US Trade policy: A return to Mercantilism
At a point in his presidential campaign when Donald Trump wanted to speak substantively about China, he provided his son-in-law and now senior advisor Jared Kushner with a summary of his views, and asked for materiel that lent support to those positions. Kushner’s research (an Amazon book search) yielded ‘Death by China’, by apostate economist Peter Navarro. That Mr. Trump and Dr. Navarro share unorthodox and widely discredited views on trade resulted in Navarro being a part of Trump campaign, and now being one of the key figures in the administration. It is Navarro’s influence that probably led to a number of tariffs called for by the President in March 2018.
The first are heavy tariffs on imported steel and aluminum, 25% on steel and 10% on aluminum. The second is a tariff on up to $60 billion of Chinese imports. Four out of the five countries that export the most steel to the US have been exempted from these tariffs. It is no coincidence that these countries are seen as traditional US allies (Table 1). The steel and aluminum tariffs look more like a punitive move against China — and are unlikely to be effective. The tariff on Chinese goods seems to be inspired by the US-China bilateral trade deficit — a factor which is never a good benchmark for economic policy. Trade balances are affected by a number of factors including relative economic strength, comparative advantages and exchange rates. And tariffs don’t have a good track record in fighting trade deficits, especially because other countries have the tools to retaliate. China’s record of keeping their economy closed, and forcing technology transfers set the ground for a trade dispute — but such a standoff is best conducted through multilateral means. The current economic deglobalization has brought us to an unnecessarily aggressive standoff, from which none of the participants are likely to emerge unbruised.
Let’s tackle the steel and aluminum tariff first. The US imports 77% of its steel from 10 countries. Leading the pack are Canada and Brazil, which make up 30% of imports, but are both exempted from these tariffs. At the bottom of this list is China, which only contributes 2.9% of US steel imports, and predictably has tariffs levied against it. If intended as a punitive measure against China, these tariffs are unlikely to succeed. The world’s largest producer of steel and aluminum, China’s largest export destinations are South Korea, Vietnam and the Philippians (the US is 26th on this list). The Chinese steel and aluminum industries will thus barely be scratched by these measures. On the other hand, Canada exports 90% of its steel to the US, while also accounting for a majority of imports. If not exempted, Canada’s steel industry would face catastrophe. But US steel importers are more likely to shift more of their consumption to exempted countries like Canada and Mexico.
The Trump tariffs are thus not an entirely new story. Two years ago, both the US and EU imposed severe duties on Chinese steel. China faces severe overcapacity in steel production, and was accused of dumping the metal onto foreign markets. However, previously anti-China steel policies have not been as explicit as tariffs. The Obama administration used duties and a far less bellicose rhetoric. Mr. Trump has declared his ambition to rebuild the US steel and aluminum industries through these tariffs. Exemptions made for countries that export most of these metals to the US mean that importers are unlikely to shift to domestic consumption organically. Even if no exemptions were made, the steel industry could neither expand enough to meet US demand, nor become any larger of an employer than it is already. A study [1] of US steel between the 1962 and 2005 found that the industry shed 75% of its workforce (400,000 workers) over this period. This was not because of globalization or reduced demand, but because of technology improvements. During the same period, steel production only dropped slightly from 130 million to 110 million tons. Productivity thus increased 5-fold. Even between 2006 and 2016, as employment in steel fell 10%, output per worker (productivity) increased 20%. The demise of steel jobs is not entirely the fault of foreign competition, but is a result of innovation and development. Domestic producers might benefit slightly due to tariffs in the medium to long run, but employment in the industry is unlikely to pick up to pre-1960 levels. The low ratio of US jobs in the steel industry to jobs in steel-reliant industries indicates the possibility of tariff-related downstream price increases. The last time similar tariffs were attempted — by Bush in 2002, they lasted a year, were challenged by a number of US trade partners, and cost between 26,000 and 200,000 jobs.
The second measure announced by the Trump administration is a tariff on up to $60 billion of Chinese imports, citing the $375 billion US trade deficit with China (out of a total deficit of around $500 billion) as precedent. China has since indicated an intention to retaliate by introducing tariffs on 128 US products, which had an import value of $3 billion in 2017.
A large portion of the deficit is based on Chinese exports of electronic equipment and clothing. The recent strength of the US economy has increased consumption of these products, thus increasing the deficit. Mr. Trump and Dr. Navarro’s economic views — such as they are — have pushed the idea that trade deficits represent a ‘loss’ conceded to other countries. Such views ignore number of important factors about the international economy.
