Donald Trump’s Economics Part 2: The Trade Wars

Donald Trump is a mercantilist, a man of the 17^th century.  Mercantilists argued that a “key objective of trade should be to promote a favorable balance of trade, one in which the value of domestic goods exported exceeds the value of foreign goods imported.” Mercantilists believed that the world’s economy had a fixed amount of wealth and that running a trade surplus will allow the nation to get a larger share of this wealth.

In the 18^th century, Adam Smith and David Ricardo demonstrated that wealth was not static, but was promoted by specialization in the use of labor, and that specialization was expanded by international trade. David Ricardo’s theory of “Comparative Advantage” holds that even if, for example, Britain is more productive than Spain in producing both cloth and wine, it would still be an advantage for Spain to trade wine for cloth, because it can produce wine more efficiently than it can produce cloth.

Smith’s attitude toward trade restrictions (including tariffs) was expressed in Book IV of his Wealth of Nations:

“What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry employed in a way in which we have some advantage…It is certainly not employed to the greatest advantage when it is thus directed towards an object which it can buy cheaper than it can make…The industry of the country, therefore, is thus turned away from a more to a less advantageous employment, and the exchangeable value of its annual produce, instead of being increased, according to the intention of the lawgiver, must necessarily be diminished by every such regulation [which restricts trade].” In other words, it is better for a person to buy his telephone from a specialist than to try to build one himself. If China builds cheaper telephones, buy their telephones and sell them something they can’t produce efficiently like soybeans or Boeing aircraft.

Certainly, history from ancient Greece to modern China, demonstrates that the expansion of trade leads to increased economic prosperity. This is not to say that international trade is an unmitigated blessing. Trade brings dislocation, it promotes some industries and discourages others, thus leading to reduced employment in some sectors of the economy and increased employment in others. Undoubtedly, this means that some people will be hurt, and others benefit. In fact, according to a paper by Bloom et.al. “there is no evidence that Chinese import competition created net job losses.”  Rather, Chinese imports led to reduced manufacturing employment in low human capital areas such as the South and the “Rust Belt” while in the high human capital coasts, these job losses were more than offset by job gains in the service industries such as research, management and wholesale trade. In other words, Chinese imports hurt workers in “Trump Country,” while helping workers in urban areas.

As Adam Smith wrote, raising tariffs to protect jobs leads to disaster. The worst example of this was the Smoot-Hawley Act, passed in 1930, a little after the stock market crash of 1929. “Within two years some two dozen countries adopted similar “beggar-thy-neighbor” duties, making worse an already beleaguered world economy and reducing global trade. U.S. imports from and exports to Europe fell by some two-thirds between 1929 and 1932, while overall global trade declined by similar levels in the four years that the legislation was in effect.” Since that time, tariffs around the world have fallen dramatically and global trade and prosperity increased dramatically.

What has Trump Wrought? 

One major problem with President Trump’s trade policy is that it is so mercurial.  According to The Tax Foundation, there have been over twenty announcements of changes to tariffs since the beginning of 2018.  Here is a small sample:

• 10/15/2019: The United States has postponed a scheduled tariff hike from 25 percent to 30 percent on $250 billion worth of goods from China. This update also includes organizational changes, new tables, and updated data on retaliatory tariffs.
• 9/12/2019: President Trump announced that the 5 percent increase (from 25 percent to 30 percent) in tariffs on $250 billion worth of Chinese goods will be delayed until October 15. The increase was originally scheduled for October 1. China has announced that it will temporarily exempt 16 U.S. products from tariffs on September 17, and that these exemptions will last for one year.
• 8/26/19: On August 23rd, the Trump Administration announced the 10 percent tariff on $300 billion worth of Chinese goods would increase to 15 percent.
• 5/22/19: The Trump administration has announced that the U.S. will lift steel and aluminum tariffs on Canada and Mexico.
• 5/10/19 update: President Trump announced that the U.S. will raise tariffs on $200 billion worth of imports from China from 10 percent to 25 percent, following through on previous threats. President Trump also threatened to impose an additional 25 percent tariff on $325 billion worth of imports from China.
• 08/16/2018: President Trump ordered a doubling of the tariffs on steel and aluminum imports from Turkey. Turkey responded by doubling its tariffs on 22 U.S. products.

What has been the result of these tariff policies? Since these tariffs have not yet been fully implemented, all we can do now is project the effects using economic models. According to the Tax Foundation, the net result of all these tariffs will be a decline in long-run GDP.  The chart below shows how tariff policies undermine the positive growth impacts of the major tax cut enacted in 2017. 

Economic myths promoted by the President

In the process of defending his policy on tariffs President Trump promoted a number of economic fallacies. These include:

1. The trade deficit is an important metric of economic welfare.  The President frequently asserts that running a trade deficit is a bad thing, and that the larger the deficit, the worse for the country.  In fact, all a trade deficit means is that imports exceed exports.  The more imports, the more “stuff” a country has. It means the country is borrowing today and living better and will pay later; not a clearly bad thing.
2. Tariffs are paid by the exporting country.  Trump has said, ““We have billions of dollars coming into our Treasury — billions — from China. We never had 10 cents coming into our Treasury; now we have billions coming in.” This untrue. When a commodity enters a country the importer pays the tariff.  Most of the time that tariff is added to the price of the good. It is the consumer who pays the tariff.
3. Protectionism increases employment.  This is also untrue. A Forbes article from September 2018 states that estimates from The Trade Partnership were that Trump’s steel and aluminum tariffs would cost the U.S. economy 400,000 jobs.

International trade is really very simple. The more trade, the more we sell stuff we produce efficiently for things we would produce inefficiently, the better our economy is. The American consumer pays for tariffs in higher prices for imports or for goods which compete with imports. Trade does produce dislocation shifting production from one sector to another or one location to another, These dislocations need to be mitigated by other policies, not prevented by impeding trade.