Adjusting to Trade… and Innovation

Beyond the overly simplistic framing of trade as “good” or “bad” — by politicians, by Econ 101 — why is the topic of trade (or rather, economies and people adjusting to trade) so damn hard? A big part of it has to do with not seeing the human side of trade, let alone the big picture across time and place… as is true for many tech innovations, too.

Speaking of: how does the concept of “trade” fit with “innovation”, exactly? They’re both about getting more from less — as well as creating new opportunities — shares Russ Roberts, host of the popular EconTalk podcast (and fellow at Stanford University’s Hoover Institution, PhD in economics). But there’s another very provocative theory at play here — fast-forwarding us from the time of the Industrial Revolution to the 2000s — that could make us rethink the relationship between trade, capital, labor, productivity/economic growth, shares Noah Smith, columnist at Bloomberg View (and former professor of finance at Stony Brook University, PhD in economics).

And where does China come in — and out — of this picture? Put it all together, and maybe, just maybe, it could help explain why we’re investing in labor-saving innovations/ automation more than ever today. Because one thing is for sure, agree both Roberts and Smith — who otherwise argue with each other on this episode of the a16z Podcast (with Sonal Chokshi) — you can’t stop the march of technology. It’s here, it’s coming, and we’re just going to have to meet it, prepare for it, …roll with it.

Show Notes

Discussion of the history of trade, including the Industrial Revolution [0:44]

How trade and technological innovation are linked [9:28]

The impact of trade between rich and poor countries [16:53], and how trade with China affected both economies [26:13]

Trade deficits, and a debate over their effects [31:17]

Transcript

Sonal: Hi, everyone. Welcome to the “a16z Podcast.” I’m Sonal. Today, we’re talking about all things trade and innovation. And it’s a really meaty topic. So we begin by talking about why, beyond the obvious, the topic is so hard, what trade is responsible for when it comes to tech change and jobs. And we cover everything from some really interesting theories of the past, and whether they matter for the present and the future, to the debates around productivity, manufacturing, China, protectionism, and more. So a hell of a lot.

To have this conversation, we have two special guests. Russ Roberts, host of the longstanding and excellent “EconTalk Podcast” and research fellow at Stanford University’s Hoover Institution. And Noah Smith, who did his Ph.D in economics at the University of Michigan, was a finance professor at Stony Brook University, and is now a columnist at “Bloomberg View.” And he’s the first voice you’ll hear.

Causes of the Industrial Revolution

Noah: We’re really talking about the part of trade they don’t teach in Econ 101. We’re talking about the adjustment to trade. And in Econ 101, there’s, pretty much, this unstated assumption that economies adjust very frictionlessly and very easily, and everything goes very smoothly. To be honest, it’s really not easy to tell when that will and won’t happen. And there’s no general theory that economists have about adjustment. Economists often think to the very end and think about equilibrium, and ignore the path for how you get there. But, you know, that can be a little bit like saying, like, World War II is great because it brought us human rights. But the road to get to the UN Human Rights Convention was a little bumpy and…

Sonal: Yeah, the reality is very messy in that way.

Russ: The only thing I would add to that. I think a good Econ 101 teacher talks about the adjustment. I think it’s a bad teacher and a bad economist who says, “Well, trade creates net benefits, so therefore it’s good for the country.” Trade is good on average for the Americans, and it obviously has big distributional effects depending on who you are, what you do. There could be long-term distributional effects, that your skill is no longer valuable. And there could be a short-term adjustment which is, it’s no longer valuable. You’re going to have to find something new to do and it may take you a bit of time to find it. And it takes a very long time.

Noah: Right. Or you may never do it and you may just retire, go on welfare, and then someone younger may then find something better when they get out of school.

Russ: Correct.

Sonal: I don’t want to go into Econ 101, but I’d love us to actually have some building blocks for the conversation, simply because there’s a lack of economics education. If you guys were to, sort of, launch off with what we need to know about trade, like, what would be some of the big ideas that we should start with?

Russ: Well, trade as a political issue goes back shockingly long. I’d say it goes back probably about 800 years.

Sonal: Why not longer?

Russ: Well, around 800 or 900 years ago.

Sonal: I’m pretty sure people have been trading for centuries.

Noah: There was probably someone in Egypt saying, like, “Oh my God, this Mesopotamian grain is going to put us all out of business.”

Sonal: Yeah.

Russ: For sure. But the issue was whether trade was good for the country or not. It’s still the issue. But around 1776, Adam Smith came along and said, “We’ve made some fundamental mistakes in mercantilism.” Mercantilism was this idea that trade could harm you because you’d lose your gold. And Smith pointed out gold is not something you can eat, it’s not really the measure of a nation’s well-being or people’s well-being. And he made the case for the benefits of trade.

