.
Since the 2008 financial crisis, the Obama administration and U.S. Congress have focused on reforming the financial sector, most famously through the sweeping Dodd-Frank Act. The epicenter of the crash was Wall Street, and thus it is understandable that the banking system has been the object of deserved regulatory wrath.
But if reformers are serious about securing the economy from another unnecessary crisis, finance is only one side of the coin; the other side is regulating the real economy, how Americans spend, save, and crucially, borrow. What we now know about 2008 is that the financial environment was a dangerous combination of leverage on the part of the banking system and buildup of household debt. Financial regulation only covers part of this equation by changing how credit flows through the economy; it doesn’t touch the reasons for why households took on unsustainable amounts of debt.
Yet the one ambitious, proactive policy area that would help protect the American economy against a repeat of 2008 is rarely mentioned in the same breath as Dodd-Frank: trade policy. Specifically, the Obama administration is currently negotiating two continental trade agreements with Asia and Europe, respectively, the Transpacific Partnership (TPP) with 11 nations in Asia and Latin America, Japan, and the Transatlantic Trade and Investment Partnership (TTIP) with the European Union. While an agreement on the TTIP is not expected to be finalized until 2016, TTP negotiators came to an agreements on October 5, 2015 after five years of negotiations.
The primary argument out of American self-interest for the TPP and TTIP is that they will boost exports to markets in Asia and Europe, creating new jobs and strengthening wages for existing workers. But the agreements should also be seen as beneficial tools in the context of a long-term economic policy aimed at greater resiliency to future crises. By reducing the cycles of debt-fueled consumption that led to the events of 2008, the TTP and TTIP can prevent similar crises in the future.
Politically, supporters of the TPP and TTIP have not connected the dots between the financial crisis, debt, and trade. They ought to though, with the loudest critics of the negotiations nakedly pursuing a strategy of guilt-by-association between trade agreements and the financial crisis. A closer examination of the connection and the arguments put forward by leading critics of the deal is thus called for.
What Caused the Financial Crisis?
Seven years on from September 2008, we have a grasp on the conditions that triggered the worst economic crash since the Great Depression. While a complete causal story isn’t forthcoming until the dust has long settled, the expert consensus is that the crisis was caused by a combination of extraordinary leverage (the ratio of borrowed money to assets) in the biggest banks and financial institutions with an extreme build-up of household debt.
Academic economists and economic policy-makers have now recognized the role of household debt as the tinder that laid under the flames of the crisis. Economists Atif Mian and Amir Sufi’s book House of Debt persuasively tracks the emergence of a real estate bubble through the 2000s. “While banking crises may be acute events that capture people’s attention, we must also recognize the run-ups in household debt that precede them,” they write. “We think debt is dangerous.” The numbers compiled by Mian and Sufi speak for themselves: total household debt doubled during the period of 2000-2007 to $14 trillion overall. When the banking system borrowed to get exposure to these bad loans and interbank liquidity disappeared in the fall, the jig was up and Bear Stearns and Lehman went down.
So if household debt was a primary factor in the financial crisis, the natural follow-up is: what caused all that indebtedness? Federal housing policy and the ease with which credit was made available was part of it and rightfully dominates Mian and Sufi’s account. But another factor behind the buildup in debt was wages. Americans experienced wage stagnation throughout the 2000s, meaning their incomes stayed flat. If we weren’t earning more as Americans in real terms, that was no reason to avoid consuming; you could just borrow. And so borrow we did. Americans’ desire for stuff didn’t track our wages, as the U.S.’s place in the global economy underwent dramatic change. Stagnant income and purchasing ability makes credit more attractive, as did the mania of speculative real estate and can’t-lose second and third homes.
So we can come to some working conclusions: the answer to ‘what caused the financial crisis?’ was roughly ‘household debt plus huge leverage in the banking system.’ The functional answer to ‘what caused all that household debt?’ is ‘wages plus cheap credit.’ To be clear, the academic postmortem may find a more convincing scientific explanation, but these are the operational understandings used today to determine policy. Risky behavior by Wall Street is part of the story; misguided economic and housing policy in Washington is another; but debt-fueled consumption by millions of American citizens is fundamental. And that’s where trade policy matters.
What Caused Extreme Indebtedness?
