Deflation: So What?

Jerry Pournelle has a good bit on deflationary spirals today.


The new fear is deflation. There's also the plea that we don't really understand deflation. Roosevelt didn't understand it either, although the New Deal took a number of measures to combat it, including requiring farmers to pour out milk and slaughter little pigs in the hopes of driving prices higher (see Amity Schlaes The Forgotten Man for a lot more on that.) What the New Deal did understand was that deflation brought about a nasty spiral, and the Great Depression hung on and on and on. Japan, having been the model for economic growth -- I suppose not many remember when Japanese visitors drove a real estate boom in Hawaii -- suddenly went bust and a deflationary period came with a long period of slow economic growth. People talk about the lost decade. Deflation, slow economic growth, and rising unemployment all went together.


As an example; for a number of years we had the North American Free Trade agreement. Ross Perot worried that the "giant sucking sound" you heard was the export of American jobs to Mexico. Indeed, a great number of maquiladores, factories just across the border in Mexico, sprang up, and a great number of jobs were moved to Mexico. Most of those were light manufacturing, labor intensive work making consumer goods. The result was lower prices of such consumer goods. That brought down prices in the US, and one supposes that it cost some US jobs, but the times were pretty good. Most of the maquiladores were built with US capital and much of the profit returned to US owned companies, while at the same time the presence of good jobs in Mexico lightened the pressure on the US borders.

Then came Wal-Mart (and others, but I particularly remember Wal-Mart) which put pressure on its suppliers to bring prices even lower. The way to do that was to export the jobs from Mexico to China while at the same time insisting on unrestricted free trade with China. (The Chinese began by demanding "most favored nation" status, meaning that they'd get as good a tariff deal as Mexico.) Chinese labor was cheaper than labor in the maquiladores. The result was the ruin of many of the maquiladores. The jobs were exported to China. I don't know if the reciprocal free trade with China brought about more US export, but it doesn't seem to have. I know that in the case of intellectual property, there tended to be the export of a few US copies followed by the widespread availability of the property -- books, movies, software, music -- in Chinese editions that didn't pay any royalties back to the US. Perhaps there were compensating sales I don't know about. Mostly, though, jobs flowed to China.

Over time a good part of the US economy shifted from making consumer goods to opening containers of consumer goods made in China. The Mexican economy was hit even harder as the maquiladores began to shrink, then close.

The result was lower prices of consumer goods, but also unemployment in the US and Mexico.

No one seems to recognize this as a self-inflicted deflationary spiral, but I do wonder if we didn't do exactly that to ourselves? And meanwhile we continue to impose all kinds of regulations -- many very good I am sure -- on American businesses. Minimum wages, safety regulations, work rules, retirement packages, health care -- all of which raise the price of American labor and make it far more profitable to export a job than to create one.

I have for a long time thought that imposing a 10% across the board tariff on imported goods -- all of them -- would make considerable sense. It might even slow down the self-inflicted deflationary spiral of lower cost goods and rising unemployment. And note that unemployment isn't free, as witness the continuing extension of unemployment benefits. Money paid as unemployment compensation is extracted from the still-profitable part of the economy, and of course unemployment compensation taxes make US labor more expensive, and thus encourages job export: job export brings lower prices and more unemployment.

I continue to be puzzled by the fear of deflation. I am not enough of an economist to know the economic arguments, although the historical analogy with the Great Depression is clear enough. I just cannot help but protest, the long period of deflation in Japan has not been the end of the world. I am not Japanese, nor do I live there, but I still fail to see that life has suddenly become horrible for the Japanese. The fear and  the observable results do not match.

I do understand that the econometric models predict that the economy will suffer in this situation. Like Pournelle, I want to know whether success has been properly defined in those models?