The “China Shock” is Short-Sighted

There is a new academic paper by David Autor, David Dorn and Gordon Hanson that challenges one of the bedrock beliefs of economics: free trade is good. Titled “The China Shock: Learning from Labor Market Adjustment to Large Changes in Trade,” the paper shows how workers in sectors more exposed to imports from China are suffering relative to other workers. This is not a new perspective at all. Indeed, the bedrock of economics is more like fresh cement compared to the ancient instinct to fear outsiders.

China Shock offers new insights, really tremendous coverage of many issues, and deserves to be taken seriously. It should not, however, be oversold (which I think Noah Smith does a bit here claiming that free trade with China wasn’t such a good idea). Even so, I think the China Shock is flawed, or more accurately, it is short-sighted. Here’s what it is missing, in my opinion:

First, theories against trade need a lot more than anecdotal, short-term empirics. And yes, when it comes to opening trade to 1/6 of the world’s population, there will be a shock before the system restabilizes that will take longer than 15 years to settle. Fifteen years is long enough to ask questions, but not to answer them.

In the parlance of econ 101, a phrase I actually dislike, there will be “winners and losers” from trade. Autor et al. are saying they found more than the expected negative impact on the losers. Nevertheless, my first impression is that their analysis of China’s integration via the WTO to the world economy is just one story, barely half told, and far too early to draw definitive conclusions. We are talking about a core principle based on centuries of history and hundreds of more compelling stories. In short, the anti-trade view tends to be short-sighted.

Second, the ultimate story that substantiates the value of free trade is the historical experience of the United States, specifically the internal growth dynamics after 1789 when the adoption of the U.S. Constitution expressly forbid trade barriers among the states themselves. “No State shall, without the Consent of the Congress, lay any Imposts or Duties on Imports or Exports…” says Article 1, Section 10, Clause 2. This is widely seen as one of the reasons the U.S. is the world’s richest large economy and has been so for over a century. Eugene Melder has a nice paper, published in 1940, on this.  More recently, there’s this passage from the 1985 Economic Report of the President:

The power of free trade is amply demonstrated in history, including the early history of the United States. Under the Articles of Confederation, protectionist interests in individual States moved quickly to restrict the flow of competing products from other States. The debilitating effects of this protectionism on the States’ economies convinced the framers of the U.S. Constitution to forbid individual States from levying tariffs (and the Federal Government from levying export duties). Federal courts have guarded the integrity of this prohibition, ruling as recently as 1981, for example, that a Louisiana tax on natural gas passing through the State was unconstitutional. The constitutional ban on State tariffs was crucial to the development of the U.S. economy not only because it established a free-trade area
among the 13 original States, but also because it ensured that the free-trade area would expand automatically as new States joined the Union.

Would Autor et al. expect to find outsize winners if trade between California and the other 49 states were given a trade restricting policy shock? I am confident that a negative California shock would be rather harmful to workers in Arizona, Michigan, Ohio, and the rest. Indeed, until a scholar can convince the public that a single city should declare autarky for its own net benefit, I will look at the debate over trade with real bemusement.

Third, any general analysis of a trade shock has to consider consumption impact, not just production. Not to knock the supply side, but it’s a one-eyed view. The suppression of inflation during this recovery has been an absolute puzzle for the Federal Reserve. I find it hard to believe how the China Shock effect on pricing has been overlooked, not in this paper, just as a general observation. The natural question to ask is how the wage effect balances against the price effect for net well-being. It’s fair to counter that the authors examine real wages, which by definition are inflation adjusted, but is that good enough?

Real wages neglect the broad consumption gains from trade, especially in this era of rapid technological change, and are based on what many economists think is a flawed measure of inflation. The inability of prices to measure quality of life improvements, new products, and more is a major controversy.

Let’s not forget the timeline: 1978, China begins to adopt property rights & free markets. 1977-95, the personal computer is invented/developed/mass-marketed. 2000, China enters the WTO. 2007, the iPhone is invented. China is the manufacturing location for a great deal of modern tech hardware, including the iPhone which is ubiquitous among U.S. consumers of all incomes and did not exist previously.

Fourth, what role does America’s labor rigidity play in all this? The authors note that a standard economics textbook would have predicted a certain kind of labor market response to a trade shock, but that theory has not been realized:

“Labor-market adjustment to trade shocks is stunningly slow, with local labor-force participation rates remaining depressed and local unemployment rates remaining elevated for a full decade or more after a shock commences.”

