Hi Cyril, Actually I wrote a review article on this literature over a decade ago. You can find it in my book with Laura Tyson and John Zysman _The Dynamics of Trade and Employment_ Ballinger 1988. I'm sure there are better and more recent reviews, but I haven't kept up with the literature. As you suspect, it is a very well studied question, but not a particularly well defined one. A lot of people have done the exercise of breaking imports and exports down into 70 or so product categories and computing the labor use due to each from an input-output matrix. You take the labor used to produce exports and subtract the labor demand "lost" due to imports and you get a net labor demand effect of the current account (preferred to the trade balance since it includes services and is thus a more complete measure of economic output involved in trade). It gives you pretty much the same result as taking the trade deficit and dividing it by labor productivity. Problem is, the trade deficit isn't just something that happens to us. It doesn't really make sense to talk about the effect of the trade deficit or the current account deficit since both are as much effects of economic events as causes of them. Take your regression. You get the standard result that deficits are negatively related to unemployment. The standard explanation for that is that when the US grows quickly (relative to the rest of the world) our incomes grow and demand for imports grows more than proportionally with income so the trade deficits worsen. It isn't that the trade deficit is causing low unemployment - - the normal explanation reverses the causation. So what causes the trade deficit and what are the effects of those things on unemployment? I've already mentioned one. When we grow more quickly than the rest of the world we import more and that causes a trade deficit. Another factor that affects the relative demand of foreign vs. domestic goods is the exchange rate - - for us the price of foreign currency that we have to pay to buy foreign goods. For a long time in the 90s the US dollar was very valuable relative to other currencies and this made other country's goods very cheap. There have been studies that show that when some exogenous factor (ie. one that effects things in the system we are studying without being affected by anything in that system) causes the value of the dollar to go up that has a negative impact on US employment, but during the 90s it was the booming economy that was probably responsible for the dollar being strong (more on that in a moment) and the dollar going up in value only partially offset! the effects of the booming economy leaving unemployment very low. But there is a flip side to the trade deficit that also figures heavily in the picture. If we are going to buy more goods from abroad than we sell, accounts have to balance some how. If we are getting more goods and services than we are selling then someone on the other side of the transaction must be willing to take our dollars and hold them. If we don't export goods and services we have to export ownership of American assets to exactly offset the current account deficit. Normally foreigners are only going to be willing to do this if saving money in dollars is a better deal than saving money in their own currency. This could happen for a number of reasons. It could be because our economy is booming and investments in dollar denominated assets like stocks are yielding a good return. It can also happen if our interest rates are high relative to the rest of the world. You sometimes hear that budget deficits cause trade deficits. The normal mechanism for explaining how th! is happens is that budget deficits drive up interest rates which attract foreign lenders who want dollars. They buy dollars with their own currency driving up the value of the dollar and making foreign goods cheap so that consumers spend the extra foreign currency on imports. If a trade deficit is caused by a booming economy or a government budget deficit, it is normally thought that the trade deficit offsets some of the employment creating effects of these exogenous causes (not that a booming economy is exogenous, but whatever the policy or event was that caused the boom would be). But an increase in investment in the US can also happen if the rest of the world has excess savings and there aren't good investments anywhere else, or simply because investments in the US look good because they seem relatively safe, or because a lot of international trade is done in dollars and countries wanting to hold reserves of currency to pay for trade may want to hold dollars. In that case it is possible for foreign investment in the US to have a depressing effect on the US economy by causing the dollar to go up in value. There is yet one more commonly discussed cause of a trade deficit and it is typically thought that it can cause a decline in employment (at least temporarily). If a change in consumer tastes or a change in technology favoring imports occurs that can cause imports to replace domestic production and, at least in the short run, reduce employment. So what about the trade deficit we have now? There has been a huge amount of debate recently over exactly what is causing it and what its long run consequences might be (how much longer it can go on for). There has been very little discussion of the employment impacts though there has been some. There is no consensus on the cause. One group blames the current account deficit on the low US private savings rate and the budget deficit. People who take that position say that we are living beyond our means and borrowing heavily from the rest of the world in order to afford it. But with interest rates so low who can blame people for buying cars and houses? Further, while income minus consumption (ie. savings as it is normally computed) is small, net worth has been growing quite handsomely because of the appreciation of assets (mainly real estate). One explanation for the low savings rate holds that people feel like they have plenty of savings because their houses have gone up! in value so much. The big problem with this view is that it doesn't answer the question why foreigners are willing to loan us so much money. During the 80s when we ran huge budget deficits we got sky high real interest rates. This made the US a very attractive place to park money and led to a bidding up of the dollar and a trade deficit (eventually interest rates came back down and the dollar went down too and soon afterwards the current account deficit declined as well). This time interest rates remain very low so why are foreigners willing to lend us money? The view that a couple of people at the Federal Reserve have put forward is that there is so much excess savings in East and South Central Asia that there aren't enough good investments in those countries to take all the money so a lot of it is coming to this country. This influx of money is helping to keep interest rates low. This to some extent