Economics is held in low repute
By Scott Sumner
Matt Yglesias has an excellent post discussing the views of Peter Navarro, who was just named head of Trump’s National Trade Council:
“When net exports are negative,” Ross and Navarro write, “that is, when a country runs a trade deficit by importing more than it exports, this subtracts from growth.”
They believe that, therefore, we can boost growth by curtailing imports:
To score the benefits of eliminating trade deficit drag, we don’t need any complex computer model. We simply add up most (if not all) of the tax revenues and capital expenditures that would be gained if the trade deficit were eliminated. We have modeled only the impacts of implicit profits and wages, not any other economic aspect of the increased activity.
Trump proposes eliminating America’s $500 billion trade deficit through a combination of increased exports and reduced imports. Again assuming labor is 44 percent of GDP, eliminating the deficit would result in $220 billion of additional wages. This additional wage income would be taxed at an effective rate of 28 percent (including trust taxes), yielding additional tax revenues of $61.6 billion.
Reading this, you might wonder why it is that in the real world, economists actually do try to develop complex computer models of the economy. The answer is that the alternative method Ross and Navarro are proposing doesn’t even remotely work.
A simple sanity check
Here’s a quick way to tell that something has gone wrong with the Ross/Navarro argument. Last year, the United States imported $180 billion worth of petroleum products — oil and such.
According to Ross and Navarro, if the United States made it illegal to import oil, thus wiping $180 billion off the trade deficit, our GDP would rise by $180 billion. With labor constituting 44 percent of GDP, that would mean about $80 billion worth of higher wages for American workers. So why doesn’t Congress take this simple, easy step to boost growth and create jobs?
Well, because it’s ridiculous.
Navarro and Ross are making the EC101 mistake of drawing causal implications from the famous GDP identity:
GDP = C + I + G + (X – M)
Students often assume that trade deficits subtract from GDP, because there is a minus sign attached to imports. What they forget is that the goods imported then show up as a positive in either the consumption of investment category. Navarro also seems to have forgotten this fact.
Navarro’s claim is not just wrong, it’s nonsensical. Naming him to lead the NTC is akin to appointing an Energy Secretary who believes cold fusion can meet all our energy needs, or putting an astrologer in charge of NASA.
But that is not how the pick will be viewed outside the economics community. Why not?
I see a number of reasons:
1. Peter Navarro has good credentials. He’s a Harvard educated economist who teaches at UC Irvine, a respected research university.
2. Other economists such as Paul Krugman have occasionally pointed to the trade deficit with China as a problem.
3. Economists often disagree about important issues like fiscal stimulus, supply side economics, the minimum wage, and the national debt. This leads outsiders to believe that economics is “not a science”.
As far as I know, leading economists (liberal and conservative) do agree that Navarro’s reasoning is inaccurate. When people like Krugman have pointed to the issue of trade deficits, they’ve been careful to state that deficits are not generally a problem, but that measures to lower saving in surplus countries can shrink their surpluses and improve AD when the world is at the zero lower bound. Navarro is implicitly relying on an aggregate demand side argument. But with the Fed in the process of raising interest rates, it’s not applicable to the US, even in the most primitive Keynesian model.
To return to the example above, the neo-mercantilists believe that if we stopped imports from China, consumption would not decline. Instead all those toys and sneakers and iPhones would be built in America with American workers. But Janet Yellen has made it clear that the Fed regards 4.6% unemployment as roughly full employment, and any attempt by Trump to boost AD will be met with tighter money. The only way to boost output significantly is supply-side policies, and mercantilism is certainly not a supply-side policy.
It’s often said that all sciences are just “applied physics”. But as systems get more complex, it becomes harder to make precise predictions. Thus when physics is applied to global warming, the predictions are less accurate than when used to derive the optimal orbit for a satellite. Hence global warming is a political issue in the way that NASA orbiting decisions are not. Obviously economics deals with a complex, hard to predict system, and is more akin to climate science than to simple physics.
Economists are like the boy who cried wolf. By insisting that Keynesian stimulus is “science” and supply-side tax cuts are “voodoo”, they have discredited themselves in the eyes of the public. When an actual charlatan comes along, no one will believe us. Especially since trade deficits do seem like a problem, from a common sense perspective.
If we are unhappy with how we are viewed, then we first need to get our own house in order.
PS. It’s not at all clear that Navarro’s ideas will actually be implemented. Some people believe that Trump is more likely to govern as a traditional Republican. The next four years will provide a test of the “Great Man” theory of history. I’m in the camp that believes presidents are far less consequential than most people assume.