And if we come to the modern times, I think most economists would say trade is important because it allows us to get more from less, just like innovation does. It’s a way to increase productivity. So instead of making things for yourself, you trade for the things that you don’t make as well as somebody else, as cheaply as somebody else. So…

Sonal: There’s actually a really good anecdote that I saw about this on Twitter recently. And I don’t know if it happened recently or not. But, basically, some guy in the last few years decided to make a sandwich from scratch. And it was everything from growing the vegetables, to milking the cow, to flying to the ocean to make salt. And, by the way, he didn’t even include that flight in this price or it would have been more, but it cost him $1,500. You know, that’s way more expensive than, like, $7 which is the average price of a sandwich.

Russ: If you tried to make everything for yourself, true self-sufficiency, you’d probably starve to death. In modern times, though, we worry about, and correctly so, that some of the people who benefit from trade are not necessarily going to be the same people who bear the costs of trade. We make something abroad, it means we’re not buying it here domestically anymore, and those people are going to have to find new ways of working. Trade makes things inexpensive for everybody. That’s great. It also makes it harder for some people to use their skills. The part that I always like to emphasize that people forget, is that when you make things cheaper for everybody, that frees up resources to make new things you wouldn’t have had before. And the last thing, I would argue, is that the biggest benefits from trade take place over longish periods of time. The opportunity for the next generation to come along and use its skills well. But it can be hard on this generation.

Sonal: The one thing economists seem to almost universally agree on is this — I mean, there’s never any universals with economists. But, like, this idea that it’s actually in your best interest as a state, country, whatever, to open up your borders to trade. Politics aside, it seems to be one of the fundamental beliefs.

Noah: Just because economists, you know, express agreement on something does not mean it’s right. But in this case, I think that, broadly, the economists’ consensus is fairly correct. But then there are some important caveats that get lost when we talk about that. And one of the things I think is important to emphasize is our ignorance. We understand some basic things about trade, and then there are probably some things about trade we don’t understand at all. So for example, if you look in history, a lot of people wonder about how trade affected the industrial revolution. As Russ said, trade can look a lot like innovation. In fact, in economic models, the gains from trade will look just like productivity, and there’s a complete equivalence between those in a lot of models. So, basically, if you have a robot to do something cheaply, you know, from the consumer’s perspective, that’s exactly the same as getting a low-paid worker in China to do it cheaply, so trade can be like innovation. But when we look at the really big epic booms in innovation, like the industrial revolution, trade may have some more complex effects on that.

Sonal: Yeah, we actually had economist Joel Mokyr on the podcast talking about the industrial revolution, but it was more about the open trade routine ideas. And how that led to what he called an unprecedented quantum leap in economic and tech progress. And included things like the steam engine and automating fiber looms.

Noah: Well, one of the big theories about the industrial revolution is that a combination of expensive labor in Britain and the Netherlands, and cheap resources from the Western hemisphere — the so-called New World — combined to make it suddenly worth entrepreneurs’ while to start using machine labor instead of humans. And the Romans had all the technology for steam engines, they even did some mining with steam. A Roman inventor had a little steam engine on his desk called the aeolipile. But they never really deployed it en masse. And China had all the technology for power looms and just didn’t…

Sonal: Yeah.

Noah: …put it together and start using it.

Sonal: Even in India too. And so these things go way back. So your point is that this wealth of the New World…

Noah: Right, the cheap capital, essentially, from the New World — cheap resources and capital, combined with expensive labor in Britain and the Netherlands. There is this theory that that’s what sparked the industrial revolution, by causing business owners to finally say, “All right. You know what? Forget you, humans, we’re just going to use a bunch of machines.” And then suddenly they said, “Wait a second, these machines are really good. Maybe we could make slightly better machines.” And tinkered and tinkered. And then you got, suddenly, on this track of continuous improvement and continuous searching for new industrial technologies to make people richer. And, obviously, that is the greatest episode of human flourishing in the world. By far the biggest event. Probably bigger than the agricultural revolution.

Russ: You can almost look at that as we flipped a switch and something just…

Noah: Something happens.

Russ: A lot of things exploded. Our lives are remarkably easier, safer, longer, higher quality in so many dimensions — not just monetary ones, and it’s always important to add that. And yet at the time, of course, the political economy of that revolution made Dickens famous. Gave Dickens something to write about — the costs of that in human toll and human lives — misery, in the short run, was very strong. A lot of people were put out of work by those machines, a lot of people had low wages as a result of those machines. And a lot of people worked with those machines and didn’t make a lot of money, and had a very dispiriting existence. Charlie Chaplin’s “Modern Times” being the best pop culture version of what that experience was like. The artisans’ life, the craftsmanship of previous days, and the meaningfulness that people got from their work suddenly changed. And the point I want to emphasize is that, that response — the anger and fear that that engendered — was very natural, very real, very justified at that point. And I think it’s important, though, to look ahead to future generations and say, even though they were very unhappy at the time and wanted it stopped, those innovations, are they happy now with the way the story turned out? That their grandchildren or great-grandchildren…

Sonal: That they could see. Fast forward…

Russ: …had these remarkable lives.

