Is there Logic to Trade Tariffs?

US Trade Balance 2010-2014

Is a trade imbalance harmful and what are the ways to correct it?

How harmful is a trade war?  What can they do, and what else will we do?

You will not find any Ted Talks or sound bites here with carefully selected statistics to prove an emotional point – most likely to mislead, influence and control you.  But I will take the tabular data provided by sources such as the U.S. International Trade Commission (from which data for the above chart was taken) and place it in graphical form so you can make some sense out of it and decide for yourself.  If you dare to make up your own mind, that is.  It might not be safe to disagree with your friends now days.  People might think you support someone they hate, or think is an idiot.

I’m not saying decision makers aren’t idiots.  But idiots given three alternatives are right one time out of three.  Intelligent people lacking data and models of how things develop in the future, making decisions instead based on received wisdom or ideology, can be wrong every time.

In what industries are the trade imbalances?  Who are winners and losers?

Oddly this is rarely mentioned.  Instead reporters mention countries, which allows them to make obscure statements about who benefits from trade.  Is anyone benefiting?  Only one group.  Is it a general problem common to all industries?  Not by a long shot and the largest problem is already fixed, but the next two problems are entirely different.  Take a minute to look at the chart above.

First thing you notice is that the biggest trade deficit is for energy, but that it is rapidly coming up toward the breakeven mark.  This data stops at 2014, and by 2018 we are nearly ready to become a net exporter.  This was done with technology and productivity, not by employing a lot of people.  Before leaving the subject of energy, I want to point out that Saudi Arabia and the United Arab Emirates are trading partners with which we have a surplus, not a deficit.  For energy partners, we have deficits with Indonesia and Russia.  With Canada we are very nearly balanced, so it is a fair swap.

Electronics, clothing and automobiles are big offenders.  This has changed since the early 1960s when we led the world in making all three.  Warren Buffet’s claim to fame is that he shut down a textile mill (Berkshire-Hathaway) and converted it to a financial services firm, effectively a big proprietary mutual fund.  Most of the electronics now come from China, Thailand, and similar countries.  The autos come from Japan, Korea and Germany.

The next three biggest negatives are metals (such as the steel and aluminum in the news this week), machinery of various sorts, and believe it or not … footwear.  More than $20 billion a year of it.

The only industry in which we have a net export is agriculture, or food, around $30 billion.  Whatever you think of other people in the world, we feed them.

If you shut down all trade there would be a lot of disruption.  But on the whole, only one industry would be harmed, and not nearly by the staggering numbers by which a dozen other industries would be helped.  Prices of some things would be higher.  Those dollars would be spent here in the U.S., so it’s really not a problem.  Your neighbors would have jobs instead of unemployment benefits, and your taxes would be lower.

Are there particular countries with which we have an egregious trade imbalance?  Yes, see chart below:

top 10 trading partners

It looks like China accounts for 2.5 times the trade deficit of any other region, with the EU second, followed by Japan, Mexico, India and South Korea.  (Germany and France are included in the EU total.)  Although the deficit with India is about the size of the one with South Korea, it is much more egregiously unbalanced so I put India earlier in my list.  Mexico is not that badly unbalanced, actually, but is just a large trading partner with a degree of unbalance.

Which of these countries have deliberate policies of restricting U.S. imports?  China, Japan and the EU are very hostile to imported goods and services, even though all three have wealthy populations.  India might plausibly argue it is not a wealthy country, but in fact the attitudes of young Indians is quite anti-American.  They view western nations as targets for exploitation.  The U.K. and Mexico are very fair trading partners.

Is a trade imbalance a problem?

In my book on The Equity Premium Puzzle, I classify trade as to whether it is based on uneven distribution of resources between the trading parties, or on the cost of labor.  Trade based on uneven resources is helpful, I concluded.  Trade based on cost of labor is not, in the long run.  I will not repeat those rather complex arguments here, just reminding you of them.

If you become overly dependent on foreign sources for key industries, you can be controlled through trade sanctions and threats.  It would be unwise to depend on Chinese steel, aluminum and computers for our military equipment, or even in our economy to such a degree that China could dictate our foreign policy.  And they would.  We do it to people all the time, and China already does it to nations like the Philippines.

