The Unassuming Economist

From a VoxEU post by Davide Furceri, Swarnali Ahmed Hannan, Jonathan D. Ostry, Andrew Rose:

“It seems an appropriate time to study what, if any, have been the macroeconomic consequences of tariffs in practice. Using a straightforward methodology to estimate flexible impulse response functions, and data that span several decades and 151 countries, this column finds that tariff increases have, on average, engendered adverse macroeconomic and distributional consequences: a fall in output and labour productivity, higher unemployment, higher inequality, and negligible effects on the trade balance (likely owing to real exchange rate appreciation when tariffs rise). The aversion of the economics profession to the deadweight loss caused by protectionism seems warranted.

 

One of the most pressing issues on the international agenda these days is protectionism. The US’ trade war with China has created international tension that is infecting stock markets worldwide, exacerbated by other disputes such as the renegotiation of NAFTA, Brexit, and US steel and aluminium tariffs. One ingredient curiously absent from this turbulence is disagreement among the experts on the merits (or lack thereof) on the underlying issue. Indeed, more than on any other issue, there is agreement amongst economists that international trade should be free.¹

Economists have been aware of the senselessness of protectionism since at least Adam Smith. In general, economists believe that freely functioning markets best allocate resources, at least absent some distortion, externality or other market failure; competitive markets tend to maximise output by directing resources to their most productive uses. Of course, there are market imperfections, but tariffs – taxes on imports – are almost never the optimal solution to such problems. Tariffs encourage the deflection of trade to inefficient producers and smuggling to evade the tariffs; such distortions reduce productivity, income and welfare. Further, consumers lose more from a tariff than producers gain, so there is ‘deadweight loss’ as well as inequality (if production tends to be owned by the rich).  The redistributions associated with tariffs tend to create vested interests, so harms tend to persist. Broad-based protectionism can also provoke retaliation which adds further costs.  All these losses to output are exacerbated if inputs are protected, since this adds to production costs.

Discussions of market imperfections and the like are naturally microeconomic in nature (Grossman and Rogoff 1995). Accordingly, most analysis of trade barriers focuses on individual industries. International commercial policy tends not to be used as a macroeconomic tool, probably because of the availability of superior alternatives such as monetary and fiscal policy. In addition, there are strong theoretical reasons that economists abhor the use of protectionism as a macroeconomic policy; for instance, the broad imposition of tariffs may lead to offsetting changes in exchange rates (Dornbusch, 1974). And while the imposition of a tariff could reduce the flow of imports, it is unlikely to change the trade balance unless it fundamentally alters the balance of saving and investment. The findings of recent studies on the impact of trade would imply that tariffs could hurt output and productivity (Feyrer 2009, Alcala and Ciccone 2004). Further, economists think that protectionist policies helped precipitate the collapse of international trade in the early 1930s, and this trade shrinkage was a plausible seed of WWII. So, while protectionism has not been much used in practice as a macroeconomic policy (especially in advanced countries), most economists also agree that it should not be used as a macroeconomic policy.

The here and now

Times change. Some economies – notably the US – have recently begun to use commercial policy seemingly for macroeconomic objectives. So it seems an appropriate time to study what, if any, the macroeconomic consequences of tariffs have actually been in practice. Most of the predisposition of the economics profession against protectionism is based on evidence that is either a) theoretical, b) micro, or c) aggregate and dated. Accordingly, in our recent research (Furceri et al. 2018), we study empirically the macroeconomic effects of tariffs using recent aggregate data.”

Continue reading here.

From an IMF working paper by Nicoletta Batini:

“France is the top agricultural producer in the European Union (EU), and agriculture plays a prominent role in the country’s foreign trade and intermediate exchanges. Reflecting production volumes and methods, the sector, however, also generates significant negative environmental and public health externalities. Recent model simulations show that a well-designed shift in production and consumption to make the former sustainable and align the latter with recommended values can curb these considerably and generate large macroeconomic gains. I propose a policy toolkit in line with the government’s existing sectoral policies that can support this transition.”

From a paper by Charles Ka Yui Leung and Joe Cho Yiu Ng:

“This paper aims to achieve two objectives. First, we demonstrate that with respect to business cycle frequency (Burns and Mitchell, 1946), there was a general decrease in the association between macroeconomic variables (MV) and housing market variables (HMV) following the global financial crisis (GFC). However, there are macro-finance variables that exhibited a strong association with the HMV following the GFC. For the medium-term business cycle frequency (Comin and Gertler, 2006), we find that while some correlations exhibit the same change as the business cycle counterparts, others do not. These “new stylized facts” suggest that a reconsideration and refinement of existing “macro-housing” theories would be appropriate. We also provide a review of the recent literature, which may enhance our understanding of the evolving macro-housing-finance linkage.”

