Monday, December 05, 2016

Trump, Brexit, and Aggregate Demand

A lot has been written about Trump, Brexit, and the so-called revolt against the Davos consensus that's been in place since Clinton (or earlier). All of it may be true, or have some truth to it, but fundamentally the economics problems today stem from a lack of aggregate demand.

I was at an econtalk between Russ Roberts and John Cochrane, and while I was struck by how incidental the usual libertarian talking points sounded, I thought that a point Cochrane made about market size was very insightful. He said "the larger the market, the greater the gains from specialization" which is obviously true. There is something very valuable in large, open, free markets and to lose that is a tragedy.

It's a tragedy happening right now as middle class workers, seeing jobs slip away, are voting for protectionist trade policies. And I'm a Chicago Boy, but still support this.

I support this because I don't see an equally strong fiscal response creating enough demand to generate the new jobs these people can do. Suppose I was willing to pay a 15% premium for a "made in America" product. But my budget constraint means I cannot. If I had more money, I would, as I would consume local manufacture as a consumption good. But taxes are so high that on the margin I end up not doing it.

I think the US can produce high quality products, and I think there is a premium it can capture for local manufacture, but I also think that the population's budget constraint means that that market is too small to employ all those individuals with manufacturing skills who have seen their work go overseas. A larger deficit would meet household's savings demand, relax their budget constraint, and I think drive demand that would help put those who produce tradable domestically back to work.