The next crisis will not look like 2008. But Americans still have not experienced a rise in real incomes, leaving us vulnerable to a new cycle of debt-fueled consumption. Trade agreements, including the TPP and TTIP, won’t solve any problems overnight, but they are tools for the long-term, like infrastructure for the global economy as they establish patterns of exchange, highways and airports for goods and services. The transformation that the agreements would bring about is a reorientation of the real economy towards exports and higher incomes.
In a 2011 address to the American Bankruptcy Institute, former U.S. Treasury official and ‘Chief Restructuring officer’ Jim Millstein gave a trenchant description of the malaise of low wages and high debt that still rings true today. Millstein put responsibility at the hands of a decades-long trend of:
“…offshoring, our corporations taking jobs overseas, our free market being available to exporters from other countries in ways their markets are not available to us, a currency that we’re not as good at manipulating as other countries are about manipulating theirs (and that affects the relative competitiveness of our products)…We have adopted hook, line, and sinker the deregulatory agenda of our financial community and we have used our trading leverage to open financial markets, not manufacturing markets abroad. As a result, the country has suffered through the worst financial crisis this country has suffered through since the Great Depression. And it’s not over. And it’s not over because we’re in a period of massive adjustment.”
The different factors Millstein identifies are often compounded in our public discourse into a single phenomenon: “globalization.” If Millstein is correct about these trends, as I believe he is, it puts the raison d’être for the TPP in stark relief. If high indebtedness and low wages is a recipe for crisis, then we need an economic policy that addresses them. In the words of the U.S. Trade Representative Michael Froman, “trade agreements are how we shape globalization,” not how we are be shaped by it.
Trade is not the only arena that impacts wages or growth—there are a number of fiscal policy decisions, for example, that would adjust Americans’ income, and monetary policy changes the cost of borrowing. But taxation comes with trade-offs and the edge of monetary policy has been blunted after years at the zero lower bound. On the other hand, expanding exports trade is an opportunity to boost wages and create new jobs in desirable industries of the future, allowing American workers to take a larger piece of the rising global pie.
Indeed, it isn’t a coincidence that the four factors Millstein identifies—offshoring of jobs, openness of U.S. markets without reciprocity, loss of competitiveness for American products, and privileging financial liberalization—are the primary goals of our trade policy. Supporters of TPP and TTIP argue the agreement will create quality jobs, strengthen American advanced manufacturing, and ensure fair and enforceable rules abroad. It is difficult to say with precision until the final texts of the respective agreements are made public, but the early signals and negotiating mandates indicate that the TPP will be a significant departure from the status quo on these issues. TTIP too would be a landmark agreement with our largest trading partner and most important geopolitical ally.
Connecting the Dots Between Trade and the Financial Crisis
But in the public debate about the TPP and TTIP, few have bothered to connect the dots between the TPP and the financial crisis — except for the biggest critics of the deal, that is. Skeptics of trade and globalization love to point out the supposed similarities between the TPP and the neoliberal policies that led to the financial crisis. Here is Senator Bernie Sanders, now a candidate for the Democratic nomination for the 2016 election:
“[T]he TPP would expand the rights and power of the same Wall Street firms that nearly destroyed the world economy just five years ago and would create the conditions for more financial instability in the future.”
Associating the TPP with the collapse of 2008 makes sense as a public relations strategy for Sanders. But is TPP really ‘more of the same’, or does it plot a new direction for the American economy?
Far from doubling down on past mistakes that led to 2008, the TPP would reorient the American economy to be more export-oriented, both in manufacturing — where the U.S. has a competitive advantage in ‘smart’, advanced manufacturing — and in intellectual and service industries like biotechnology, engineering, and architecture. The TPP is recognition of the fact that our lead in these industries is not likely to be permanent or as resolute as it is now. As for Sanders’ criticism, financial liberalization is a relatively small aspect of the TPP (though it will play a larger role in TTIP); the priority sectors for the U.S. in both negotiations remain manufacturing and services.
For those still skeptical of the economic benefits, the Obama Administration has quietly been making a compelling argument, what U.S. Trade Representative Froman calls the “production platform of choice.” Envision the world a day after both the TPP and TTIP have been signed and ratified. Suddenly, the U.S. would be squarely in the middle of two economic blocs that together cover two-thirds of global GDP. The U.S. would have a highly privileged and unique position as the sole bridge between growing Asian and established European markets besides Canada. The U.S. would leapfrog to the head of the queue with cheap energy, strong rule of law and intellectual property protection, and a narrowing gap for labor costs between us and the rest of the world. The benefits to American labor could be substantial. Export-related jobs in the U.S. pay higher wages than the average job. Companies with access to multiple, diversified markets are also more resilient to downturns and local shocks. The rising middle class in Asia has a strong demand for American goods and products, giving us a built-in market our competitors would love to have.
