Latest Government Findings Show that the U.S. Trade Deficit May Increase More Under the Korea FTA Than Was Previously Thought
As the New York Times reported in December, the government’s official projections show that the Korea FTA will increase the U.S. trade deficit. “The study was conducted in 2007 by the United States International Trade Commission, an independent agency that analyzed the effect of imports on the American economy, after the Bush administration negotiated the original agreement with South Korea.”
(In fact, the original study – released in September 2007 – found that the U.S. global and bilateral trade balance would improve with the Korea FTA. However, the USITC found an error in the intervening years, and released a corrected version in March 2010 that found a worsening of the U.S. global trade balance.)
But the December 2010 supplemental deal negotiated by the Obama administration – which lengthened the tariff phase-out period for certain autos and trucks but did not change the fact that the tariffs are ultimately eliminated – does not alter these findings. That is because the USITC model looks at the change in trade flows when the agreement is fully implemented and tariffs are fully phased out. Given that the supplemental agreement did not alter ultimate tariff elimination, but only altered timelines for cuts, it did not alter the USITC findings of an increased U.S. trade deficit.
Enter new unofficial USITC Numbers…
Sen. Ron Wyden’s (D-Ore.) office released numbers today that it describes as coming from USITC staff economists – but not from the USITC itself. (More on this below.) While the numbers at first glance appear to paint a rosier picture, a closer look reveals that – like the March 2010 numbers – the U.S. trade deficit is projected to worsen.
In two new projections, the Korea FTA may lead to a larger increase in the U.S. trade deficit than under the 2007 official USITC study. Whereas the old numbers showed an increase in the U.S. trade deficit of $308 million to $416 million, the new numbers show an increase in the U.S. trade deficit of $297 million to $486 million. In other words, two scenarios are possible – and both show the FTA leading to an increase in the U.S. trade deficit. Under one of the scenarios, the trade deficit is actually $70 million higher than under the USITC’s previous estimates.
The original USITC study of the Korea agreement – as well as the new numbers – indicate that jobs may be lost in many high-wage industries, including auto manufacturing and electronics manufacturing. The average hourly earnings of workers in the electronic equipment manufacturing industry, projected to lose a significant number of jobs, were $30.38 in 2008. This was 40.5 percent greater than the average hourly earnings of all workers employed in the private sector.
The report Sen. Wyden requested from the USITC staff predicts large rises in the trade deficit in several sectors, totaling up to $2.1 billion for motor vehicles and parts, other transportation equipment, electronic equipment, metal products, textiles, apparel and iron-containing metals. Table 1 displays the predicted trade balance changes in these sectors, which do not differ greatly from the predictions in the official USITC reports on the Korea FTA.
The original USITC study developed ranges for the statistically likely FTA effects, or “low” and “high” estimates. The new numbers, however, reflect instead the scenarios of fixed wages or fixed labor supply, as we discuss below. Several sectors actually fare worse under the new projections than under the old USITC numbers. For instance, the motor vehicles sector was projected to experience a deficit of $531 million to $708 million under the original USITC study. Under the new numbers, the car sector sees an increased deficit of at least $548 million – at least $17 million higher than the low estimate. Or take the electronics sector. Under the old USITC numbers, the sector was projected to experience a deficit of $762 million to $790 million. Under the new numbers, the sector is projected to experience a deficit of $782 million to $812 million. This is an increase in the projection of losses of around $20 million.
Why These Numbers Look Different Than Those Presented in the Top Line of Wyden’s Memo
The first few pages of the Wyden memo paint a different picture than that above, stating that the new projections show the FTA increasing U.S. exports of goods to Korea by $11 billion, and increasing U.S. imports from Korea by about $7 billion – leading to an improvement in trade balance. Given that the fundamental question is what the Korea FTA would mean for America’s trade balance and thus jobs, it is worth understanding the seemingly conflicting data in the report.
At first glance the Wyden memo seems to suggest that the U.S. trade balance in goods (also known as merchandise) will improve by about $5.6 billion because this is the projected change in the bilateral trade balance with Korea. (These results can be derived from the bilateral trade flow numbers in Tables 2.A and 2.B)
However, due to the way that bilateral trade pacts affect global trade flows, the Korea FTA’s results for overall U.S. trade balance in goods are dramatically different from the change in the bilateral balance with Korea.