My second reaction to the paper was not to blame the shock for the slow labor adjustment, rather it was to blame federal and state labor market regulations that hinder flexibility. Increased trade adjustment assistant (TAA) surely slows the adjustment, just like unemployment compensation slows the search for work while causing skills to atrophy. The insight that free foreign trade is incompatible with controlled markets domestically is well documented, and the U.S. case in recent years only confirms that challenge. I think what this paper shows is the weakness of U.S. labor regulations, which were exposed by the size of the shock.

The bottom line is that Autor, Dorn, and Hanson have written a brilliant paper, and it is one that I will be reading more closely and pondering for a long time. But I do want to make it clear that the paper does not change my priors. Free Trade is Good. No exceptions, no limits.



The choice: higher minimum wage or more jobs?

The Congressional Budget Office was asked to estimate the effects of $10.10 national minimum wage, and it reported the impact of a $2.85 increase over the current $7.15 would be (1) higher incomes for millions of lower-income workers and (2) the total loss of income for 500,000 Americans. Policymakers and voters should understand that mandating higher wages is not costless, and one cost in forcing employers to give raises to the lowest-paid workers will destroy some jobs. That’s just reality.

To make the math simpler, the CBO estimates means this: Every penny increase to the federal minimum wage costs 1754 jobs.

Of course, the effect is not so simple, but the CBO number is a fair starting point. A more realistic model would note that each penny increase will be more harmful than the last. Why? Because a higher minimum effects (1) more people (2) more deeply.  At the margin, almost every job involves a labor-capital tradeoff. Capital investments to replace suddenly more expensive labor (that prices it above its marginal value) will not occur immediately. But the timing of capital addition to displace labor will correspond to the size of the cost differential. In short, a $1 increase will cause a shallower and slower job loss than a $2 increase.

So what to make of the notion of a $15 minimum? Set aside the completely destructive approach of encroaching on local sovereignty and local conditions — seriously, why can’t Ohio set its own minimum wage? Or not. Let Ohio be Ohio, and trust the people of Ohio to manage their own wage setting.  But, I mean it, set aside the illogic of a national wage. Can we model the job losses of a $15 versus $12 versus $10.10?

Based on the simple CBO penny cost above, I calculate the $15 minimum wage will destroy 1.36 million jobs nationally.  But, importantly, I know it will be far worse.  The impact is exponentially higher for every penny.  If one assumes that each dollar increase has a 50% larger impact – an exponent of 1.5 – then the $15 minimum will cost 2.2 million jobs.  If the impact is 100% larger for each dollar increase, then the loss is 3.7 million jobs.

This is not a choice I would recommend. In fact, I would recommend allowing any adult the freedom to work at any wage they want. How is it moral to deny a person their choice of a job? If a person prefers a lower paying job that is a short walk from home, in a location they love, doing work they enjoy — there are just too many factors to be fairly managed by a one-size-fits all wage floor.

The Presidential Tax Plans (and the Fiscal Sandwich)

I was asked to talk about presidential candidates’ tax plans today on Trish Regan‘s FoxBiz show. As usual, I prepared more content than the video medium allows, so let me share some thoughts with you here. Disclaimer: I am not advising any candidate. I speak for myself here, not for Glenn, or anyone else.

Now the way media invites go for a guest is that I will get a call or email asking if I would be able to talk about topic X at time Z. I usually take those for TV if I have something to say. Often I decline when the topic is outside my range of economics, national security, or (hoping someday) superhero movies and how to be an awesome dad/husband/dog owner/soccer coach/Spurs fan/garage organizer. This time the producer said the topic was “presidential candidates’ tax plans.” Cool!

Since I am in DC on a work trip, this was an opportunity to appear in studio, or at least in the FoxBiz side studio. Cool. I said yes, did about an hour of homework to study up on who has said what lately, and off we go.  I arrived early so got made up by the team there, then waited in the “green room.”  Being early, I switched channels from FOX to FOX Business so I could see what others are seeing for the ten minutes before I appear.

