Economy

Why Trump Is So Clumsy About Fighting 'Free Trade'

There are better ways than simply slapping tariffs on imported goods.

Photo Credit: Albert H. Teich / Shutterstock

President Trump announced last week that he plans to impose 25 percent tariffs on imported steel and 10 percent on imported aluminum. It’s important to note that any policy pronouncement from this president is done within the paradigm of a real estate wheeler-dealer who sees deals of any kind as a zero-sum game. I win, and you lose; there is no such thing as a good trade deal that works as a win-win for both sides.

Expressing the opposite view is Paul Krugman, who writes, “Trade isn’t a zero-sum game: it raises the productivity and wealth of the world economy.” And the corollary also applies as well: any action taken to disrupt the free flow of goods between countries is likely to provoke a counter-reaction, the result being a trade war in which every country loses out (there are already early indications of the latter, as seen in a tweeted headline from a UK paper, “Hit the Chevy with a Levy, Tax your Whiskey and Rye”).

Given that Krugman won a Nobel Prize for his work on international trade, it is unsurprising that he gives a full-throated endorsement of free trade:

“If there were an Economist’s Creed, it would surely contain the affirmations ‘I understand the principle of Comparative Advantage’ and ‘I advocate Free Trade.’ For one hundred seventy years, the appreciation that international trade benefits a country whether it is ‘fair’ or not has been one of the touchstones of professionalism in economics. Comparative advantage is not just an idea both simple and profound; it is an idea that conflicts directly with both stubborn popular prejudices and powerful interests. This combination makes the defense of free trade is close to a sacred tenet is any idea in economics.” (pg. 131)

The two “sacred tenets,” free trade and comparative advantage, are inextricably linked. After all, a “comparative advantage” begets the question, compared to what? We export goods to other nations when we can do that relatively better than they can and likewise import goods or services that we have a comparative disadvantage in producing. So tropical fruit is exported from, say, Mexico or Chile, rather than from Canada. And Australia’s abundance of natural resources explains why it has become a mining superpower. Of course, this classical model of trade and comparative advantage breaks down somewhat in an ultra-globalized world in which capital accounts have been largely liberalized (thereby allowing businesses to “arbitrage” wage rates/regulation by migrating to offshore manufacturing facilities with lower regulatory thresholds and cheap labor), and where technology is highly mobile and can be used to diminish natural advantages such as climate or natural resources. Technology and labor skills can also be altered by national development strategies of the kind exemplified by the countries of Asia (South Korea being a prime example), as Robert Wade illustrated in his seminal work, "Governing the Market."

The bottom line is that it is a mistake for a country simply to follow an idealized playbook from an economics textbook on free trade/comparative advantage, and allow itself to be out-gamed via strategic trade policy/national development decisions taken elsewhere—particularly when the economy is not operating at full employment, which is key to optimizing the benefits of free trade. It’s all very well to argue that cheaper imported goods are benefits, but it is hard to consume those benefits when one is unemployed against a backdrop of rusting unused factories that have been shuttered, and where the jobs have been sent to Mexico. As misconceived as Trump’s actions might appear, then, one senses that the latter dynamic is the source of his angst when he talks about the U.S. getting “a bad deal” from countries like China (although frankly, this president seems to think that any country with whom the U.S. runs a trade deficit is ripping off America).

Within the Trump administration, when the discussion turns to trade imbalances, it almost invariably turns to China. Whether it was economic nationalist Steve Bannon, or the current director of trade and industrial policy, and the director of the White House National Trade Council, Peter Navarro, Beijing is generally seen by these two trade hardliners as the epicenter of America’s trade problems (even though Bannon has left the administration, his economic nationalism, along with that of Navarro, appears to be in the ascendant at this juncture).

Here is the economic nationalist case against Beijing: China manipulated its exchange rate via the purchase of U.S. bonds. The undervalued exchange rate resulted in a high savings rate in China, while the U.S. government used the proceeds of its bond sales to stimulate the domestic economy and support wars in Afghanistan and Iraq, which built up yet more debt. China produces goods at very low cost due to extremely low wages and sells them to U.S. citizens via its undervalued exchange rate. They obtain dollars that they recycle in similar fashion over and over again. The U.S. accumulates goods via this vendor financing, while the vendor accumulates dollars that are invested in bonds. Meanwhile China dumps goods into the U.S., destroying valuable jobs at home.

The process described above continued uninterrupted for years, increasing debt in the U.S. and building up large foreign exchange savings in China. All the while, Uncle Sam financed the housing market, resulting in an historic housing bubble. That housing bubble resulted in a false signal of a wealth gains that were then invested in the stock market leading to a stock market bubble, both of which financed over-consumption, and the buildup of yet more trade imbalances, until the entire system came crashing down in 2008, destroyed the savings of millions of Americans (including among others, Steve Bannon’s father).

