Global Economics and Management

The Trump Tariffs on Autos

I am reading this WSJ article with dismay. Tariffs of this magnitude in a sector with such a high share of imports and such an important place in consumer expenditures (about 15% of consumer expenditures go to vehicle purchases or leases) are bound to be highly disruptive. Auto tariffs will lead to higher prices and lower sales, resulting in themselves in a possible recession. Combine them with the other tariffs being contemplated, and the effects could be nothing short of catastrophic.

But I am thinking that perhaps we need these tariffs now. Maybe they should be 50%, or 100%. It is only by clearly demonstrating the massive costs of protectionism that we will remember the enormous benefits of globalization. Humans are not good at reasoning through the consequences of policy. They need to experience them. So let's experience them, and be forever after vaccinated against the folly of protectionism.

Brad Setser opines, and his analysis seems just right to me.

Adair Turner on Global Warming

One of my favorite podcasts is the Financial Times' "The Economics Show". The guests are invariably excellent, the podcast is relatively short (at about half an hour) and it is packed with insights. I can't think of a better companion podcast to the Global Trends course.

In one of the recent episodes, the great Martin Wolf speaks to Adair Turner, who "chairs the Energy Transitions Commission, a think-tank focused on climate mitigation, and was previously the first chair of the UK government’s committee on climate change in 2008-12" (according to the podcast introduction). In this episode, the host and his guest discuss the effects of Donald Trump's election on the energy transition and the move away from carbon-based energy sources. It is expected that the Trump Administration will pursue much less aggressive carbon abatement policies. This causes Adair Turner to speculate that global carbon emissions may not be curbed are aggressively as would be the case otherwise - not just because of the direct effect on US emissions, but also because of knock-on effects on other countries who may be less willing to reduce emissions in the absence of strong US leadership on the issue.

Yet not all is cause for concern. Much of the energy transition comes from technology, not policy. And on this front, there are many reasons to be less pessimistic. The great march of technology is already responsible to the bending of the curve of carbon emissions in several countries - not least the US, where they peaked in 2007. Indeed carbon emissions fell during the first Trump administration (see the graph below, from the US EPA). This was not, of course, caused by policy during those four years - it occurred despite policy. If you are worried about climate change, you should continue to care about US policy of course, but you should focus more on what is happening in countries that are in the intensive phase of their growth process. There, in the race between technology and carbon emissions, carbon emissions are still winning. In the US, technology is winning. The real issue is whether all this will be enough to prevent warming by more than 2 degrees Celsius, which is when the most dramatic effects of climate change would be felt. The podcast discusses possible scenarios.

Source

Twin Deficits

Tomorrow, in our penultimate session of Global Trends, we will discuss global imbalances. Much of our discussion will center on domestic public debt. But much of the policy discussion around imbalances is concerned with external debt. What often escapes the attention of commentators is that the two are fundamentally linked. The concept of twin deficits helps illustrate why.

In the online lecture I spend a bit of time going over national accounts identities. This can be painful, but you will be well-served, in your careers, by some familiarity with how macro aggregates like GDP, consumption, savings, imports, exports, etc., are defined and measured. So that's why I do it. But as with everything in economics, it is a lot easier to understand what is going on if you step back and think of these concepts in intuitive terms. 

When a country spends more than it produces, it runs a deficit. That's easy to grasp. What's production? The answer is GDP - the total value added by an economy every year. What's spending? Well, a dollar of production can be consumed, invested, or spent by the government (econ nerds call the sum of these absorption). The difference between production and spending is either a deficit or a surplus. If a country spends more than it produces (like the US), it runs a deficit. By definition, that means it must import more stuff than it exports (there are positive net imports). If a country runs a surplus (like China), that means that it produces more than it spends, and so of course the difference must be positive net exports - or a current account surplus.

Spending more than you produce sounds great. We value spending. But it comes at a cost: since a deficit country is a net importer, it must borrow from the rest of the world. Foreigners are accumulating domestic assets at a faster rate than domestic agents are accumulating foreign assets. In the lecture I conclude that, in such a case, there is a capital account surplus. That means that foreigners are accumulating net claims on the economy. The economy is going into debt to finance all that excess spending.

