Tag: tariffs

The Economics of Trade: Wilbur Ross Is Mistaken

Billionaire investor Wilbur Ross, a supporter of Donald Trump, made the following comment in a letter to the Wall Street Journal (Aug 15): “It’s Econ 101 that GDP equals the sum of domestic economic activity plus “net exports,” i.e., exports minus imports.  Therefore, when we run massive and chronic trade deficits, it weakens our economy.”

In reality, the last sentence –beginning with “Therefore”– does not follow from the first.

Mr. Ross is alluding to the demand side of National Income Accounts, wherein Y=C+I+G+ (N-X). That is, National Income (Y) equals spending on Consumption (C) plus Investment (I) plus Government (G) plus Net Exports (Imports N minus Exports X).  

Taking such accounting too literally, a reduction in imports may appear to be mathematically equal to an increase in overall real GDP.  But that is dangerously incorrect, as the 1930s should have taught us.

The accounting is true by definition (a tautology). But economics is about behavior, not accounting identities.

If trade deficits “weaken our economy,” as Mr. Ross asserts, then we should expect to see real GDP slow down when trade deficits get larger and see real GDP speed up when trade deficits get smaller or become surpluses.  What the data show is much different – the exact opposite in fact.  


Why We Trade

Imagine life in isolation, waking every morning before sunrise to make your own clothes, build and repair your meager shelter, hunt and harvest your own food, concoct rudimentary salves for what physically ails you, and attend to the upkeep of your brutish existence engaging in other difficult and tedious tasks. Forget leisure or luxuries; all of your time would be consumed trying to produce basic necessities merely to subsist.

Fortunately, that’s no longer the way most of humanity organizes its economic activities. We don’t attempt to make everything we need or want to consume, but instead specialize in a few, or a couple, or just one value-added endeavor – one profession. This specialization is possible because we accept and embrace the concept of cooperation in the form of exchange. We realize that by specializing, we can focus our efforts on what we do best, and produce more value than would be possible if we had to attend to the production of all of our needs and wants. Because we can exchange our output (monetized in the forms of wages and salaries) for the output of others, we don’t even have to know the first thing about hammering a nail, mixing mortar, making thread, yarn, and cloth, threading a needle, whittling an arrow to kill a deer, or any of the details of the incredibly complex processes and supply chains that generate the products and services we consume daily.  Fortunately (but sadly, too), most of us never give it a second thought.  

If two people focusing their efforts on the tasks they do best and exchanging their daily surpluses enables both to consume more or better quality output, then it should readily follow that four people or eight or eighty or eight million participating in this cooperative economic relationship can lead to much higher volumes of output (wealth) and much greater consumption and savings (higher living standards).  This is the purpose of exchange. It enables us to specialize.  And when there are more participants in the market (more with whom to exchange) there is greater scope for more refined levels of specialization. That means greater opportunities to match individuals’ precise skills and faculties (or to cultivate then match those precise skills and faculties) with increasingly specialized tasks and professions created in response to the increasingly refined demands of societies as they produce even greater wealth and higher living standards. 

We’ve come a long way from exchanging cloth and wine.  No longer are people’s choices restricted to being sober and clothed or naked and drunk. Today, we can almost have it all. Whereas once there were witchdoctors serving as generalist medical practitioners, today (in Washington, DC, I am told) there is burgeoning demand for the services of psychiatrists who specialize in treating the emotional and psychological adjustment costs associated with being an expat spouse of a foreign diplomat from Western Europe.  It’s become that specialized. Imagine hearing: “Sorry, my specialty is in talking spouses of diplomats through their neuroses brought on by resettling in Washington from places like Stockholm, Amsterdam, Paris, or London.  Since you’re from Warsaw, let me recommend a different specialist who focuses on treating Polish ex-pats with similar conditions.”

The purpose of exchange is to enable each of us to focus our productive efforts on what we do best.  By specializing in an occupation — instead of allocating small portions of our time to the impossible task of producing each of the necessities and luxuries we wish to consume — and exchanging the monetized output we produce most efficiently for the goods and services we produce less efficiently, we are able to produce and consume more output than would be the case in the absence of specialization and trade. The larger the size of the market, the greater is the scope for specialization, exchange, and economic growth.

Free trade is the extension of free markets across political borders.  Enlarging markets in this manner – to integrate more buyers, sellers, investors and workers – enables more refined specialization and economies of scales, which lead to greater wealth and higher living standards. When goods, services, capital, and labor flow freely across borders, Americans can take full advantage of the opportunities of the international marketplace.