Trish is a great host, and my bet is that she will become a bigger star in the years ahead. But this was my first time talking with her, and I knew it would be wise to get a gist of what was happening now and what was on her mind. Good tip: always do this preview if you can. Some green rooms are less organized. I’ve been in major network green rooms where the remote TV control is broken. Anyway, on this day, Trish says right before the commercial break something to the effect, “When we come back, we will talk electionomics and what the Trump tax plan is all about.”

Uh oh.

There is no Donald Trump tax plan. There’s some bravado about how he knows the tax code better than anyone and how he’s going to go after hedge fund guys. That’s it. Pitchfork populism and the fact that he knows how to abuse loopholes in the tax code. Those seem like disqualifiers in my opinion, but, I really had nothing in the tank if Trish wants to ask follow-up questions.

Thank God for the iPhone. Thank God for mobile Google searches. And thank God for Miss Collins who taught me to read quickly in 5th grade at Prarie Lincoln Elementary.

Two minutes later, I am in the studio. Earpiece in, Mic on the lapel. Smile and think about talking to my sisters about policy issues. (That’s how I get ready for any media talk. My sisters are brilliant, but they are not swimming in the econ literature nor are they up to speed on policy wonk world. So I figure if I can explain to them, especially with a splash of humor, that should work for everyone in the USA).

What I WANTED to say is that Marco Rubio, Jeb Bush, and Rand Paul have put out serious, important, and substantive tax plans (Check Dan Mitchell’s analysis here and this superb dynamic candidate plan overview at the Tax Foundation). Nobody else has put out real policy plans, although a few candidates such as Ben Carson have established important principles. I was going to say, “Well, Trish, Electionomics is much more about establishing what your principles are rather than serious policy plans. So when a candidate like Jeb puts out a serious plan, it opens him up to attack, and we should respect the political courage it takes to be serious. So give credit to Rubio, to Bush, and to Paul.”

I anticipated some questions about how those plans have been estimated to create bigger deficits. Critics say Jeb’s plan will cost 1.2 trillion dollars of lost tax revenue over ten years. Paul’s will cost $3T, and Rubio’s will cost $4T.

We should all challenge the premise here. Saying any tax plan will “cost” something is false. Every cost means more Americans keep their money instead of Uncle Sam. More importantly, why the 10 year benchmark? A good tax plan will dramatically increase GDP growth, not to mention personal incomes. Beyond ten years, a good tax plan should narrow the deficit path.

I WANTED to say something else, that needs to be said, which is:

It is a mistake to link fundamental tax reform to budget deficits in isolation. Look at what President Obama has done. Obama increased tax rates, tax revenues, and tax complexity. The man is 3 for 3 on increasing the tax burden, year after year. Yet the six largest deficits in US history have all occurred with Obama in the White House. The annual deficit during Obama’s first term was over One Trillion Dollars each year. Even though CBO reports the deficits in the current year to be a third of the peak, they also project that Obama fiscal structure will cause deficits to rise toward One Trillion Dollars per year within ten years. That is a terrible legacy being left by this White House to the American people.

I should end the blog post there, because that structural deficit legacy is so important, but let’s think about why. Higher deficits seem to correlate with higher tax complexity. That is because tax policy is only half of the fiscal sandwich. (Yes, I really wanted to say fiscal sandwich on live TV. I know it is stupid, but it sounds like a nice blend of wonky good point and something that the sisters would laugh at. One can hope.) The other half of the fiscal sandwich is federal spending. And if a candidate – a serious candidate – has a plan to slow the growth rate of federal spending, then you’ve got yourself a president.

In the end, Trish gave me a lot of air time. I tried to introduce some reality to the Trump TV bubble. But there was much left unsaid. As for things unsaid on tax plans, Hillary and Bernie are offering even less substance than Trump. That’s electionomics for you!

The Refugee Crisis is Just Beginning

The surge of Syrian refugees into Europe is a crisis with many fracture lines. I’ve been asked to comment on it multiple times given my role in working on immigration issues as the editor of PEREGRINE, even though our focus at Hoover is on immigration to the United States.

