Published daily by the Lowy Institute

Trump’s economic worldview

The president-elect misses the difference between an individual firm and a national economy.

Photo by Drew Angerer/Getty Images
Photo by Drew Angerer/Getty Images
Published 9 Jan 2017 

The central tenet of Donald Trump’s economic worldview is that America has for too long supported a world economy which has not paid its international dues, with foreigners free-riding on the globalised economy that the US created and maintains. Perhaps this argument can be made on the security side, but on economics the global institutional framework favours America. Of course the rest of us have also benefitted greatly. But Trump’s threatened trade initiatives will be distorted – to everyone’s disadvantage - if they are based on a misunderstanding that foreigners have taken unfair advantage of America’s munificence.

Take trade, Trump’s main gripe. The starting point of all trade (whether international or domestic) is that both partners benefit from a deal: why else would they do it? But Trump, although schooled in ‘the art of the deal’, misses the difference between an individual firm and a country’s overall economy. He starts with a businessperson’s view: ‘if only I could sell more, I would expand production and make more profit’.

For countries, this micro-focus is the wrong starting point. The long-term benefits of trade come not from an individual firm hiring more workers and exporting their output: this works only to the extent that there are unused resources of labour and capital willing and able to be put to valued work. Far more fundamentally, the benefits of trade come from using the country’s overall productive capacity more efficiently, shifting productive resources so as to produce higher-value things that America is good at making, and swapping these for things that foreigners can make more cheaply.

If the new administration imposes the foreshadowed 35%-45% tariffs on Mexico and China (or the current suggestion, a 10% general import tax), the economy doesn’t respond like an individual firm, grabbing the opportunity to increase output when competitors are handicapped by a tariff. Instead, a new macro-level equilibrium is established with the exchange rate, prices and interest rates all rising. Imports are 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 work through, higher protection makes America a bit less productive, while any impact on the trade balance or growth is trivially small.

This profound misunderstanding of the macro-challenge is reflected not just in Trump’s outraged tweets that Mexico has stolen American jobs: it is also the core belief of his key trade advisors, set out by Professor Peter Navarro and Wilbur Ross in a pre-election manifesto on trade and tax,  described by a leading academic as ‘a complete mess’. Professor Navarro singles out China for virulent criticism, blaming China for leaving more than 40 million Americans and Europeans ‘without a decent job’.  His documentary films ‘Crouching China’ and “Death by China’ can be found here.  

Raising tariffs is like putting rocks in your harbours. Ad hoc ‘stay-home’ deals with Carrier and Ford may give the impression that jobs can be retained, but the future of American manufacturing lies in high-tech. Jobs for Kentucky coal miners and assembly-line workers can’t be brought back.

America has a future in manufacturing (output is as high as it ever was), but assembly-line workers have been replaced by computers and robots. The rise of Mexico and China as manufacturers accounts for no more than one fifth of the fall in American manufacturing employment; the rest is due to technology advances. Even Germany and Japan, which have toiled assiduously to foster manufacturing, have seen employment in this sector halve since 1970.

It’s probably true that China’s double-digit growth spurt in the decades before 2008 did indeed depend on an artificially competitive exchange rate and subsidies to the state-owned enterprises. But China’s past sins against good global citizenship were corrected long before Professor Navarro launched his complaints. China’s export-led growth strategy ran out of steam a decade ago and its trade surplus is now modest. Everyone (including the US Treasury and even Fred Bergsten at the Peterson Institute)  agrees that the renminbi is no longer manipulated to achieve unfair international competitiveness. If China let the renminbi float (as foreigners often urge) its exchange rate would depreciate, strengthening its competitiveness. When China has dumped its excess production on the world, America has been active in using the powerful anti-dumping provisions of the WTO to protect American industry.

What about the now-defunct Trans-Pacific Partnership (TPP)? Is Trump correct in seeing this as another example of excessive US generosity, helping ungrateful foreigners at the expense of US workers? There certainly were some trade-enhancing elements which, for example, would have helped Vietnam gain access to US markets, but probably more at the expense of other foreigners than US workers. In any case the main thrust of the TPP was to put in place rules which would help US firms compete internationally. Recall how Bernie Sanders, another anti-TPP American, described it: 'The Trans-Pacific Partnership is a disastrous trade agreement designed to protect the interests of the largest multi-national corporations at the expense of workers, consumers, the environment and the foundations of American democracy.' In economic terms, the main loser from the TPP’s demise is American industry. Beyond economics, the undermining of America’s pivot to Asia is probably considerable and certainly adverse.

Let’s not forget, either, how America has dominated the key international agencies (IMF and World Bank), retaining veto governance rights and slowing the adaptation of these agencies to the rise of the emerging economies such as China. America has also set the international agenda for the G20 and the OECD. It’s easy to identify issues which cry out for more effective international coordination: company tax and sovereign debt rescheduling are just two examples. These are far more important than the ‘platinum standard’ issues (intellectual property enhancement and investor/state dispute settlement) promoted in the TPP. Yet American vested interests are not yet ready to have these more-sensitive issues resolved through international rules.

Free-trade advocates tend to be a bit doctrinal, and argue as if any deviation from purity will be catastrophic. Let’s not be starry-eyed about the virtues of free trade. Of course there were winners and losers from globalisation. Exposing America’s manufacturing sector to competition from low-wage Mexico and China has been a key factor in America’s income maldistribution and the chronic fall in the wage share of GDP - problems that could be addressed through domestic policy but remain unresolved. You could easily argue that the benefits of NAFTA were unevenly divided, with Mexico getting the main advantage.

It should also be noted that the real world has successfully accommodated many deviations from free trade. Like all countries, America has been ready to tweak the rules to help local industry. If Australia’s world-leading, wave-piercing catamarans are to be sold to America’s defence forces, they have to be made in America. When the Australian Reserve Bank looked at the possibility to taking the world-beating polymer currency technology to the USA, it transpired that Senator Edward Kennedy and Crane Paper Company had the note-printing market sewn up. Ronald Reagan persuaded the Japanese to impose ‘voluntary restraints’ to reduce their all-conquering car exports to America. Thus Trump’s ad-hoc deals might be a form of crony capitalism, but won’t be a major departure from the universal tradition of trying to knobble the foreign competition wherever you can get away with it.

Taking both the winners and losers into consideration, America has unique advantages in international trade. It starts with the huge advantage of its size and advanced stage of development. If you want to export globally, you will have to meet American-set standards. If the Australian company Cochlear wants to sell its high-tech hearing equipment to the world, it will have to manufacture where the standard-setting Federal Drug Administration can give its blessing. Taking all this into consideration, it is simply mistaken to see America as a loser from globalisation.

How much harm can Trump do? Many observers of the Great Depression attribute a key role in the disaster to the Smoot-Hawley tariffs of 1930. In fact, many other aspects of policy were equally misguided. When Trump has the reins of power in his hands, he will of course find that his actions are constrained: much of American manufacturing is already so deeply integrated with global supply chains that those who manage it will be profoundly unenthusiastic about his attempts to undo this integration. As well, his threatened tariffs may be merely bargaining chips in a poker-game to redistribute the benefits of globalisation. But things can go wrong: a tit-for-tat trade war with China could be initiated at the drop of a tweet. This would be very bad news for us all.

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