August 6, 2018 4:13PM

Weighing Trump’s Trade Apologists

In the wake of the recent “trade agreement” between President Trump and EU Commission President Jean Claude Juncker, we have seen a surfeit of commentary heaping praise on the U.S. president for his strategic trade policy vision and tactical brilliance. Much of that praise has come from people who share the president’s flat-earth view that trade is a zero-sum game played by national governments where the objective is to promote exports, block imports, and secure a trade surplus. Trump throwing U.S. weight around to assert the rule of power over the rule of law is music to this crowd’s ears.

But then there are the apologists who know better; the enablers. They are the bigger problem. In their obsequious tones, they explain how our brilliant president is blazing his own path toward free trade and that the evidence of his success is all around us. If we just disregarded Trump’s nationalist rhetoric, ignored his belief that the trade deficit means the United States is getting ripped off, shoveled away his mounting pile of destructive, protectionist actions, and stopped believing our own lying eyes, we too would rejoice in the greatness of a man who is committed—above all else and above all others—to free trade. 

Engaging in such extreme mental contortions is no easy task, but that’s exactly what an op-ed by tax reform luminaries Steve Moore, Art Laffer, and Steve Forbes in the New York Times last week expects readers to do.

Moore, Laffer, and Forbes (MLF) portray Trump’s “gunboat diplomacy” (you open your markets fully or I’ll close ours!) as strategic genius, akin to Reagan’s nuclear arms race, which broke the Soviets’ backs.  They conclude: “Just as no one ever thought Mr. Reagan would stem nuclear proliferation, if Mr. Trump aggressively pursues this policy, he could build a legacy as the president who expanded world commerce and economic freedom by ending trade barriers rather than erecting them.” Well, yeah, maybe he could.  But so far Trump has only increased trade barriers, more are coming, and there are no negotiations underway—with anyone—aimed at lowering tariffs or other barriers to trade.  But just close your eyes and imagine.

MLF make the following claim:

President Trump won a victory for freer trade last week when he and the president of the European Commission, Jean-Claude Juncker, agreed to find ways to lower tariffs and other barriers to each other’s exports. The outlines of the deal are still sketchy, but it calls for the Europeans to buy more American petroleum, soybeans and manufactured goods and for Mr. Trump to reduce his auto and steel tariffs. We were particularly heartened that Mr. Trump and the Europeans now have a handshake agreement to aim for zero tariffs on both sides of the Atlantic.

The only accurate part of this paragraph is that “the outlines of the deal are still sketchy.” As I described last week, nothing was agreed at that meeting except that new tariffs would not be imposed for the time being. In his Rose Garden statement after meeting with Juncker, Trump said they had agreed to “work together toward zero tariffs, zero non-tariff barriers, and zero subsidies on non-auto industrial goods (my emphasis).” But there is no timetable and if there were, those discussions would exclude agricultural products, natural resources, services, and—well—automobiles and parts, which together constitute a big chunk of transatlantic trade.

Instead of moving us in the direction of lower tariffs and broader trade liberalization, a more accurate interpretation of the meeting is that Trump made clear that he is digging in for a trade war of attrition with China and that he fully expects Juncker to have his back.  The plan includes such banana republic tactics as buying the quiet of Trump’s trade war casualties ($12 billion for farmers and likely more to come for manufacturers) and compelling the EU (and other trade partners) to purchase more U.S. soy, natural gas, and other products previously destined for China, lest the steel and aluminum tariffs remain in place, and auto tariffs follow—perhaps as early as October.  Considering that the EU will have a tough time absorbing much of the U.S. supply rendered “excess” by Trump’s tariffs and the retaliation they incited, it is only a matter of time before Trump loses patience and transatlantic discord starts boiling again.

MLF:

This was Mr. Trump’s idea. The night before the agreement, he proposed in a tweet that “Both the U.S. and the E.U. drop all Tariffs, Barriers and Subsidies! That would finally be called Free Market and Fair Trade!” Amen.

Of course, zero trade barriers would be great. But Trump’s idea? Hardly. In 2002, in the Doha Round, the Bush administration put forward a far more ambitious proposal for zero tariffs on industrial goods for all countries by 2015. More recently, the Transatlantic Trade and Investment Partnership (TTIP) negotiations included proposals to eliminate tariffs, non-tariff barriers, and subsidies. Neither of those efforts was successful, but the idea has been in play since well before Trump came to town and is not especially radical.

MLF:

This is a winning strategy that we’ve long endorsed with our friends at the White House because it is fully consistent with what Mr. Trump has often told us: his threat of tariffs is a negotiating tactic to get to lower trade barriers and a “level playing field.”

I’m not sure where MLF have been lately, but they seem to have overlooked the fact that the president is not only “threatening” tariffs. He has already imposed them on $100 billion of imports from Europe, Canada, Mexico, Japan, China, and most of the rest of the world. In the next week or so, another $16 billion of imports from China are likely to be hit, and another $200 billion could be subject to 25 percent duties by as early as September.

