Human Capital And Trade Deficits

Michael Mandel had an interesting take on the US trade deficit in Business Week earlier this month (btw: he also has a weblog).

His opinion is that the US trade deficit isn’t as big a deal as people often think. One of the reasons: that the ongoing import of human capital into the US (which of course isn’t measured in the trading accounts ledger) more than compensates for the deficit:

But get with the 21st century, folks. The trade in goods and services represents only one part of America’s connection with the rest of the world. What’s equally important — and what the trade numbers miss completely — is the incredible flow of people into the country. Each year, the U.S. receives about 700,000 legal immigrants, as well as a host of temporary skilled workers and undocumented immigrants.

Now I wouldn’t go down the same road as Mandel with the deficit question per se, but he obviously raises an interesting point here – and one, of course, that immediately strikes a chord with me.

First an obvious point: GDP, GNP or whatever variant of measured transactions you want to use only give one estimate of the wealth of a country. These indicators only give a measure (and a fairly rarified and abstract one at that) of market transactions.

But of course every society has any number of other sources of wealth which are not measured by the market: housework by women, and motherhood in general obviously form part of these. Sun in Spain in winter, or ice in Russia in summer, or rain, or the texture of your surface soil might be others.

It is for this reason that the UN has a human development index to offer a broader perspective on what might be called the ‘wealth of nations’.

Indeed in the development process of an economy, one of the key transitions is that of moving large numbers of people living in a subsistence rural economy out into a broader market system. The migration process from the land to the city in China in recent years would be a clear example of this: and China’s spectacular growth numbers would be the visible result. But since many people were working and living outside the measured ‘cash’ economy before the change we need to remember that China was not really as poor as it seemed, nor has the real wealth of the individual actually risen as much as the numbers suggest.

Sometimes I think here that economists could learn from sociologists (or at least should listen to them more). Durkheim once had a claim to fame based on a comparative suicide study. He tried to investigate why suicide rates apparently varied so widely been societies and professions, and to give a sociological ‘meaning’ explanation for this (eg ‘anomie’). Later people realised that the indicators which apparently were being explained, were actually part of the cause: differing attitudes to suicide produced differences in what was recognised as a suicide between one society and another – ie the measures were different.

We have somewhat similar problems in economics: if it moves measure it…. but if it doesn’t move? An up and coming example of this in Europe will be the handling of elderly care. If more people leave the labour market to ‘care’ for an elderly relative (family care), then the GDP numbers will be negatively affected: but will our real social wealth have deteriorated? Clearly not, or at least ‘it depends’.

So now for Michael Mandel:

This flow of immigrants brings a much bigger value to the U.S. than most people realize. Let’s do a back-of-the-envelope calculation. One way to estimate the value of a person’s human capital is to look at the present discounted value of his or her future income, adjusted for inflation. That is, what you are worth is what society is willing to pay you over your working life.

So, if you expect to earn an average of $50,000 per year in real terms for the next 30 years, a little twirl of the spreadsheet shows that the discounted present value of your future earnings totals roughly $800,000 (assuming a discount rate of 5%, after inflation). Calculated in this way, PhDs in their 30s possess human capital valued at about $1.2 million, and holders of master’s degrees have human capital worth about $840,000. Similarly, the human capital value for a person with a college degree is about $660,000; for a high-school graduate, about $390,000; and for someone who has not graduated high school, about $260,000.

Of course Mandel here focuses on the upper end of the income scale, the skilled migrant. This makes the argument look more attractive, and hence more palatable perhaps to his readers.

But the issue isn’t essentially any different with the hundreds of thousands of poor immigrants who arrive – legally and illegally – in the US every year, and work in construction, agriculture, low-pay services like industrial cleaning, or in the domestic sector.

What in another context would be termed start-up costs, are here near to zero. The years of the human life where the person is a dependent, the formative years, have been paid-for elsewhere. And this has a real net worth.

I think Mandel is right to draw attention to this problem, there is a real transfer of wealth here, and it isn’t measured. But this doesn’t help the US with the deficit situation, except in one sense: all the extra wealth that these extra workers can produce in the future can help pay-off the debts the US is now accumulating.

“it follows that new foreign workers are bringing about $200 billion of human capital into the U.S. each year. True, this is a rough estimate — further refinements could make that number quite a bit higher or lower. But what’s important is that even as America is building up bigger foreign debts on the negative side of the national balance sheet, it’s also building up bigger human capital assets on the positive side.”

However this is for the future: but what also is actually important is the here and now. Any country running long-term CA deficits has an ability to pay issue: it is dependent on the willingness of others to accept what you offer in return. So unless the Federal Reserve is thinking of opening some extra lounge space (following the recent Tom Hanks film) in its major airports (since bank vaults would hardly be the ideal storage area for accumulated human capital resources), and unless the US’s creditors are willing to accept international transfers in this form (who knows, Japan could really use a hefty inflow of immigrants), then it seems to me that there is still an outstanding trade issue awaiting to be addressed.

Postscript: If I am using the US as an example, it should be obvious that I have the needs of the EU and its economic future very much in mind here.

Background reading:

One interesting summary of some of the issues with GDP is a speech Alan Greenspan gave back in 2000: GDP One of the Great Inventions of the 20th Century.

A good starting point for a review of the issues involved in the US trade deficit can be found in this paper by Nouriel Roubini and Brad Sester: Will Bretton Woods 2 Unravel Soon?

An alternative view on the deficit can be found in this speech by Ben Bernanke.

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About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

4 thoughts on “Human Capital And Trade Deficits

  1. While I agree that immagration legal and illegal has always been a plus for the economy it is not cost free. First is the cost of educating their children etc.
    Second is the cost of supporting the marginal workers they displace at the bottom

  2. “it is not cost free”

    Oh, of course. You’d have to do a real growth accounting exercise to see what were the real benefits. All I think Mandel is drawing attention to is that there is a substantial up-front plus element which normally isn’t included in the evaluation.

    “is the cost of educating their children etc.”

    Well children as children, I don’t see any special on-cost, as you have to do this with ‘natives’ too. If you mean ‘special cultural adaptation costs’ for the education system etc, then obviously you are right.

    On the other hand this too would have pluses and minuses, most of which would be hard to evaluate, which takes us back to the what you can and what you can’t measure problem.

  3. I’m no economist, but aren’t the benefits of past immigration right there in the GDP?

    And wouldn’t you expect that an extrapolation of GDP-numbers into the future already includes the benefits of current and future immigration?

  4. “but aren’t the benefits of past immigration right there in the GDP?”

    Yes clearly they are, but few choose to break the numbers down to look at this.

    On the extrapolated GDP numbers, forecasting is a less accurate science than weather forcasting. The degree of accuracy of GDP estimates more than 1 quarter forward isn’t exactly impressive. Normally we have to wait for all the revisions to even get accurate numbers for the past.

    Incidentally, and talking of which, Spain last week made an upwards revision of its GDP numbers based for the last four years: based precisely on allowing for the number of undocumented workers active in the Spanish economy. I’ll probably post something on this during the week.

    BTW: nice blog Jasper :).

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