June 23, 2015
Dean Baker
Al Jazeera America, June 23, 2015
View article at original source.
The accidental timing of events can offer remarkable insights into the underlying the reality. Last week saw the Fed meeting to debate interest rate hikes at the same time that President Obama and the Republican Congressional leadership were desperately struggling to find ways to past fast-track authority in order to facilitate passage of the Trans-Pacific Partnership (TPP). While it may not be immediately apparent, the view of the country’s elites on these two events tells us a great deal about economic policy.
As folks recall, the defeat of the original fast-track proposal infuriated the elites. Folks like George Will, David Brooks, and the Washington Post editorial board are appalled that Congress may block the TPP. They have raised various issues, but one recurring theme is that TPP will promote economic growth, and the opponents are apparently willing to sacrifice this growth if they block the deal.
The claim TPP will promote growth is dubious. After all, a study by the United States Department of Agriculture found the impact on growth will be a rounding error in GDP. Furthermore, none of the studies that have made growth projections incorporate any negative impact on growth due to higher drug costs or other price increases associated with stronger and longer patent protection.
These models also don’t make projections on the distributions of the benefits of the growth from the TPP. After all, if the TPP leads to a higher GDP, but all of this goes to the Silicon Valley and Wall Street crews, it is understandable that most people will not be very excited about it.
But even ignoring these issues, it is difficult to take these concerns about the lost TPP growth very seriously. The highest growth projection from any of the standard models is that it will eventually lead to a 0.4 percent increase in GDP. This impact will not be felt until after the TPP is fully implemented, roughly a dozen years in the future.
To put this in perspective, this is roughly the amount that the economy typically grows in 2-month period. In other words, if we accept the high-end projection and we had put the TPP in place back in 1993 then the economy would be as rich at the end of June as it would be in the no TPP world at the end of August. That would be nice, but hardly a game changer in terms of its economic impact.
By contrast, the Fed is actively planning to raise interest rates in order to slow the economy. They decided not to hike interest rates in June, but is widely accepted that they will begin to raise interest rates sometime this year, possibly as early as September.
The point of raising interest rates is to slow economic growth. The ostensible concern is that if the economy grows too much, it will push down the unemployment rate. This will in turn lead to more rapid wage growth, which could trigger spiraling inflation. In order to avoid going down this route the Fed is prepared to slow growth now rather than taking the risk of inflation getting out of control.
The impact on growth could be substantial. Many economists, including some on the Fed, would have it target a rate of unemployment that it would set as a floor. It would then raise interest rates as much as necessary in order to keep the unemployment rate from falling below this floor.
To see the impact on growth, suppose that this floor unemployment rate for the Fed is 5.2 percent. Suppose the economy could actually get to a 4.0 percent unemployment rate without causing inflation to accelerate. This was in fact the year-round average unemployment rate for 2000, a year in which the inflation rate was stable.
Economists usually estimate that a 1.0 percentage point drop in the unemployment rate is associated with 2.0 percentage points of additional growth. Arguably this calculation understates the full impact at the moment since such an extraordinary number of people have dropped out of the labor force in the Great Recession and its aftermath. But even with the two for one assumption, the 5.2 percent floor for the unemployment rate would be costing us 2.4 percentage points of growth or 6 TPPs.
In this case, the amount of GDP that we would be needlessly sacrificing from pre-mature Fed tightening would not only be six times as large as the highest estimates of the gains from the TPP, it would be felt almost immediately rather than something that is phased in over more than a decade. In addition, the lost GDP is comprised almost entirely of lost wages to those at the middle and bottom of the wage ladder.
In addition to costing jobs, the Fed’s pre-mature tightening would lower the wages for the bottom half of the labor force by reducing their bargaining power. In a tighter labor market, workers at the middle and bottom of the wage distribution are better situated to demand higher wages. In other words, the Fed’s decision to raise rates earlier and faster than necessary will be heading off growth that would primarily benefit those at the middle and bottom of the income distribution.
So there is the lesson from the TPP and the Fed. When it comes to any amount of growth where the primary beneficiaries are the rich, growth is sacrosanct. We would have to be nuts to consider foregoing the growth that could come from the TPP. But if the beneficiaries of growth are likely to be people who work for a living, well growth is just not that big a deal. And now everyone understands both trade policy and the Fed.