The purpose of trade is to enable us to specialize; the purpose of specialization is to enable us to produce more; the purpose of producing more is to enable us to consume more.  More and better consumption is the purpose of trade. Thus, the benefits of trade come from imports, which deliver more competition, greater variety, lower prices, better quality, and innovation. The real benefits of trade are measured by the value of imports that can be purchased with a unit of exports — the so-called terms of trade. When we transact at the local supermarket, we seek to maximize the value we obtain by getting the most for our dollars.

But when it comes to trading across borders or when our individual transactions are aggregated at the national level, we seem to forget these basic principles and assume the goal of exchange is to achieve a trade surplus. We forget that trade barriers at home raise the costs and reduce the amount of imports that can be purchased with a unit of exports.  U.S. trade barriers hurt U.S. citizens, as consumers, taxpayers, workers, producers, and investors. Americans would be better off if we simply undertook our own reforms – on tariffs, regulations, and other artificial impediments to commerce – without regard for what other government’s do. Yet we don’t.

Although tariffs and other trade barriers have been reduced considerably since the end of the Second World War, U.S. policy continues to accommodate egregious amounts of protectionism.  We have “Buy American” rules that restrict most government procurement spending to U.S. suppliers, ensuring that taxpayers get the smallest bang for their buck; heavily protected services industries, such as air transportation and shipping, that drive up the cost of everything; apparently interminable farm subsidies; quotas and high tariffs on imported sugar; high tariffs on basic consumer products, such as clothing and footwear; energy export restrictions; the market-distorting cronyism of the Export-Import bank; antidumping duties that strangle downstream industries and tax consumers; regulatory protectionism masquerading as public health and safety precautions; protectionist rules of origin and local content requirements that limit trade’s benefits; restrictions on foreign investment, and so on.

It is sad, but true, that Congress seems to have forgotten why we trade.


Miscellaneous Tariff Bill Shows Why Washington Needs a Refresher in Business Accounting

Nearly two and a half centuries after Adam Smith vanquished the mercantilists, mercantilism is the beacon of U.S. trade policy.  In descending order of priority, U.S. trade policy is oriented toward three objectives: (1) Accelerating export growth; (2) Limiting import growth; (3) Effectuating a trade enforcement regime that maximally supports the first two objectives. The coexistence of the “exports good, imports bad” philosophy with 41 straight years of trade deficits explains why trade is so often maligned and demagogued (i.e., “We’re getting crushed in trade!”), and why trade liberalization is such a tough slog politically. 

Anyone who reads the press releases from the U.S. Trade Representative’s office, the House Ways and Means Committee, the Senate Finance Committee, or the big business trade associations is familiar with the statistic that 95 percent of the world’s consumers live outside the United States.  That mantra is deployed to promote the importance of exports – to suggest that removing foreign trade barriers is essential to U.S. export growth, which is essential to U.S. economic growth.  But rarely does anyone in official Washington make the valid point that if 95 percent of the world’s potential customers live abroad, so do 95 percent of the world’s suppliers, 95 percent of the world’s supply chain partners, 95 percent of the world’s workers, and 95 percent of the world’s investors.

The fact that the United States accounts for only 5 percent of the world’s population means there are numerous channels through which engagement with the world increases U.S. wealth and living standards, and that U.S. barriers to imports, investment, and immigration are at least as important to surmount as are foreign barriers to U.S. exports. But official Washington considers dismantling foreign market barriers, while fortifying U.S. import barriers, to be its remit.

A brief refresher on business accounting is in order.

Lesson 1:

Profits equal revenues minus costs.

In simple arithmetic terms: P = R – C.

Lesson 2:

With reference to the simple equation above, a business can realize higher profits by increasing R or decreasing C.  To be more precise, higher profits require revenues to increase faster than costs increase or for costs to decrease faster than revenues decrease.

Lesson 3:

For any given firm, revenues equal the value of its domestic sales plus the value of its export sales, and costs equal the materials, labor, and overhead used in production, as well as transportation expenses, selling expenses, taxes, and other expenses incurred in the process of delivering the good or service to the customer.

Lesson 4:

By increasing overall supply and reducing the average price of manufacturing inputs and final end-user products, imports help reduce the cost of production for businesses and the cost of living for American households. For businesses, those lower costs generate greater profits to reinvest or distribute to shareholders or they enable lower prices to help them compete.  For households, those lower costs mean lower prices and more resources to save or spend elsewhere in the economy.

Lesson 5:

The goal of trade policy should not be to maximize business revenues.  The goal of trade policy should be to maximize profits (or put in economic terms: to maximize value-added, i.e. GDP). The equation in Lesson 1, above, shows that reducing costs contributes to profit growth just like increasing revenues contributes to profit growth.