We are now equipped to understand how twin deficits work. Suppose the government starts to spend more, without raising taxes. This means it is going deeper into a budget deficit. The extra government spending also feeds into absorption, since government spending is spending. All other things equal, that tends to increase the trade deficit, by the reasoning above. So there you have it, twin deficits: a government budget deficit goes hand in hand with a foreign trade deficit.

When you have persistent twin deficits, year over year the domestic public debt increases, and the country's overall foreign indebtedness also increases. That's the situation that has prevailed in the US - and in many other countries - for many years.

I mention all this because an article in the Wall Street Journal today, by Greg Ip, takes this reasoning to its logical conclusion: if you want to reduce external deficits, as President Trump wants to do, you can work to reduce the government deficit. This is a much more effective way to "stop sending billions to foreigners" than to raise tariffs. It does not involve any of the drawbacks of tariffs that we repeatedly discussed in class: inflationary effects; distortionary effects that reduce growth; retaliation from foreigners that hurt domestic producers, etc.

Note that in my discussion above, trade policy does not appear even once. While some economists think that low tariffs have something to do with a high trade deficit, most mainstream economists (including myself) have come to the reasoned conclusion that trade policy has little or even nothing to do with deficits. It's all about how much we spend relative to how much we produce. It's all about how much we save relative to how much we invest (these two statements are the flip-sides of the same coin, as slide 18 of the lecture makes clear).

Greg Ip, who is one of the smartest economics commentators active today, grasps this point at a fundamental level. You should too!

UPDATE: In loosely related news, the WSJ also ran an excellent article today on the pass-through of tariffs to prices. The main character in that story is the elasticity of demand - that all of you are of course intimately familiar with from core managerial economics! The article gives a good foundation for the quick calculation that we did in class regarding the inflationary effects of President Trump's tariff initiatives.

The Russia-Ukraine War, the United States, and the Role of Europe

This week in Global Trends, we will be discussing geopolitical developments. I called the module "The Rise of New Powers". The main theme of the session is that global risks have become more unpredictable, because of the rise of new and powerful state and nonstate powers. This has threatened the hegemony of the United States, achieved after the end of the Cold War, and resulted in a more multipolar world - organized around major powers such as the US, China, and other rising powers like India. But things are fractured and uncertain within these blocks. We discussed some of this disintegration earlier in the class when we studied the retreat from global governance that we seem to be witnessing in many domains: multilateral trade negotiations (which are failing, and even being reversed), the building of an ever more integrated Europe (which suffered the setback of Brexit and is stalled more generally), and threats to the credibility of major defense alliances such as NATO.

This week's news has been full of developments relevant to these themes. President Trump welcomed Prime Minister Modi of India to the White House. Vice President Vance gave a speech at the Munich security conference that berated European countries for their stances on various civil liberties issues, and largely ignored the elephant in the room - the Russia-Ukraine War - creating a big rift with Europe. President Trump spoke to Vladimir Putin and announced that the US would begin bilateral talks with Russia to end the conflict in Ukraine. It has since transpired that the EU (and European countries more generally) would not be invited to these talks. These events led to consternation among European political elites. The Wall Street Journal featured a great piece by Yaroslav Trofimov on the US-EU relationship. Europeans are vowing to spend more on defense, to guarantee the security of Ukraine themselves and perhaps even to reform their economies to make them stronger and more resilient. They feel that the risk of further invasions by Russia is very real. It is fair to say that for the first tine in a long while, they feel an existential threat at their doorstep. 