Sonal: …into the future. I actually remember you talking about this in “The Human Side of Trade,” where, like, 40% of the workforce in the 1900s was in farming, and now it’s, like, 20%. So if you go back in time, that farmer would have been really crying and sad about the lack of opportunity for himself and his kids. But if you brought that farmer into the present, he’d actually cry in happiness, to see his great grandkids have so much more than he did or they did when they were going through the really hard times. But it’s obviously really hard to see that big picture right now.

Russ: It’s hard to do that. And I think it’s important to do that, because economic change is dynamic by definition, and it’s lively, and it’s hard to know what’s going to happen. But often, the longer run impact is very different than the immediate impact.

Trade and innovation

Noah: Absolutely. Not just [in the] long run, but I think it’s important to emphasize the nonlinear impact. The fact that sometimes small things can have big consequences. But now, back to the theory. So, one theory of the industrial revolution is that it happened because, basically, business people started replacing overpriced British and Dutch workers with robots.

Sonal: Yeah.

Noah: The robots of the day. And the question is, what if, in a much smaller way, in the 2000s, we started replacing robots with cheap workers in China? What if we were going the opposite direction? And what if trade can temporarily, under certain circumstances, have a slowing effect on innovation? I mean, it’s obviously not going to stop the industrial revolution from happening, or something like that. We’re not talking about effects that big anymore. But what if trading with, you know, the New World, so to speak, with all its abundant resources, made capital really cheap and caused a tech boom? And what if the, sort of, productivity slowdown that we saw starting in the early to mid-2000s, actually — what if part of that came from relying on outsourced labor in that boom, instead of on better machines?

Sonal: Why is that idea important? Like, what’s the natural implication of that?

Noah: The natural implication of this is that, basically, the more cheap labor you get, the less incentive there is for labor-saving innovation, for entrepreneurs and technologists to invest in labor saving innovation. And I don’t necessarily endorse this theory. It is an idea.

Russ: It’s a clever idea. And I think there’s some truth to it. The reason I think it’s an important idea is that it suggests an explanation for the productivity slowdown that isn’t as alarming as the view that says, “We’ve figured everything out that we can, and everything is going to get worse from here on out.”

Sonal: Yeah. Like the Robert Gordon view of things. Fall of growth, death of innovation.

Noah: Maybe we took a one-decade pause in automation. And maybe now that wages have risen so much in China, and things like that, maybe now we’re going to get back to the task of automation.

Sonal: Innovating. In this conversation, it’s basically machine improvements to save labor. That’s your definition of innovation in this context.

Noah: Right. If it doesn’t save us labor, why are we doing it?

Russ: Right. You would think that the opportunity to use inexpensive labor outside of the United States — a lot of it is from China, but it’s also lots of other places — should still lead to gains to Americans in the form of lower prices through the innovation that’s taking place. So in a way, if you think about what’s the difference between China closing its borders, and we never had this opportunity to trade with China. You’re suggesting we probably would have invested more in capital here that would have raised workers’ productivity here. Ironically, what happened instead, is that workers, you’re saying, got less access to capital, therefore didn’t get those productivity gains. But we, as consumers, still should have gotten the benefits of that in the form of the lower price, because that shouldn’t affect it?

Noah: Exactly. And so, really, under some pretty simple conditions, you can show that as China opens itself up and we choose to outsource to China, the overall aggregate short-term gains will be bigger than they would’ve been if we had done the hard work of trying to invest in new machines. But, if you think about the long-term effects — so that’s talking about what we call, you know, static efficiency or short-term effects. You can show pretty easily that that’s going to be bigger. And that’s what Econ 101 always talks about, static efficiency. When I’m talking about…

Sonal: Wait, what’s static efficiency, exactly?

Noah: Static efficiency just means, like, how much cheap stuff are we getting today? How much productivity are we getting today?

Russ: How much is the pie bigger than…

Noah: How much is the pie bigger?

Russ: …than it could be if we’d not had that opportunity?

Noah: Exactly. The pie today, when we think back to the industrial revolution and the, sort of, long-term consequences. If you buy this theory, then for hundreds of years, entrepreneurs were doing the easy thing of getting a whole bunch of cheap medieval laborers to run their printing presses, and looms, and mines, and whatnot. And they were maximizing their static efficiency, their short-term productivity. But, because they didn’t do the hard work of invention and innovation, they didn’t get those knock-on effects further down the road. And when they finally said, “Okay. Oh, my God. Workers are so expensive we’re going to just spring for a steam engine.” Maybe in the short term, that cost them more. And so they wouldn’t have done it if they hadn’t had to. But in the long-term, that opened up whole new veins of innovation.

