Friday, March 11, 2016

Trump's Tough Talk on Trade

Last night’s Republican presidential candidate debate was more about substance than show, so let’s examine some of the substance.

As you know, Donald Trump has been calling for increased tariffs on goods from Mexico and China and even Japan. In that he is clearly breaking from Republican and conservative orthodoxy.

Modern Republicans have always favored free trade over protectionism. Following Adam Smith, they have argued that no single nation can be the lowest cost and most efficient producer of everything. Different countries offer different goods and services at better prices. This has generally been thought to benefit consumers, though, obviously, if the Indian software engineers produce programs more cheaply than can their American counterparts, it is not a good thing for American engineers.

One should also mention that if you outsource work to other parts of the world, you often do not have to worry about bureaucratic regulations, labor unions or diversity quotas. And besides, if we are to believe Bill Gates, Indian computer specialists are simply better. There’s more to it than currency manipulation.

For his part Trump has argued that America has been consistently exploited and disadvantaged by free trade deals. He believes that our negotiators have represented us badly but that he, who has never negotiated a free trade deal in his life, will do better. The notion that someone who has never been part of any government knows the way it functions better than people who have spent years, even decades working the system, is risible.

Trump tends to blame it on currency manipulations—devalue your currency and your exports are cheaper, your imports more expensive. Others have suggested that the cost of labor is the primary factor. If a worker in China makes a quarter of what an American worker makes, the cost of production will obviously be significantly lower. If he works harder and better, the advantages multiply.

How will Trump re-negotiate new trade deals? He has consistently said that he will use the threat of tariffs. He threatens to raise tariffs on Chinese goods by 20% or 45%, depending on the day and the hour.

And yet, as Ted Cruz pointed out, raising tariffs on products manufactured in China will naturally raise the prices of everything you buy at your local Walmart. It represents a tax on American consumers. If they cannot pay it, they will do without. If they stop buying at Walmart, Walmart will lay off workers and close stores. 

Cruz also added that many economists believe that when Herbert Hoover signed the Smoot-Hawley tariff into law in 1929, it contributed mightily to the stock market crash and it significantly aggravated the Great Depression. Obviously, there is some disagreement about the point, but surely the Smoot-Hawley tariffs did not cushion the shock of the Depression.

As Cruz suggested, once America placed tariffs on foreign good, foreign countries retaliated by increasing tariffs on American goods. Today, upwards of 20% of American workers are involved in activities that produce goods for export, so increased retaliatory tariffs would cause a serious economic contraction.

Hearing this point, Trump was undeterred. He replied that if we could no longer import products from around the world, American manufacturers would take up the slack. We would produce in America what we would no longer be buying from Mexico and China. It beggars belief to suggest that we could do so quickly and efficiently and that we could, with our much higher wage rate, produce these goods and services at a price that Americans could afford. Besides, how much time would it take to build a factory and to train workers to produce iPhones in America? If we cannot and if it takes a considerable period of time to do so, the standard of living of most Americans would fall precipitously.

And, this does not answer the question of what we would do with the oversupply, for example, of agricultural products. If farmers cannot sell outside of the country, their income and revenues would in many cases collapse.

The Foundation for Economic Education, a free trade group, offers an extensive analysis of the influence of Smoot-Hawley.

In an article from 2012 it explains:

In 1930 a large majority of economists believed the Smoot-Hawley Tariff Act would exacerbate the U.S. recession into a worldwide depression. On May 5 of that year 1,028 members of the American Economic Association released a signed statement that vigorously opposed the act. The protest included five basic points. First, the tariff would raise the cost of living by “compelling the consumer to subsidize waste and inefficiency in [domestic] industry.” Second, the farm sector would not be helped since “cotton, pork, lard, and wheat are export crops and sold in the world market” and the price of farm equipment would rise. Third, “our export trade in general would suffer. Countries cannot buy from us unless they are permitted to sell to us.” Fourth, the tariff would “inevitably provoke other countries to pay us back in kind against our goods.” Finally, Americans with investments abroad would suffer since the tariff would make it “more difficult for their foreign debtors to pay them interest due them.” Likewise most of the empirical discussions of the downturn in world economic activity taking place in 1929–1933 put Smoot-Hawley at or near center stage.