Congress demonstrates occasional, attenuated appreciation of these lessons.  Every few years (8 times since 1982), Congress has passed a Miscellaneous Tariff Bill, which temporarily suspend duties on certain, “noncontroversial” products—usually intermediate goods, such as chemicals, electronic components, and mechanical parts—that are not manufactured domestically but are needed by U.S. producers to generate their own output. Although limited in impact by its temporary nature, by the “no domestic production” requirement, and by the caveat that the suspended duty must not reduce tariff revenues by more than $500,000, the MTB does provide some cost savings to U.S. producers. The last MTB provided an estimated $748 million of import tax relief.

As described in this new paper – released ahead of a House vote tomorrow on legislation to resuscitate the MTB process – Congress should recognize that tariffs are always costs that reduce GDP and act with greater resolve to eliminate all import tariffs permanently.


Congress Fist Bumps Itself Over Tariff “Reform” Bill That Keeps 97% of Import Taxes in Place

This week congressional trade leaders introduced The American Manufacturing Competitiveness Act of 2016 (AMCA), a bill to reform and reinvigorate the stalled Miscellaneous Tariff Bill (MTB) process.  MTBs are legislative vehicles through which Congress temporarily suspends import duties on certain qualified products typically used as inputs in U.S. manufacturing operations. Soon followed the self-congratulatory triumphalism.

House Ways and Means Committee Chairman Kevin Brady (R-TX) said: “This bipartisan bill will empower American manufacturers to compete around the world, create new jobs at home, and grow our economy.”

Ranking Member Sander Levin (D-MI) added: “The MTB is a critical tool that supports American manufacturers and workers, and I’m pleased that we’re finally moving forward with this legislation.”

Senate Finance Committee Chairman Orrin Hatch (R-UT) boasted: “With this legislation, we offer a smart bicameral and bipartisan approach for MTBs — one that improves transparency and allows domestic firms to receive appropriate tariff relief on products that can only be found abroad so that those firms can produce American-made goods here at home.”

Ranking Member Ron Wyden (D-OR) moralized: “We need to do everything we can to make U.S. manufacturers more competitive — that includes passing a miscellaneous tariff bill that reduces costs of components we don’t make here in the U.S.”

Let’s unpack this. 


Little-Known Facts About U.S. Trade With China

Trade with China in ServicesWilliam Galston’s Wall Street Journal column, “Why Trade Critics Are Getting Traction,” asks why U.S. employment in manufacturing fell from 17.2 million in December 2000 to 12.3 million last year.    He suggests that “import penetration from China [not Mexico] has been responsible for up to 20% of U.S. job losses.” But “up to” 20% explains very little, and that figure is at the high end of a range of estimates about 1999-2011 from a working paper by David Autor, David Dorn and Gordon Hanson. They speculate that “had import competition not grown after 1999” then there would have been 10% more U.S. manufacturing jobs in 2011.  In that hypothetical sense, “direct import competition [would] amount to 10 percent of the realized job loss” from 1999 to 2011.  Since 2007, however, the study’s authors find “a marked slowdown in import expansion following the onset of the global financial crisis, which halted trade growth worldwide.”

Deep recession and weak recovery is what slashed manufacturing jobs since 2007, not imports. In reality, imports always fall in recessions.  Although Autor, Dorn and Hanson emphasize imports of consumer goods (clothing and furniture), nearly half of U.S. goods imports (47.7% last year) are industrial supplies and capital goods which are essential inputs into expanding U.S. production.  That is a big reason why imports rise when U.S. industry expands and fall in slumps.

Even if “up to” 20% of manufacturing jobs lost since 2007 could be blamed on imports from China, as Galston claims, that need not mean the overall numbers of U.S. jobs were reduced.  “There is no evidence,” writes Galston, “that increased competition from China has produced offsetting employment increases in other industries whose products are traded internationally [emphasis added].”  Confining overall employment effects to “traded goods,” as Autor, Dorn and Hanson do, arbitrarily excludes services – such as financial and legal services, accounting, advertising, travel, telecom and insurance.   Services account for 32% of U.S. exports, and the U.S. runs a large and growing trade surplus with China ($28 billion in 2014) and with the world ($233 billion). Dollars foreign firms earn by exporting goods to the U.S. are commonly used to import services from the U.S. or to invest in U.S. real and financial assets; both those activities create U.S. jobs. Hollywood, Madison Avenue and Wall Street are big, high-wage U.S. exporters.

Confining the job impact to traded goods also excludes U.S. jobs in transporting, wholesaling and retailing Chinese goods (Walmart, Amazon…), as well as shipping U.S. exports to China and Hong Kong.  Incidentally, the U.S. ran a $30.5 billion trade surplus with Hong Kong last year, which isn’t counted trade with China though it really is.

