How should Asian policymakers respond to the disruption that will flow from U.S. President Donald Trump's wrongheaded international trade agenda? Trade growth and globalization have been the drivers of Asia's post-World War II miracle. Now this engine of growth is going to be thrown into reverse by one of the major players. How serious is this, and what should those on the receiving end of new policies do? The short answer is "Keep calm and carry on."
The well-regarded Peterson Institute for International Economics in Washington did not mince words in assessing the Trump threat to international trade: "Trump's stated trade policies would be horribly destructive," it noted in an analysis ahead of the Nov. 8 presidential election. But these policies -- 35% tariffs on Mexico and 45% on China -- would be "horribly destructive" only if they trigger retaliatory action by other countries, with a self-reinforcing spiral of escalating protection. This is the image we carry of the American Smoot-Hawley tariff measures in 1930, which are blamed for triggering a series of tit-for-tat steps that shrank global trade by 66% between 1929 and 1934.
For this unhappy outcome to again become reality, other countries would have to respond to the initial tariff hike with reciprocal increases. Suppose, instead, that Beijing did nothing in response to either a 45% tariff directed specifically at China, or -- as seems to be the current manifestation of Trump's protectionism -- a general import tariff of 10%.
First, to look at this from Trump's viewpoint -- as an American businessman competing with foreigners who are now subject to a tax. This has to be good for business, surely. With tariffs boosting the cost of America's imports, domestic production becomes more competitive, output rises and the trade deficit falls.
But the proper perspective for an economic policymaker is at the macro level, with the entire economy responding to establish a new equilibrium. The exchange rate, prices and interest rates all go up. Imports become dearer, so consumers have less to spend on other items. Foreigners, with less income, spend less on American exports, which are also less competitive because of the higher dollar exchange rate.
When all the complex interactions of a modern economy with a floating exchange rate are worked through, the answer is that the new protection has made America a bit less productive, but any impact on the trade balance or growth is trivial.
Thus, the critical thing is to avoid a global shift toward autarky: Countries do not get rich by turning toward self-sufficiency. The relevant analogy is that trade protection is like putting rocks into your harbors. It does not help countries that do it, and the best response for trading partners is not to follow such a foolish example.
TIT FOR TAT
The huge gains already made in integrating the global economy cannot be easily unwound. Trump will find that many American companies are horrified by the damage his protectionist policies would do to their business models because they are already deeply integrated into global supply chains. Time will demonstrate the foolishness of the Trump trade agenda.
A strong counterreaction could set off something akin to the collapse of world trade in the 1930s. The period between the two world wars demonstrates that it is possible to shrink globalization, and profoundly damage economies, if policies are sufficiently perverse. With the disaster of the Great Depression in mind, it should be possible to avoid a repetition, provided Trump's foolishness is allowed to run its course without triggering tit-for-tat responses.
But what about the specifics of China's alleged trade infringements -- subsidies to state-owned enterprises, a "manipulated" exchange rate, dumping of products where China has gross overcapacity, a huge trade surplus, and capital controls? Most of these issues have, in fact, disappeared or been ameliorated over time. China's trade surplus is now modest. Its export-oriented growth model ran out of steam a decade ago.
On the perennial issue of currency manipulation, whatever China's earlier sins, the exchange rate is no longer manipulated to achieve unfair international competitiveness. Even Fred Bergsten of the Peterson Institute -- a tireless critic of China's exchange rate policy -- has accepted this. In fact, if China let its exchange rate float -- as outside commentators have urged -- the resulting depreciation would enhance its international competitiveness, without any grounds for suggesting manipulation.
Some of the complaints about China might encourage useful domestic reforms: Many Chinese policymakers would agree in principle with the idea of reducing subsidies to SOEs over time. They can get on with this sensitive task without even thinking of Trump. On dumping of surplus goods, a remedy consistent with World Trade Organization rules has been underway for some time. Under former President Barack Obama, America had already undertaken substantial measures in response to perceived dumping by China, and these remedies can continue without bringing down the whole edifice of WTO-sanctioned trade.
What about the impending future of the Trans-Pacific Partnership now that Trump has withdrawn the U.S. from this painstakingly negotiated trade agreement? For some countries, notably Vietnam, the loss of potential new markets in America is significant -- although, as with all preferential trade arrangements, this opportunity for Vietnam was at the expense of export opportunities for countries that might be more efficient suppliers than Vietnam. In any case, this is an economy that is doing just fine without the extra access to the U.S. Much of the rest of Asia -- Indonesia, Thailand, India and so on -- was in any case unconvinced of the net benefits of the TPP, and so remains unaffected by its demise.
The TPP might well have been a catalyst for domestic reform, with Japan as prime exemplar. Again, the first-best policy response is clear: These are reforms that countries can implement without the TPP. Japan is tentatively showing the way by passing the TPP legislation even without the prospect of America adding substance to the treaty. This opportunity for efficiency gains still exists, whatever Trump does.
Within a time period that might correspond to Trump's term in office, the futility of his protectionism will become apparent; it will either be quietly abandoned or it will leave him unelectable. It is not as if he has stumbled on a new truth in economics -- that trade autarky is better than openness. His populist version of protectionism may have won some votes, but over the longer term the wrongheadedness of these policies will become apparent.
For Asian policymakers the response is clear. Asserting faith in the benefits of further globalization might be useful, but the best course is action to seize the opportunity for closer integration. There is still much work to be done to tighten integration through smoothing administrative frictions and developing common standards. The Regional Comprehensive Economic Partnership, which excludes the U.S., provides the framework. And with the TPP out of the way, this can be given greater attention.
The aim should be steady progress in identifying and removing bottlenecks and inhibitions to trade at the operational level, rather than reviving the high-level "platinum-standard" principles of the defunct TPP. The best response to Trump's protectionism is to demonstrate clearly that his agenda is misguided and that globalization offers a superior policy path.