Sonal: There’s actually a concrete example that just jumps into my mind about this right now playing out today, which is India’s decision, or discussion around not having driverless cars, because they don’t want to displace the labor that can — they don’t want to take people’s jobs away, essentially. And then my initial reaction is exactly what you’re talking about, which is — but they’re doing this at the cost of then investing in these labor-saving long-term innovations.

Russ: That’s a fantastic example, because as Benedict Evans points out in an “EconTalk” podcast, one of the impacts of, you know, autonomous car introduction is a dramatic reduction in the cost of getting from here to there.

Sonal: Yeah.

Russ: So if you think about a current cab ride. A current cab ride or Uber has a huge labor component, and it also has an insurance component. But the cost of getting from here to there is going to go down. And that means that more people are going to go from here to there. Which means there’s going to be more opportunity and more resources available to do new things. So the worry is, and this is the essential trade political question. The worry is, are those new things going to be useful in employing the people who used to be the drivers of the cabs and the Uber’s? And that is the real question.

I think we’ve politicized trade dramatically in the last few years. Is it just for the benefit [of] corporations, of the top 1%? And I think that’s totally wrong. However, there is a real issue, which is, will the people whose skills have been employed productively in, say, the cab or truck driving business — will they be fruitfully employed, beneficially employed — in whatever comes along? And new things will come along. That, I’m very confident about. What I’m not so confident about, and am concerned about, as, like, everyone should be, is whether the skills of the people who are displaced are going to be available.

Sonal: So we’ve morphed into a discussion now or debate around tech and jobs.

Russ: But it’s the exact same discussion that people should have about trade with China and displacing manufacturing jobs in the United States, or in innovation like the autonomous car displacing drivers.

Sonal: Is it the same as the debates that have played out since the beginning of time, or is it actually different now because technology is accelerating faster? Because a big part of this is the adjustment time.

Noah: The debates are always the same. That doesn’t mean that the underlying truth is the same. And sometimes we confuse this. So for example, anti-war movements were making broadly the same arguments during the Iraq war and during World War II. But those were obviously very different wars.

Sonal: That’s a good analogy. So how does that play out in this question of trade?

Noah: The people who were scared of trade are scared because of things that very immediately affect them.

Sonal: Right.

Noah: When you hear economic debates, almost everyone is talking about what immediately affects them — what they see in their own job, in their own industry.

Sonal: Their day-to-day livelihood or their children. Maybe one generation out at the most.

Noah: Exactly.

Sonal: Yeah.

Noah: And so you see people wondering, “Will I lose my job? Will my business face…”

Sonal: But that’s old.

Noah: “…increased competition?”

Sonal: So I’m still not hearing what’s new. What’s the different underlying truth in this case?

Trade between rich and poor countries

Noah: What’s new is the type of trade, what will happen, who we’re trading with. What we’re trading, what kinds of trade we’re opening up. What the policy changes are, and what kind of other innovation technology is growing that alters this process. Those things can be very different. So, for example, opening up trade — the simple example — opening up trade with a rich country, like a country in Europe or, you know, Japan, for example — is in Econ 101 or any theory going to be very different than opening up trade with a very poor, low-wage country. So…

Russ: Same with immigration.

Noah: Same with immigration.

Russ: High-skilled immigration is going to be very different. Both of which are good for the country as a whole, but have very different effects on particular groups…

Noah: That’s absolutely right.

Russ: …of people within the country, so that the politics are going to respond to that in different ways.

Noah: Yeah. And so the point is that trade issues now, for example — people are talking about TPP and TTIP, which is basically a trade treaty with, you know, Japan and Korea, a trade treaty with Europe. Those are trade with rich countries, and that’s not going to look at all like opening up trade with China did in the 2000s. It is not going to resemble it at all, and yet people treat it as if it’s the same thing. One interesting thing is, if you look at some of the research papers that are coming out now like Autor and his co-authors.

Sonal: Autor et al.

Noah: Autor et al.

Sonal: If I recall, he’s arguing now that some of the benefits of trade with China actually were not as great as he thought they were, and that we could have, in fact, slowed down our process of trading with them. As, kind of, the gist of what the latest paper was.

Noah: Right. So, what’s interesting is that during the ’80s and ’90s, people were very scared of trade with Japan and Germany. You know, Japanese car companies coming in and out-competing our companies, and blah, blah, blah.

Sonal: Yeah.

