As President Trump talks more openly about aggressive action on the trade front to support the US economy, traditional economists and commentators, especially many on Wall Street, are raising the volume on a scare campaign, aimed at suggesting all sorts of imaginary negative consequences. They fail to recognize that persistent global trade imbalances, whereby trade surplus countries overproduce and excessively rely upon deficit countries’ consumers for growth, pose the most serious risk to global growth and economic stability.
In recent days, President Trump has spoken openly about terminating NAFTA, the free trade agreement with Canada and Mexico. And separate reports have emerged in Axios and the Financial Times that he wants to impose tariffs on Chinese imports into the US.
Both policies can make good sense if applied carefully and in a well-targeted fashion. (We know from private discussions that many Democrats would support these policies, privately if not publicly.) NAFTA has cost the US about a million jobs in the 23 years since it came into force, mainly in manufacturing jobs that have moved to Mexico. It’s also helped to drive down real wages, especially in the automotive industry. If the US withdrew from NAFTA, it would make sense to levy tariffs in the range of 10% to 25% on Mexican manufactured imports. It’s likely that businesses would react by immediately halting investment in Mexican production facilities and looking into bringing production back to the US. For example, BMW is spending $1 billion on a Mexican plant likely to employ 1,500 workers when it opens next year. That plant’s production is primarily for the US market: in the first half of this year, BMW sold 171,291 cars in the US, 16 times as many as the 10,737 it sold in Mexico. Tariffs applied to the sectors where we have lost the most jobs to Mexico, such as motor vehicles, electronics, machinery, and furniture, could lead to a significant boost to investment, production and jobs in domestic US manufacturing industry.
With China the numbers are even larger. China accounted for nearly half of the US trade deficit last year, $347 billion out of a total of $750 billion. According to an estimate by Rob Scott of the Economic Policy Institute, Chinese imports cost the US 3.4 million lost jobs between 2001 and 2015.
If the Trump Administration levied a tariff of say 25% on foreign steel due to subsidized overcapacity, this would lead immediately to a rise in US steel prices. If the Administration made it clear it was committed to the new policy, it would give steelmakers the confidence to invest for the future, and we would see increased production and hiring in steel. Any steel tariff would be better if it included downstream products with substantial steel content to prevent subsidized foreign steel from avoiding the tariff simply by exporting valued added products.
The expansion in the domestic economy would outweigh the effects of the price increases in the steel supply chain—leading to faster growth in real gross domestic product (GDP), exactly the goal Trump and the Republicans are seeking. This policy would also put pressure on the Chinese government, making it clear that for the first time the US was determined to act instead of just talk about the problem of China’s strategy of dominating the world steel market through billions of dollars of government subsidies.
Traditionalists have raised the spectre of a “global recession” and “trade war” they claim could follow remedial trade action by the US government. They are wrong for three reasons.
First, World Trade Organization rules prevent other countries from raising tariffs unless they file and win a WTO case that declares the US action unlawful. That process takes years. If the US were to lose, no retaliatory tariffs would be imposed if the US simply dropped the tariffs.
Second, other countries are far more dependent upon exports to the US than we are dependent upon exports to them. We need to realize that we have the market power. Other countries have far more to lose should they choose to escalate any trade dispute.
Third, most of these “global recession” forecasts are based on economic models that specifically exclude the expansionary effects of a tariff on a domestic US industry. In some cases, that’s because the free trade biases of the economists who built the models are built into the underlying assumptions of the model. In other cases, it’s simply because the models are old—they don’t have enough depth to handle trade effects. In effect, they are obsolete for today’s world.
A New Trade World
In fact, the world-view of many of these pundits is obsolete. They worry irrationally about the end of what they call the “liberal global economic world order that has supported prosperity since 1948”. (the phrase comes from noted Dutch economist Willem Buiter) What Mr. Buiter and his colleagues fail to recognize is that this world order was ended by a series of events including: the end of Communism, which brought millions more low-wage workers into the global workforce; the aggressive implementation by China of growth led by state-supported exports; and globalization itself, which intensified competition and depressed living standards for all the relatively high-wage workers in developed nations like the US.
We are in a new world. The US is still the world’s largest economy (although China is not far behind). It’s up to us to take a long-term, truly global view, and develop a strategy by which deficit nations can address their deficits, attack inequality by boosting the incomes of the working and middle classes, and establish a world order where surplus nations can no longer use beggar-my-neighbor policies to export unemployment to deficit nations.