So how would the TPP help to avoid the next economic calamity? By providing new sources of growth to the economy via exports, replacing the need for debt-fueled consumption and boosting real growth in the U.S., not illusory, bubble gains.
Since Millstein’s talk in 2011, American households have reduced their indebtedness and paid off home, auto, and education loans, but this has been achieved on the back of extraordinary risk elsewhere in the system. At present, monetary policy is pushed to its limit, pushing equities to sky-high prices that few believe are a true reflection of facts on the ground. Fiscal policy and government spending are also unlikely to make a real difference in terms of growth, and high public debts in the municipal arena in Chicago, Puerto Rico, and elsewhere could mean further contractions. The continued vulnerability of the economy to external shock — think the worst-case in Greece or in China — means we should take out an insurance policy today in the form of favorable trade agreements.
Trade policy is exactly designed to avoid the pitfalls that led to the last crisis, through a slow, decades-long process of moving the U.S. towards export-based growth. We don’t know what will trigger the next crisis, but as Mian and Sufi point out, we do know what makes them worse: high levels of household debt and excessive leverage.
In this sense, and only in this sense, Sanders is right that “the TPP is much more than a ‘free trade’ agreement.” The TPP is an attempt to change the fundamentals of the American economy, away from the path it charted prior to the financial crisis — high debt, imports for consumption with few exports, and giving international free riders a pass. In economic and psychic terms, it isn’t a stretch to say that the 2008 crisis caused a deep wound to the U.S. and the rest of the world. Along with the TTIP, the TPP is like the suturing that helps heal that wound.
Trade integrates the U.S. in the global economy again in ways that were lost throughout the decade of debt-fueled consumption and folly — and financial crisis.
The views presented in this article are the author’s own and do not necessarily represent the views of any other organization.
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How Trade Will Help Avert the Next Crisis
Abstract Background
November 20, 2015
Since the 2008 financial crisis, the Obama administration and U.S. Congress have focused on reforming the financial sector, most famously through the sweeping Dodd-Frank Act. The epicenter of the crash was Wall Street, and thus it is understandable that the banking system has been the object of deserved regulatory wrath.
But if reformers are serious about securing the economy from another unnecessary crisis, finance is only one side of the coin; the other side is regulating the real economy, how Americans spend, save, and crucially, borrow. What we now know about 2008 is that the financial environment was a dangerous combination of leverage on the part of the banking system and buildup of household debt. Financial regulation only covers part of this equation by changing how credit flows through the economy; it doesn’t touch the reasons for why households took on unsustainable amounts of debt.
Yet the one ambitious, proactive policy area that would help protect the American economy against a repeat of 2008 is rarely mentioned in the same breath as Dodd-Frank: trade policy. Specifically, the Obama administration is currently negotiating two continental trade agreements with Asia and Europe, respectively, the Transpacific Partnership (TPP) with 11 nations in Asia and Latin America, Japan, and the Transatlantic Trade and Investment Partnership (TTIP) with the European Union. While an agreement on the TTIP is not expected to be finalized until 2016, TTP negotiators came to an agreements on October 5, 2015 after five years of negotiations.
The primary argument out of American self-interest for the TPP and TTIP is that they will boost exports to markets in Asia and Europe, creating new jobs and strengthening wages for existing workers. But the agreements should also be seen as beneficial tools in the context of a long-term economic policy aimed at greater resiliency to future crises. By reducing the cycles of debt-fueled consumption that led to the events of 2008, the TTP and TTIP can prevent similar crises in the future.
Politically, supporters of the TPP and TTIP have not connected the dots between the financial crisis, debt, and trade. They ought to though, with the loudest critics of the negotiations nakedly pursuing a strategy of guilt-by-association between trade agreements and the financial crisis. A closer examination of the connection and the arguments put forward by leading critics of the deal is thus called for.
What Caused the Financial Crisis?