Noah: And so what I’m saying is that when economists around in the late ’90s and early 2000s went back and looked at those episodes, what they found is that the displaced workers almost all found new jobs in doing very similar things for the same or higher pay. If you look just at manufacturing. It affects more than manufacturing. But if you look just at manufacturing, manufacturing employment really held up very robustly during all of that so-called Japanese and German competition, all throughout the end of the ’90s. You know, very robust, and you had this very smooth adjustment. And people seeing that we’re like, “Okay, safe.”

Then China. First, we had most favored nation trading status, permanent normal trade relations, and then the WTO entry. And what Autor, Dorn, and Hanson found is that the adjustment of the average worker in competition with Chinese workers was much, much slower and worse. And they found that, you know, the average displaced manufacturing worker in the ’80s and ’90s who was displaced by Japanese competition tended to find just as good or better a job. The average manufacturing worker displaced by Chinese competition in the 2000s got a crappy low-paid service job, or went on welfare, or disability — which, in some cases, has acted as a shadow welfare system. So people who drew the lesson from the ’80s and ’90s that the economy always adjusts real quickly, and that trade is essentially safe, didn’t think very carefully about the difference between trading with other rich countries and trading with a labor-rich capital poor country.

Sonal: Like China and India?

Noah: Like China, and maybe like India. Although, there’s some difficulties with infrastructure in India that means that India’s unit labor costs may still be high. So when we talk about cheap labor, one thing to mention is we don’t just mean wages, we actually mean unit labor costs. Which is basically, for a given worker, how much can I produce? And so, China’s labor was cheap not just because Chinese wages were low, but because Chinese wages were low relative to Chinese productivity. Indian productivity is held back by the fact that electricity keeps going out. And it’s very hard to get the products on the roads — the infrastructure sucks. So when you have an Indian factory on the coast, Indian unit labor costs are lower than Chinese unit labor costs. The reasons China was cheap — I mean, cheap wages were part of it, but they were subsidizing energy, they were giving everybody really cheap coal without worrying about the environmental impacts. They had very low labor standards. And they had a bank finance system that essentially fed super cheap capital, super low interest loans, to all these Chinese enterprises.

Sonal: Overall lower unit labor costs.

Noah: Overall lower unit labor costs. And it was so low, and so sudden, and China is just so big. I mean, if we traded with a tiny little poor country, we wouldn’t notice anything, but China is four times the size of our population. And trading with that sudden monster of a labor dump being dumped on our markets had a very deleterious impact on the lives of a lot of the workers that it hit in America.

Russ: So here is the problem I have with that analysis. There’s, obviously, some truth to it. I think the trade shock from China is different from the trade shock from Japan or Mexico. And I think they’re probably right that the adjustment for workers in the 2000s was tougher than the adjustment for workers in the ’80s. That it was much harder. I do think it’s part of a very long trend, though, that goes back to 1945. The aftermath of World War II, manufacturing employment steadily left the United States. It just got a little quicker in the ’80s, and then quicker still in the 2000s as a proportion of total employment. So the question is, for me, what did we learn from this? And is it because they are different kinds of countries?

Sonal: Yeah.

Russ: Is it the speed of the adjustment that we’re struggling with? Or is it a third factor, which I want to put on the table, which is that the labor market — I don’t think works as effectively as it worked in the ’80s and the ’90s. People are having a lot harder time moving to find new work, and we don’t fully understand why. There’s different theories. Is it because the jobs are in the cities and rents in the cities are very expensive? I don’t think we understand why. And if we don’t understand why, we’re going to have a very tough time doing the right kinds of policies to adjust to it.

Sonal: Exactly.

Russ: No matter what, it’s certainly true that we need a better system to help people find new opportunities, right? And give them the skills that they need to find new employment. But we don’t really have a good understanding of what the nature is of the problem we’re trying to fix. And the reason that’s important, and this is, again, where it ties into technology and autonomous cars, artificial intelligence, robots, etc. The worry among different people, and I think it’s a genuine worry, is that in the past, when you were displaced by technology, you’d find a new opportunity that the new technology helped facilitate, because it made things less expensive. But what if the technology takes over everything, and there’s no place left for people’s skills?

Noah: That’s a really important question, but let’s go back to a couple points. Manufacturing employment shrank as a percent of the total workforce since 1945, but total manufacturing employment didn’t.

Russ: We had a growing population.

Noah: And total manufacturing employment has shrunk since 2000 dramatically. So, at the exact same time China entered the WTO, total manufacturing employment in the United States — which had been at a stable level for decades and decades — starts to plunge?

Russ: We also, at the same time, had the introduction of the computer and the internet.

Noah: That was in the ’90s. And the big investment boom for computers was in the ’90s. And that’s when we got word processors, and spreadsheets, and blah, blah, blah. We got broadband in the late ’90s.

Russ: Yeah, we also got the application of those techniques.

