Weak & unbalanced secular growth is the problem not bilateral trade or immigration

Global Trumpism could have been avoided. 

An economy has three broad sources of demand that enable the expansion of aggregate sales (nominal GDP) on domestically produced goods and services.*

• Domestic private sector (households and corporations) consumption and investment spending
• Public sector expenditure (which recycles income back to the non-government sectors)
• Foreign sector purchases (exports to foreign domiciled agents/entities)

Aggregate expenditure is funded by:

• Domestic private sector dissavings in the form of leverage (debt issuance and/or asset sales), equity issuance, or spending out of existing income
• Public sector debt issuance, asset sales, and taxes
• Foreign sector leverage, equity issuance, or spending out of existing income

These three sources of demand funded by various types of dissavings drive the national production of goods and services which in turn employs the available domestic labor and capital resources.  Consequently, it becomes problematic when spending on domestically produced goods and services becomes insufficient to the point where labor and capital are left to remain idle.  In other words, the economy is producing below its full productive capacity (output gap).  In terms of labor, lackluster aggregate and local spending growth results in higher levels of unemployment, reduced labor bargaining power, and depressed real income growth.  As far as capital, anemic conditions disincentive a greater level of investment spending since existing capital becomes redundant and risk-adjusted returns on potential investments are perceived to have fallen.  In the long run, a lack of investment reduces the economy's long run productive capacity.

Market monetarists importantly point out that a reduction in aggregate income/spending (NGDP) growth expectations can lead to less present spending which reinforces the underlying affliction.  Monetary policy, unlike fiscal, works primarily through the private sector by adjusted expectations in a way that either promotes or discourages an increase in private dissavings/leverage.  The Fed projects a loosening or tightening bias depending on their perception of the strength of economic activity.  Thus, if a lack of aggregate domestic revenues is inhibiting the private sector from fully absorbing all the available resources in the production process, fiscal and monetary authorities can counteract this directly through deficit financed government spending and indirectly via deficit financed tax cuts or monetary easing.  Moreover, responding to private sector demand shocks in a predictable manner helps mitigate the effects on present activity that derive from negative future expectations.  Thus, the US being a monetary sovereign of a large diverse industrialized economy has all the tools necessary to deal with insufficient aggregate or local income (spending) growth.

Therefore, trade, technology, and demographic shocks to aggregate demand can be problematic only if fiscal and monetary authorities are not responding reactively enough to them.  Although global trade and technological advancements can both boost the supply side, should these trends result in depressed demand and an excess supply of labor that leaves households insecure and unable to bargain for higher living standards, the existing economic order will rightfully come under fire unless policy helps mitigate the negative effects of such structural changes.  President Trump is a byproduct of the unwillingness on the part of the political class to forcefully address this underlying fragility. In allowing it to fester, this social dissatisfaction inevitably turned into political upheaval.  Should these political trends jeopardize the aggregate progress made over the last few decades, rampant cronyism and a lack of enlightened self-interest will be to blame.

Global imbalances in savings and investment must be taken into account.

Although domestic policymakers have the capacity to maintain a level of full employment that helps alleviate social tensions and political risks, doing so would still leave in place potentially destabilizing imbalances in global savings and investment.  When the rest of the world seeks to accumulate (save) dollar denominated assets (US capital inflows) on net rather than recycle dollar deposits back into the US via spending on good and services, the United States must run a current account deficit (See prior post).  As part of the current account, the much politicized trade deficit is a consequence of this desire by the foreign sector to stockpile dollar asset issued by US domiciled entities.  In large modern economy like the US, these portfolio (capital) flows are vastly larger and a greater determinant than trade flows.  The latter is forced to adjust to the former.

This global imbalance of capital flows can be problematic in a number of key ways.

