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Richmans' Trade and Taxes Blog
The Case for Free and Balanced Trade
In the 2016 presidential campaign, trade has become a major economic and voting issue. For decades both political parties have supported expansion of free trade through trade agreements. So have most academic economists. But a few have urged a policy of balanced trade with the rest of the world. Free trade and balanced trade are not necessary mutually exclusive.
When trade is balanced, all trading partners benefit. Countries can increase that benefit by reducing their barriers to imports, as long as trade remains balanced. Then they will exchange goods that are cheaper to produce in one country for goods that the other country can produce more cheaply. This is called the law of comparative advantage. Both countries benefit. David Ricardo pointed this out in the early 1800s.
But what happens when trade is not balanced? Is free trade still a good thing? Unfortunately, U.S. policy makers in Washington have thought so and so have most economists. They are wrong. The U.S. economy has been suffering annual trade deficits for decades that resulted in economic stagnation, slower than normal economic growth, and the loss of millions of manufacturing jobs. The Table below shows how the trade deficits for selected years during the period covered by the foregoing graph caused a reduction in Gross National Product and led to slow growth. The slow U.S. economic growth rate of the last 17 years is unprecedented. From 1999 through 2015, the average U.S. growth rate was just 2.1% per year, as compared with over 3% for almost every ten year period during the previous 5 decades.
The following table shows how negative net exports reduced Gross National Product during selected years from 1960 to 2015
Gross Domestic Product (Billions of dollars)
Note that the Growth of GDP would have been positive instead of negative in the years 2000, 2008, 2009, and 2015 if trade were balanced.
The Bureau of Economic Analysis of the Department of Commerce publishes the GDP figures so these facts could not have escaped the thousands of economists who saw nothing to worry about because they were the result of “free trade”. Nevertheless most of them ignored the obvious relation between the trade deficits and the effects of GDP. One of the most popular textbooks in international economic, Paul Krugman, M. Obstfeld and M. Melitz in their International Economics, Theory and Policy, Custom Edition 2012 have no discussion of the U.S. trade chronic deficits and their causes at all. Another by Dominick Salvatore in his 11th Edition of International Economics blames the U.S. trade deficits on the “excessive appreciation of the dollar during,the first half of the 1980s and the overvaluation of the late 1990s and early 2000s” and on “deep structural imbalances in the form of excessive spending and inadequate national saving.” He writes, “The current U.S. trade deficit is unsustainable in the long run as is the large trade surplues of Germany (among advanced nations”). He barely mentions China, only that it enjoys rapid growth and a trade surplus. His solution for the U.S. is to correct its structural imbalances, a long run solution maybe. But it means continuing trade deficits as far as the eye can see.
The burden of the slower economic growth has fallen disproportionately on the blue-collar American middle class. They have lost highly-productive middle-class manufacturing jobs and have been forced to take less rewarding jobs in the service sector.
Most of the problems of international trade are related to this fact that a number of big countries including China, India, Japan, Germany and South Korea are running huge trade surpluses year-after-year while their principal trading partner, the USA, has run chronic trade deficits. So their economies are booming at the expense of the U.S. economy.
All academic economists have decried mercantilism. Adam Smith, the founder of modern economics in his 1776 magnum opus (An Inquiry into the Nature and Causes of the Wealth of Nations), called it a policy of “beggaring all their neighbors.” Similarly, John Maynard Keynes has written that the U.K. would not countenance “beggar-thy-neighbor” policies by its trading partners.
The problem is that mercantilism works. Trade surplus countries gain factories and jobs as a result of undervaluing their currencies and adopting other mercantilist policies such as trade barriers (tariff and non-tariff) and export subsidies. China, Japan, Germany, Korea, have grown rapidly while the trade deficit countries have stagnated, losing factories and jobs.
Fortunately, there are a growing number of respected economists who have been explaining the connection between trade deficits and economic growth. One is Prof. Ralph Gomory, Research Professor at the Stern School of Business at New York University. He is the co-author with Prof. William Baumol, distinguished former Professor of Economics at Princeton University, of a seminal work published in 2000. They showed that countries can acquire a “comparative advantage” by specializing in any industry in which they can obtain economies of scale and become low-cost producers. And Prof. Gomory has called attention to mercantilist policies being practiced by some trade surplus countries.
Another is Prof. Peter Morici at the Robert H. Smith School of Business at the University of Maryland. He proposed a dollar-yuan conversion tax that would be applied to Chinese imports into the United States at a rate that would be adjusted to the degree of Chinese currency market undervaluation, similar to our proposal described below. Yet another is Donald Trump’s chief economic advisor. Prof. Peter Navarro at the University of California-Irvine, who is on record with his view that the chronic trade deficits have cost a huge loss of manufacturing jobs. In the last chapter of his 2015 book (Crouching Tiger), he calls for steps such as “countervailing duties, and other appropriate remedies (p. 276)” against Chinese products, but worries that the influence of those American manufacturers who produce in China will prevent such needed action.
We have proposed a system for balancing trade. We recommend that trade deficit countries protect themselves by applying single-country-variable tariffs, called “scaled tariffs.” whose rates rise or fall depending on whether our trade deficit with that country is increasing or decreasing. When trade is reasonably close to balance, the rate would fall to zero. Many fear the trade surplus countries would take retaliatory action but these actions would hurt them more than us as we point out in our book, Balanced Trade (Lexington Books, 2014).
The U.S. trade deficits became an important issue in the 2016 campaign for the presidency of the U.S. when the candidate of the Republican Party, Donald Trump, registered his objections to unbalanced trade and the exodus of U.S. factories to foreign countries. Balancing trade would double U.S. economic growth according to the Table above,, restore the blue-collar middle class, and begin the process of restoring U.S. economic and political power.
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The author is Professor Emeritus of Public ad International Affairs at the University of Pittsburgh and holds a Ph. D. in economics from the University of Chicago
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