Noah: It absolutely could be. What I’m saying is, the common notion that manufacturing employment steadily declined is wrong. What actually happened was that manufacturing declined as a percentage of our economy, because most of the new things we wanted from the new economy — new technologies — were services. Basically, we got a whole bunch of manufactured stuff, and the amount of physical stuff that we bought stopped increasing very fast, but we kept employing about the same number of people, and their productivity increased. But the percentage of manufacturing in the economy went down because our demand for services increased much faster after, you know, the 1960s than our demand for manufactured stuff.

But it wasn’t until the 2000s that absolute manufacturing employment started to fall, and that manufacturing employment started to fall along with manufacturing productivity slowing down. So you saw a productivity slowdown at the same time as a fall in employment. When you see the trend in manufacturing worker productivity suddenly get flatter, and yet manufacturing employment plunge off a cliff, in absolute terms, not just relative terms, for the first time in many, many decades — you’ve got to wonder. If this unprecedented decrease in the absolute level of manufacturing employment was from automation, why did it coincide with the productivity slowdown? Why wouldn’t we see a productivity speed-up? If the manufacturing employment started plunging off a cliff because of technology, why don’t we see a productivity speed-up in that industry, because instead we see a slowdown?

Russ: The only thing I’m confident of is that it’s tangled together, there’s a bunch of things going on at the same time. I agree that it’s possible that the dominant effect is trade rather than technology. I also would suggest it’s really hard to measure productivity and output in this area, because we’re agglomerating…

Noah: It’s a lot easier in manufacturing than in other industries…

Russ: It is. It doesn’t mean it’s easy.

Noah: …because you can count the actual things.

Russ: Yeah. But that’s not enough. You can’t count the things because you’ve got to aggregate computers, airplanes, bolts, screws, nails, and other things. So you’ve got to use a dollar value. And then all of a sudden, you’ve got issues of how do you aggregate?

Noah: Within industry productivity, you can measure, like, number of planes.

Russ: Right. That’s…

Noah: You’re not aggregating by price there.

Russ: Correct.

Impact of trade with China

Sonal: We’re talking about the manufacturing and the productivity slowdown. But where does this idea of people being able to buy more because of the cheap products that are coming into the market fit in? Because while people may have had a hard time finding jobs, they can buy more with less.

Noah: We do that by trying to adjust for inflation. So, if we have very slow inflation, prices aren’t going up that much relative to wages. What we’ll see is what we call real wage gains. If…

Sonal: You get more money for…

Noah: …you get more stuff.

Sonal: …for your money. Right.

Noah: More money for your buck, then your real wage is going up. It turns out that real wages in the United States have been pretty close to flat. Now, they’ve risen the last couple years, but in the 2000s, real wage gains were very, very anemic. Here is where it gets tricky. There’s many different measures you can use for inflation, so how much should the price of healthcare weigh in that? How much should the price of rent weigh in that versus the price of the TV? It’s very tricky. And you can use some inflation adjustments that show a pretty strongly rising real wage, or that show essentially no wage slowdown in the 2000s.

Sonal: Right.

Noah: Or you can use PCE, inflation shows that one.

Russ: The PCE. But the other problem, of course, is quality. So, weave in something like a TV. A TV today is very different from a TV 15 years ago. Incredibly different from a TV of 30 years ago. The number of things that your phone does and replaces is thousands of dollars’ worth of technology. I have a video camera, I’ve got a still camera. So when the phone gets more expensive in nominal terms, meaning the actual dollars you pay, or a little bit cheaper sometimes, but it does a thousand more things or holds a thousand times more songs…

Sonal: It’s like a category error, right?

Noah: Right.

Russ: …you need to adjust for that and the Bureau of Labor and Statistics isn’t particularly good at adjusting for it. So that’s another caveat you have to put on the real wage issue.

Sonal: But what do you make of this argument about, just going back to the theme of trade in connection to this, and the entry of China and what that did for our economy? When I think of the reverse, that you could, say, limit trade — and this is like the protectionist argument that comes up sometimes. I think about it disproportionately affecting poor people, because they’re the ones who go to Walmart to buy the cheap products on the shelves.

Russ: Well, if you don’t have any job at all, obviously, the fact that prices are cheaper is not so important to you. If you do have a job, even a job that pays less, but if prices are a lot lower, you could still be better off.

Sonal: Right.

Russ: And one way to think about Walmart, it’s a retail outlet for China.

Sonal: That’s exactly how I would think about it.

Russ: The thing that’s remarkable to me is that we are lucky right now to live in a time when the unemployment rate is incredibly low, it’s 4.3.

Sonal: Didn’t we actually just hit a statistic, that we are actually finally have risen on the jobs? I just saw this this week.

Russ: The employment rate, the actual percentage of people who are employed which is not…

Noah: Employment to population ratio, the best labor market indicator.

Russ: The best. Much more important than unemployment.

Noah: Prime age, prime age.

