Trade Agreements or Boosting Wages? We Can’t Do Both

It’s widely expected that in tonight’s State of the Union address President Obama will call for actions to boost wages for low- and moderate-wage Americans, and also for moving forward on two trade agreements—the Trans-Pacific Partnership (TPP) and the Trans-Atlantic Trade and Investment Partnership (TTIP).

These two calls are deeply contradictory. To put it plainly, if policymakers—including the President—are really serious about boosting wage growth for low and moderate-wage Americans, then the push to fast-track TPP and TTIP makes no sense.

The steady integration of the United States and generally much-poorer global economy over the past generation is a non-trivial reason why wages for the vast majority of American workers have become de-linked from overall economic growth. This is not a novel economic theory—the most staid textbook models argue precisely that for a country like the United States, expanded trade should be expected to (yes) lift overall national incomes, but should redistribute so much from labor to capital owners, so that wages actually fall. So, it can boost national income even while leaving the incomes of most people in the nation lower than otherwise.

The intuition on how is pretty easy. Take the most caricatured example of how expanded trade works: the United States produces and exports more capital-intensive goods (say airplanes) and imports more labor-intensive goods (say apparel). By focusing on what we’re relatively better at producing (capital-intensive airplanes)and trading this extra output for what our trading partners are relatively better at producing (labor-intensive apparel), we can see national incomes rise in both countries. This specialization in the United States requires shifting resources (i.e., workers and capital) out of apparel production and into airplane production. But each $1 in apparel production lost requires more labor and less capital than the $1 in airplane production gained—causing an excess supply of labor and an excess demand for capital. Capital’s return rises while labor’s wage falls.

Taking standard trade models and plugging in U.S. data yields the conclusion that expanded trade has reduced wages for American workers without a 4-year college degree by enough to lower the annual earnings of full-time, full-year workers by roughly $1,800. And this is an annual loss—it will repeat (or even grow, if trade grows) next year and the year after. Over a lifetime of work, the effect of expanded trade is large indeed.

Other empirical work is consistent with this finding. One recent paper has shown that the decline in national income accruing to workers (instead of capital owners) is more strongly associated with expanded trade than any other influence. Another has found that wages and employment of workers without a 4-year college degree have been depressed by rising imports from our most important low-wage trading partner (China).

To be clear, there are plenty of things keeping wages down for most American workers (though the most commonly cited suspect—technological change—is actually pretty innocent), and expanded trade does not explain the majority of the wage/productivity schism. But it pushes in the wrong direction, and its weight is non-trivial. So why would policymakers who are serious about making wages rise be pushing TPP and TTIP?

Of course, we’re not even sure what TTIP and TPP will contain. And every new trade agreement (particularly those ushered through by a Democratic administration) comes with assurances that the flaws in earlier ones will be substantially corrected. This seems hugely unlikely, but just for fun, we can imagine what a useful trade agreement might look like.

Probably the most important change relative to past agreements would be a binding mechanism to keep countries from managing the value of their currency for competitive gain. The persistent U.S. trade deficit is dragging on output and employment growth and keeping full recovery from the Great Recession from happening more quickly. This deficit is, in turn, nearly entirely driven by the practice of some of our trading partners of purchasing U.S. assets (mostly Treasury bonds) to boost demand for U.S. dollars and hence boost the value of the dollar in international markets. This makes U.S. exports expensive and other nations’ imports cheap. Plenty of proposals exist to stop this currency management, and including them in a trade agreement would actually be quite useful. It’s worth noting that while such a proposal may have seemed heretical a decade ago, even former Treasury Secretary Larry Summers has endorsed it recently.

Another issue that could be hugely helped in an international trade agreement is the institution of a financial transactions tax. A tax on financial transactions would raise substantial amounts of revenue in a progressive fashion, and would have the potential of squeezing out low-value financial transactions that generate fees for the industry without adding economic value. The number one argument mobilized against a financial transactions tax is that any given country should not (or even cannot) institute one on their own without seeing their domestic financial industry flee to countries without such a tax. A trade agreement seems like the perfect instrument for harmonizing the tax across borders to keep this destructive tax competition from occurring. In fact, using trade agreements to harmonize all capital income taxation would be useful—in a world with freely-moving capital, the ability of governments to tax capital owners to fund domestic priorities is strained. A trade agreement that tackled such an issue would be genuinely useful.

Another useful issue in a trade agreement would allow countries that have raised the price of emitting carbon in an effort to mitigate global climate change (either through direct carbon pricing, caps on carbon, or regulatory changes) to impose a tariff on imports from countries that do not have any  mechanism to increase the price of carbon. Such “border adjustment tariffs” are quite common—and are sometimes actually necessary to insure genuine “free trade” (ie, non-discrimination between domestic and foreign producers).

Why do I have such little faith that any of these (or any other) potentially useful planks will be part of TTIP or TPP? Because every other trade agreement in recent decades has first and foremost put low- and moderate-wage U.S. workers in direct competition with the global labor force while carving out protections for capital-owners and executive managers. Given this history, it is just hard to see how moving aggressively on trade promotion authority, TTP, or TTIP fits in at all with an economic strategy that aims to boost wages for most American workers.