1. If the US private sector responds to foreign demand for its assets by issuing too much debt that ends up funding unproductive investment, this risks a level of leverage that threatens financial stability and long-term economic growth.  As witnessed before the Great Financial Crisis, global demand (capital inflows) for US mortgage securities set the circumstances for the US housing and consumption bubble and bust.  In the bust, a legacy of unproductive/wasteful and excessively risky investments as well as a debt burden are left to remind us of the pitfalls of too much private sector and financial leverage. 
2. If the US government reacts to foreign demand by increasing treasury issuance to fund socially productive investment or tax cuts, absent faster NGDP growth, the US debt/GDP ratio may rise to a level that is political unacceptable.  Although the US government does not have a solvency constraint, the post-recession period has demonstrated that policymakers are unwilling to engage in an extended period of fiscal expansion even in the presence of idle resources and an output gap.  Should Trump successfully convince the Republican Party to fund socially productive investment or tax cuts for those with the greatest marginal propensity to spend (middle class and poor), the US may be on the cusp of a better growth trajectory.  On the other hand, cutting taxes on the already wealthy may not necessarily result in enough growth in domestic activity to justify such a skewed fiscal program.  Any attempts to offset tax cuts that increase the share of income going to the top percentiles of the income distribution by cutting social spending on the lower end will work to exacerbate already lackluster GDP trends.  This is because income and wealth inequalities that can't be channeled productively force up the savings rate at the top of the distribution while causing the savings rate at the bottom to decline.**
3. If neither the public nor private sector take on a greater degree of leverage to accommodate the foreign sector's demand for US issued dollar assets, as mentioned above the domestic economy is at risk of experience a chronic period of inadequate spending and income growth.  The near exclusive use of monetary policy in the developed world since the crisis has failed to gain as much traction as once expected in large part because the private and public sectors have been reluctant to releverage.  The rise of Trump and populists globally suggest that a prolonged period of feeble growth and elevated underemployment that leaves too many feeling disempowered and hopeless is not a politically sustainable equilibrium.

It's also important to note that both a private credit boom (#1) and rising unemployment (#3) precipitates a drop in the private sector savings rate.  Therefore, to avoid excessive private sector leverage while maintaining a politically acceptable level of treasury issuance (however misguided the latter goal arguably is), this global imbalance must be dealt with for global growth to rebound sustainably.  Ironically, this requires more global coordination and communication, not less.

In this excellent post, The US shouldn’t blame Mexico for “losing” at trade — it should blame Germany, Matthew C. Klein explains why.

American (and British) “profligacy” is simply the result of the rest of the world’s unwillingness to spend more. Foreign savings rates depend on Anglo dissavings, particularly the willingness of the Anglosphere countries to sell claims on their future income to foreigners. 

From this perspective, any negotiator committed to putting “America first” should focus exclusively on those countries with the largest current account surpluses, since those are the ones putting the most pressure on America’s trade balance and those making it harder for American households to save. Moreover, negotiators should be pressuring those countries to make policy changes that would increase the purchasing power of their domestic consumers, since that’s the most durable and effective way to aid American exporters and reduce the importance of debt.

A better framework would replace the myopic focus on bilateral trade balances with an understanding of global trends in saving versus spending. This would mean ignoring Mexico, focusing somewhat less on China, and focusing much more on the euro area, Switzerland, Korea, Taiwan, and Singapore. Importantly, solutions exist that should satisfy American negotiators while also improving living standards for many people in the targeted countries. Gains for Americans shouldn’t have to come at the expense of foreign workers.

Countries that persistently run large current account surpluses do so by using their income to purchase foreign assets rather than spend on global goods and services.  This impulse to save on aggregate rather than increase domestic spending also means that the surplus country cannot absorb the total volume of goods and services that they are capable of producing internally.  To avoid an involuntary and costly increase in inventories, this excess production must then be exported (dumped) abroad.  At the expense of current account deficit nations, surplus economies are therefore over-reliant on foreign demand to drive economic activity at home.

As the great Michael Pettis prescribes, surplus countries that have relatively anemic domestic demand should seek to rectify issues of income inequality by increasing their low household share of GDP.  This is so because both a high degree of income inequality and a low household (labor) share of income force up the savings rate.  As mentioned earlier, this need not be a problem as long as this savings ends up funding productive investment domestically or abroad.  Thus, it is when surplus economies are unable to direct savings (portfolio flows) by financing viable and socially useful investments that their excess savings negatively affect global economic activity.  When this is not possible or worse when excess savings ends up financing a debt fueled asset boom, it is preferable for surplus economies to institute policies that boost their household sector's share of aggregate income instead.  In increasing the household share, this causes household consumption as a percentage of GDP to rise and the economy to rebalance.

Counterintuitively (given the present protectionist mood), solutions that actually promote the improvement in living standards of foreigners would not only elevate their standing, but also provide the US economy with a new source of employment boosting demand.  Since exports are a function of foreign demand, for the trade deficit to close the US requires that the global community rebalance in a way that boosts their consumption spending.  In doing so, this should usher in a global environment that is more conducive to the sale of US tradable goods.  Importantly, although labor-saving automation has and will continue to play a role, a globalization that produces rapidly rising wages in developing countries should help restore labor bargaining power and wages in developed economies.  Tighter global and domestic labor markets lessen the ability for multination corporations and domestic producers to suppress wages by engaging in global and interstate labor market arbitrage.

