The Trade Balance, Free Trade, and Energy

Obama had a bad week at the G20.  He was rebuked by Western leaders on the weak dollar consequences of QE2, and he failed to secure a Trade Agreement with South Korea.

There is something not terribly compelling about a trip to India, Indonesia, Japan, and South Korea, and pitching these countries on expanding exports from the US to create US jobs.  After the pummeling he received back home, it feels like our President got his audience confused.  Furthermore, Tea Party influence (and an honest assessment of the facts on the ground) is beginning to raise fundamental questions about the net benefits of our free trade dogma in the first place.  We should understand that all of economics is up for re-examination.

Before the “FREE TRADE – PROTECTIONISM” shouting really gets started, let’s give the subject the fresh thinking it deserves.

First a review of the big picture:  The trade deficit was $375 billion in 2009, down from $700 billion the prior year.  The deficit appears to be up about 40 percent so far in 2010.  In recent years, the US has exported about 5 million manufacturing jobs overseas, a consequence of globalization.  Conventional wisdom focuses on China as the problem, with their weak currency policy.  The Obama administration appears intent on increasing the heat on China, and stoking our competitive juices to rev up our export engine, with the aid of some fresh trade agreements.

Let’s try viewing the good objective of balanced trade through a fresh lens.

Point one:  If you want to tackle our trade deficits, focus on energy.  Crude oil is by far our largest import, $340 Billion in 2008, or half the trade deficit, dwarfing other sectors.  The drop in oil prices explains most of the drop in the trade deficit in 2009, as do higher oil prices in 2010 explain the subsequent deficit increase in 2010.  US oil production peaked in the 1970s, while our demand continued to grow, with the gap being filled by imports as this graph illustrates:

The growing volume gap is of course further amplified by rising prices. If we are serious about balanced trade, we should get serious about an energy policy that will free us from our dependence on imported oil.

Point two:  We need to re-examine the core premise of our free trade policies, the theory of “comparative advantage”.  As Herman Daly points out, when David Ricardo wrote about comparative advantage in “On the Principles of Political Economy and Taxation” (1817), he explicitly based his argument on the immobility of capital, and explained the logic of this assumption:

“Experience, however, shows, that the fancied or real insecurity of capital, when not under the immediate control of its owner, together with the natural disinclination which every man has to quit the country of his birth and connexions, and entrust himself with all his habits fixed, to a strange government and new laws, checks the emigration of capital.”

This is clearly a different world than we live in today.  With the free mobility of capital, globalization and trade is driven not by comparative advantage where everyone gains according to theory, but instead, by absolute advantage in which there are clear winners and losers, even if in aggregate, the world gains.  This is the predicament of the unemployed US steelworker or textile worker.  Let’s see reality for what it is.

Point three:  There is a complementary path to balanced trade besides competing for exports when US labor costs and stricter environmental safeguards make America “uncompetitive” with certain emerging economies.  This is the path advocated by Jane Jacobs in the Nature of Economies and other works.  It is an approach modeled on natural systems.  It understands that cities and regions are the critical organizing centers for diverse and therefore resilient, place based economies, in contrast with monoculture export driven economies.  Such economies are designed for efficiency, but lack resiliency.  Contrast the relatively resilient health of New York or San Francisco, versus the distress of the “mono-culture” auto centric Detroit.

Jacobs draws lessons from nature, in a fresh view toward development that has never been more relevant than today.  She examines the development history of healthy, place based economies, rather than blindly following theory based on faulty assumptions.  She calls for import substitution, dependent upon local demand not foreign politics, recirculating income with a higher multiplier, building a more diverse economy and therefore resiliency in the process.

If we combine these three points with the imperative to materially reduce our carbon emissions in absolute terms, and grow good quality and sustainable jobs back home, our trade policy priority becomes our economic policy priority:

It’s energy, stupid. 

Here are just the most obvious first steps:

  • Set an oil import reduction target for the next ten years.
  • Tax carbon.  Begin by bringing our gasoline tax in line with Europe and Japan.  Institute a tax on jet fuel.  Why should my mom pay tax on the gasoline for her Toyota, while Tiger Woods pays no tax on the jet fuel for his Gulfstream.
  • Engage a serious study on how to architect a fair and effective market for carbon emission rights (quotas).  It need not be a “cap and trade” recipe for Goldman and others to rip us off.
  • Eliminate the $70 billion + of subsidies for the fossil fuels industry
  • Increase subsidies, carefully, for smart renewable energy
  • Have all Federal and State government agencies follow GE’s lead and convert their fleets to electric cars.  Demand all companies do the same or lose the deductibility of car expenses.
  • Increase subsidies for electric car critical components and the light weighting of cars as per Amory Lovins.
  • Get serious about mileage standards.  A Chevy Suburban is a “car”.
  • Increase subsidies to community development and other financial institutions to fund labor-intensive energy efficiency conversions.