The accidental timing of events can offer remarkable insights into underlying reality. Last week saw the Federal Reserve meeting to debate interest rate hikes at the same time that President Barack Obama and the Republican congressional leadership were desperately struggling to find ways to pass fast-track authority in order to facilitate passage of the Trans-Pacific Partnership (TPP) trade agreement. While it may not be immediately apparent, the views of elite commentators on these two events tell us a great deal about their views on economic policy.
The defeat of the original fast-track proposal, due to a revolt by House Democrats, infuriated the likes of George Will, David Brooks and members of The Washington Post editorial board, who all expressed deep dismay that Congress may block the TPP. They have raised various issues, but one recurring theme is that the TPP will promote economic growth and that the opponents are apparently willing to sacrifice this growth if they block the deal.
The claim the TPP will promote growth is dubious. After all, a study by the United States Department of Agriculture found the impact on growth would 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 the TPP’s stronger and longer patent protections.
These models also don’t make projections on the distribution of the benefits of growth from the TPP. After all, if the TPP leads to a higher GDP but all of it goes to Silicon Valley and Wall Street, it is understandable that most people are not very excited about it.
But even ignoring these issues, it is difficult to take these concerns about lost TPP growth very seriously. The highest growth projection from any of the standard models is that it would 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 two months. In other words, if we accept the high-end projection and we 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 TPP-less world at the end of August. That would be nice but hardly transformational in terms of economic impact.
By contrast, the Fed is likely planning to raise interest rates in order to slow the economy. The Fed’s board decided not to hike interest rates in June, but it is widely accepted that the Fed 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 quickly, 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 take the risk of inflation getting out of control.
The impact on growth could be substantial. Many economists, including some at the Fed, would have it set a floor unemployment rate. 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 get to a 4.0 percent unemployment rate without causing inflation to accelerate. This was the average unemployment rate for 2000, a year when 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 with the 2-for-1 assumption, the 5.2 percent floor for the unemployment rate would be costing us 2.4 percentage points of growth — or the impact of six TPPs (under the most optimistic assumption of growth from TPP’s passage).
In this case, not only would the amount of GDP that we would needlessly sacrifice from premature Fed tightening be six times as large as the highest estimates of the gains from the TPP, but also that growth would be felt almost immediately rather than something that is phased in over more than a decade. In addition, the lost GDP consists almost entirely of lost wages to those at the middle and bottom of the wage ladder.
In addition to costing jobs, the Fed’s premature 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 would head 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 that primarily benefits the rich, growth is sacrosanct, and we would have to be nuts to consider forgoing 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. Let that be a lesson for all on how our elite commentators think.