But was the resultant fiasco a product of “unfair” trade, or was it symptomatic of a broader problem of financialization? If the latter, then Beijing might be the wrong target, and protectionism the wrong policy response. This is a particularly germane question, given that the perpetuation of our current system of finance—along with the corresponding refusal/failure to fix this after 2008—has led to yet more private debt accumulation and the re-emergence of the trends that led to the 2008 crisis: a capitalism characterized by securitization, globalization, the proliferation of complex financial derivatives, deregulation and a corresponding reduction in supervision and legal oversight (even the modest regulations introduced via Dodd-Frank are steadily being gutted a mere 10 years later).

In that context, here is why trade deficits can hurt: If households attempt to net save by spending less than they are earning, businesses attempt to net save (reinvesting less than their retained earnings), and a country runs a large trade deficit, then nominal incomes and real output will fall, absent a robust fiscal policy response that focuses on employment (as opposed to tax subsidies for already profitable businesses—see Amazon.com—or tax cuts for the rich). The government has already dropped the ball on fiscal policy (with a “tax reform” heavily tilted toward the 1 percent). As L. Randall Wray and Eric Tymoigne have highlighted, “the essential point is that the United States government has been willing to become less involved in economic affairs and the improvement of the economic welfare of its population,” which has been exacerbated by trade deficits. Cheap imports are great if you’ve got a job and the spending power to buy the goods. But the de-emphasis of activist fiscal policy has meant that a larger share of the burden of improvement and maintenance of the standard of living has been put on the private sector, especially households, via debt accumulation (aided and abetted by the vendor style financing arrangements, which were exemplified in our trading relationship with Beijing).

Trade deficits, then, create demand leakages, which have to be offset from somewhere. You can do this via the government sector (fiscal policy), or dissipation of yet more private sector dis-saving (and debt accumulation). As far as the latter goes, market strategist Robert Parenteau has suggested, “that a drop in private income flows while private debt loads are high is an invitation to debt defaults and widespread insolvencies—that is, unless creditors are generously willing to renegotiate existing debt contracts en masse” (the creditors clearly haven’t done that yet, and no reason to expect that to change imminently, given the current political configuration).

Turning trade deficits to surpluses is another way to mitigate the problem, but how to achieve this when the U.S. has not run sustained trade surpluses for decades? Additionally, as Krugman and other critics of Trump’s proposed policy response have pointed out, a blunt resort to protectionism is likely to prove self-defeating, given the probable retaliation from America’s trade partners, the concomitant disruption of global supply chains, and the corresponding rise in imported goods prices, which cuts into consumers’ buying power (by acting as a functional tax hike). In other words, it’s a “lose-lose” proposition.

The other problem in relying on trade to improve growth and employment is that, put simply, it takes two to tango. To reduce its trade deficit or, more unrealistically, to run a trade surplus, the U.S. would have to secure cooperation from its trading partners (the use of tariffs seldom achieves this and it is also hard to believe that countries like Germany or China would readily abandon their mercantilist model, simply to help the U.S.). Furthermore, a reliance on trade to promote fuller employment renders U.S. economic performance subject to the vagaries of other countries’ policies. Domestic fiscal policy, by contrast, does suffer from these twin deficiencies.

However, even those who understand that trade imbalances can create job shortages or demand shortages often argue for more stimulus spending (or tax cuts), with little concern for how the stimulus is distributed throughout the economy because of that canard that “national planning” will subvert the workings of the free market. There are, however, a number of problems with leaving everything in the hands of the amorphous market—for example, if the government stimulus merely ends up in the pockets of firms as profits and there is no guarantee that those profits spur hiring of more workers (which is why we have proposed a program that supports direct employment via a Job Guarantee). Yes, it is true that a fiscal program of this sort may not replace all of the manufacturing jobs lost due to persistent trade deficits. But (per Tymoigne and Wray), “there are [needs] at least as great in the area of public services, including aged care, preschools, playground supervision, clean-up of public lands, retrofitting public and private buildings for energy efficiency, and environmental restoration projections.”

As U.S. producers have increasingly struggled with a renewed flood of cheap Chinese imports, the result has often been the closure or offshoring of manufacturing plants and the consequent loss of employment of thousands of American workers. Trump has explicitly addressed his hawkish trade stance to these constituencies (even if his actions hitherto have done much to address their complaints). But there are better ways to address the problems than simply slapping tariffs on imported goods. If we refocus government fiscal policy to create full employment, then most trade issues would become a sideshow and the “flood of cheap imports” would be viewed less as a job threat, and more a means of enhancing the consumption preferences of a fully employed workforce. Surely, this is preferable to penalizing the population via trade wars, or of forcing the poor and unemployed to bear the entire burden of adjustment as and when trade liberalization takes place. A resort to protectionism is crude, but free trade’s champions cannot simply dismiss the realities of job displacement without a viable policy response beyond the assertion that free trade itself is a sacred tenet of economics.

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Marshall Auerback is a market analyst and commentator.