Magazine December 5, 2016, Issue

A New Trade Consensus

Reduce deficits and don’t forget about the workers

President-elect Donald Trump has shown Republicans how to forge a new electoral college majority by energizing blue-collar voters. His victory, with its demands to restrict trade and immigration, also marks the end of free-market advocates’ control over the Republican party. But there is a way that these advocates might find common ground with blue-collar Republicans to accelerate wage growth, better fund looming pension benefits without tax increases, and defeat the next iteration of liberalism.

Republicans have always been a coalition of voting minorities, and their share of the vote has been slowly shrinking as the country’s demographics have shifted. Trump’s blue-collar voters offer the GOP a way to enlarge its base. It won’t be easy, however, to find common ground between Trump supporters and traditional free-market Republicans.

As growth has slowed and government spending has reached historic highs, it’s no surprise that the beneficiaries of government policies — workers, retirees, newly arriving immigrants, and the poor — have started competing with one another for benefits. Tea-party Republicans want spending cuts to ensure the solvency of their pensions. Blue-collar Trump voters want restrictions on trade and immigration to raise their wages. Both factions fear that government spending slows growth.

It would be easier to find common ground if free-market advocates recognized that an abundance of low-skilled workers can slow wage growth in an economy with constrained resources. Most economists assume that the amount of capital invested per worker largely determines productivity and that productivity determines wages. From this perspective, an abundance of low-skilled workers doesn’t slow wage growth when savings don’t constrain GDP growth.

But in today’s knowledge-based economy, capital no longer drives productivity. Companies such as Google can scale to economy-wide success without much capital. Properly trained talent and the economy’s capacity and willingness to bear risk now constrain growth, while savings sit unused despite near-zero interest rates. An increase in low-skilled workers spreads constrained resources — talented supervision, for example — over a greater number of workers. This slows productivity and wage growth, because low-skilled workers don’t add to constrained resources in proportion to the demands they place on them.

When manufacturers move plants to Mexico, most economists are confident that opportunistic risk-takers will reemploy displaced workers and that competition between employers will increase investment, productivity, and wages. But properly trained talent has moved to Silicon Valley and outsourced blue-collar employment to Asia, while the engineers who remain design products and factories that increase the productivity and wages of Mexican workers. This brain drain slows low-skilled American productivity and wage growth; it is no surprise that the wages of displaced manufacturing communities have been stagnant for decades.

Meanwhile, 40 million foreign-born adults and their 20 million native-born adult children, including 35 million predominantly low-skilled Hispanic adults, depend on the same limited pool of talented supervisors and job creators to raise their wages. With these constraints on growth, an increase in low-skilled employment puts downward pressure on wages.

Struggling workers want America to deploy its constrained resources in their behalf and not in behalf of newly arriving low-skilled immigrants and offshore workers. They want high-paying jobs, not handouts. And retiring Baby Boomers, who are expected to increase government spending by 9 percent of GDP over the next 30 years, want reassurance that their pensions will be paid. To dismiss these concerns as racist underestimates their legitimacy.

Despite Trump’s good intentions, America can’t maximize prosperity and remain competitive by manufacturing something for $20 that it can buy for $2. It must trade with low-wage economies. Like innovation, trade increases prosperity by lowering the cost of goods. If displaced workers couldn’t find work at higher wages than the now-lower cost of imported goods, the goods wouldn’t be cheaper to manufacture offshore. Trade necessarily lowers the cost of goods more than wages, which makes the economy richer as a whole.

But low-skilled workers bear 100 percent of the cost of lower wages, while high-wage workers, retirees, and the non-working poor capture a large portion of the value of cheaper goods. Given this imbalance, it’s unclear whether trade benefits low-skilled workers. Anyone claiming to know is either naïve or disingenuous. But given the value of trade, it would be wise for blue-collar Republicans to accept compensatory income redistribution through progressive taxation rather than demanding heavy protectionist restrictions.

Nevertheless, workers needn’t endure perennial trade deficits, which reduce the demand for low-wage work, for the country to enjoy the benefits of trade. Trade deficits occur when countries such as Germany lend the U.S. economy the proceeds from the sale of goods to Americans, rather than using them to buy goods made by American workers. To prevent trade deficits from reducing the wages and employment of lower-skilled workers — the economy can always achieve full employment at lower wages — Americans must borrow and spend these savings. But today, savings sit unused despite near-zero interest rates, putting downward pressure on wages as they accumulate.

We could eliminate trade deficits by issuing a dollar of import licenses for every dollar of exports and allowing licenses to be traded freely. Such a simplification would minimize the discretion of policymakers by eliminating the need for tariffs and quotas, which are impossible to manage effectively.

It’s worrisome to give policymakers limited control over trade, but trade deficits may be worse. Economics teaches us that the first dollars of imports are much lower-cost than American-made goods; the last dollars, however — imports in excesses of exports — are virtually the same cost as American-made goods. Were that not the case, we would continue to buy cheaper offshore goods. For little additional benefit to consumers, we allow the rest of the world to dump its unused savings onto America at great cost to low-skilled employment and wages, growth, the stability of banks, and the efficacy of monetary policy. In turn, slow growth inflames demands to increase government spending, restrict free trade, and repudiate an unsympathetic and uncompromising establishment — so much so that these sentiments have overtaken the Republican party. Balanced trade would help mitigate these grievances.

In addition to eliminating trade deficits, we could lower corporate taxes to make America a more competitive place to create jobs, increasing demand for employment and putting upward pressure on wages. We could also increase the ratio of high-skilled to low-skilled workers. Talented innovators, entrepreneurs, and supervisors create employment and increase productivity, which also puts upward pressure on wages.

Restricting low-skilled immigration would achieve this effect, but it would also reduce production and slow growth. A more effective policy would recognize that the cost of retiring Baby Boomers, China’s eventual military threat, and federal debt at 75 percent of GDP necessitate faster growth than America can achieve organically. Doubling the number of full-time, 95th-percentile, ultra-high-skilled workers from 5.5 million to 11 million might double America’s growth rate and tax revenues. Unlike most other taxpayers, these workers pay significantly more in taxes than they consume in government services. With America already issuing over 1 million green cards per year, a doubling is achievable. By refusing to replace low-skilled immigration with ultra-high-skilled immigration, Democrats have squandered America’s most significant opportunity for growth. Republicans must capitalize on this forgone opportunity.

Every faction of the Republican coalition must recognize that, in the next election, Democrats will compete fiercely for the blue-collar voters they have neglected. To build an enduring alliance with these new Republican voters, free-market advocates must find common ground with them and use it to both accelerate wage growth and increase tax revenues without tax increases. A thoughtful plan needn’t alarm voters who want their president to unite a divided country.

Mr. Conard is a visiting scholar at the American Enterprise Institute, a former partner at Bain Capital, and the author of The Upside of Inequality: How Good Intentions Undermine the Middle Class.

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