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This is the second installment of a critical review of Dean Baker's second reaction  to the debate kicked off by the WaPo's piece on Modern Monetary Theory , written by Dylan Matthews. The first installment  discussed Dean's views on using the monetary channel to boost aggregate demand, and began criticism on his views on devaluing the currency and increasing exports. This post continues that critique, and later takes up his views on work sharing.
Expanding US Exports at the Expense of Decreasing Real Wealth? (continued)
Dean goes on:
”To see this point, imagine a more extreme case. Suppose that we had a trade deficit equal to 50 percent of GDP. If the countries who were buying up dollar assets then decided that they had enough, so we could no longer rely on imports to meet half of our domestic demand, does anyone believe that the U.S. economy could quickly and painlessly replace our imports with domestic production?”
No, of course not! But, why do economists like Dean and Paul Krugman insist on relying on far-fetched scenarios to try to argue against simple truths that may apply today? The current account balance will probably be around 4-5% of GDP this year. As the economy recovers it will probably rise to 6% of GDP again, which represents a very real benefit to the United States. But there's no reason to expect that this growth would continue indefinitely or ever reach 50% of GDP. Why should it? What are the dynamics that would drive things this way, and make other nations value the dollar so much, that they will keep their own populations barefoot?
China, India, and Japan are all under pressure domestically to change their policies and make more of their production available to their own people. Europe may also abandon austerity soon, as they experience its ravages.
The long-term trend in the current account balance won't be up, It will be down, gradually down, for reasons I mentioned above. It just doesn't make sense for foreign nations to continue giving more than they're getting from the US. So, the 50% GDP scenario is just ridiculous. Why even bother suggesting it? What does the thought experiment prove, except that Dean Baker isn't thinking through a realistic model of the forces accounting for the international trade patterns we see?
In fact, Dean isn't even really serious about suggesting that this scenario somehow corresponds to a result of MMT economics. He says:
”I would not attribute this view to the MMTers, but then the question becomes one of a degree. Perhaps a trade deficit of 6 percent of GDP is okay, but presumably somewhere between 6 percent and 50 percent we get into a problem. It seems the question then has to be how quickly the U.S. economy could adjust to a much lower trade deficit and what is the risk that foreign countries will slow or stop their purchases of U.S. assets? We may differ on the answer to these questions, but they are the questions that must be asked.”
I think these are important questions. We should ask them. But, has Dean answered them? And do his answers indicate any serious problems for the United States economy? And if so, how does that relate to MMT? If these changes could possibly produce cost-push inflation in the United States, then MMT has some answers for that kind of problem. On the other hand, if other nations stop exporting so much to the US, then that may create less demand leakage for our economy. In which case, MMT predicts that we will get closer to full employment and also that we will have to moderate deficit spending as full employment is approached.
Dean continues with more scenarios about what would happen if foreign nations began to charge us more from imports. I won't reproduce each of these here or critique them. But, invariably, there is a general pattern to them.
It is: suppose “A” happens involving a decrease in US imports, and a rise in the price of those imports, then that would reduce real living standards in the US. But the impact on Americans wouldn't be uniform. Specifically those who compete with foreign workers would find their wages increasing much faster than the decline in standard of living for the general population.
In presenting examples of this pattern, Dean doesn't discuss any possible feedback effects of the assumed changes. For example, if US imports rose in price by 20%, what would be the feedback effect of such a price rise on US exports? Maybe nothing, but maybe, also, the net effect on changes in living standards would be much reduced.
Also, what is the effect on productivity? Dean points out that the decline in living standards could wipe out 40% of productivity gains, but what if the rise in prices stimulates unexpected productivity gains in the areas where imports are an important part of the economy?
Ultimately the details in discussions like this are very important. But we need to remember that scenarios of the kind posed by Dean make certain detailed assumptions about what might happen, but invariably ignore the possibility of the full range of side effects that may also occur. Without having good models that can predict both direct impacts of changes in import/export posture of trading partners of the US and the short-term feedback effects of these impacts, we really can't say what the final outcome would be in lowering living standards. But Dean Baker doesn't have such models.