To the unfortunate determinant of the US and global middle class and poor, a nationalistic protectionism that sees other countries as adversaries instead of allies makes this mutually beneficial geopolitical alternative unlikely.  In the long term, the Trump administration's antagonism may even cost US firms the opportunity to partake in what (hopefully) will one day be a recovering market in Europe as well as China's potentially rising consumer economy.  Moreover, by pitting domestic workers against their foreign counterparts, Trump's ideology impedes global labor's ability to unify under the common goal of improving living standards for all labor dependent households (minimum international labor standards).***  What is needed then is for the beneficiaries of globalization to remake it in a way that more greatly empowers rather then exploits their populations before it's too late.

The global financial system has been unable to channel global savings toward productive investment.

To reiterate as long as a current account deficit (trade deficit) is used to finance an expansion of productive investment, then global trade bolster's the deficit economy's present and future output capacity.

Michael Pettis' essay, Is Peter Navarro Wrong on Trade?, highlights this (the whole piece is a must read),

The latter case describes the economic history of the United States during much of the nineteenth century. At least partly because of its very unstable financial system, American savings were too low to fund the economy’s very high investment needs. Fortunately, Americans had access to substantial British, Dutch, and other European savings, and as these countries exported their excess savings to the United States, the United States ran both a capital account surplus and the necessary trade deficit—using the former to purchase foreign-produced capital goods or commodities or, when used to purchase foreign consumer goods, to free up domestic income to fund investment. The bigger the trade deficit, the greater the net amount of capital the United States was importing, and on average the more productive investments Americans could fund. During this time, American producers got richer on European savings while European savers got richer on American productivity, and so both sides benefitted over the long run from the U.S. trade deficit.

Conversely, a situation where the global financial sector lacks the capacity to recycle the savings of one economic area toward productive investments will either cause debt or unemployment to rise in some other part of the world.  In this case, an ever increasing current account surplus becomes a drag on global growth.  In the absence of plentiful investment opportunities or a capital shortage, an elevated savings rate in a current account surplus country forces down the savings rate of the rest of the world.  This dynamic enabled the explosion of private sector leverage that eventually led to the Great Financial Crisis and a sluggish recovery characterized by years of lost output and high unemployment.

Matthew C. Klein,

Instead of financing productive investments in predominantly poorer countries, foreign savings inflated housing bubbles and sustained current consumption in America (and the UK) while propping up overvalued currencies at the expense of the domestic manufacturing base. Making matters worse, the wasteful spending was mostly financed by unsustainable private borrowing. Rising indebtedness became a substitute for income growth. (And of course things look even worse if you focus on the composition of gross flows rather than the net results.)

What matters is whether the return on the investments exceeds the cost of funding them, and whether the structure of the funding is flexible enough to handle inevitable swings in earnings.

The general problem is that there is too much money and not enough worthwhile investment opportunities. Recent upticks notwithstanding, real interest rates have collapsed because people, particularly nonfinancial businesses, are more keen on saving rather than spending. Those few places willing (or stupid enough) to borrow and spend on worthless projects have been subsidising the rest of the world while sacrificing jobs in productive industries.

Worse, an excess desire to save that drags down global spending can actually reduce planned investment.  This is so when business expansion under such state of affairs is perceived to be too risky, insufficiently profitable, or redundant relative to the expected level of future sales.  Future expectations if left unchecked can become self-fulfilling. 

Back to Pettis,

By reducing demand generated by consuming households and not replacing it with demand generated by productive investment, the net effect of the conditions that create a savings glut can easily slow the economy and even reduce productive investment. Why, after all, would a manufacturer expand her production facilities or a merchant expand his distribution network if the ultimate buyer is buying less?

Desired investment levels depend on profit expectations, which themselves depend on expected demand. If policies that transfer income from poor to rich, and so suppress consumption, don’t unleash savings into higher actual investment levels, they can easily cause instead a reduction in desired investment levels, so that paradoxically investment actually falls. What’s the point, after all, of maintaining investment levels if the ultimate clients, household consumers, can no longer consume all that is produced?

To add from Bill Mitchell:

The lesson was clear (from Greece) – the longer the recession lasts and the weaker any subsequent recovery is – the more is the likelihood that gross capital formation will deteriorate significantly, which then reduces the long-run growth potential of the nation.

This is where the world's current/capital account imbalances intersect with the present debate concerning the possibility that developed economies may be suffering through a period of secular stagnation.  Secular stagnation is the phenomena where the propensity to save (augment net worth by accumulating net assets) is chronically in excess of planned investment spending.  To prevent this post from dragging on too long, please refer to Larry Summers and this Brad Delong essay to understand how today's global imbalances could condemn developed economies to stagnation.  This is the discussion that policymakers need to have if the world is to avoid such a dire scenario. 

Focusing on bilateral trade and immigration is serving as a distraction.

