Posted by on March 14, 2017

This essay was written for a job opportunity that no longer interests me. However, I decided to post it since a lot of work and thought was put into it. I hope you enjoy it.

It goes without saying that every economic change has produced winners and losers, but history has shown that with any progress towards a freer economy, the winners have far outweighed the losers. In this essay, I will argue that free trade today is no exception. First, I will show that free trade has not significantly contributed to the decrease in American manufacturing jobs. Then I will discuss the benefits of free trade to America’s middle and lower classes, the ones assumed to suffer from it. Last, but not least, I will talk about the real reasons behind the suffering of America’s middle class.

Prior to the year 2000, the decline in America’s manufacturing jobs was relatively gentle. After the turn of the century, however, the trend dramatically accelerated with, according to the Bureau of Labor Statistics, up to 5 million manufacturing jobs being lost between 2000 and 2015. Over time, a sector that accounted for almost a quarter of America’s employment in 1960 has dropped to 8% by 2016.

Looking at these statistics, it is understandable that the millions of American despairing of their living standards may see a correlation between China entering the WTO in 2001 and the decline of the American manufacturing powerhouse. The truth is that even though international trade did produce some losses, a study by the Center for Business and Economic Research at Ball State University shows that 85% to 88% of the manufacturing job losses since 2000 are actually attributable to technological changes, while trade only accounts for 13%. And this development is not restricted to America. Germany, a country with a legendary manufacturing sector and the largest trade surplus in the world (including with China), has also seen a decrease in manufacturing jobs.

According to the same Ball State study, America’s average manufacturing productivity has increased by 90% between 1998 – 2012. With productivity increases came income increases which allowed many of America’s households to climb the social ladder. According to the American Enterprise Institute, the percentage of middle-class households (earning between $35,000 – $75,000 in 2009 dollars) has declined by almost 10% in the last four decades, but this is primarily a sign of growing prosperity, since the percentage of high-income households (over $75,000) has increased by over 16%. Meanwhile, the percentage of low-income households has fallen by almost 8%.

Moreover, the US Chamber of Commerce estimates that imports increase the purchasing power of the average American family by as much as $10,000 yearly, which is a fifth of the median household income. A 2014 study shows enormous discrepancies between income levels in the distribution of these gains. Lower-income households spend a larger percentage of their disposable income on heavily traded goods, such as clothes, while households with higher incomes spend a larger share on non – tradable services, such as yoga classes. Consequently, the study found that free trade increases the purchasing power of the lowest income percentile by a gigantic 62% and the median income by a significant 29%. On the other hand, the purchasing power of the upper percentile is only increased by 3%.

In spite of all this, protectionists such as Sanders and Trump have fared very well during the general election. That is very problematic since their populist claims against free trade are hurtful not only for the obvious harms of protectionism but also because they draw attention away from what is really destroying the American Dream for the middle and lower classes: the increasing costs of housing, healthcare, and higher education.

These three sectors have seen prices soar well beyond the general increase in the US Consumer Price Index (CPI). Firstly, as discussed in this blog post, housing prices and rents have skyrocketed across many of America’s cities, especially in places such as Los Angeles where rent costs as much as 47% of the average tenant’s salary (substantially above the 30% considered affordable). Moreover, Jason Furman, Chairman of the Council of Economic Advisers, claims that the discrepancy between the real cost of construction and the real cost of housing in America has increased by around two-thirds since the 1990s.

Soaring housing costs affect labor mobility and the possibility of workers to move to areas with strong employment markets, as shown by this study. So, housing costs have a negative impact on both the income and expenses of many households.

Similarly, according to this BLS report, medical consumer prices since 1997 have increased by 98% as a whole, but by as much as 200% for hospital care. This contrasts with the 50% increase in overall consumer prices during the same period. Like housing, this increase has had both a direct negative impact on standards of living and an indirect one: as this article discusses, take-home pay has lagged productivity gains largely because of the rising costs of benefits, especially medical ones.

Healthcare inflation comes second only to the even more shocking increase in the cost of higher education, which equaled, according to this article by The Economist, four times the rate of inflation. As a result, Mark Kantrowitz, one of the nation’s leading student financial aid experts, has found that only 9.8% of students in 1993-94 graduated with excessive debt but that the number had risen to 14.4% by 2007-08, and that it is now as high as 27.2%.

These “hyperinflations” are mainly a result of poor government policies and interventions. In the case of housing, government-mandated supply constraints (such as zoning laws, and construction and labor regulations) have strongly inflated prices for the benefit of asset owners but at the expense of everyone else, especially renters and first-time buyers. It is no wonder that the densely populated but heavily deregulated city of Tokyo (pop. 13.3 million) has started more housing units in 2014 than the State of California (pop. 38.8 million) or even the entire country of England (pop. 54.3 million).

The soaring costs of health care and education can be explained by one of the oldest rules in economics: the tragedy of the commons. Soaring costs are the inevitable results of markets where the consumers do not bear the costs of their consumption. Largely due to government policies, including the tax incentives for employer-provided insurance, roughly 89% of medical costs are paid by a third party, either a private insurance company or the government. But this goes as high as 97% for hospital care – the service that inflated the most. No market can function where there is so little consumer discipline.

Likewise, the increase in the cost of higher education can be directly attributed to government support for this sector. A recent study by the New York Federal Reserve found that private colleges raise their tuition by $0.65 for every dollar of student loans provided by the government. This inflationary incentive is made even worse by the failure of the government to use its lending to provide important market signals. With such perverse incentives, it is no wonder that the undersupplied STEM fields enjoy, according to a PayScale report, annual returns to higher education of 12% while the oversupplied liberal arts fields are lucky to break even. It is also not surprising that as much as 48% of recent graduates report that they are working in fields that do not require a college degree, while industry reports massive shortages of skilled labor.

In conclusion, there is no denying that even though America has enjoyed large increases in wealth, especially for the lower and middle classes, thanks to globalization, trade liberalization and technological improvements, they are some sectors where government meddling has caused the American Dream to recede for some. It is therefore imperative that we create a government that works for the people, rather than one that blocks the path of prosperity.

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Posted in: Economics, Policy

Comments

  1. Pete
    March 14, 2017

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    Great article Artus!

    The acorn doesn’t fall far from the tree.

    Pete Schaefer

    • Artus
      March 15, 2017

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      Hello Pete,
      I’m very happy you enjoyed the article! I think a lot of the credit belongs to Dad who spent a lot of efforts making sure this young acorn doesn’t venture off.

      Please say hello to the family from me.

      Bests,
      Artus

  2. Anonymous
    March 17, 2017

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    March 17, 2017

    Artus,
    Great article which encompasses all segments of our daily, western life. I believe your last sentence sums up a Perfect situation re government, which in real terms we do not see today. Government has become a separate “entity” TO the People rather than FOR the People. We trust in our future we will revert back to the original: FOR.

    Enjoyed our chat today and look forward to breaking bead together.

    Cheers,
    Fraser

    • Artus
      March 18, 2017

      Leave a Reply

      Hello Fraser,
      I’m glad you enjoyed the read.
      I enjoyed the talk too.
      Cheers,
      Artus

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