Some think that this will cause Europe to indeed step-up. They argue that if the events of the last week serve any useful purpose, if the blunt admonitions of the Trump Administration are to have any silver lining, it may be that the Europeans became so doubtful of US support, and so antagonized by the new administration's pronouncements, that they will wake up. Some even think that is President Trump's intent. But as both a European and and American, I have my doubts that they will. As I have often said in class, European economies are sclerotic. They spend too much and tax too much, thereby distorting their economies in ways that reduce innovation, investment and entrepreneurship, and leads to a stagnating GDP. Where will they find the resources to fund more military spending? Their demographic trends are nothing short of catastrophic, with fertility rates well below the level of replacement. They have enjoyed a free ride on the US in terms of defense and innovation, and do not seem to have the stomach to change course on either front. I was struck by Trofimov's sentence in the above article, that "Ukraine’s army today is larger and more capable than the German, French, Italian and British armies combined." Chat GPT disputes the strict veracity of this claim. But even if it is not strictly true, it is certainly plausible that military readiness in Europe is not - and can't be expected to be - sufficient to repel an attack on the Baltic States or Poland, without US direct military involvement. Getting from A to B in terms of economic dynamism and strategic readiness seems like a tall order for still-fractious EU countries. 

The case we will study, incidentally, is that of the Russia-Ukraine war. Russia, despite early setback, has been painstakingly clawing at some of Ukraine's territory, at great cost in human lives. As a very useful recent WSJ article details, the progress has been slowed lately, but Ukraine is not regaining any ground. If the Western alliance waivers, one cannot hope for a reversal of the current dynamics. The stakes for Europe are indeed enormous.

Caveats on Inequality

Today in class we will cover trends in local and global inequality. This is a highly complex topic, suffused with strong opinions and political connotations. So it is hard to have a dispassionate discussion. But we will try!

One major difficulty in the discussion of inequality trends is measurement. Pretty much any statement you make on the level of inequality or on its time path can be subject to debate and criticism. For instance, there is a raging debate on whether income-specific price adjustments would lead to higher or lower inequality. It is extremely important to be very precise in what you say here, because the topic is extremely complex. Let me give an example.

In a famous paper from 2013, Enrico Moretti, an economist at UC Berkeley, wrote: "While nominal wage differences between skilled and unskilled workers have increased since 1980, college graduates have experienced larger increases in cost of living because they have increasingly concentrated in cities with high cost of housing. Using a city-specific CPI, I find that real wage differences between college and high school graduates have grown significantly less than nominal differences. Changes in the geographical location of different skill groups are to a significant degree driven by city-specific shifts in relative demand. I conclude that the increase in utility differences between skilled and unskilled workers since 1980 is smaller than previously thought based on nominal wage differences." I like to cite this paper in support of the idea that inequality between skill groups may not have increased as much as you would think, because the rich tend to locate in places where services like housing and healthcare are more expensive.

But in a recent string of papers, LSE economist Xavier Jaravel reaches a seemingly different conclusion. In one of these papers he writes: "This paper develops a new public database to estimate inflation heterogeneity across socio-demographic groups in the United States in real time. These distributional CPIs (D-CPIs) are fully consistent with the methodology of the official CPI and are available from 2002 to the present day by household income, age, race and other characteristics. Using this database, I establish three results showing that D-CPIs have important implications for the measurement of long-run trends in inequality and poverty, as well as of real wage dynamics during crises. First, “real” inequality across household income quintiles increased about 45 % faster with DCPIs between 2002 and 2019, compared to the official CPI. While the pre-tax income gap between the top and bottom household income quintiles increased by 15.6 % during this period according to the official CPI, it increased by 22.6 % with D-CPIs." In another paper he applies the same insight to international comparisons of income: "We (...) build purchasing power parity indices using identical barcodes across countries. We find that adjustments for product variety, non-homotheticities, and taste heterogeneity are quantitatively important. Our results suggest that standard price indices from the World Bank’s International Comparison Program (ICP) are biased downward for low-income and more populated countries, implying that international inequality is underestimated and that standard estimates of worldwide GDP per capita are biased upward. Using our preferred CES PPP index accounting for product variety instead of standard ICP indices, we find that the Gini coefficient across countries increases by 40%, while worldwide GDP per capita falls by 22%."

So which is it? First, note that Moretti compares skill groups (high school versus college educated), and Jaravel compared income quintiles. That's not the same thing! Second, Moretti compares locations with different price levels, but Jaravel looks at entire economies, and compared prices for different baskets of goods for different income groups. 

