining another 35,000 vehicle exports.  How much will that be offset by increased car exports when we lower our tariffs?  And how much of our truck market will be lost when our tariffs on Korean trucks expire in ten years.  Has anyone noticed that, in spite of hundreds of thousands of Hyundais and Kias on the road, you don’t see a single Korean pickup truck?  The 25% tariff is the reason why.  Protectionism works.  Tariffs work.

Here’s my prediction:  instead of improving our balance of trade with Korea, it will worsen.  From today’s trade deficit of about \$12 billion per year, our trade deficit with Korea will steadily worsen to as much as \$50 billion per year.   And I won’t forget this prediction or Obama’s claims.  Beginning with ratification of this treaty (if it’s ratified), I will begin tracking our deficit with Korea, and will especially monitor the deficit in cars (exhibit 18 of the Bureau of Economic Analysis monthly report of U.S. International Trade in Goods and Services.

I’m sure the President thinks he’s made a good deal for the American worker.  But there’s simply no way that a free trade deal with a badly overpopulated, export-dependent nation like Korea, much less one that caps American exports without capping Korean exports at the same level, has any chance of doing anything other than driving up our trade deficit and killing more American jobs.

## November Employment Report a Cold Slap in The Face

December 3, 2010

http://www.bls.gov/news.release/empsit.nr0.htm

The November employment report, just released this morning by the Bureau of Labor Statistics (link provided above), was so bad that the most difficult task I faced in writing this post was choosing which piece of data to highlight in the headline.  The fact that per capita employment has fallen to match the lowest level of the recession?  Or the fact that unemployment by any honest measure (one that doesn’t use the “mysteriously vanishing labor force” trick to hold the numbers down) has risen to nearly match the highest levels of the recession?  The fact that the number of unemployed workers rose to 18.9 million?  Or the fact that the employment level (the number of people working) fell for the third month in a row and for the sixth time in the last seven months?

In the end, I decided to simply sum it all up as a “cold slap in the face” for economists and the administration.  So much for the slowly rebounding economy.

The “expert” economists were forecasting that the economy added 168,000 jobs in November.  Instead, if you believe the rosy figures of the “establishment survey” upon which this data is based, the economy added only 39,000 jobs.  The more thorough and accurate household survey reveals that the economy actually shed another 173,000 jobs in November (the sixth decline in seven months), boosting unemployment to the official rate of 9.8% or, using my more accurate calculation, 12.0%.   The “expert” economists may be shocked at this data, but anyone who understands my theory of population density and has been following this blog should have been expecting it.

Here’s the data:

Unemployment Calculation

And here are charts of the data:

Notice how my calculations of unemployment – “U3a” and “U6a” – correlated perfectly with the BLS’s calculation until the recession escalated, at which point the BLS began holding down the numbers by resorting to the “mysteriously vanishing labor force” trick, or simply assuming that so many people dropped out of the labor force, apparently no longer needing a source of income.  (Hoping that you believe such things.)

The additional 39,000 jobs reported by the establishment survey break down as follows:

• professional and business services temporary help:  + 40,000
• health care:  + 19,000
• mining:  + 6,000
• manufacturing:  – 13,000
• retail:  – 28,000

It’s worth noting that the decline in manufacturing employment is the fourth consecutive month of declines, correlating perfectly with the steadily rising trade deficit and hi-liting the futility of Obama’s plan to boost manufacturing employment by doubling exports in five years.

Think this is bad?  It’s going to get worse.  The stimulus program is winding down, Congress is under pressure to cut spending, taxes are likely to rise and, worst of all, the administration has proven absolutely gutless in doing anything to improve our balance of trade.  Raising taxes and cutting spending, while necessary to head off a bigger economic disaster down the road, in the short term add up to taking money out of the economy, a recipe for a double dip recession.  Or worse.

## Study of Effect of Wages on Balance of Trade

December 1, 2010

I haven’t posted much recently and just wanted to let you all know that I’m alive and kicking.  I’ve been working hard on the study I promised a while back on the relationship (if any) between wages and the balance of trade.  It entails going through the trade data for every nation, sifting out the trade in manufactured products, and then correlating that to Purchasing Power Parity for that nation (an approximation of wages).  It’s a ton of work that I hope to have complete in a few days.

In the meantime, I may be posting about the lame-duck session of Congress.  With dire warnings from the president’s commission on cutting the debt clashing with calls to extend tax cuts and payments for unemployment, something’s got to give.  More later.