Dean goes on by pointing out that critics of his position who claim that if we implemented it we would have to lower our standards of living to the Chinese level are just wrong about this because there is no mechanism that would cause this to happen given our higher levels of productivity. He is right about this, in my view. But MMT economists wouldn't make such a claim. They'd just claim, instead, that his proposed currency de-evaluation posture would cause us to send more real wealth to other nations and receive less real wealth from them, long before we would have experienced that if we did not follow his suggested policy. So, they would ask how this effect benefits us in the short run?
Dean would probably reply by saying that it would strengthen our industries and create higher paying manufacturing jobs. And then MMT economists would respond by saying: that's true, but we can also create good jobs, even manufacturing jobs, and strengthen our industries if the Government uses the right combination of stimulus measures and a Federal Job Guarantee (JG) implemented at a living wage with a full fringe benefits program to create effective demand. 
They'd add that this kind of stimulus would bring back private sector expansion here, and eventually would result in very few workers in the JG program within a year of its implementation. So, they'd argue: why not do full employment here first. Then other nations would either like the return of prosperity to the US and continue to export to us as they have been doing; or they will become alarmed at the size of the initial Government deficit. In which case, they'll de-value our currency themselves by raising their prices. In this way they'll implement Dean's proposal for us, but at a later date than otherwise. So the question becomes, why preempt their devaluation of the dollar with our own devaluation at a much earlier date at the cost of free space for the Government to help employ people on projects that will create goods and services that may serve public purposes?
Dean then continues with other arguments about re-balancing trade and its effects which are largely correct. But his remarks on the devaluation strategy not being “a beggar thy neighbor” strategy are only correct if we assume that such a strategy would not lead to negative compositional effects at the higher level of the international economic system.
If US attempts to devalue were followed by other nations responding in kind , then a race-to-the-bottom could result which would harm workers in all the major nations of the world. In this context MMT would probably say, don't devalue. Instead use fiscal policy to fully employ all of your working people, and then let other nations devalue your currency as they please. There will be far less danger of a race to the bottom in this scenario, since your attempt to employ all of your own people to domestic tasks producing valued outcomes, can hardly be viewed as an attack on the desires of other nations to continue to export to you.
Is Work Sharing a Separate Channel for Raising Aggregate Demand?
”In my original comments I did not mention work sharing, but it really should be included in any discussion of full employment policies. There is nothing natural about the current length of work weeks and work years. They are the result of a set of historical processes and policy decisions which could well have been otherwise. In Western Europe, the standard work year for full time workers is around 20 percent shorter than in the United States. . . .
“In this context, it is difficult to see why we should not look to meet a shortfall in demand in part by encouraging employers to reduce work hours. The government already subsidizes layoffs through unemployment insurance. What can be the logic in saying that the government will pay half wages for workers who have lost their jobs, but not compensate for lower pay due to a reduction in work hours?
“There are strong arguments that it is better for workers, employers and the economy as a whole to keep a worker on the job where they can be continually upgrading their skills rather than risk the possibility that they endure a long period of unemployment. This is a well-researched topic. The long-term unemployed have great difficulty finding new jobs and many will never be re-employed. If we have a route to avoid this risk, why would we not take it?
“If it ends up being the case that increased use of work sharing leads to changes in the standard work week or work year, that would be great in my view. This would lead to more family friendly work places and likely better lives. The basic point would be that workers would be getting the benefits of increased productivity growth partly in the form of more leisure, not just higher income. (This assumes that we can restructure the economy so that workers do get the benefits of productivity growth.) Also, this should be great news for the environment. There is a very solid correlation between income and greenhouse gas emissions. If people can get more time off in lieu of higher take home pay, it would be a relatively painless way to reduce greenhouse gas emissions.
I find myself in complete agreement with the proposals in the past few paragraphs and the arguments for the benefits of work sharing. I have only one problem with it, and that is why Dean classifies this proposal as a separate channel from the Government deficit spending channel?
From my point of view, making the standard work week 35 hours and mandating the kinds of fringe benefits they have in Europe and compensating workers directly with Government subsidies for the reduction of 5 hours of work per week they receive, is definitely using the Government channel to raise aggregate demand, since the increased demand comes from the Government subsidy assumed by the proposal. It's not a proposal the economists developing MMT have put forward. But I've put forward a similar proposal , and I see nothing in it that is in conflict with MMT.
So, I think we're back to three channels, not four, and given the objections I've recorded above to the first two channels, I think it's time to move to Dean's problems with “exclusive” reliance by MMT on the fiscal policy channel.