Russ: It’s finally getting better. And you emphasize prime age because a lot of the drop that we’ve seen is actually the aging of the population, not a crisis in the labor market.

Sonal: Like what happened in Japan.

Russ: Right.

Noah: We could use age-adjusted prime age.

Russ: Not going to disagree with the reality that for 10 years, we didn’t do very well. We had a horrible recession that was just a disaster. But now things are pretty good, and yet the perception of how the economy is going is, “It’s awful.”

Noah: A lot of people are just thinking politically. When you ask them, “How is the economy?” They think, “Do I like the president?” I want to say something else. The thing about slow adjustment, about some workers, sort of, permanently losing their livelihood, the stuff about competing with low wage versus high wage countries, the thing about the possible innovation slowdown in automation from a decade of cheap labor. All these caveats, they’re all over. This is all about the past, and this is an argument about the past. The China shock is over. China unit labor costs are now at parity with the United States’ labor costs, and there is nothing on the horizon that looks anything like China. Basically, the China shock was this giant one-time thing. Suddenly, you had a fifth of humanity with very little capital and a huge amount of labor, and high productivity, and all this cheap financed energy, and capital, and stuff — be dumped on the world economy. A fifth of humanity in one decade.

Sonal: Sticker shock, all at once, huge scale.

Noah: Correct. It’s all at once. China’s no longer undervaluing its currency. That was very mercantilist. They were building up their U.S. dollars so, like, modern-day gold. They were doing that in the 2000s. They have stopped now, and have actually been propping up their currency instead of making it artificially cheap. They’re selling off that giant pile of reserves, they’re going into reverse mercantilist mode. So all of this is over. And so this argument is an academic argument for “How should economists think about trade, how should economists study trade, how should economists talk to the public about trade?” It is not an argument about “What should our trade policy be right now?” Trade has gotten less ambiguous a lot in this decade than it was last decade.

Russ: My only comment is we focus a lot on our neighborhood, which is realistic and understandable. But I think it’s important to remember that trade has transformed lives elsewhere.

Trade deficits and their effects

Sonal: We didn’t talk about the argument of asymmetry in trade, and what happens when you have one country that’s being more protectionist and another one that’s not. I’ve heard the argument. I think Paul Krugman made it, or maybe Adam Smith, I don’t remember, but, “Even when you’re open and everyone else isn’t, everyone still benefits.” And that’s the bottom line of this free-trade idea. What happens when it is disproportionate?

Russ: So, in the 1980s, when the debate was over whether we should let Japanese cars come into the United States to compete with American cars, a lot of people said, “We shouldn’t because they don’t let other products of ours into their market.” And my view was, “If they want to harm their own citizens by keeping out American products, that’s their choice. Don’t confuse that with the fact that we benefit when we let in Japanese cars.” There’s a mistake and focus on the value of exports. That, somehow, trade is only fair if we have balanced trade. That we import exactly the amount that they accept of our goods. It misunderstands the fact that trade in goods is not the only thing we do. We trade in money, and assets, in capital surplus, and services as well. And so, America, on average, is going to be better off when we open our borders. Not as much as it would be if other countries joined us and opened theirs, too. People say, “Yeah. But we need to use that as a negotiating tool.” And my view is, it doesn’t work very well historically. So if we say to China, “We’ll practice free trade only when you do.” They’ll say, “Okay, fine. We won’t, and you won’t.” And then we’ll end up in, not just a trade war but possibly a real war.

Sonal: Right.

Russ: So, I think trade is very important for that reason. It builds bonds between countries, even if other countries don’t want to be as open as we are, say, for political reasons. Just one more example. And the Japanese don’t let in rice, foreign rice, because the Japanese farmers are very small and very politically powerful.

Sonal: Yeah, just like the corn farmers in the U.S. I mean, like, high-fructose modified corn starch or corn syrup. Whatever. You know what I’m talking about.

Russ: We pay a premium for sugar, because we keep out foreign sugar. People in China pay an enormous premium for rice. It’s just pure politics. And the world would be a better place, I believe, if we didn’t listen to that.

Noah: So, that’s generally right. There are a couple caveats.

Russ: Thank you, Noah.

Noah: Thank you, Russ.

Sonal: I like how you guys are fighting by caveating, it’s great.

Noah: Well, caveating is important.

Sonal: It’s very important.

Russ: It’s the economics way of life sort of caveat.

Sonal: It’s actually the “a16z Podcast” way, which is, I love nuance.

Noah: So, to inject some nuance. The idea that trade builds bonds between countries, I believe, is an overrated idea. Because on the eve of World War I, Great Britain and Germany were each other’s largest trading partners. My friend Paul Poast, who is a political science professor, has shown that trade agreements are a great way of cementing alliances. But if you don’t have an alliance, then, you know, it’s not as helpful. The other caveat is that exporting at the company level raises productivity.