Seven years on from September 2008, we have a grasp on the conditions that triggered the worst economic crash since the Great Depression. While a complete causal story isn’t forthcoming until the dust has long settled, the expert consensus is that the crisis was caused by a combination of extraordinary leverage (the ratio of borrowed money to assets) in the biggest banks and financial institutions with an extreme build-up of household debt.
Academic economists and economic policy-makers have now recognized the role of household debt as the tinder that laid under the flames of the crisis. Economists Atif Mian and Amir Sufi’s book House of Debt persuasively tracks the emergence of a real estate bubble through the 2000s. “While banking crises may be acute events that capture people’s attention, we must also recognize the run-ups in household debt that precede them,” they write. “We think debt is dangerous.” The numbers compiled by Mian and Sufi speak for themselves: total household debt doubled during the period of 2000-2007 to $14 trillion overall. When the banking system borrowed to get exposure to these bad loans and interbank liquidity disappeared in the fall, the jig was up and Bear Stearns and Lehman went down.
So if household debt was a primary factor in the financial crisis, the natural follow-up is: what caused all that indebtedness? Federal housing policy and the ease with which credit was made available was part of it and rightfully dominates Mian and Sufi’s account. But another factor behind the buildup in debt was wages. Americans experienced wage stagnation throughout the 2000s, meaning their incomes stayed flat. If we weren’t earning more as Americans in real terms, that was no reason to avoid consuming; you could just borrow. And so borrow we did. Americans’ desire for stuff didn’t track our wages, as the U.S.’s place in the global economy underwent dramatic change. Stagnant income and purchasing ability makes credit more attractive, as did the mania of speculative real estate and can’t-lose second and third homes.
So we can come to some working conclusions: the answer to ‘what caused the financial crisis?’ was roughly ‘household debt plus huge leverage in the banking system.’ The functional answer to ‘what caused all that household debt?’ is ‘wages plus cheap credit.’ To be clear, the academic postmortem may find a more convincing scientific explanation, but these are the operational understandings used today to determine policy. Risky behavior by Wall Street is part of the story; misguided economic and housing policy in Washington is another; but debt-fueled consumption by millions of American citizens is fundamental. And that’s where trade policy matters.
What Caused Extreme Indebtedness?
The next crisis will not look like 2008. But Americans still have not experienced a rise in real incomes, leaving us vulnerable to a new cycle of debt-fueled consumption. Trade agreements, including the TPP and TTIP, won’t solve any problems overnight, but they are tools for the long-term, like infrastructure for the global economy as they establish patterns of exchange, highways and airports for goods and services. The transformation that the agreements would bring about is a reorientation of the real economy towards exports and higher incomes.
In a 2011 address to the American Bankruptcy Institute, former U.S. Treasury official and ‘Chief Restructuring officer’ Jim Millstein gave a trenchant description of the malaise of low wages and high debt that still rings true today. Millstein put responsibility at the hands of a decades-long trend of:
“…offshoring, our corporations taking jobs overseas, our free market being available to exporters from other countries in ways their markets are not available to us, a currency that we’re not as good at manipulating as other countries are about manipulating theirs (and that affects the relative competitiveness of our products)…We have adopted hook, line, and sinker the deregulatory agenda of our financial community and we have used our trading leverage to open financial markets, not manufacturing markets abroad. As a result, the country has suffered through the worst financial crisis this country has suffered through since the Great Depression. And it’s not over. And it’s not over because we’re in a period of massive adjustment.”
The different factors Millstein identifies are often compounded in our public discourse into a single phenomenon: “globalization.” If Millstein is correct about these trends, as I believe he is, it puts the raison d’être for the TPP in stark relief. If high indebtedness and low wages is a recipe for crisis, then we need an economic policy that addresses them. In the words of the U.S. Trade Representative Michael Froman, “trade agreements are how we shape globalization,” not how we are be shaped by it.
Trade is not the only arena that impacts wages or growth—there are a number of fiscal policy decisions, for example, that would adjust Americans’ income, and monetary policy changes the cost of borrowing. But taxation comes with trade-offs and the edge of monetary policy has been blunted after years at the zero lower bound. On the other hand, expanding exports trade is an opportunity to boost wages and create new jobs in desirable industries of the future, allowing American workers to take a larger piece of the rising global pie.
