Raymond Richman       -       Jesse Richman       -       Howard Richman

 Richmans' Trade and Taxes Blog

Much Ado About Trade Wars
Raymond Richman, 7/26/2018

The media are all hyped up about trade wars. Where were they when USA factories were shutting down and moving overseas costing millions of Americans good-paying manufacturing jobs and when the trade deficits showed up endlessly in the Gross Domestic Products accounts causing slow economic growth? They still do not mention them except to deride Pres. Trump when he mentions it. Nor are economists free of blame. Balanced trade is easy to achieve but not by tariffs on particular products but by scaled tariffs, variable-single-country-tariffs that work like devaluing a currency, the traditional method of achieving balanced trade.

Nearly all economists are strong advocates of free trade. That is a hangover from the decades before WWII when the U.S. was the leading trade surplus country. When the U.S. became the world’s leading trade deficit country, economists did not change their outlook and economists were silent about the harm those deficits were doing to our basic manufacturing industries. They still are.

Prof. Martin Feldstein of Harvard wrote in a recent issue of the Wall Street Journal (7/6/2018) that he is a “strong advocate of free trade” and writes that, “If the U.S. reduces the trade deficit with one country, it must increase the net trade deficit with others to keep the total unchanged.” Notice his qualifying phrase “to keep the total unchanged.” That phrase hidden in his rhetoric is a non-sequitur; keeping the total trade unchanged is not a policy objective. He is saying that tariffs and subsidies and exchange rates do not have any effect on the trade deficits which is utterly false. Our trade objective should be to increase the total welfare of Americans by specializing in the production of goods that we have comparative advantage in producing and trading them for an equal value of goods that our trading partners have a comparative advantage in producing.

Balanced trade is always beneficial for both trade partners. When a country has a trade deficit with one of its trading partners and with the rest of the world, economists cannot show that the trade is beneficial to both trading partners.

Unfortunately, the conditions for a free trade policy do not exist in the real world. No economist should be in favor of free trade unless the following conditions are satisfied by the trading partners: a common currency, absence of any artificial barriers to trade, and free movement of capital and labor. Those conditions are imposed on the States by the U.S. Constitution. But they do not exists internationally. Being for free trade in the international community has no rational basis. Formal (tariffs) and informal barriers (especially in countries which lack free markets), industries are subsidized, artificially low foreign exchange rates are  maintained vis-à-vis the USA, and barriers to the free movement of capital and labor are the rule, not the exception. Several countries have large chronic surpluses with the U.S. They acquire huge amounts of U.S. government and corporate debt, and often use the funds to acquired business assets in the U.S. The U.S. has a huge chronic trade deficit with the rest of the world.

The U.S. had chronic surpluses before 1970 and was the world’s leading creditor nation until chronic deficits converted it to the world’s leading debtor nation by the mid-1980s. After the GATT agreement of 1994 and the establishment of the World Trade Organization, the U.S. trade deficit exploded as the following table shows:

As one sees from the table, the 1994 Gatt agreement led to huge trade deficits for the United states. That is the price one pays for having lawyers as Trade Representatives instead of economists and business administrators. The last column of the table tells us that GDP was affected adversely by the trade deficits falling short of what should have been its balanced trade level by as much as 5.56 percent and was no doubt a contributing cause of the severity of the Great Recession of 2008-2015.

The U.S. can balance its trade as the Trump administration is doing by imposing tariffs on particular products of trade surplus countries. Unfortunately, this gives trading partners the opportunity to do likewise.

There is a better way, the scaled tariff, the single-country-variable tariff that we proposed in the book Balanced Trade (Lexington Books, 2014), a tariff that applies to all goods and services imported from trade surplus countries. The tariff rises as the trade deficit with a particular country rises as the trade deficit with a particular country increases and falls as trade moves toward balance. The highest tariff would apply to China and much lower tariffs would apply to countries whose trade surplus is much less. About a half dozen countries, accounting for more than 80 percent of the U.S. trade deficit, would fall in this group. Countries with relatively small surpluses would be unaffected. The following table shows the ones that would be affected, and our estimate of a suggested initial tariff.

Countries could not retaliate as they are doing in response to the administration’s imposition of the steel and aluminum tariff and countries that have nearly balanced trade or a trade deficit with the U.S. would not be affected. Brazil, for example, has a trade deficit with us and would be harmed by tariffs on selected products like steel and aluminum. If they did impose tariffs on selected products, it would increase the trade deficit and raise the variable tariff.

Countries that have large chronic trade surpluses with the U.S. in 2017 include China $375.6 billion, Japan $68.9 billion, the European Union $151.4 billion, Mexico $70 billion, Vietnam $38.4 billion, and Ireland $38.1. Balancing trade with those few countries would reduce our trade deficit over 90%.