After listening to conflicting advice from his economists, President Harry S. Truman famously demanded to be briefed by a one-handed economist. And to the average citizen seeking enlightenment on the likely impact of the Trans-Pacific Partnership (TPP) on the US economy, it must be similarly frustrating. On the one hand, the Peterson Institute just released a study by Peter A. Petri and Michael G. Plummer (2016) (PP) estimating that the TPP would raise US real incomes by 2030 by 0.5 percent, with percentage gains to labor that would be slightly higher than those to capital. On the other hand, the Global Development and Environment Institute (GDAE) at Tufts University has released a study by Jeronim Capaldo et al. (2016), which predicts that the TPP would reduce US income by 0.5 percent, reduce employment by almost half a million jobs, and increase income inequality. Most news reports, in an effort to be even handed, have reported the results of both studies, more or less treating them as equals.1
To decide which of these studies is more credible, three questions should be asked: First, is the model that is used appropriate for exploring trade policy? Second, has the TPP been depicted in that model in a sensible way? And third, are the results of the model credible?
I argue not only that the PP model is superior on all counts but also that whatever the merits of the model used by GDAE, it is simply not suited for credibly predicting the effects of the TPP.
Is the Model Appropriate?
The PP paper supplements the so-called Global Trade Analysis Project (GTAP) model, which has been developed collaboratively with the express purpose of estimating impacts of trade policy. It reflects the modern microeconomic theory of trade and has been made available to hundreds of scholars through a project at Purdue University. The behavioral equations in the model are combined with the latest data on trade flows, employment, output, tariffs, and nontariff barriers for 18 different industries in 24 country blocs with every TPP country explicitly modeled. The model generates predictions for real incomes, real wages and real profits, exports, imports, foreign direct investment, and industrial structure. Specifically, it captures how TPP specialization raises US wages and profits, increases the buying power of US consumers, and provides benefits from foreign direct investment.
The GDAE predictions come from a Global Policy Model (GPM), which was actually developed to explore the macroeconomic relationships between countries and how unexpected shocks such as the global financial crisis could be transmitted among them (Cripps and Izurieta 2014). It reflects a version of Keynesian theory, designed to explain short- and medium-term fluctuations. The model predicts a level of income and employment as outcomes, and as the creators of the original model emphasize, it has no internal mechanism that would lead the economy towards full employment over the long run. The model’s equations have not been published, nor has it been made available to other scholars for interrogation or replication (Bauer and Erixon 2015). Because of its macroeconomic focus, the GPM does not have the granularity that allows it to estimate variables such as exports, imports, foreign direct investment, and changes in industrial structure. As a result, its predictions ignore the benefits to the TPP economies that occur through increased specialization, the realization of scale economies, and improved consumer choice. In essence, as a trade study, the GDAE study is like Hamlet without the Prince!
Depicting the TPP
The PP paper goes to great lengths to estimate both the tariff and nontariff barriers that will be reduced by the TPP. Since the TPP will be implemented over a decade or more, it is appropriate to assume that wages and prices are flexible and adjust so supply equals demand, and the economy will eventually achieve the same normal level of employment as in the baseline prediction. This assumption also allows the model to predict how the TPP will ultimately affect wages of skilled and unskilled labor as well as profits. In other words, it captures the net impact on the demand for types of labor and capital when some industries contract while others expand. A weakness in the model used by PP is that it provides no information about the adjustment costs of workers who could be displaced and forced to find new jobs. However, the predictions generated by the model on import growth can be used to estimate this displacement. Indeed, PP show that even under the most pessimistic assumptions, this displacement would amount to a small fraction of annual churning in the US labor market that occurs through normal job separations and hires.
The GDAE model has no variables that actually depict trade policy and none that capture the gains from international specialization. Indeed, several of the countries are lumped together as a bloc (e.g., Brunei, Malaysia, Vietnam, and Singapore) as are Peru and Chile, so that key differences among them are not distinguished. The TPP is introduced into the model in an ad hoc fashion as a shock to aggregate demand. Since the equations of the model are not available, the reader has to rely on verbal descriptions of the generation of the effects of the TPP. These descriptions are convoluted.
The authors claim that by intensifying competition the TPP will lead to a race to the bottom as workers are laid off and wages in all TPP members are squeezed at the expense of profits, and all TPP countries are forced to raise interest rates in order to retain capital. In all TPP countries, employment drops and remains permanently lower. Labor’s share in income in all countries declines, and this decline is presented as a headline result of the study. Yet this conclusion is actually based on the authors’ assumption rather than a response generated by their model. In addition, the description of what happens once the TPP is implemented is biased. It emphasizes the negative effects of more imports and capital outflows but ignores the offsetting positive effects resulting from more exports and capital inflows.
The PP outcomes are plausible. TPP countries all benefit, with smaller countries experiencing proportionately larger gains in trade and incomes. In the United States in 2030 real incomes are raised by $131 billion (0.5 percent of baseline GDP). Given that the model they use allows for gains from increased variety and exploiting scale economies, the finding that labor and capital both benefit is quite possible. And their finding that labor would gain slightly more in percentage terms than capital is in line with the shares these factors have in the increase in value-added.
The GPM, by contrast, predicts a (permanent) decline in employment in every country in the TPP, which totals 770,000. The authors claim their model is “more realistic,” yet their model also predicts declines of 5.4 million jobs in the rest of the world! Indeed, GDP in non-TPP developing countries (i.e., China, India, Indonesia etc.) falls by 5.24 percent. It is not believable that a trade agreement of this magnitude could cause the rest of the world to plummet into recession.
To see how implausible this is, consider what the model would predict if the TPP process was actually reversed. Imagine if all TPP countries significantly raised their trade barriers and restricted capital movement. Presumably employment would rise in all the TPP countries—despite the loss of exports and curtailment of FDI inflows—and the rest of the world would boom! Indeed, given the model’s conclusions it is hard to understand how a world in which trade barriers have been continuously reduced has enjoyed so much prosperity in recent decades. What the model actually implies is that the whole world would be far better off with a trade war than with the TPP!
1. See Bauer and Erixon (2015) for a critique of the GPM and the confusion created by the Capaldo (2014) study of the Transatlantic Trade and Investment Partnership (TTIP), which also used the GPM to produce results that differed dramatically from all other TTIP studies.