What influence did Smoot-Hawley have on farm income. The FEE explains:

The tariff dramatically lowered U.S. exports, from $7 billion in 1929 to $2.4 billion in 1932, and a large portion of U.S. exports were agricultural; therefore it cannot be assumed that the microeconomic inefficiencies were evenly distributed. Many individual states suffered severe drops in farm incomes due to collapsing export markets arising from foreign retaliation, and it’s no coincidence that rural farm banks in the Midwest and southern states began failing by the thousands.

As for states and regions that depended on mining and automobile manufacturing, the results were also unfavorable. Naturally, the downturn in production influenced the banking system in those areas of the country:

The worldwide retaliation against U.S. minerals greatly depressed income in mining states and can be partially blamed for the collapse of the Wingfield chain of banks (about one-third of the banks in Nevada, with 65 percent of all deposits and 75 percent of commercial loans). U.S. iron and steel exports decreased 85.5 percent by 1932 due to retaliation by Canada. The cumulative decrease in those exports below their pre-tariff levels totaled $369 million. Is it any wonder that Pittsburgh saw 11 of its largest banks, with $67 million in deposits, close in September 1931? How about U.S.-made automobiles? European retaliation raised tariffs so high that U.S. exports declined from $541 million per year to $97 million by 1933, an 82 percent drop! Thus there was a cumulative export decline of $1.57 billion from the pre-tariff volume to 1933. Is it any wonder that the Detroit banking system (tied to the auto industry) was in complete collapse by early 1933?

Increasing tariffs, or even threatening to do so, is a roll of the dice. Do you want to take that kind of gamble?

While we are talking trade, we turn to a Wall Street Journal editorial about the Trump policy toward trade with Japan.

The Journal begins today’s editorial by quoting Trump on trade with Japan:

“We have a trade deficit with Japan of over $100 billion a year,” he said during his post-primary press conference in Florida on Tuesday. “They’re killing us. You know what we sell to Japan? Practically nothing.”

The Journal sets out to fact-check the claim… the better to raise the level of the substantive debate about policy:

Is $116 billion worth of annual goods and services exports to Japan practically nothing? Japan is the fourth largest U.S. export market in goods after Canada, Mexico and China. In 2013 the top U.S. exports to Japan were agricultural products ($12.1 billion), machinery ($10.7 billion), medical devices ($8 billion) and aircraft ($7.1 billion).

The deficit with Japan is less than $100 billion:

According to the U.S. Census Bureau, the overall U.S. trade deficit in goods with Japan was $68 billion last year. Vehicles accounted for much of the deficit, but that’s primarily because Japanese car makers can produce superior small cars at a lower cost than can U.S. manufacturers. Federal fuel economy standards harm American automakers more than trade does.

The Journal notes that Trump likes to blame it on Japan’s currency manipulations:

Nonetheless, Mr. Trump on Tuesday rapped Japan for “playing around with the yen,” which he claimed has undercut U.S. companies. “Caterpillar is being hurt very badly by Komatsu” of Japan, he said.

In part this is true. In part it is not true. The yen has fallen over the years, but Caterpillar has also been hurt by the construction slowdown in China. Mining activity has declined significantly, and since Caterpillar makes mining equipment, it has been hurt, too:

The yen has fallen by about 25% to the dollar since 2012 when it was widely thought to be overvalued, and this has benefited Japanese exporters. But the Bank of Japan’s monetary interventions have been aimed at stimulating domestic demand and inflation, not boosting exports. In any case, Caterpillar’s recent struggles are mainly due to plunging commodity prices that have hurt global sales for its mining equipment amid slowing demand from China.