If foreigners accumulate enough money to buy your land and corporations, and you let them, then they control you just as surely as if you had a strategic dependence.  Your culture also becomes overly influenced by foreign ideas and values.

How do you correct a trade imbalance?

Normally a long term trade imbalance would weaken your currency, which would correct the imbalance by making your goods and services cheaper.  If this does not happen, either because other countries don’t have a trust factor to build up value in their currency, or have profligate expenses, or policies of excessive stimulus (e.g. China, the EU) which hold their currencies low, then you might need to do something else.

Here are the alternatives for fixing a trade imbalance:

  1. Let free markets take their course, and let your currency decline in value.  If others are manipulating their currency with stimulus, you will have to match them or this will not work.  In the U.S. we don’t tolerate inflation well, and are backing off of stimulus at the moment.  Our president has said he doesn’t want a weak currency, probably because it is inflationary.  So in the current case, we will not match their fiscal policy and letting free markets take their course is not going to help.
  2. Develop alternative sources for materials imbalances.  Oil is a classic example of this, and we have developed fracking technology, partly through government incentives to do so, and sure enough, the energy imbalance has dropped, and caused disruption around the world.  Since we were not previously doing a lot of new domestic drilling, this did not manifest as a displacement of jobs by productivity.  Notice that this does not apply to steel and aluminum.  China, for example, is not a great source of either.  They buy the raw materials from other countries, many of them in this hemisphere, sometimes from thieves or those who don’t mind destroying the environment to get them.
  3. Increase productivity to lower prices of the things you do export.  You have to be already exporting something for this to work, so it works with agriculture and financial services, but not with electronics and textiles because we have long ago abandoned those industries.  There are two problems:  First, it can reduce the number of jobs in those industries, since the main emphasis is on productivity.  Second, if your trading partner simply blocks your imports with rules and regulations, this doesn’t work.  Our fastest growing companies like Facebook, Google and Amazon are simply blocked by China’s totalitarian government.
  4. Impose tariffs on goods from countries with which you have a trade imbalance, in industries in which you have a trade imbalance, preferably in industries for which you have a critical need.  No point in picking fights over something unimportant.

To sum up, we already did number 2 in a big way, and strategies 1 and 3 are blocked by the policies and behavior of other countries.  That leaves 4, the tariff thing.

Will tariffs create a trade war?  Possibly.  There is nothing wrong with a trade war if you can win it, and it is a simple matter of adding up the numbers.  We have massive deficits with China and the EU.  As long as:

  • we only target industries in which we have large deficits with those two countries,
  • we are willing to match any retaliatory tariffs they impose,

then we will win any such trade war.  They simply have much more to lose than we do.  If trade with them stops altogether, fine.  I say we don’t even look back.  China would become a 3rd world country again.  The EU is already headed that way through mismanagement and unrestrained immigration.

How harmful is a trade war?  What can they do, and what else will we do?

The existing trade war.

In case you hadn’t noticed, there is already a trade war going on which is extremely vicious.  It is often illegal and targets any business that sells by mail order, whether it’s a mom and pop operation with a new kitchen widget, or the sleek products of our latest tech companies.

The small company products are the ones targeted illegally, sometimes aided and abetted by Amazon.  Chinese manufacturers clone a proprietary product and sell it as the original.  See well documented example of Elevation Lab’s under desk headphone holder.  For a broad based report including the kitchen widgets, see article on CNBC.

Large company products are copied in style, are usually not exact clones, and are sold under other brand names.  As far as what appears on the surface (I don’t know about the insides) this seems legal.  It is buyer beware.  Some devices don’t work.  Others work quite well.  I have bought a number of under-$100 tablets.  Half of them didn’t work or didn’t last and I threw them away.  The remaining ones work well, and even with losses were half the price of big names like Samsung and Apple.  I’m currently pondering whether to buy a laptop this way.  Here are examples of some current choices:

  • $999 Macbook 13″ directly from Apple
  • $399 refurbished (grade C) Macbook from Double Dex sold through Walmart
  • $289 new Jumper EZ book (note name and style similarity, see photos) directly from China on Banggood.com

macbook 13 from applemacbook 11 refurb

jumper 13 from banggood

The next steps in a China trade war.