I did not know what to make of these seeming contradictions, so I asked ChatGPT 4.0. I got a pretty good answer, though it required some probing!

The Trump Tariffs

Teaching Global Trends is intellectually stimulating because whenever I do so, events unfold that show the direct relevance of the topics we discuss in class. Just as we conclude a part of the course on globalization and its discontents, President Trump decided to unilaterally impose tariffs of 25% on imports from Mexico and Canada (Canadian energy products will receive a 10% rate) and a 10% tariff on imports from China. 

This move has trade economists (including yours truly) shaking their heads. Economists consider trade restrictions to be bad policy - it's the subject of a quasi-consensus, even among economists like Paul Krugman who recognize the importance of market failures. However, nobody listens to economists these days (economists need to ask why, but this is another topic). Trade restrictions are generally quite popular with the broader public. We discussed why in class: the gains from trade are mostly unseen and widely spread, while the costs in terms of jobs lost are visible and concentrated. 

So how impactful are these tariffs likely to be? In class a while back I did a rough calculation on the board for the effect of tariffs on prices. I said that imports are about 15% of US GDP, so a 10% uniform tariff on imports, if it leads to an 80% pass-through on prices, should lead to a 0.8*0.15*.1 = 1.2 percentage point increase in the price level. You can quibble with the assumptions, but it gives a ballpark. It is a significant one-time rise in prices, but it is not hyperinflation.

You can do a similar rough calculation for GDP growth. The great Brad Setser, over on X, did just that yesterday. Again, there are assumptions here, especially the idea that the US will "just pay" the cost of tariffs. The bottom line is that the tariffs will cost about one percentage point of real GDP. 

Another option to anticipate the cost is to ask ChatGPT. I did that yesterday, and got a pretty good answer. My prompt was "Sketch out the likely effects of a uniform 25% tariff imposed by the US on imports from Canada and Mexico on US GDP growth and inflation. Provide quantitative answers." I did not ask about the 10% tariff on China, but ChatGPT gave ballpark estimates that accord well with the estimates that I reached in class and that Brad Setser reached on X.

I could have done that with DeepResearch instead, and gotten a more refined answer. What this really suggests is that my job will soon be obsolete. This happens to be the topic for today's class!

But back to the topic at hand. Beyond the expected cost of the tariffs, there is the issue of whether the tariffs will actually see the light of day. And here, at least for the Mexico and Canada tariffs, there is reason to be doubtful (the tariffs on China seem to be the subject of a much greater political consensus, so may be here to stay). Incidentally, this may explain the puzzling fact that the tariffs on Mexico and Canada were set to levels so much higher than those on China. And indeed today, we learn of a one-month delay on the tariffs on Mexico. I would not be surprised if Canada also made some sort of "concession" that will earn them a reprieve. Your mileage may vary on whether you think this sort of pressure tactic, applied to longstanding allies, is productive or not. What you should take away from this is that this is the modus operandi that now prevails: the US has decided to use its geopolitical clout much more aggressively.

Only time will tell the effects this will have on the US and the world trading system. The Director General of the World Trade Organization, the great Dr. Ngozi Okonjo-Iweala, recently gave her thoughts on this broader topic on an FT podcast (which is recommended for those interested in Global Trends). If you paid attention to the first 3 modules of the class, you will understand the context of her remarks very well. It accords with the conclusion of our discussion after Module 3: undoing globalization will prove very difficult to do. Like her, I am optimistic, on the whole, about the future of globalization and of the world trading system, despite the recent bumpy ride.

A Repost of "Rich Enough?"

In class today I mentioned a 2024 GEM blog post that I wrote, expressing marvel at the state of the US economy. I repost it here to invite comments from the current Global Trends class. We will of course revisit this issue at our next class, entirely devoted to technological progress. Your comments are welcome, including critical ones of course!