Indeed, it isn’t a coincidence that the four factors Millstein identifies—offshoring of jobs, openness of U.S. markets without reciprocity, loss of competitiveness for American products, and privileging financial liberalization—are the primary goals of our trade policy. Supporters of TPP and TTIP argue the agreement will create quality jobs, strengthen American advanced manufacturing, and ensure fair and enforceable rules abroad. It is difficult to say with precision until the final texts of the respective agreements are made public, but the early signals and negotiating mandates indicate that the TPP will be a significant departure from the status quo on these issues. TTIP too would be a landmark agreement with our largest trading partner and most important geopolitical ally.
Connecting the Dots Between Trade and the Financial Crisis
But in the public debate about the TPP and TTIP, few have bothered to connect the dots between the TPP and the financial crisis — except for the biggest critics of the deal, that is. Skeptics of trade and globalization love to point out the supposed similarities between the TPP and the neoliberal policies that led to the financial crisis. Here is Senator Bernie Sanders, now a candidate for the Democratic nomination for the 2016 election:
“[T]he TPP would expand the rights and power of the same Wall Street firms that nearly destroyed the world economy just five years ago and would create the conditions for more financial instability in the future.”
Associating the TPP with the collapse of 2008 makes sense as a public relations strategy for Sanders. But is TPP really ‘more of the same’, or does it plot a new direction for the American economy?
Far from doubling down on past mistakes that led to 2008, the TPP would reorient the American economy to be more export-oriented, both in manufacturing — where the U.S. has a competitive advantage in ‘smart’, advanced manufacturing — and in intellectual and service industries like biotechnology, engineering, and architecture. The TPP is recognition of the fact that our lead in these industries is not likely to be permanent or as resolute as it is now. As for Sanders’ criticism, financial liberalization is a relatively small aspect of the TPP (though it will play a larger role in TTIP); the priority sectors for the U.S. in both negotiations remain manufacturing and services.
For those still skeptical of the economic benefits, the Obama Administration has quietly been making a compelling argument, what U.S. Trade Representative Froman calls the “production platform of choice.” Envision the world a day after both the TPP and TTIP have been signed and ratified. Suddenly, the U.S. would be squarely in the middle of two economic blocs that together cover two-thirds of global GDP. The U.S. would have a highly privileged and unique position as the sole bridge between growing Asian and established European markets besides Canada. The U.S. would leapfrog to the head of the queue with cheap energy, strong rule of law and intellectual property protection, and a narrowing gap for labor costs between us and the rest of the world. The benefits to American labor could be substantial. Export-related jobs in the U.S. pay higher wages than the average job. Companies with access to multiple, diversified markets are also more resilient to downturns and local shocks. The rising middle class in Asia has a strong demand for American goods and products, giving us a built-in market our competitors would love to have.
So how would the TPP help to avoid the next economic calamity? By providing new sources of growth to the economy via exports, replacing the need for debt-fueled consumption and boosting real growth in the U.S., not illusory, bubble gains.
Since Millstein’s talk in 2011, American households have reduced their indebtedness and paid off home, auto, and education loans, but this has been achieved on the back of extraordinary risk elsewhere in the system. At present, monetary policy is pushed to its limit, pushing equities to sky-high prices that few believe are a true reflection of facts on the ground. Fiscal policy and government spending are also unlikely to make a real difference in terms of growth, and high public debts in the municipal arena in Chicago, Puerto Rico, and elsewhere could mean further contractions. The continued vulnerability of the economy to external shock — think the worst-case in Greece or in China — means we should take out an insurance policy today in the form of favorable trade agreements.
Trade policy is exactly designed to avoid the pitfalls that led to the last crisis, through a slow, decades-long process of moving the U.S. towards export-based growth. We don’t know what will trigger the next crisis, but as Mian and Sufi point out, we do know what makes them worse: high levels of household debt and excessive leverage.
In this sense, and only in this sense, Sanders is right that “the TPP is much more than a ‘free trade’ agreement.” The TPP is an attempt to change the fundamentals of the American economy, away from the path it charted prior to the financial crisis — high debt, imports for consumption with few exports, and giving international free riders a pass. In economic and psychic terms, it isn’t a stretch to say that the 2008 crisis caused a deep wound to the U.S. and the rest of the world. Along with the TTIP, the TPP is like the suturing that helps heal that wound.
Trade integrates the U.S. in the global economy again in ways that were lost throughout the decade of debt-fueled consumption and folly — and financial crisis.
The views presented in this article are the author’s own and do not necessarily represent the views of any other organization.
