Trade Debate Changing As Tariffs Show Their Purpose

The trade debate is changing. Gone are the days when free trade was the answer to everyone’s prayers. Even the International Trade Commission couldn’t run the numbers in a 2022 report on NAFTA and the Korea-U.S. Free Trade Agreement to make it look like anything more than a boom for multinationals who either shifted production to Mexico or got to sell more soybeans to the Koreans (but not more cars). The U.S. has trade deficits with both countries. Mexico’s surplus with the U.S. is rising as it surpasses China this year in import value. More and more of America’s auto industry is moving south of the border at great loss to blue-collar labor, right at the time when the auto industry is making a switch to battery-powered cars – a vehicle that requires much less in the way of auto parts.

Many have argued that the U.S. would of course have a trade deficit with other countries because we are richer than most and have a large market. But is the U.S. all that much richer than Germany? We have a trade deficit with Germany. We have a trade deficit with all of the rich European Union, for that matter.  Is the U.S. that much richer than Japan? We have a deficit with Japan. Is Brazil richer than the U.S.? We have a trade surplus there.

Others say that the trade deficit makes sense because it is cheaper for us to make things elsewhere, namely Asia, and that keeps the price of goods down.  Given the last year of inflation not seen since the 1970s, all those goods imported (all near record $1.09 trillion worth) did nothing to lower core inflation in the United States.

The core economies of the world all run trade surpluses with the U.S. Two of the most important developing countries – Mexico and China – all have surpluses in the hundreds of billions of dollars.

You know the trade debate is shifting when even the Financial Times is noting that one country’s trade surplus comes to the detriment of another country.

Countries that run a persistent current account deficit will eventually be forced to adjust via a currency crisis, but there is no mechanism to discipline countries that run a persistent surplus. Yet the surplus of one country must always lead to the deficit of another.  – excerpt from a Financial Times editorial dated Sept. 5, 2023.

The top five countries the U.S. imports from all have surpluses.

Writing on this Twitter-X feed earlier this month, Michael Pettis, a senior fellow at the Carnegie Endowment, said “trade imbalances lead to demand suppression by deficit countries, unbalanced by demand expansion by surplus countries. The net impact is either reduced global demand (and higher unemployment) or higher global debt.”

In the U.S., it has meant higher debt. It also meant stagnant wage growth and near destruction of once vibrant manufacturing towns from upstate New York to Santa Fe Springs, California.

In China, Xi Jinping talks about growing the consumer base to have more goods made and bought at home. But that would require dozens of provincial governments to be on the same page and that has never been the case in China. Their maxim is to fire up the economy on all 12 cylinders to reach full employment. If that means overcapacity, so be it, they will just sell it to the West. This has been the China model since its “opening up” in the 1990s. This year might be the first year we see the full impact of Section 301 tariffs on China. They have imported roughly $10 billion less per month to the U.S., and Zero Covid is not a good enough excuse for that.

A Sept. 6 op-ed in the WSJ went after the 301s. The Editorial Board correctly stated that those tariffs did not lower the deficit, it merely shifted it to other countries.

From the WSJ’s perspective, if the tariffs on China didn’t work, let’s just remove them. “Countries and companies trade because they see a mutual advantage,” they wrote. “When American consumers buy clothing and Scotch on a global market, while American producers sell soybeans and Boeing jets, the magic is that both sides benefit.”

That’s not quite true, said Pettis in response. “When the purpose of exports is mainly to pay for imports, both sides can benefit by specializing in each side’s comparative advantage,” he said. But when the purpose of exports is to externalize weak domestic demand, as is the case in austere Germany and mostly low-income countries like Mexico and China, Pettis says that “the world is worse off, not better off. The mistake the WSJ editors (and many others) make is to treat trade ideologically. Rather than simply assert that trade must always maximize productivity, it would be much smarter to work out the conditions under which it does and those under which it doesn’t.”

Prior to 2018, anyone associated with such a polite society think tank like Carnegie would be loath to criticize globalization, let alone hint that U.S. trade imbalances were a problem. Now, such commentary is part of the trade debate.

“Countries that run a trade surplus basically subtract more from global growth than they contribute,” George Magnus, an economist at Oxford University’s China Center told the Washington Post on Sept. 4. “It’s doing more for its own growth than it’s contributing.”

CPA’s chief economist Jeff Ferry says the problem with persistent trade deficits is that they undermine the industrial base of advanced nations like the U.S., leading to depressed regions, greater inequality, income losses for millions of workers, and political polarization.  “The trade deficit is a signal that a nation cannot or will not produce enough to meet its own domestic demand,” Ferry says. “An advanced nation should not need to borrow from overseas to support current consumption. The U.S. is only doing this because foreign surplus nations like China and Germany are exploiting U.S. economic gullibility, and because our politicians would rather make ourselves and our children indebted rather than face up to the challenge of boosting U.S. production.”

The increasing deficit in manufactured goods “leads to inequality here because the industries that benefit—like software or investment banking—are high-paid white collar industries,” said Ferry in his response to the WSJ editorial. “This is bad for U.S. economic growth, equality, and social/political cohesion. The trade deficit undermines domestic production, destroys high-paying jobs in high-growth industries. The global solution can’t be multilateral because surplus countries would never agree to anything that eliminates the global suckers (from buying from them). You need to impose a unilateral solution,” Ferry said.

Imports from any country with three consecutive years of surplus equal to 2% of GDP should be restricted entry to the U.S. by means of tariffs and/or volume quotas. This would force surplus nations who benefit from offshore manufacturing to the U.S. to try and find new countries willing to consume all their production.

But this would put the bulk of the world, which are emerging economies, in a bind. São Paulo, Brazil shoemakers are not going to go out of business to be replaced by Chinese shoemakers. Are they?

The likely response would be that countries would simply erect similar barriers. This is a death knell for free traders. They hate this idea. It keeps them up at night.

If surplus nations were tariffed to bring in a more balanced trade between them and the U.S., we would return to nationally generated economic growth, based on savings, investment & technological change. “The advanced world would evolve into economic spheres: North America, Europe, China, India, and Other Asia,” said Ferry, meaning global trade surely does not end. “But trade would be broadly balanced between them. Competition between spheres would drive growth.”

It’s a moving target. Currency misalignment also drives the U.S. deficit. The dollar goes further abroad than it does at home.

With 2024 being an election year, the trade debate will heat up. The torches are already lit.

On Aug. 23, The Atlantic wrote how Trump’s tariffs were a failure because the deficit is over a trillion dollars and China hasn’t gone back to just making Christmas ornaments and Happy Meal toys, apparently.

Reason magazine said that protecting local industry is bad and that no president should focus on the trade deficit.

The Washington Examiner said “tariffs are a bad idea”.

One year after the Section 301s went into effect, the International Monetary Fund said that tariffs were not an effective tool to counter trade imbalances. They blamed that on an overvalued dollar.

The IMF said in 2019 that the average U.S. tariff on Chinese goods was up about 10 percentage points since 2018. But China’s yuan fell 10% versus the dollar, “largely as a result of these trade actions. Such flexibility allows it to help buffer trade shocks,” the report said.

Tariffs, export restrictions, and tax incentive programs at home that target industries that favor China imports (see solar, for example) have led to more production at home. Combined, it has led to less Chinese imports.

Imports have risen from other countries, but the main ones – including Mexico which has a free trade agreement with the U.S. – and Vietnam, which pays an average 4.9% tariff thanks to its Most Favored Nation status – have nothing to do with the imposition of tariffs. In fact, if they had tariffs, their imports would likely be down, as well.