To get the global numbers, one needs to look at Tables 3.A and 3.B. Subtracting the import figures from the exports figures reveal that the Wyden memo predicts the total U.S. trade deficit in goods will increase by between $297 million to $496 million under the FTA. This finding in sum is that the effect of trade diversion on U.S. exports is greater than the effect on U.S. imports, so the U.S. trade balance with the world (including Korea) will worsen after the FTA goes into effect, but the balance with Korea alone improves. The bottom-line USITC finding of an increased U.S. trade deficit contradicts Obama’s stated purpose for passing the FTA – to promote his goal of doubling exports to create two million jobs.
Unorthodox Assumptions Guide Latest Findings on Korea FTA
As Nobel laureate Paul Krugman has written, basic macroeconomic principles suggest than an increase in the trade deficit will lead to a loss of jobs: “If you want a trade policy that helps employment, it has to be a policy that induces other countries to run bigger deficits or smaller surpluses. A countervailing duty on Chinese exports would be job-creating; a deal with South Korea, not.”
However, the latest USITC finding projects that – under one scenario – an increase in the trade deficit will be associated with a gain of 280,000 jobs. This seemingly implausible outcome is a function of the underlying assumptions of the USITC economists’ modeling. Under the USITC’s standard modeling, they hold the supply of labor fixed, but allow wages to vary.
(This is the long-standing standard practice in the economics profession. “Protection and Real Wages,” the 1941 seminal work by Wolfgang Stolper and Nobel laureate Paul Samuelson, used a fixed labor assumption, which the authors characterize as “the conventional method of comparative statics.” The two free traders’ study, incidentally, found that trade liberalization would be likely to lower the wages of U.S. workers. )
The latest report goes against the USITC best practices by inverting these assumptions: wages are held fixed, but jobs are allowed to vary. Senator Wyden’s office explains this methodological decision thusly: “The U.S. economy has changed significantly since 2007 [the date of the original study]. Since then, the U.S. suffered a severe financial crisis and one of the worst economic recessions since the Great Depression. The current unemployment rate – which hovers around 10 percent – contributes to the souring of the national mood toward trade. … For these reasons, we requested that ITC staff with economic modeling skills provide quantitative technical assistance examining the agreement based on current data and economic conditions. The ITC staff then conveyed these quantitative results to the staff of the Senate Committee on Finance’s Subcommittee on Trade. We (the staff of the subcommittee) find that these results show that, in an economy with substantial unemployment and underused capital, the agreement has the potential to create about 280,000 American jobs, but that job growth would be uneven among states and across industry sectors, with some sectors losing out while others benefit.”
Okay, fair enough. But keep in mind that the ITC study projects what the employment impact will be in the long-term. Do he ITC economists believe that we’ll continue to have 10 percent unemployment 20 years from now? If so, that definitely is much more newsworthy than whatever the president plans to say in the State of the Union tonight.
This deviation from organizational practice may be one of the reasons that the USITC is going out of its way to distance itself from the findings, inserting a footnote into their new study that states: “Material presented in Sections II and III was prepared by staff of the Office of Economics of the U.S. International Trade Commission (USITC or Commission) in response to requests by staff from the Senate Finance Trade Subcommittee, and does not reflect the views of the Commission or Commissioners. The technical assistance is not an official Commission document and if referenced, it should be referenced “work of the staff of the USITC: not a Commission-approved document.””
Modified USITC Analysis Replicates Flaws of Corporate Studies
Table 11 of the Wyden memo breaks down the jobs impact of the “fixed wage” scenario. A close look reveals that 223,000 (81 percent) of the projected 280,000 job gains come from the services sector. This replicates a serious problem from a pro-FTA corporate study.
In a May 2010 study, the U.S. Chamber of Commerce utilized a CGE model to project job gains. Their model is deficient in the way that it deals with the service sector. The study finds that the vast majority of employment gains from FTAs is in the services sector. Of the 5.4 million jobs gained from FTAs, according to the Chamber, 4.8 million, or 88 percent, are in the service sector. This is despite the fact that reliable quantification of the impacts of FTA service provisions (since there are no services tariffs) and of services trade are widely recognized as inadequate. The model shows only 379,000 manufacturing jobs gained from FTAs, so it claims that FTAs support 12 times as many services jobs as manufacturing jobs. Yet, the Chamber finds that FTAs boost U.S. services exports by only $20 billion. Although there are some cross-linkages between the production of goods and the provision of services, only $4,200 in annual services exports was created by the implementation of the FTAs for every services job created by FTAs, according to the Chamber.
The U.S. Department of Commerce, by contrast, has found that only 2.8 million jobs are supported by total U.S. services exports to all countries, and that each of those jobs are supported by $203,000 in annual services exports. In other words, the Chamber’s estimate of the number of jobs created by the implementation of FTAs alone is 73 percent greater than the Department of Commerce’s estimate of total services jobs supported by all U.S. services exports. These huge discrepancies between the Chamber’s estimate of the employment effects of services trade and the Department of Commerce’s estimate raises serious questions about the validity of the Chamber’s analysis.