A new IMF working paper revisits ” the issue of classification errors in the U.S. Current Population Survey. While the results still support the previous literature’s conclusion that the job finding probability plays a more important role in explaining unemployment fluctuations (“outs of unemployment”) than the job separation probability does (“ins to unemployment”), they moderate the conclusion that “Out Wins”. Moreover, once the proposed adjustment is applied, the importance of the participation margin in explaining unemployment fluctuations becomes smaller than previously argued—around 10 percent in this paper vs previous estimates of 20 to 30 percent (Elsby, Hobijn and Sahin, 2015). Therefore, the misclassification correction procedures in the labor force survey continue to be an important issue in understanding labor market dynamics. The results of this paper suggest that policymakers should pay closer attention to the job separation margin than previously thought and less on the participation margin.”

From a new post by Timothy Taylor:

“A lot of people have heard, one way or another, that the country of Bhutan decided back in the early 1970s to pursue Gross National Happiness. The King at that time is supposed to have said:  “Gross National Happiness is more important than Gross Domestic Product.” But in practical terms, what does that actually mean?”

[…]

“1) It is bog standard economics that GDP was never intended to measure happiness, nor to measure broader social welfare. Any intro econ textbook makes the point.  A well-known comment from “Robert Kennedy on Shortcomings of GDP in 1968” (January 30, 2012) make the point more poetically. But for those who need a reminder that social welfare is based on a wide variety of outcomes, not just GDP, I suppose a reminder about Gross National Happiness might be useful.

2) Bhutan’s measurement of 124 weighted indicator variables, and their distribution through the population,  is probably about as good a way of measuring Gross National Happiness as any other, and better than some. But it’s also pretty arbitrary in its own way.

3) The interesting question about GDP and social welfare isn’t whether they are identical, but whether they tend to rise together in a broad sense. For example, countries with higher per capita income also tend to have more education and health care, better housing and nutrition, more participatory governance, and a variety of other good things. .A few years ago I wrote about “GDP and Social Welfare in the Long Run” (April 6, 2015), or see “Why GDP Growth is Good” (October 11, 2012).

4) “Happiness” is of course a tricky subject, which is why it’s the stuff of literature and love.  After a lot of consideration, Daniel Kahneman has argued that “people don’t want to be happy.”  Instead, they want to have a satisfactory narrative that they can tell themselves about how their life is unfolding. If incomes, education, and life expectancy rise over, say, 40-50 years but on a scale of 1-10 people don’t express greater “happiness” with their live, does that really mean they would be equally happy with lower incomes, education and life expectancy–especially if other countries in the world were continuing to make gains on these dimensions? There is an ongoing argument over whether those who have higher income express more happiness because they get to consume more, or because they feel good about comparing themselves who are worse off. It’s easy to say that “money doesn’t bring happiness,” and there’s some truth in the claim. But for most of us, if we lived in a country with lower income levels and could watch the rest of the world through the internet and television, it would bug us at least a little, now and then.

It seems to me easy enough to make the case that looking at Gross National Happiness as is better than an exclusive focus on doing nothing but boosting short-term GDP. But outside the fictional mustachio-twirling econo-villains of anti-capitalist comic books, no one actually believes in an exclusive focus on GDP. For me as an outsider, it’s hard to see how Gross National Happiness has made Bhutan’s development strategy different. After all, lots of countries at all income levels emphasize lots of goals other than short-term GDP. And the government of Bhutan pays considerable attention to GDP, as the authors note, “While there is importance given to GNH in Bhutan, governmental organizations (especially commerce related ones) focus keen attention on GDP and how it measures trade, commerce and the economic prosperity of the country. In addition, the IMF has provided a great deal of technical assistance to Bhutan to help improve its national accounts …”

My own favorite comment on the connection from GDP to social welfare is from a 1986 essay by Robert Solow (“James Meade at Eighty,” Economic Journal, December 1986, pp. 986-988), where he wrote: “If you have to be obsessed by something, maximizing real National Income is not a bad choice.” At least to me, the clear implication is that it’s perhaps better not to be obsessed by one number, and instead to cultivate a broader and multidimensional perspective. If you want to refer to that mix of statistics as Gross National Happiness, no harm is done. But yes, if you need to pick one number out of all the rest (and again, you don’t!), real per capita GDP isn’t a bad choice. To put it another way, a high or rising GDP certainly doesn’t assure a high level of social welfare, but it makes it easier to accomplish those goals than a low and falling GDP.”