Tag: trade

Is the U.S. Trade Deficit a Problem to Solve?

Since 1975 – for 41 straight years – the United States has registered annual trade deficits with the rest of the world.  That means that year after year, Americans spend more on foreign-produced goods and services than foreigners spend on U.S.-produced goods and services or, put simply, the dollar value of U.S. imports exceeds the dollar value of U.S. exports.

For almost as long, some economists have been arguing that trade deficits are unsustainable – they sap economic growth, bleed jobs, and saddle our descendants with debt.  Perhaps if one looks at the trade deficit (or the slightly broader current account deficit) in isolation, these concerns might seem to have merit.  But looking at the U.S. trade or current account deficits without considering the capital account surplus is a meaningless, misleading exercise.

Yesterday, I published this piece at Forbes online, explaining why the trade deficit is not only not a problem, but that the associated capital surplus (the excess of inward investment over outward investment), which includes high-quality foreign direct investment, bestows huge advantages on the U.S. economy.  In that piece, I ask trade deficit hawks (or scolds, as I call them) to furnish their best, fact-based, comprehensive arguments – to finally step up to the plate and explain why it is that the trade deficit is a problem to solve.  

It would be of immense public policy value if we were to be able to catalogue and compare the arguments of both sides (and those who may be in the middle).  After all, one of the reasons that trade is so maligned is that the public has been lead to believe that the trade account is a scoreboard, with the deficit indicating that Team America is losing – and it’s losing on account of poorly negotiated trade deals and foreign cheating.  Helping the public reach that conclusion (rather than find the truth) may be the goal of some noisy contributors, but I suspect there are plenty of trade deficit hawks with purer motives, if not convincing arguments.


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.


Trump’s New Trade Proposals Borrowed from Democrats

Donald Trump’s campaign has undoubtedly given protectionist rhetoric a new energy in American politics.  China, he says, is “killing us on trade” and the Trans-Pacific Partnership is “a rape of our country.”  Early on, he got attention for calling for a 45% tariff on all goods from China and for saying we should impose tariffs of 35% on imports from companies that invest overseas. 

On Tuesday, he delivered a highly publicized trade policy speech where he doubled down on his belligerent, mercantilist rhetoric.  He also offered some more detailed and thought-out policy proposals.  Here are the seven proposals he laid out:

  1. “Withdraw the United States from the Trans-Pacific Partnership.”
  2. “Appoint the toughest and smartest trade negotiators.”
  3. “Identify every violation of trade agreements a foreign country is currently using to harm our workers … [and] use every tool under American and international law to end these abuses.
  4. Renegotiate or withdraw from NAFTA
  5. “Label China a currency manipulator.”
  6. “Bring trade cases against China, both in this country and at the WTO.”
  7. “Use every lawful presidential power to remedy trade disputes, including the application of tariffs consistent with Section 201 and 301 of the Trade Act of 1974 and Section 232 of the Trade Expansion Act of 1962.”

Despite the outlandish nature of Trump’s rhetoric, there’s actually nothing new or radical about these proposals.  They are, in fact, just what trade-skeptic Democrats have been demanding consistently for over a decade.


Cato Trade Scholars Endorse the Trans-Pacific Partnership

On June 30, U.S. Trade Representative Michael Froman, former U.S. Trade Representative Clayton Yeutter, and other trade policy experts joined Cato’s trade scholars in the Hayek Auditorium for an event titled: ”Should Free Traders Support the Trans-Pacific Partnership?” The main purpose of the event was to reveal the findings of a forthcoming paper by my trade center colleagues and me, in which we provide a chapter-by-chapter assessment of the 30-chapter, 5,500-page trade deal and reach the conclusion that, yes, free traders should support the TPP.

In our assessment, we make the distinction between free trade and free trade agreements:

For free traders, the ideal is free trade: No border barriers; no domestic regulations or policies that have protectionist intent or effects or that otherwise bestow relative privileges on domestic companies or their products; no superfluous rules that are merely tangentially related to trade, but violations of which can be invoked to erect new impediments to trade. Measured against those standards, the TPP – with its 5,500 pages of explicit rules and exemptions – would not pass the free trade test. The TPP is not free trade. Like all other U.S. trade agreements, the TPP is a managed trade agreement, with provisions that both liberalize and restrict trade and investment. Some free traders would reject the TPP out of hand for its failure to eliminate all restrictions.