The Chamber’s large estimate of the impact of FTAs on services employment is partially based on the notion that FTAs substantially reduce the cost of providing services internationally, thereby promoting greater trade in services and creating U.S. jobs. However, an analysis of services exports to FTA and non-FTA partners casts doubt on this thesis. The U.S. government only releases data for U.S. services trade with 34 countries (generally the most important U.S. services trade partners), but the available data can be used to infer broad trends in the growth of exports to FTA and non-FTA partners.
Over 1998-2008, U.S. services exports to the FTA partners for which there are data (Canada, Australia, Chile, Israel, Mexico, and Singapore) grew at an average annual rate of only 5.5 percent, while U.S. services exports to non-FTA partners as a whole grew at an average annual rate of 5.7 percent. The “FTA export growth penalty” for services holds true starting in the NAFTA era as well: between 1993 and 2008, U.S. services exports to FTA partners as a whole grew at an average annual rate of only 3.2 percent, while U.S. services exports to non-FTA partners as a whole grew at an average annual rate of 4.0 percent. Given that U.S. services exports to non-FTA partners are growing faster than U.S. services exports to FTA partners, it is hard to understand how the Chamber found such a large positive effect of FTA implementation on U.S. services trade and employment.
In other words, the projection of service sector job gains in the Wyden memo is based on flawed modeling, and leads to the implausible result that 81 percent of the jobs gains from the Korea FTA would come in the services sector even though the model does not account for changes in services trade barriers.
Arguments Against General Equilibrium Modeling in Examining Trade Policy
There are several reasons to seriously question the methodological basis of the latest numbers from ITC staff economists.
First, few policymakers would be comfortable with either assumption of economic modelers (i.e. holding either wages or jobs fixed), whose predictions have a poor past record. Indeed, past USITC projections have been overly optimistic. For example, a 1999 USITC study using roughly the same model estimated that China’s WTO accession tariff offer would increase the U.S. trade deficit with China by only $1 billion dollars. In reality, the trade deficit with China skyrocketed by $167 billion between 2001 and 2008. Although China’s WTO accession alone (and the favorable trade treatment that came with it) likely did not cause the entirety of the huge rise in the deficit with China, it almost certainly contributed more than the ITC’s projected $1 billion dollars.
Second, and because of this track record, many analysts are turning to empirically based methods that have a firmer grounding in reality. For instance, a study by the Economic Policy Institute examined the U.S. historical experience with major changes in bilateral trade policy – namely changes in trade flows with Mexico and China after NAFTA implementation and Chinese World Trade Organization (WTO) accession, respectively. It used this as a basis to determine the likely impact of the Korea FTA on trade flows and jobs. EPI found that implementation of the Korea FTA would boost the U.S. trade deficit with Korea by $13.9 billion over the next seven years. This rise in the trade deficit, in turn, would cost the U.S. economy about 159,000 net jobs. This is equivalent to losing 90 percent of the manufacturing jobs in Detroit.
Public Citizen conducted a similar exercise in our report “Lies, Damn Lies and Export Statistics: How Corporate Lobbyists Distort Record of Flawed Trade Deals,” available at: http://bit.ly/bx3JJn. Examining the relative export growth record to the broader set of America’s 17 FTA partners, we found that American exports to FTA countries have on the whole grown at less than half the pace of U.S. exports to countries with which we do not have such pacts. If the difference between the FTA and non-FTA export growth rates for goods for each year were to be put in dollar terms, the total U.S. FTA export “penalty” would be $72 billion over the past decade.
True, these studies examine a relatively small sample. But the very fact that they don’t engage in questionable modeling assumptions may put them on firmer footing than the numbers produced by USITC staff economists.
Indeed, this empirically based work echoes the findings of trade negotiators. The Korea pact’s chief negotiator, Ambassador Karan Bhatia, offered a frank assessment while he served as President George W. Bush’s deputy U.S. trade representative. In an October 2006 speech to a Korean audience, Bhatia said that it was a “myth” that “the U.S. will get the bulk of the benefits of the FTA.” He went on to say, “If history is any judge, it may well not turn out to be true that the U.S. will get the bulk of the benefits, if measured by increased exports.” He added that, in the instance of Mexico and other countries, “the history of our FTAs is that bilateral trade surpluses of our trading partners go up,” meaning that the U.S. trade deficit with those countries increased.