Galston acknowledges that “rising productivity” [output per worker] is “part of the story” about manufacturing jobs.  In fact, it is essentially the whole story from 1987 to 2007, when U.S. manufacturing output nearly doubled.  The deep recession and slow recovery explain what happened to manufacturing jobs over the past ten years, not foreign trade.  

Index of U.S. Manufacturing Output and Employment

US-Africa Summit Will Not Solve Africa’s Problems

As the U.S. President Barack Obama prepares to meet 50 African leaders on Wednesday, August 6, it is worth reflecting on the factors behind the recent progress occurring in countries of Sub-Saharan Africa. As we write in our new paper,

The real gross domestic product [in Sub-Saharan Africa] rose at an average annual rate of 4.9 percent between 2000 and 2008 — twice as fast as that in the 1990s. […] As a result, between 1990 and 2010, the share of Africans living at $1.25 per day or less fell from 56 percent to 48 percent, while the continent’s population almost doubled in size. If the current trends continue, Africa’s poverty rate will fall to 24 percent by 2030.4 Since 1990 the per-capita caloric intake in Africa increased from 2,150 kcal to 2,430 kcal in 2013.5 Between 1990 and 2012, the proportion of the population of African countries with access to clean drinking water increased from 48 percent to 64 percent.

Although Sub-Saharan Africa is also becoming more democratic and better governed, a large gap between the quality of its institutions and those in the West persists. The continent remains, for example, economically unfree and heavily protectionist, not just vis-à-vis the outside world but also within the continent. For 25 African countries, the tariff costs of exporting or importing manufactured goods are higher within Africa than with the rest of world.

While international summits cannot not solve Africa’s internal problems, our paper argues that the upcoming meeting is a good opportunity for the U.S. administration to eliminate the existing trade barriers facing African exporters – regardless of whether they come in the form of explicit tariff barriers or implicit ones, such as agricultural subsidies:

[T]he elimination of the existing barriers to trade should be at the forefront of the efforts to help. Such barriers include tariffs, particularly on agricultural exports, which make it difficult for African economies to fully exploit their comparative advantage. As Brookings Institution researchers Emmanuel Asmah and Brandon Routman note, the structure of the tariff protection in the United States — but also in the European Union — is a significant part of the problem. The tariffs imposed up to a certain amount of imports may be low, yet the tariffs imposed for imports above the permitted quota might be very steep, in some cases up to 350 percent. Furthermore, agricultural subsidies in rich countries cause surplus production, which is often dumped on the world markets, depressing prices and undermining the livelihood of farmers in poor countries.

Congratulations to the Free Traders of the 112th Congress

Do you remember the 112th Congress—the one that repeatedly almost shut down the government while still managing to raise taxes and spending? It turns out they did some interesting things with trade policy. The votes recorded in Cato’s congressional trade votes database have been counted, tabulated, and analyzed, and the results are mixed. The predictable legislative outcome was that with a Republican House and Democratic Senate, the 112th Congress furthered the bipartisan establishment trade policy of reciprocal tariff reduction and unilateral subsidy expansion.

The more interesting revelations come from looking at the voting records of individual members. Rather than simply noting whether a policy would promote or diminish free trade or would increase or decrease America’s engagement in the global economy, Cato’s Free Trade, Free Markets methodology distinguishes between barriers (like tariffs and quotas) and subsidies (like loan guarantees, tax credits, and price supports). This distinction enables us to place members within a two-dimensional matrix.

Free traders are those that oppose both barriers and subsidies. Interventionists are those that support both barriers and subsidies. Isolationists are those that support barriers but oppose subsidies. Internationalists are those that oppose barriers but support subsidies. 

The release of this report offers a wonderful opportunity to name names. First I’d like to point out that last term, three Republican representatives voted consistently to support trade barriers. Just to be clear, these barriers are taxes expressly intended to prevent you from buying things you want. The representatives are Walter Jones of North Carolina, Frank LoBiondo of New Jersey, and Steve LaTourette of Ohio. While Walter Jones consistently opposed subsidies (making him the House’s only isolationist last term), Messrs. LoBiondo and LaTourette joined 115 Democrats as interventionists.

With that unpleasantness out of the way, I would like to offer my congratulations and gratitude to the 112th Congress’s free traders. There were 19 in the Senate and 85 in the House. The high number of free traders in the House last term is due mostly to the fact that there was only one trade subsidy vote; if there were more, I’m sure many of these names would disappear from the list, but many would not and they all deserve credit nonetheless.