Expressing his doubts over the possibility of any agreement on trade disputes with China, President Donald Trump tweeted: " ... if not, remember, I am a tariff man"
He seems to be basking in his aura as a self-styled tariff man. He has for some reasons or other come to the conclusion that tariff is the only economic medicine that can make "America great again''. His economic adviser Larry Kudlow (he has no formal qualifications in economics), along with other members of economic team, seems to be in sync with him.
President Trump in line with his "America First'' policy to make "America Great Again'' formulated a trade policy which is essentially a doctrine of economic nationalism based on zero-sum outcome (it is suggested that this doctrine has been articulated by Peter Navarro, a well-known Sinophobe and one of Trump's economic advisers). On the basis of this doctrinaire view, Trump has come to the conclusion that the trade imbalance is the single major threat to US economic power because it transfers wealth from the US to other countries, therefore, exports are good for the US and as a logical extension to that argument, imports are bad for the US. That remains the main line of economic reasoning for Trump. He is giving the long discarded and discredited concept of Mercantilism a new lease of life, but one can be quite sure it will run out of oxygen pretty soon. Unfortunately by then terrible damage will have been done to the global multilateral trading system.
Any first-year university economics student is able to clearly explain why trade is a positive-sum game. Overall, trade contributes to increased national output and consumer purchasing power, a win-win situation for all.
The US ran trade deficits with 102 countries, including Bangladesh (US$4.2 billion), in 2017. The US recorded a deficit of US$796 billion in merchandise while earning a surplus of US$230 billion in services, making the overall trade balance in deficit of US$566 billion in 2017. China accounted for about 65 per cent of the US trade deficit but is the source for only 18 per cent of total imports in the same year.
However, trade deficits are nothing new for the US. In fact, the country has been running trade deficits since early 1970s on a continuous basis. Profound economic changes causing structural changes are at the root not only of US trade deficits but also of trade deficits in many other industrialised countries. And in the US, under the Trump administration trade deficits have become primary focus of its attention, in particular to remedy the declining employment in manufacturing in the country.
In macroeconomic theory, a country's trade imbalance (net exports) is equal to national savings minus investment. So the US trade deficit simply reflects insufficient savings (private plus government savings) to match investment. Negative household savings and budget deficits in the US cause this trade deficit. This leads to capital inflows from other countries, including China, to bridge this gap. Such capital inflows contribute to build up of private and public debt as reflected in foreign holdings of US currency and US treasury bonds. This capital inflows push up the US dollar, making US exports less competitive. But even more importantly, the current global monetary system confers the dominant role to the US dollar as the reserve currency, making it the most sought-after currency. As US budget deficits escalate, the US treasury will issue more bonds which will mostly be purchased by foreign investors, including Chinese investors, which will further add to the upward pressure on the dollar. Many have already commented that the deficit is "Made in the US'' not "Made in China''.
So, Trump's trade deal can not and will not change the underlying saving and investment behaviour in the US nor will alter the overall trade balance. Furthermore, trade deficits are a multilateral issue, this can not be solved bilaterally with China or any other country on an individual basis. Any attempt to do so by raising tariffs on Chinese imports will only be matched by imports from elsewhere. To address the problem Trump will have to rein in budget deficit which his tax cuts will further aggravate. At the same time both households and businesses must consume less and save more.
If we look more closely at the breakdown of US composition of exports and imports between merchandise and services over time, it becomes clear that since the early 1960s the US ran trade surpluses in merchandise, while it ran trade deficits in services. But that scenario has completely reversed since the very beginning of the 1970s when the US started to run trade deficits in merchandise while running trade surpluses in services - and that is the situation still now. This clearly indicates that over this period profound structural changes have taken place - and continues to take place - in the US economy and shifting comparative advantage to developing countries, resulting in the changing composition of its imports and exports and causing job losses in the US manufacturing sector.
Furthermore, Trump's assertion that trade deficits are the root cause of declining manufacturing jobs does not live up to any theoretical or credible empirical evidence. But he is not bothered about that. He has also completely missed the point that the most plausible causes of declining manufacturing jobs are rapid technological innovations and increased labour productivity in the US. If he looks back to the history of US agriculture in the 19th century, he will, I hope, grasp what is happening to the manufacturing sector in the US now. Trade deficits have hardly anything to do with the declining manufacturing employment in the US. As it is demonstrably clear that the US has comparative advantage in services exports, Trump should pursue to reduce barriers to trade in services which still remain high unlike in manufacturing (trade in services do not face tariff barriers but mostly regulatory barriers which are called technical barriers to trade). This can not be done bilaterally. Whether he likes it or not, he has to pursue it through the World Trade Organisation (WTO). Instead, he and his economic advisers are primarily pursuing a non-trade agenda masked as trade agenda -and there lies his hostility to the WTO.
Trump on assumption of his office took a series of trade-related actions to reduce trade deficits with the objective of totally eliminating them and become a trade-surplus country to make America Great Again. But his most important instrument to deal with trade deficits is to use tariffs which have become the centrepiece of his trade policy instrument. By the beginning of 2018, his trade policy started to take its shape. He introduced 25 per cent tariff on steel imports and 10 per cent tariff on aluminium. His particular ire has been directed at China because the US runs large trade deficits with it. He imposed 25 per cent tariffs on Chinese imported electronics, aerospace and machinery worth US$ 50 billion. He further extended his tariffs on another US$100 billion of Chinese goods, now just covering one third of Chinese imports into the US. If the trade negotiation underway between China and the US does not yield desired outcome for the US, tariffs on US$200 billion Chinese goods will jump from 10 per cent to 25 per cent with effect from March 01, 2019. China is not the only country facing the wrath of the tariff man, the EU and the two closest neighbours of his country, Canada and Mexico, also have been targeted for tariff impositions.
Trump also claimed that tariffs revenue will also make "America rich again''. If that is the case he will be making history for the first time. But he forgot to mention that tariffs are a tax and passed on to consumers in the form of higher prices. He seems to consider tariffs as fees payable for the right to trade in the US like membership fee of his golf club. While tariffs will contribute to generate revenue (it contributes just about 1.0 per cent to US tax revenue), when costs of tariffs resulting from production and consumption distortions are adjusted (also called deadweight loss), net benefits to the economy will be negative. In effect, his tariffs on steel have been blamed for the closure of five GM car plants with 15,000 job losses, Caterpillar, a construction and heavy equipment manufacturer, is also planning to shed jobs.
To understand the Tariff Man and his economic logic, one must suspend the normal economic reasoning and think, instead, like a real estate dealmaker where deals are made bilaterally and any regulatory institutions are considered a hindrance to be able to undertake unilateral action to bully the opponent into an unequal position to strike a favourable bilateral deal at the expense of the opponent (as Trump is trying to do with China now). This line of thinking of the Tariff Man makes him to intensely dislike a multilateral institution like the WTO. Now he has launched his trade war and he is following his familiar path to bullying China into negotiating a trade deal on his own terms completely bypassing the WTO and offers hardly anything in return. It is quite plausible he might end up getting nothing, but, for the argument's sake, if we assume he secures a victory, one would shudder to think what that victory will look like.
Muhammad Mahmood is an independent economic and political analyst.
