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 Richmans' Trade and Taxes Blog

How to Avoid Trade Wars While Balancing Trade
Raymond Richman, 6/25/2018

Trade agreements are excellent examples of crony capitalism. If one party to a trade agreement imposes a tariff on the products of an industry it favors, it is simple enough for an affected country to do likewise, initiating a trade war.  Even if the initiating country had good reasons for imposing a tariff or other barrier to  trade, other parties to the agreement may object because it violates the letter of the agreement. When the Trump administration imposed a tariff on steel and aluminum products on the grounds that the two industries are critical to its defense, China immediately imposed a tariff on USA agricultural products, a sector favored by the USA in trade negotiations. Canada and the European Union announced they would impose tariffs on USA goods in retaliation to the USA tariff.  

Trade agreements usually provide some relief for a member experiencing chronic trade deficits. One that is generally acceptable is a devaluation of its currency. A devaluation means that the prices of imported goods will rise and the prices of exported goods will fall in terms of foreign currencies. As a result, the country may import less and export more. The trouble is that a currency devaluation would affect countries with which the devaluing country has a trade surplus. If a country has a chronic trade deficit with one or a few countries, one would like the devaluation to affect only them.

Only a few nations have a large trade surplus with the USA. China, 375.6 billion; Japan, 68.9 billion; the European union, 151.4 billion, including Germany 63.7 billion; and Mexico, 71.0 billion accounted for 83.9 percent of the total USA trade deficit in goods in 2017. Why do these countries have chronic trade surpluses with the USA? The answer might be that they have formal and informal barriers to imports from the USA, they produce a product in great demand in the USA, their currencies are undervalued relative to the US dollar, and they lower wages in manufacturing than the USA. The USA could appeal to the World Trade Organization if some of their practices are illegal. But it would take years to get a decision and from past evidence, the American petition would be denied.

 The USA has at its means a solution. It is called the “scaled tariff”, a single-country variable tariff, It raises the prices of imports from a single country but does not lower the prices of its exports, namely, a cross-the-board-variable-tariff on a single-country’s exports to the USA. The rate of tariff would depend on the size of the trade imbalance and would increase as the trade deficit widens and fall as the trade deficit narrows. We introduced it in our 2014 book Balanced Trade. It encourages a country experiencing a chronic trade surplus to import more from the trade deficit country because the rate of the tariff falls as the trade imbalance is reduced. The primary effect of the variable tariff will be to diminish demand for the goods of the trade surplus country by the trade deficit country. There will be diminished trade between the two countries. The taxed country will have an incentive to balance its trade with the country imposing the tax by increasing its imports from it the trade deficit country

How could a trade war be started by the country affected by the variable tariff? By itself breaching the trade agreement. But this would enlarge the USA trade deficit and increase the variable tariff.

Why a tariff on steel and aluminum would cause a trade war by countries enjoying enormous trade surpluses—in effect growing at the expense of the USA—is surprising. It is the USA that should start a trade war with China, the European Union, and Japan. That is decades overdue!