And, the Journal adds that Komatsu also manufactures in America, as does Nissan, and as, of course, do many other foreign manufacturers:

By the way, Komatsu employs thousands of workers at nine U.S. locations, which include Rolling Meadows and Peoria, Illinois. Notwithstanding the weakening yen, Japanese auto makers have also increased production in the U.S., in part to avoid import duties, hedge foreign exchange risks and reduce shipping costs. More than three-quarters of Nissans sold in the U.S. are produced domestically.

As for the Trans-Pacific Partnership trade agreement, it would force Japan to reduce tariffs on American agricultural products.

The Journal points out:

The best way to boost American exports is to remove trade barriers with new trade agreements. U.S. farm producers would particularly benefit from the Trans-Pacific Partnership with Japan and 10 other countries. Japanese tariffs on beef would fall to 9% in the 16th year of the deal from 38.5% while the 20% tariff on ground pork would be eliminated in six years. Japan’s 21.3% levy on poultry and eggs would be abolished in six to 13 years.


Leo G said...

I think Mr. Trump is missing the most important "savings" that China has over America and Canada, that is environmental regulations. These, I believe should be accounted for in goods shipped from China to N.A. Especially the electronic goods. Whilst America has the lions share of rare earths, the Chinese produce 90% or more of the world's market in these, as they have such insignificant laws regarding the environment.

Marsh said...

These two American loving men ( as opposed to your globalists) say otherwise.

They predict Trump's fair trade ideas will lead to an economic boom for our country.

An added benefit will be not losing our sovereignty like we would if TTP is made into law.


Trump 2016!!!

David Foster said...

Yes, it is important to avoid trade wars, but it is also important to understand the limitations of the theory of Comparative Advantage. The developer of this elegant model, used the example of wine and cloth as produced in Britain and Portugal, and showed that if Portugal is better at wine production than at cloth production ("better" in terms of labor efficiency), then it makes sense for Portugal to focus on wine production--even if in *absolute* terms it is better at both products than is Britain--and to import its cloth, the converse being true for Britain.

But this model doesn't consider industry dynamics over time. Britain's focus on cloth led to the creation of textile machinery, which led to the explosive development in that country of mechanical engineering inventions and skills. After these had led to the steam engine industry, the railroad industry, the large-scale metalworking industry, etc etc, a decision by Portugal to focus on the wine and ignore the cloth wouldn't have looked so good in retrospect.

sestamibi said...

OK, well I was going to talk about the theory of comparative advantage as proposed by David Ricardo, but David Foster above beat me to it (and did it better). The only thing I can add is that Portugal might have focused on producing wine, but it would still ultimately be limited by the amount of land available to produce grapes--no matter how efficient the process.

So instead I will point out that the Republican party's commitment to free trade is a fairly recent move, and that earlier in the 20th century when the party really WAS controlled by big business it did everything it could to protect its clients. Let's not forget that Smoot, Hawley, and Hoover were all Republicans too.

Today the parties' positions have reversed (for full discussion see yesterday's NY Times front page article about the issue), and this reflects an unfortunate belief among all too many Americans which goes something along these lines:

"I am a (white?) American blue-collar worker, and I am entitled to live better than the rest of the world, because that's the way it's always been in my lifetime. I am entitled to the equivalent of $75 an hour with bennies for putting bumpers on Ford Focuses. My standard of living must never fall, and government must step in to insure that."

This belief motivated both the Wellstonian Left and the Buchananite Right, despite the fact that two generations of Americans now have been facing intense foreign competition--two generations that in fact have never lived under the ancien regime!

I don't like this either. I wish we could go back to the 50s again, but the reality is that all those brown and yellow people in the rest of the world have every right to aspire to a better standard of living too--which for many of them consists of 2000 calories a day not fished out of garbage cans. If that comes out of our hide, well then we'd better start getting used to it. Or better yet, embracing free trade that would "lift all boats".

Anonymous said...