The civil war in Syria is to blame, not Europe or the “West” as some have claimed. Syria had a population of 22 million people, and best estimates are that 4 million have fled the country and nearly 8 million are internally displaced. Although the focus of media coverage has been on refugees flooding into the European Union, keep these numbers in perspective. Turkey has taken in 1.8 million, and the tiny country of Lebanon has taken in 1.2 million. And Europe?  Germany says it anticipates taking in 800,000 refugees and asylees this year which is 4x normal (asylum is a refugee status for someone already in-country). The Economist has a useful graphic contrasting different European refugee acceptance numbers and per capita rates. Some countries such as Poland are willing to accept only Christian refugees (roughly 1/10 of the Syrian population). In contrast, some states in the Gulf region are taking in zero refugees.

Images of dead refugees carry great moral impact, but I am not so quick to judge. I may believe it is right for America to be more open to immigrants than any other nation, even proud of our historic openness, but I respect the sovereignty of other countries to be closed. Japan and Australia, as two examples, are ethically and culturally distinct in their regions. A nation has no moral obligation to welcome foreigners as fellow citizens. But does it have an obligation to protect refugees during a war?

The challenge for Europe is this: will welcoming refugees now lead to an acceleration of even more refugees in 2016. It is naive to think there is no feedback loop. Almost every one of the 18 million people that remain in Syria would be better off anywhere else. And what of the people of Africa’s civil wars?

Let’s not pretend there are easy answers.

As for the U.S., the President establishes an annual cap on the number of refugees admitted. Currently that cap is 70,000 people per year (see this fact sheet from I would like to see that set higher. However, I think our focus should be on refugees for nations nearer to home, notably in Central America. The U.S. has already contributed $4 billion to aid international and NGO efforts to help the refugees.

The other policy dimension to this, in my eyes, is the wages of pacifism. By allowing Syria to fester, by not engaging early on and ousting the Assad regime in 2011, by precipitously withdrawing U.S. troops from Iraq, the White House pursued a pacifist fantasy that was a central causal factor in today’s crisis.

There are sins of omission in foreign affairs.

What Shape is Talent?

I’ve been thinking about talent in the U.S. military. Talent management is impossible without talent evaluation, and for most organizations that means performance evaluation. Much as I would like to point to the science of performance management, my research in recent years suggests that there’s more art than science at this stage, certainly in the private sector. Although General Electric is famous as a leadership factory that successfully uses forced ranking to identify its top (and bottom) people, that model has proven to be disastrous at Microsoft and possibly at Yahoo! In sharp contrast, the new fad is for firms to eschew performance evaluations entirely, a model that Adobe announced to great fanfare last year. With wild variance in practices, it is impossible to advise “best practices” to the Pentagon or any of the services. However, it is more than possible to advise pragmatic, well-grounded principles.

The very best performance evaluation system may, in fact, be deployed by the U.S. military right now. Because the services are free to operate their own PE model, there are 4 (or 5 if we count the Coast Guard) different models in operation. Based on what I’ve seen, two are world class.

Let’s focus here on what the real world tells us about the shape of the distribution of talent. A forced rank method assumes that units have a “normal” or bell-shaped talent distribution. A forced ranking system, to be effective, should afford raters the correctly sized buckets to match the shape of their team’s performance distribution. For example, if a commander has 10% of his people clearly in the bottom, but is required to identify 20% in the bottom, everyone loses. The team loses, the boss loses, and the larger organization loses. If those numbers are reversed (20% bad, but 10% bucket), the outcome is also destructive to the higher goal of managing people effectively. The key moral of this story is that an effective PE system should have the flexibility to let the rater fit his evaluations to the the shape of his talent.

Imagine that talent is not normally distributed. A provocative academic paper published in 2012 (O’Boyle and Aguinis)1 found that talent is distributed more similar to a Paretian distribution, i.e. pyramid shaped, than to a normal distribution. They identified a consistent “superstar” phenomenon in five different fields, from professional basketball to academic research. This is an important point, and basically a valid point, yet a careful examination of the data reveals that the O’Boyle-Aguinis case is overstated.

Talent in the NBA

Consider, by way of explanation, performance of pro basketball players. As a random case study, I pulled all player statistics for the 1981-82 NBA season, a total of 373 player records including Dr. J and Moses Malone. Larry Bird and Magic Johnson were in their early prime, and neither was among the top 10 scorers. A histogram of total points scored by each player reveals a distinct Paretian distribution (figure 1 here).