Playing the China Card Wisely Is Obama’s Last Best Chance to Sell the Trans-Pacific Partnership

The Trans-Pacific Partnership is the economic centerpiece of the Obama administration’s much ballyhooed “strategic pivot” to Asia, which – in 2009 – heralded U.S. intentions to extricate itself from the messes in Iraq and Afghanistan and to reassert its interests in the world’s fastest-growing region. After six years of negotiations, the comprehensive trade deal was completed last year and signed by its 12 charter members earlier this year. But the TPP must be ratified before it can take effect – and prospects for that happening in 2016 grow dimmer with each passing day.

One would assume TPP ratification a policy priority of President Obama. After all, he took office promising to restore some of the U.S. foreign policy credibility that had been notoriously squandered by his predecessor. If Congress fails to ratify the agreement before Christmas, Obama will leave office with American commercial and strategic positions weakened in the Asia-Pacific, and U.S. credibility further diminished globally.  The specter of that outcome would keep most presidents awake at night.

In Newsweek today, I put most of the blame for this precarious situation on a president who, throughout his tenure, has remained unwilling to challenge the guardians of his party’s anti-trade orthodoxy by making the case for trade liberalization generally, or the TPP specifically:

Superficially, one could blame election-year politics and a metastasizing popular antipathy toward trade agreements for the situation, but the original sin is the president’s lackluster effort to sell the TPP to his trade-skeptical party and the American public. In the administration’s division of labor, those tasked with negotiating the TPP kept their noses to the grindstone and brought back an agreement that reduces taxes and other protectionist impediments to trade…

What to Make of the International Trade Commission’s TPP Analysis?

The 2016 election season has put international trade in the spotlight – or, actually, under the heat lamp – like never before.  But just as some of us in the trade policy community started getting big heads over the increasing prominence of our pet issues, the U.S. International Trade Commission released this report yesterday, which concludes that the Trans-Pacific Partnership Agreement, if implemented, would boost real annual GDP by 0.15 percent by the year 2032. In other words, the economic growth from TPP could be wiped out by a single new major EPA regulation.  So much for the importance of trade, I guess.

Of course, some will downplay the magnitude of the issue and turn these modest gains into positive talking points to encourage TPP ratification. In addition to GDP, small gains are estimated for real income, employment, and trade, as well.

Others will suggest that the estimates overstate the benefits, as the ITC studies are wont to do.  But as Dan Pearson explained a few months ago in this paper, the ITC’s assessments are not intended to be interpreted as projections into the future. They are static comparisons. The TPP study compares today’s economy without TPP to today’s economy with TPP.  The results are just estimates of what the various outcome metrics would be ceteris paribus.  Accordingly, the utility of the estimates is limited and the validity of the model cannot be tested by comparing real future outcomes to these estimates because in the real world there is no ceteris paribus. Things change.

For example, the model doesn’t take into account things like: supply shocks (such as another fracking-type boom) or demand shocks (such as mass adoption of hand-held devices); transitions from human labor to robots; changes in institutions; the policy reactions of other countries to the TPP; accessions to the agreement by other countries; the impact on the multilateral trading system, and so on.  All of these factors matter at least as much as the terms of the TPP itself. 

So the question is: Why even bother performing these studies?  The real outcomes are determined primarily by information that is unknown and difficult to estimate with reasonable accuracy when the models are run. The results are politicized and misused by advocates and proponents of trade agreements alike.

As it stands now, the ITC is required under the terms of the Bipartisan Congressional Trade Priorities and Accountability Act of 2015 (the Trade Promotion Authority Bill) to conduct an economic impact assessment of a trade agreement within 105 days of the president entering into such an agreement. While there is some useful information to obtain from these assessments, it seems that their greatest utility is to provide political cover to members of Congress.


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.