Buy power, sell ideas

 SELLING stuff to foreigners tends to be the last hope for economies whose own consumers are unwilling or unable to part with their cash. The current slump is no different, with rich-country hopes heaped on export-led growth. A new report—Trading myths—published today by the McKinsey Global Institute investigates trade, exposing a number of fallacies about how trade has developed over time, the things that are bought and sold internationally, and the impact of open markets. The first myth (some are more mythical that others, but it’s a good theme for a paper) is that advanced economies are losing out to emerging markets, so that trade deficits are ballooning.  That’s not the case, as the chart below shows. In fact, the bigger story is not a myth but the mystery of why net trade is so stubbornly stable. Britain’s currency, for example, has depreciated by 20% since 2008. On paper, that should boost exports and lower imports.  In reality the trade pickup has been poor.

Another myth concerns the components of trade. McKinsey recon most people think that cheap goods—imported cars and televisions say—drive advanced countries’ deficits. The truth is that rich countries import lots of oil, gas and coal, and the prices of these have been historically high since the mid 2000s (second chart).  A recent article by a colleague explains this in more detail. Moreover, most advanced economies—12 out of 15—actually run a surplus for knowledge-intensive manufactured goods (pharmaceuticals and aeroplane engines, say). The big picture is that rich countries buy power, and sell ideas.

America and Britain get their ideas to the international markets in a slightly different way. Rather than exporting goods packed with ideas, their knowledge exports are bound up in services (third chart). This suggests a risk: services might be easier to copy than goods. A recent report on financial innovation, for example, made clear that in finance, new ideas are rarely patented.

A third theme of the paper is the link between trade and employment.  The report starts out by dispelling a couple of jobs-related myths.  Trade, McKinsey recon, is not responsible for a decline in manufacturing jobs. The loss, and it has been significant, is more to do with increased productivity, combined with weak demand. Second, the notion that trade creates only low-paid jobs is wrong.  In fact, many of the jobs gained through trade have been in ideas-intensive sectors, where work is well paid (fourth chart).

This then leads to the tricky question of whether trade is one of the factors causing wage inequality in rich countries.  As McKinsey say: An ongoing, as yet unresolved, debate is taking place about the impact of wages and inequality.  It might appear that a 16 per cent decline in the real wages of low-skilled employees in the Unites States from 1990 to 2005, for instance, was due to a trade profile that favours the high skilled. This is an empirical question, which can be answered through research.  Academics are split: some papers find a relationship, others do not.  The report doesn’t cover the detail of why trade might, in some cases, lower wages.  If there is a link, a strong candidate would be the ‘specific factors’ trade model popularised by Paul Samuelson.  The broad idea is that essential inputs—which could be capital, land or labour—used by the export sector will become more valuable as that sector gains from opportunities to sell internationally. So chemists and turbine designers in rich countries get a wage boost.  By a similar logic inputs only in import-competing sectors do worse.  That could mean that workers with import-specific skills might see wages reduced with more trade. Even if this link exists, the solution is not less trade, as McKinsey rightly point out.  That just makes the size of the aggregate pie—for all countries—smaller.  Instead, rich countries first need to clear the trade channels debris left by years of tariff and subsidy distortion.  This will ensure a greater aggregate gain from trade.  To sustain this, they need to prevent valuable ideas being pinched, by promoting intellectual property rights.  Finally, to reduce inequality, those lacking export-specific skills need to be trained up so that more workers gain from the opportunities trade brings.  Overall, McKinsey offer policymakers a simple menu:  open up your trade channels, protect your ideas and educate your workforce.  Simple to say, but hard to do.