Three players were in a class by themselves that season. George Gervin set the maximum at 2551, followed closely by Moses Malone and Adrian Dantley. Breaking points into 20 bins over 5% ranges between 0-2551, you can see that only two other players were within the top quartile bins.  However, the problem is that total points is not actually how coaches assess basketball players, right?  We know that other factors matter just as much, even if we focus on offense. Assists. Rebounds. But it turns out that every quantifiable aspect of talent also follows a Paretian distribution. Consider total rebounds.


Most NBA players get 1/3 of the rebounds that the superstars get, and a full quarter of players get 1/10 of the max. That’s Paretian. A slam-dunk for the O’Boyle-Aguinis thesis, if you will.

However, this is not how coaches evaluate talent. Rather, coaches consider how efficient players are in terms of their shooting percentage, and they also are sensitive to how much performance is achieved per minute or per game. Is it fair to label someone as a bottom talent if they only get to play 1 or 2 games in an 82 game season? No, and if we convert the above data into output per minute, then we see a very different distribution. A normal distribution.


That should give HR executives some relief that their models are not completely miscalibrated. But a look at rebounds per minute should still concern us, because it is not normal at all.


A performance evaluation system that uses any number of bins will not fairly assess NBA rebounders. Keep in mind, this is over a fairly large population of players. Most organizational units look more like teams, with maybe a dozen members. There’s no way a typical team will be able to (1) identify the right talent to measure, then (2) measure talent correctly, and finally (3) fairly rate people according to any neat distribution.

Take the U.S. Army for example, which uses a 3-bin rating: Above-Center-Below Mass. De Facto, only Above and Center are used, with no more than 50% of rated individuals in a unit allowed to have the Above rating (“ACOM”).  How is that fair if the talent distribution is normal?

My final step in considering NBA talent merged three performance metrics into a single score, what I label the PlayerScore. It works like this: each metric is transformed into a 0-1 score. For example, the top points/minute score is a 1.0, and other scores cascade below it from 0.97 to 0.83 to 0.00. There are many ties. I included rebounds per minute and assists per minute as well, then took the average of those three. The theoretical maximum is 1.0 for a player that gets a 1.0 in all three areas. In 1981-82 NBA, the top player had a 0.643, he played for the Los Angeles Lakers, and his name was Earvin Johnson. Right behind him was a guy named Larry Bird with a 0.621 score. But that’s just looking at three measures, and you could easily weight them differently or use a half dozen other measures such as steals, shooting percentage, foul shots taken and made, and so on.


The point is that talent is approximately normal, but only under extremely favorable assumptions, on average, over large populations. In the real world, team talent is abnormally distributed. And it will change shape from one season to the next. All these observations about the real world affirm the lesson:

An effective PE system should have the flexibility to let the rater fit his evaluations to the shape of his talent.



America’s Xenophobia: An Honest Account

With over a dozen legitimate GOP candidates vying for their parties nomination, immigration has become the primary policy battleground. Donald Trump, Ted Rick Santorum, and Ted Cruz are signaling their toughness with anti-immigrant remarks. In opposition are more libertarian candidates, notably Jeb Bush and Marco Rubio. The debate on the Left is much more muted, probably on purpose, because Hillary Clinton is shamelessly unprincipled and Bernie Sanders has a troubled history on the issue.

Yet there is a claim, almost conventional wisdom, that the Republican party is more racist and xenophobic and anti-immigrant that is not only oversimplified (wrong) but ahistorical. In short, there’s a fantasy among far too many Americans today that the Democratic party is and always has been “good” on race issues. Let’s remember, this Democratic party is the same party that went to war for slavery. It’s not as if the old party went out of business and sold the logo to some upcoming SuperPac in 1924. Or 1964.

POLITICO’s Mike Kazin warns us that an anti-immigration GOP is likely to lead to Democratic dominance for decades, just like in 1924 when “a Congress dominated by Republicans enacted equally harsh policies against immigrants. Their success helped usher in the longest period of one-party rule in the 20th century.”

But is that what really happened? The Immigration Act of 1924 passed by large majorities in the House of Representatives and the Senate. Kazin seems to gloss over the reality of how decisive Democrats were in these votes.  The tally in the House was 323 to 71. The tally in the Senate was 69-9. Only nine Senators opposed the act, and only 3 of those voting Nay were Democrats.