Sonal: What do you mean by exporting at the company level?

Noah: So, when a company enters a foreign market, it experiences a jump in productivity. Obviously, companies that were more productive to start with are going to be more competitive in foreign markets. There’s pretty good evidence that exporting forces companies to up their game in general.

Russ: Trade generally does that, right?

Noah: Trade generally does that. So…

Sonal: By the way, is that as true of services as it is of products?

Russ: It’s harder to export services.

Sonal: Right.

Noah: Services, we do have a lot of service exports, actually.

Russ: We have foreigners who come to America to go to college.

Noah: Things like that.

Russ: That’s an export.

Sonal: Right.

Noah: And our universities are competing with Chinese universities. The point is, if we have a large trade deficit, that’s not necessarily bad. Because, you know, if there’s unbalanced trade, someone has got to run the deficit. But if we have a large trade deficit, it means we’re not exporting as much as we would be if there were balanced trade. And that could be depriving some of our companies of this pressure of international competition that forces them to up their game.

Sonal: It’s kind of similar to the argument you made earlier, actually, about just how it improves innovation overall. It’s actually in the same vein.

Noah: Could. It could be in the same vein. You know, in most economic models, technology falls from the sky like manna from heaven, and companies just take the technology that the magic inventors somewhere invent, and they apply this.

Sonal: It’s like the deus ex machina in, like, literature.

Noah: Yes, it is. There’s an argument to be made that encouraging your companies, and not just your big companies like Boeing, but your small companies, to get out there and sell on the foreign market instead of just, sort of, cozily selling to, like, the neighbors in Ohio.

Sonal: Their limited market. Right.

Noah: But actually try to get out there and sell to people in Bangladesh or wherever.

Sonal: Well, that’s where the internet comes in.

Noah: But I worry that our companies are experiencing lower productivity from lack of exporting. Obviously, in the 2000s, the currency thing with China was part of that. But even then, it was a modest part. I think, really, the case is we have got this giant domestic market, and we run, you know, trade deficits. But we’ve also got this giant domestic market and it’s just really easy for companies to, kind of, slack off.

Russ: Well, I disagree because I think politically that it’s going to end up with politically powerful companies getting more than just the incentive to export.

Noah: I mean, small companies. I mean small companies.

Russ: Even small companies, I just don’t think that should be a policy goal, to have exports for exports’ sake, because I just think it leads to too many problems.

Noah: Japan does a lot of things wrong, but it also does some things right. And it has an export promotion agency called JETRO. If you’re a small Japanese company, you don’t know how to sell stuff to Bangladesh. JETRO will hook you up with local resources, and will try to hook you up with some financing, and things like that to basically nudge you toward these markets. Yeah, I think America could absolutely use something like that.

Russ: Well, we have the EXIM Bank, which mainly works as a subsidy to Boeing, not small companies.

Noah: That’s, yeah, right.

Russ: And they claim that they’re good for small business. And I think the political — what you would design, Noah, and what I might design if I were in agreement with you, would be different than what we’re going to get.

Sonal: So we ended on the note that China had this unprecedented scale, this shock effect, because of the fact that it was a one-time tenure, one-fifth of the world. We’re talking about the past. So what happens next when it comes to — we think about the evolution of technology. We’ve alluded to, you know, automation and what’s happening with jobs. But just more specifically what happens next?

Russ: The easy answer is, we have no idea. But the second answer which is, I think, going to be true no matter what happens is that it’s going to be very hard to do something about it even if we don’t like the outcome. Technology is incredibly powerful right now, innovation is incredibly powerful. We’re going to get autonomous cars in the United States if the technology works out. I don’t think the political power of the taxi cab industry is going to stop it, just like I don’t think the hotels can stop Airbnb. And so I think we should be focusing on the costs of that transition and preparing people…

Sonal: Education, etc.

Russ: …with education and better skills to cope with it.

Noah: I couldn’t say that any better. Russ, I completely agree.

Russ: You guys finally agree completely with each other on this one.

Noah: I mean, on this point, you can’t stop technology. And you can’t suppress it. These things are coming. CRISPR is coming to design your babies someday.

Russ: I was going to say, yeah.

Noah: Driverless cars are coming. We’re going to have to roll with it.

Sonal: Yeah.

Noah: We’re going to have to be flexible. We’re going to need things like continuing education throughout people’s entire life, and not just, you know, teach them stuff and then release them into the workforce. We’re going to need all kinds of things to become more flexible and to roll with these things. Because trade in the 2000s was something we might’ve been able to manage better than we did. But that’s over, and the challenges of the future are completely different than the challenges of the past.

Russ: Well said.

Sonal: Thank you for joining the “a16z Podcast,” guys.

Russ: Thank you.

Noah: Thank you.