is causing our asset booms and our low savings rate and allows us to get away with running big government budget deficits. The problem with this view is that if Asians like the dollar so much why has its value been dropping like a rock in the last two years? The demand for dollars should be driving the dollar up. Yet another view holds that technical change in US retail (read WalMart) and changing consumer tastes (less buy America sentiment) have effectively created an exogenous increase in demand for imports of consumer goods from China and business services from India. Meanwhile Japan continues to run a trade surplus with the US. When this sort of shift happens we would expect a decline in the value of the dollar as foreigners would have more dollars than they want to buy US goods and that should lead to a decline in the price of the dollar as the supply abroad moves us down the demand curve. And this has happened. People who advocate this view point to the fact that a very large fraction of the demand for US assets of late has come not from private investors but from Asian central banks that have been defending their currencies against appreciation. They have been trying to keep the value of their currencies constant against the dollar (or at least keep them from going too much) so that they can continue to export to us. In the case of China, the value of their currency is directly linked to the dollar by the government so that if American's want to buy more Chinese goods than Chinese want to buy American goods (or other foreign goods with dollars) then the government has to keep the dollars or trade them for another foreign currency. They have been keeping the dollars. Japan and China's central banks have accumulated more than a trillion dollars in US assets in the last few years doing this. So what is the cause of the trade deficit and what is its likely impact on employment? Very few economists think that the whole cause of the trade deficit is purely a shift in demand for foreign goods. Most think that other factors such as the surplus of capital in the rest of the world, the US budget deficit and low savings rate, and the relative robustness of the US economy are all contributing to current situation. Exactly how much each factor matters and how changing different things might affect the economy is what gets debated. For example, there seems little doubt that if the Chinese were to allow the value of their currency to climb relative to the dollar we would see some decline in Chinese exports to the United States - - at least relative to what would happen if they left the exchange rate fixed. This would probably cause at least a temporary improvement in the job situation. On the other hand, to the extent that the problem is low domestic savings the demand! might just shift from China to other foreign countries as we have to spend the foreign currency that is being invested in the country somewhere. The same thing could be said about Tarriffs. Whatever the causes and the consequences pretty much everyone agrees that the current account deficit is too big to be sustainable. Most people are predicting that the US dollar will fall another 20 to 40% in value sometime in the not too distant future in order to bring the trade deficit down. Several of the central banks of Asia have begun to get uneasy about the size of their dollar holdings and have reduced their rates of purchase or even started selling dollars. Eventually this sort of action is expected to reduce the value of the dollar much further making foreign goods very expensive. While you might think this would tend to increase US employment (and it could if the change happened slowly and in an orderly fashion), there is serious concern that this could happen in a cataclysmic currency crisis with the dollar dropping rapidly and US interest rates rising rapidly as dollar denominated bonds become hot potatoes. What keeps this from happening is that it is in no one's interest for it to happen. What might make it happen anyway is that most think the current path is unsustainable and were the bottom to fall out, no one would want to be holding dollars when it does. Were this to happen we'd likely see a major recession in the US and quite possibly in the rest of the world as well. More responsible budget policy would be the one thing we could do that would make a hard landing least likely. So does that answer your question? - - Bill Dickens
William T. Dickens The Brookings Institution 1775 Massachusetts Avenue, NW Washington, DC 20036 Phone: (202) 797-6113 FAX: (202) 797-6181 E-MAIL: [EMAIL PROTECTED] AOL IM: wtdickens >>> Cyril Morong <[EMAIL PROTECTED]> 04/17/05 08:26PM >>> I asked the other day about research that addresses the link between the trade deficit and unemployment rates. My guess is that it has been studied quite a bit, with probably alot of papers on it. But I tried something myself anyway. I ran a regression in which the yearly percentage point change in the unemployment rate was the dependent variable (UE). The independent variables were BAL = the yearly percentage point change in the trade balance (as a percentage of GDP). For example, in 2000 it was -3.8% and in 1999 it was -2.8%. So for 2000, the change was -1.0. LF = the yearly percentage point change in the labor force participation rate. PR = the yearly percentage change in productivity. GDP = the yearly percentage change in the real per capita GDP (with the labor force used instead of the population). The OLS regression equation was UE = .40 + .36*BAL + .12*LF - .92*PR - .36*GDP The r-squared was .84 and the stadard error was .40 The t-values were BAL 2.63 LF 2.74 PR -3.67 GDP -11.09 So holding the other factors constant, as the yearly percentage point change in the trade balance gets more positive (negative), the yearly percentage point change in the unemployment rate gets bigger (smaller). This says that as we get bigger trades deficits, the lower the unemployment rate (at least compared to the previous year). It looks like as the labor force participation rate rises, the unemployment rate goes up, ceteris paribus. But the bigger the productivity improvement, the lower the unemployment rate. I expected the opposite. I thought that if productivity goes up, firms could increase output without adding workers. And of course, the bigger the increase in GDP, the lower the unemployment rate. So if GDP goes up 4.0%, then the unemployment rate would fall 1.42 percentage points. If the trade balance gets 1.0 percentage points more negative, then the unemployment rate would fall .36 percentage points. If productivity rises 3.0%, then the unemployment rate would fall 2.75% points. If the labor force participation rate rise 1.0 percentage points, unemployment would rise .12 percentage points. There may be time series issues like serial correlation which I have not tested for. There may also be other factors like minimum wage laws, regulations, etc that might affect this. Comments welcome. Cyril Morong