The Mystery of 10-year Treasury Yields

Today in Global Trends we will discuss monetary economics, and monetary innovations. One set of economics principles that we as business school professors need to drill down into our students concerns monetary policy. It is a highly complex subject, but it can be conveyed in simple, intuitive terms. That's what I try to do in the lecture for Module 4. The main thing to keep in mind is the ebb and flow of monetary policy: when the economy is weak, central banks (e.g. the Fed, the ECB, the Bank of Japan) cut short term rates. This is to stimulate demand and economic growth: with lower short maturity rates, the hope is that longer term rates will also fall, so that people can afford mortgages, car loans, etc. - stimulating the housing sector, the auto industry, etc., reducing unemployment, and lifting growth When the economy is strong, and inflation becomes a risk, the central bank does the opposite to tamp down demand and limit price pressures. The delicate balance that monetary policymakers try to maintain between growth and inflation is known as "fine tuning". It is more of an art than a science, but being a good economist helps a lot with the "art" part!

Monetary policy only works if the transmission mechanism also works. There are several pieces to the transmission mechanism. The main piece is the link between short-maturity rates (which the Fed controls) and longer maturity rates (which are set by banks based on their cost of funds, competitive pressures, demand conditions in the market for loans, etc.). The idea is that lowering rates will reduce the cost of funds to banks, and induce them to charge lower rates for longer term loans (banks borrow over the very short run and lend over the longer run, pocketing the difference in interest rates between short and long rates - that's the business model!).

I mention all this because, much to the surprise of many, the recent cycle of Fed rate cutting had not led to a fall in longer term rates. In other words, the transmission mechanism seems to be failing. A recent JP Morgan report has the details, which I would like us to discuss in class. Here is the crucial graph, comparing this round of rate cuts to previous ones:

The Ongoing Populist Wave

Tomorrow in Global Trends, we will discuss the backlash against globalization. This is usually one of the most lively sessions in the course, because everyone has strongly felt beliefs and opinions on the rise of the populist right. This rise has been latent for a long time in many countries around the world. In France for instance, the National Front (now called the National Rally) has seen its vote share rise steadily since the 1980s. In the US, there has always been a populist movement, which ebbed and flowed, but included the candidacy of Pat Buchanan for the presidency in 1992 and 1996. In India, the BJP, a Hindu nationalist party, has been gaining in prominence and first came to power in 1996. Many other examples abound. 

While the gradual rise of the populist right has been mostly hidden and latent, because the parties that represent it usually failed to come to power, things changed dramatically in June 2016, with the Brexit vote. With this referendum, the British people voted to exit the European Union. Five months later, Donald Trump was elected President of the United States. In country after country (Sweden, Austria, Hungary, Poland, Brazil, Italy, Argentina...), the populist right managed to come to power, and in many others came close enough that its influence was felt throughout the political spectrum.

This is not only a US phenomenon. This is a global trend - which is why we are discussing it in my class. Initially, there was some expectation that the populist wave would fade. Brexit was not a success, and many Britons have come to regret their choice. In the US, President Trump initially failed to gain reelection. In France, the populist right failed to come to power and President Macron was reelected in 2022. But these setbacks were short-lived, and parties loosely associated with the populist right are on the ascendant again in country after country. This makes understanding the characteristics of these movements essential: they will be around, and as professionals you will have to contend with them (the pilgrimage of US CEOs to Mar a Lago in recent months, in order to pay tribute to President Trump, is a testimony to the fact that this has been internalized by US economic elites). There are no easy answers to the questions of why the populist right is on the ascent, and what the consequences will be. For instance we don't really know if Donald Trump's protectionism is posturing to extract concessions from trading partners, or if steep tariffs going to be implemented across the board (my best guess - and hope - is that it is the former).

A recent Bloomberg article adds data consistent with the above observations. It is recommended reading, as it provides a general overview of the state of the populist right around the world. Why is this wave happening? What consequences will it have? Will populists seriously slow down globalization, and how is the nature of business activity likely to change as populists come to power and abandon some traditional tenets of the right, such as free trade? These are some of the questions I would like us to tackle tomorrow.

