What's happening at the
Tuesday 22 Aug 2017 | 00:30 | SYDNEY
Tuesday 22 Aug 2017 | 00:30 | SYDNEY

External trade imbalances and the ‘tragedy of the commons’

By

COMMENTS

9 August 2017 08:51

President Trump likes to apply business-oriented thinking to national economic policy. Nothing illustrates this better than his fixation with reducing America’s bilateral trade imbalances, especially with China and Mexico. He sees global trade in terms of individual deals. As the largest economy, the United States can dominate this deal-making if it is done country-by-country rather than multilaterally (where groups of countries might form coalitions to strengthen their bargaining position). The outcome of this strategy may be that all countries (including America) end up worse off – a result which the International Monetary Fund is calling an example of the ‘tragedy of the commons’: each country, seeking its own advantage, produces an outcome which is worse for everyone.

Trump intends to use NAFTA re-negotiations to reduce the bilateral imbalance with Mexico and other trade negotiations to cut back the deficit with China. If he succeeds in expanding America’s exports and cutting imports with these countries, this will put pressure on an economy already at full capacity (the unemployment rate is well below the rate usually associated with full employment), pushing up the exchange rate and nullifying any gains from negotiated higher exports or lower imports. The bilateral balances with the offending countries might be reduced, but America’s overall external imbalance will be much the same. If other countries follow suit and take measures to cut their bilateral trade deficits, the result would be that global trade is reduced and distorted. All trading partners lose.

How to avoid this irrational outcome? The first step is to focus attention not on the bilateral imbalances, but on the global imbalances – each country’s imbalance with all its trading partners taken together. An exact balance of imports and exports is rarely optimal. Some countries (like Australia) have more investment opportunities than others (think, perhaps, of Japan with its ‘bridges to nowhere’). It makes sense for Japanese savers to have the chance to invest in Australia, and for Australia to have the benefit of investing more than it would have done if all its investment had to be funded from domestic saving. To our mutual advantage, Australia runs an overall trade deficit and Japan runs an overall trade surplus, in each case with corresponding funding flows in the capital account.

But these imbalances can be unsustainable and represent future problems. The graph below shows the IMF’s calculation of ‘excess’ balances (i.e. deficits or surpluses that deviate from its calculation of desirable levels), as a percentage of world GDP. It shows the US does indeed have an ‘excess’ deficit on this measure that has worsened over recent years.

The automatic adjustment processes to correct these imbalances are very weak, and sustained deficits cumulate in excessive international debt which could set off a crisis. Here is what the Fund recommends the deficit and surplus countries should do:

Source: IMF

The IMF’s action plan says nothing about increasing protection to reduce imports or doing deals to artificially encourage export industries. At the macro-economic level, the key adjustments are in national saving and investment. The Fund’s underlying message is that if the surplus countries don’t take part in the process of reducing excessive balances, then some deficit countries (implicitly, the US) are likely to take unilateral or bilateral measures that will make everyone worse off.

Coincidentally, there is a neat example where President Trump’s retreat into bilateral dealing has backfired. By taking America out of the Trans-Pacific Partnership, he has allowed Australian beef a substantial competitive advantage in the $US2.65 billion Japanese import market, with Australia supplying over half of the imports. Thanks, Mister President!

You may also be interested in...