Modern economies rely on specialization and comparative advantages. China, which is responsible for over half the world’s steel production, exports steel to countries like Vietnam and the Philippians. And its chief imports include iron ore, plastics, and soybeans. Similarly, while the US exports refined petroleum, automobiles, airplanes and pharmaceutical products, they import large quantities of crude oil and electronics. These differences in product specialization do not indicate weakness, but economic maturity. It would be a lot costlier (not to mention nearly impossible) to produce every required product domestically. Manufacturing in the US has seen massive drops in employment, even though the sector’s contribution to GDP remains consistent. Rising productivity has helped the industry, but leaves behind employment losses. It is still far from making up for gaps that will open up by cutting trade ties with the world.
A large part of the US deficit with China flows back home as investments into US Treasury bonds. US Financial and Current Accounts help us see these flows with more clarity. Another factor here is differing tax regimes in different countries. As Paul Krugman points out, Peter Navarro is guilty of such a mistake when addressing US trade with Germany. Navarro and Commerce Secretary Wilbur Ross argue in a whitepaper that value added taxes give US firms a disadvantage in Germany (where the VAT is 19%). This ignores the fact that German companies are subject to the same tax domestically, and will not face a VAT when exporting to the US.
Balance of Trade is also affected by factors such as macroeconomic performance, relative currency positions, and savings and investment patterns. The US runs a trade surplus with China in services, an example being export of education services that occurs when scores of Chinese students study at US universities. Balance of Trade is thus, as Larry Summers notes, not a good metric for formulating economic policy. Even though large and persistent trade deficits need to be taken seriously, there is no evidence that tariffs help in reducing trade deficits. Paul Krugman, Larry Summers, and George Hatsopoulos have written that improving US economic competitiveness requires improving the low savings rate, and resulting inadequate levels of investment.
A possible assumption behind Mr. Trump and Dr. Navarro’s thought process could be the US’s place in the global power structure. In the 1980s and early 2000s, the US had a lot more relative influence and ability to enforce punitive measures against countries like China. This allowed Raegan and Bush to levy tariffs without as much of a fear of retaliation. The global reality has since changed, and a retaliation against the US today would be quite severe today. This is especially true in areas like semiconductors — 25% of US exports head to China, but only account for 3% of Chinese imports. Chinese restrictions on US semiconductor imports would cause a major disturbance in the industry.
It is clear that Mr. Trump’s economic advisors do not hold international institutions like the World Trade Organization in high regard. But enforcing WTO rules more stringently might be the best solution to international trade foul play. Which brings up an important point — China is far from a fair player in the trade game. China has not yet opened up its economy to the extent to which it committed after joining the WTO. Additionally, China’s Intellectual Property transgressions are severe. The Cato Institute estimates that nearly 70% of software used in China — valued at close to $8 billion — is pirated. China forces US firms to transfer alarming amounts of intellectual property to their Chinese partners, as a way of attaining self-sufficiency. Apart from a WTO standoff, a multilateral approach in cooperation with the EU and Japan could have been another option against Chinese malpractices. But with an administration which is skeptical of an internationalist approach, and an ongoing deglobalization cycle, such approaches are improbable.
Trade wars produce no winners, because trade is not a zero sum game. The ratio of harmful to liberalizing trade interventions made by countries since the 2008 crisis is 4:1. International flows of capital, and cross-border flows of goods and services are lower than their pre-2008 levels. While this current deglobalization spell is bigger than the standoffs initiated by Mr. Trump, it is important to remember what is at stake. International trade systems are one of the greatest post-war achievements of the global economy. The regular settlement of disputes at the WTO, and the highly intricate negotiations that go into any trade treaty between nations is a testament to the success of the post-war world diplomatic order. Bellicose tariffs and aggressive confrontations are a manifestation of cyclical trends, but represent a step backwards in the post-war world order.
One needs to ask whether the populists’ tendency to surround themselves with sycophants and selective evidence is the wrong basis for economic policy. One needs to ask if such severely consequential policy is in fact being left to the whims of those who turn away from non-partisan evidence. True.
References:
[1] Collard-Wexler, Allan, and Jan De Loecker. 2015. “Reallocation and Technology: Evidence from the US Steel Industry.” American Economic Review, 105 (1): 131–71.
Data, Bureau of Economic Analysis
Data, Federal Reserve Economic Data, Federal Reserve Bank of St. Louis
Data, Global Trade Alert