Lamentably, the anti-establishment, anti-status quo social mood has been co-opted by demagogues that are seeking to retreat from international relationships in favor of a short-sighted nationalism.  This risks a systemic fragmentation that results in less effectiveness when dealing with the enduring repercussions of the Global Recession.  It makes the outcomes of the global savings and investment imbalances more uncertain and unpredictable.  Worse, this political environment has replaced cooperation/collaboration, trust, respect, and a positive-sum mutuality with divisiveness, suspicion, paranoia, and a zero-sum mentality.  This toxic mix has empowered the darkest human tendencies while punishing vulnerable people who have also been victimized by systemic exploitation.  All of the above increases the potential for a long term secular stagnation that will dangerously reinforce political instability and social turmoil.

Let's not debate immigration

In fact, there’s a positive reason not to want a debate about immigration. Ms. Cooper is an economist and so should know that everything carries an opportunity cost. And the opportunity cost of debating immigration is high. Our time and cognitive bandwidth is limited, so time spent debating migration is time spent being silent about other questions.

From this perspective, debating immigration serves a reactionary function, as it silences debate about another question: is capitalism today best serving people’s interests? Debating immigration encourages the idea that immigrants are to blame for stagnant real wages and poor public services, and deflects attention from the possibility that the causes of these lie instead in secular stagnation  

The world is in desperate need of global leaders that are willing to practice a form of enlightened self-interest that refrains from placing blame on the vulnerable and instead returns focus on how to improve living standards for as many people as technologically feasible.  When it comes to this endeavor, human beings are not short of good ideas even (especially) if their adoption may require that we discard outdated theories.  Let's get back to debating them in hopes of making such lofty goals not only imaginable but attainable.  It begins by believing that such progress is possible even when faced with the prospect of social, economic, and political upheaval.

• The US government should satiate the global community's desire to save by issuing sovereign securities to fund socially useful investments that enhance the economy's productive capacity (a return to actual full employment policies via job guarantee/labor force attachment programs as well as greater public financing of infrastructure, education, healthcare, social security, R&D).
• Nations running persistent current account surpluses should seek to rebalance by increasing their household income and consumption share of GDP.
• Major central bank policies must accommodate rather than offset the above adjustments preferably by instituting NGDP place level targets.  Crucially, global central banks should allow unemployment to reach much lower rates before thinking about tightening.  Not doing so keeps labor's bargaining power excessively weak which exacerbates the deficiencies in aggregate demand.  

*The above post uses the following accounting identities to make points.
GDP = Consumption + Investment + Government Spending + Net Exports
Current Account Surplus = Capital Account Deficit
Exports – Imports = Savings – Investment
Exports > Imports = Savings > Investment = Current Account (trade) Surplus
Savings > Investment = Consumption < Investment
Consumption < Investment = Exports > Imports (excess unconsumed domestic production from investment is exported abroad)

**Part of the financial assets of wealthy households are simultaneously the liabilities of those lower on the income/wealth distribution.  In other words, the wealthy finance the spending of the poor through the expansion of credit.  As income is diverted to rich households that have a lower marginal propensity to spend, credit at the lower end replaces income growth.  This helps maintain the pace of nominal GDP particularly when business and public expenditures are weak.  As witnessed during the GFC, there are limits to household credit driven NGDP expansions.  Without a domestic credit boom, greater foreign demand, higher rates of investment spending, rising income inequality negatively affects economic growth.

*** Also see: If you’re going to border-adjust a carbon tax, why stop there?

If “border adjustment” is appropriate for discouraging pollution, why shouldn’t it also be used to uphold labour standards? What’s the point of having minimum wages, protections for collective bargaining, and occupational safety requirements if the jobs are just going to be offshored to countries — often less-than-democratic ones — with different priorities?

Again, consider China, which, while far from unique, is the most striking example of a country that complemented its natural advantages as an export base with policies directly contrary to the values championed by its biggest export markets. Among the most egregious of these policies is the hukou system, which has the practical effect of depriving many Chinese workers of legal rights and economic benefits they are theoretically owed if they happen to have been born in the “wrong” part of the country."

"Besides encouraging Western companies to relocate manufacturing — and research — to China, this also had the effect of suppressing Chinese demand for imports, which in turn put pressure on America and many European countries to goose their own domestic spending with unsustainable household debt booms.

In other words, this was bad not just for the relatively small proportion of Americans and Europeans who competed with Chinese manufacturers, but for the world as a whole. The analogy to greenhouse gas emissions isn’t particularly hard to draw.

So while it may not be obvious how governments committed to ensuring basic standards for their own citizens should border-adjust these forms of “social dumping“, the arguments for doing so are just as reasonable as the arguments for border-adjusting taxes on environmental pollutants.