Some Further Thoughts on Democracy

Today in class we launched into an interesting discussion of democratic backsliding. I believe it was Tasha, in the back row, who made pointed observations on the relative levels of democracy in the US versus countries of Europe that feature coalition politics and parliamentary systems. The US does not practice coalition politics because there are two parties, so that one of them typically has a majority in some political arena (the House, Senate or Presidency). This is a consequence of Duverger's Law, named after a French political scientist who observed that single-round first-past-the post electoral systems tend to deliver two parties. In Europe, in contrast, electoral regimes are either multi-round first-past-the-post, or proportional, or blended, which leads to more than two parties and makes coalition politics often necessary.

Tasha argued that European democracies are more democratic than the US because the latter features several institutional peculiarities that make it deviate from pure democratic principles. For instance, the Senate and electoral college attribute more weight to small, rural areas, violating the rule of "one person, one vote". This is known as malapportionment. Tasha also mentioned partisan redistricting as a departure from strictly democratic norms, since parties in control of certain states can draw congressional boundaries to benefit themselves (both parties practice this). There are several other examples, if not in the rules, then at least in the practice of American democracy, that have come under criticism. For instance, issues of voter suppression, low turnout, and undue influence by deep-pocketed interests are often highlighted to criticize the functioning of US political institutions.

Tasha's arguments amounted to a statement that the US is less democratic than European countries, and perhaps also that it is backsliding away from democracy at a faster rate. I expressed skepticism. The truth is that I find this to be a fascinating question, but that I am not sure of what I believe one way or another. I can certainly see merits in Tasha's position - and accept and recognize the distortions that she identified in the US system - yet the picture seems more complex. Here are some things I would be comfortable arguing:

1) If one defines democracy as responsiveness to voter preferences, then I am not sure that coalition politics dominate over the US system. We have undergone several alternations of power between the parties in recent electoral cycles in the US. When George W Bush was elected, he had a majority in the House and Senate (though not for long when it comes to the Senate). When Barack Obama was elected in 2008, he had a House majority and a filibuster-proof Senate majority (although again the latter did not last very long). Then when Donald Trump won in 2016, he again had a trifecta, and so did Joe Biden in 2020, and again Trump in 2024. In other words, control of the US Federal government has alternated frequently between the parties, reflecting swings in the preferences of the electorate. I am not sure we have seen the same thing in coalition-based countries in Europe (I am excluding Britain from this discussion, as it has Duverger-like tendencies due to single-member district elections with a single round of voting). Indeed, the coalitions usually involve the same usual suspects. For instance in Germany, SPD-CDU coalitions are common. France currently is attempting a coalition of disparate parties but France swung sharply to the right in the recent election, and this is not reflected in the composition of the various governments that President Macron is attempting to put together. In sum, coalition-based politics are not very responsive to swings in voter preferences, at least in the short run.

2) Some of the distortions that Tasha deplored in the US also exist in Europe. France has a Senate and the UK has a House of Lords. Neither of these institutions are very democratic. While the financing of campaigns is often publicly funded in Europe, there are other ways for interest groups to affect public policies. For instance in France, business leaders often come from the same schools and social networks as politicians, and there is a revolving door between politics, civil service, trade unions and the private sector. I have personal knowledge of many such examples. It is not transparent, it involves less money, but it entails just as much influence of politics by special interests - maybe more. All these countries, including the US, have work to do to make their institutions more democratic, more transparent, and more responsive to the electorate.

3) Despite these defects, modern democracies are very democratic by historical standards. Whether it is the US, the UK, Germany, Japan, South Korea, France or any number of advanced industrial democracies, there are vibrant, pluralistic electorates. These electorates are frequently consulted through elections of various kinds. The number of decisions that a US voter is asked to make every two years - federal and local - is simply staggering. There has never been a period in history when voters had such control over who governs them. And when you compare industrial democracies to autocracies of various kinds, there is a huge institutional gulf. When it comes to political rights, I would much rather be a citizen of the above-listed countries than of Russia, China, or even Turkey. Whether the US is more or less democratic than some others is a very interesting - and unresolved - question. But all these countries are very democratic, and I don't see the prospect of a sustained and steep decline in democracy in any of them in the near future.