This legislation sets the (low) standard for racist nativism in the history of U.S. laws. It was inspired by racist theories of Nordic superiority over southern Europeans, Jews, Asians, etc. The law instituted a strict immigrant quota on each country. Immigrants from Germany, England, and Sweden were limited to 51,227, 34,007, and 9,561 respectively per year. No more than 100 immigrants were allowed from most other countries, including China, India, Japan, Greece, Persia, and Turkey. Jewish immigration in particular was curtailed.  The theory on the hard Left then, as now, was that low-skilled immigrants stole jobs.

The most forceful proponent in favor of the Immigration Act of 1924 was U.S. Senator Ellison “Cotton Ed” Smith, a Democratic Party politician from South Carolina. “The time has come when we should shut the door and keep what we have for what we hope our own people to be,” Smith proclaimed in an infamous speech. Zero-sum economic thinking on the Left has not changed since, even if the racial tones have been excised.

Kazin is wrong. The xenophobia of 1924 was not a Republican project. Indeed, President Calvin Coolidge spoke against the Japanese quota in particular in his signing statement. An even clearer indication of the partisan difference came five years later in 1929 when an effort in the Senate to repeal the quotas was defeated. Look at the tallies of the 1929 vote here if you don’t believe me. A majority of Republicans voted for repeal (26-19), while three-quarters of the Democrats voted against (10-24).

The conclusion we should make is not that one party is better than the other, more or less racist than other, or any such simple claim. There are heroes and villains in both parties. A particular hero is President Harry Truman, a Democrat who spoke so dangerously of his Christian faith in the brotherhood of man. Truman merits the last word:

What we do in the field of immigration and naturalization is vital to the continued growth and internal development of the U.S. – to the economic and social strength of our country – which is the core of the defense of the free world. Our immigration policy is equally, if not more important to the conduct of our foreign relationships and to our responsibilities of moral leadership in the struggle for world peace.

I have long urged that racial or national barriers to naturalization be abolished. … I want all our residents of Japanese ancestry, and all our friends throughout the far East, to understand this point clearly. I cannot take the step I would like to take, and strike down the bars that prejudice has erected against them, without, at the same time, establishing new discriminations against the peoples of Asia and approving harsh and repressive measures directed at all who seek a new life within our boundaries. I am sure that with a little more time and a little more discussion in this country the public conscience and the good sense of the American people will assert themselves, and we shall be in a position to enact an immigration and naturalization policy that will be fair to all.

What’s Happening to the World Economy?

A recession is coming. With the sudden 1000+ point drop in the Dow Jones Industrial Average today, following another major devaluation of China’s currency (8 percent?  My God, 8 percent?), and the incessant weaknesses in the U.S. labor force during this weakest of all recoveries, the signs of a new recession are all here. But remember, a recession is always coming.

The first instinct is to wonder if the Federal Reserve should press ahead with raising the core interest rate during its September meeting. To do so in the face of so much volatility — and what feels like an imminent recession — seems to be completely counter to the basic folk wisdom of monetary policy. A central bank should lower, not raise, interest rates during the down cycle, right? I suppose that folk wisdom is correct, but beware panic thinking. Some thoughts, very briefly:

  1.  Just because the stock valuations are volatile does not mean the US economy is recessing. That’s a huge leap. Indeed, the quick bounce back in stock prices today shows that there are plenty of buyers ready to scoop up equity from panic sellers. Don’t lose sight of low unemployment, steady GDP growth, and other fundamentals.
  2. China’s devaluation (and the weakness in oil and other commodity prices) confirms global weaknesses. At a minimum, these signs indicate that other leading economies are weaker than the U.S. economy.
  3. Both previous points beg the question why U.S. interest rates are set to zero. I would argue that the zero rate has many large, second order costs. It is a major burden on other currencies, for one. By keeping US rates low, the Fed is effectively weakening the dollar relative to other currencies. There is no escaping the fact that the Fed is a central player in the currency trials — putting pressure on China, Japan, and Europe to keep their rates (and pegs) lower still. That seems destabilizing to me, and the blowback is finally here.

I think the Fed missed its optimal moment to raise rates. Zero was and still is too stimulative. A healthier U.S. economy demands a return to normalcy with interest rates, and I’m frustrated that the insistence on high asset prices may cause a crash. Today was a warning. Let’s hope it is not too late for the Fed to get rates normal.