I took the list of possible steps China would take from a BBC Business News article:

  1. File complaints to the WTO.  The World Trade Organization, successor to GATT, started after WWII, was designed to make it more profitable for countries to trade than fight.  Further, it was designed to give countries leverage to control one another without fighting.  Members of the WTO, in theory, must give every other member “most favored nation” status, not charging higher tariffs to one nation than another.  If they go to war, they can be sanctioned and trade blocked or tariffs imposed.  The WTO has not really been successful.  Russia joined only in 2012, and invaded Ukraine in 2014.  Some deterrent.  China has claimed an entire ocean region (probably for oil) of waters adjacent to major nations like The Philippines.  The WTO is rendered less effective by bilateral and regional trade unions, like the EU and NAFTA and the TPP, at better-than most favored nation trading terms, which is exempted under WTO rules.  In other words, the WTO has no teeth.  If you are already in a trade war, it does not affect your bilateral and regional trade agreements.
  2. Limit U.S. beef imports.  This is presented as if it were important.  They’ve only recently been allowed after being banned for more than a decade, so very little impact.
  3. Tell Chinese customers not to buy American cars.  GM does sell a good many cars in China.  But you don’t really think those are manufactured here and shipped there do you?  Of course not.  Here is a picture of GM manufacturing plant in Shanghai:
    GM Cadillac plant in Shanghai
    The real trend is toward Chinese manufacturing of cars sold in the U.S.  A Chinese company now owns Volvo.  As for GM, 32,000 Buick Envison models have been produced in Shanghai and sold in the U.S.  That is the tip of the coming iceberg.  Even Russia gets ripped off by China, with a contract for fighter jets canceled half way through as clones started rolling off Chinese assembly lines.  It’s not just China.  Take a look at 13 popular “American” models manufactured overseas.  GM is destined to become not a seller of American-made products in China, but yet another gateway for selling Chinese products in the U.S.
  4. Tell tourists to stop visiting the U.S.  The first problem I have with that is the idea of a country “telling” its citizens where to go.  We should not even be trading with such countries.  It is aiding and abetting totalitarianism.  The second problem I have with that is, well, let’s put it this way.  If you want your town to become a 3rd world tourist trap for wealthy Chinese, go ahead.  I’m not interested.  I’d rather be wealthy myself.  And I certainly don’t want my livelihood subject to the whims of a totalitarian government, long time strategic enemy of the United States, which uses the spending power of its citizens whom I’ve made wealthy as a strategic weapon.
  5. Sell some U.S. bonds.  Even the BBC reporter admits this is not much of a threat.  They would be picked up by other countries.  We are already raising interest rates, which is the effect of bond sales.  And since we have our own currency, we can create it through the Federal Reserve to buy bonds at any time, lowering the value of our currency and making our exports more attractive.  In other words, if the Chinese sell U.S. bonds, they merely give up the leverage they have used to make gains in the already-on-going trade war to begin with, and the U.S. trade imbalance with the entire world will self-correct by currency value changes as it should have long ago.

Conclusions.

A trade war really is a kind of war.  The thing is, it’s like Pearl Harbor.  If you have been attacked, even if it is a sneak attack over time, you have to respond, or fold as a country.

Most likely, as the BBC reporter suggests, China will do nothing serious.  But the reasons are not given.  Here they are.  First, current trade policy moves will be seen as political posturing by Republicans who want to win (or avoid losing) in the fall 2018 mid-term elections.  Second, China will not so easily give up its strategic goal of being the [sole] manufacturer to the world, thus controlling the world.  It wants to capture the U.S. car market.  It is emulating Japan, and that’s what Japan did as a next step after capturing the U.S. electronics market.  It can’t do that if there is a trade war going on.

How did we respond to Japan?  Reagan imposed selective tariffs, and forced them to revalue their currency upward, which produced a deflationary catastrophe in Japan that cost them their leadership position in world trade.

 

 

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