Bill Whittle

David Foster said...

People who work for a living (with whatever collar color) and who do not have extremely rare skills sets (or credentials/connections allowing them to simulate having such skill sets) have been hit more or less simultaneously by a whole range of factors:

1) Imports and offshoring--enabled by low-cost sea transportation and rapid air transportation; puts physical-goods producers in competition with their counterparts in every country in the world which is capable of manufacturing

2) The ability of many *services* jobs to be offshored via the Internet (reading medical images, some forms of legal research)

3) Immigration, legal and illegal--increased competition for people in jobs which must inherently be performed in the US

4) H-1B visas--creates competition from a set of employees whose residency in the US is entirely at their employers' will and hence have virtually no negotiating leverage

5) Automation--while I'm not one of the "robots will take all the jobs" crew, we are seeing at least a continuation of the historical trend toward mechanization of work

6) Bad public policy, and especially the hostility toward manufacturing

7) Runaway education-based credentialism

It is the *simultaneity* of these factors that makes things so difficult. Consider for example someone who is a server administrator for a financial institution. Immigrants from India (for example) increase the labor pool in his skill set. His employer may outsource the IT function to another company that largely employs H-1B (4)s. Or they move the entire back-office processing environment to India (2). Or they may move server operations to the Cloud on Amazon Web Services (5).

Meanwhile, our former server administrator will find his way barred to a whole range of jobs because he doesn't have an MBA, even when the value of the MBA to the actual skills required is questionable to say the least.

n.n said...

Currency manipulation, regulatory disparity, labor inequality, restricted "free" trade, and cost of living inflation, are a few practices that undermine capitalism.

sestamibi said...

@David Foster

Everything you say is true, and for the most part I agree with you, but it is just the end of the aberration that we experienced from 1945-1973. As I point out above, that was forty-three years ago, so the vast majority of Americans have NEVER lived under such conditions, yet we expect to bring them back. Good luck with that.

Ares Olympus said...

Stuart: For his part Trump has argued that America has been consistently exploited and disadvantaged by free trade deals. He believes that our negotiators have represented us badly but that he, who has never negotiated a free trade deal in his life, will do better. The notion that someone who has never been part of any government knows the way it functions better than people who have spent years, even decades working the system, is risible.

I agree his assertion lack credibility. But what's more curious to me is Trump's assertions that we're being screwed by others in negotiations, while good trade agreements should always be seen as win-win, each side is gaining something.

I guess what's opposite between me and Trump is that I try to avoid zero-sum games where my advantage is a liability to someone else, while Trump seems to not only thrive in competition, and derives personal satisfaction in "screwing others", while paranoid others are doing to him what he wants to do to them.

I also contrast to John Perkins' account of his work decades ago in using economic development as a weapon for third world countries, where development is "given" in exchange with debt, and then debt is used as leverage to privitization and foreign ownership of industrial productions of a country, allowing the wealth to be extracted without military power, although he claims we did use covert power of assassinations and character assassinations to promote governmental overthrows to leaders who don't cooperate.

So its hard to have pride in our country I accept we abuse our privileges of the most powerful economic country to extract wealth from other countries to enrich ourselves.

Myself, again, I'd prefer to deny that reality, and convince myself our motives are honorable, and trade deals are fair, and we're helping to raise the standard of living of these poorer countries. But its a difficult belief to hold.

On a small step forward perhaps, a surprise bipartisan bill was passed recently, and signed by Obama to ban products made by slave labor, although I imagine its easy to be ambiguous where exploitive labor exists and where "mutual benefit" exists for people lifting themselves out of poverty.

It's hard to know if good can come out of such efforts, and its worth seeing what effects they have. Or like we've banned trade with Cuba for 50 years, and its done little to weaken Castro's revolution.

Trump has his own inspirations like "Let's boycott Apple" for not cooperating with the FBI. I don't have much confidence in random inspirations like that.

Unknown said...
This comment has been removed by a blog administrator.