Last week, Commerce Secretary Wilbur Ross wondered why there was so much handwringing over the matter of assessing 25 percent tariffs on another $200 billion of Chinese goods: “Fifty billion dollars a year on an $18 trillion or so economy is three-tenths of one percent. It's not something that's going to be cataclysmic.” Well, it might not be immediately cataclysmic, but a more relevant comparison is that the total value of all duties collected by U.S. Customs in 2017 was just $33 billion. Only in a George Orwell novel could this beefing up of duty collection be called free trade.

MLF:

The next step should be to extend this zero tariff offer to other key allies, including Britain, Canada, Mexico and South Korea.

Again, this is willful ignorance, right?  Anyone who writes about trade in the New York Times has to know that nearly all tariffs between the United States and Canada and between the United States and Mexico are already zero today under the NAFTA, and that the Korea-U.S. free trade agreement includes a roadmap to get us almost all the way there in a decade. One major exception is Trump’s insistence on preserving the 25 percent U.S. tariff on pick-up trucks until the year 2041.

MLF:

If Mr. Trump’s goal is‎ more jobs and higher wages, America comes out the big winner under the zero tariff scenario. Most of our major trading partners have higher tariffs than we do. A study by the president’s Council of Economic Advisers calculates that the average American tariff is 3.5 percent, while the average European Union rate is 5 percent, China’s is nearly 10 percent and the world average is around 10 percent. On a level playing field, American companies can compete with anyone, and our exporters will gain advantage if trade barriers are abolished.

Actually, what this tells us is that the U.S. government has been better to American businesses and households than the governments of China and the EU have been to their own domestic entities. Trump’s tack amounts to his threatening to reduce the freedoms of Americans unless and until the other governments allow their citizens to be freer. So much for America first.

Moreover, jobs and wages are linked to the performance of businesses. American workers benefit, generally, when their employers are profitable. Profits are maximized by maximizing revenues and minimizing costs.

Generally speaking, U.S. export revenues could be higher if U.S. exporters faced lower barriers abroad. But import tariffs don’t compensate for those foreign barriers. They exacerbate the problem because half of the value of U.S. imports are inputs to U.S. production and tariffs raise their costs. Threatening to raise the cost of production on U.S. businesses (and the cost of living for U.S. households) unless foreign governments reduce their own tariffs makes no economic or business sense. Higher tariffs abroad and higher tariffs at home conspire to squeeze profits from both ends, and that’s not good for U.S. employment or compensation. This back of the envelope analysis shows how Trump’s tariffs imperil the expected benefits to U.S. manufacturers from the tax reforms, which MLF were instrumental in advancing.

The optimal response to higher foreign tariffs, which work to reduce U.S. business revenues, is to lower our own tariffs, which would reduce U.S. production costs. So not only is the economics wrong, but the strategy hasn’t produced the results that MLF are celebrating. So far China and nearly every country hit with steel and aluminum tariffs has refused to negotiate under duress. What if these governments continue to remain unwilling to submit to Trump’s gunboat diplomacy?  Even if they were inclined to, why would they have any reason to believe that Trump wouldn’t use the same tactics to get more concessions next time? This is a dubious and very dangerous “strategy.”

In any case, the fact that the United States has lower average tariffs than most countries helps explain the relative success of the U.S. economy over the years. The United States remains the world’s top destination for foreign direct investment, and lower tariffs give us an advantage in the competition to attract and retain that investment. One of the arguments for corporate tax reform with which MLF presumably agree is that lower rates would free up profits to be reinvested in the U.S. economy. Lower taxes on imports have the same effect. We didn’t need agreement from Beijing or Brussels to reduce U.S. corporate rates and we certainly don’t need their consent to do the same for tariffs.

MLF:

The alternative is higher tariffs on steel, aluminum, autos and hundreds of products imported from other countries, particularly China. Those actions have led to retaliatory tariffs imposed on products grown or manufactured in America. This has hurt farmers, the stock market and economic growth.

It’s difficult to fathom that MLF consider higher U.S. tariffs on these inputs and consumer goods to be leverage. Those U.S. tariffs are hurting the economy and threatening to negate the benefits of the tax reform they helped achieve. Those enduring costs, as well as the retaliation impacting U.S. farmers and others are what Trump’s trade policies have wrought.

MLF:

A no-tariffs trade strategy would also allow the United States to seize the moral high ground in the debate. Mr. Trump would be transformed from the evil disrupter of international commerce to a potential savior — just as 30 years ago Mr. Reagan’s international image changed from superhawk to peacemaker almost overnight.

After insulting and bullying U.S. trade partners, imposing enormous costs on the global economy, fomenting profound business uncertainty and diplomatic angst, and snuffing out any remaining fumes of good will toward his administration, it is unlikely that President Trump would ever be considered anything more sparing than an evil disrupter. But in the final analysis, it is apparent that the intended audience for the MLF op-ed is none other than President Trump himself. 

The last few paragraphs make clear that the authors—all Trump advisors—are trying to encourage the president to end up on the right side of history. For that they deserve some credit. But they still lose more points for excusing the president’s numerous transgressions, giving intellectual cover to mercantilists and nationalists who believe the United States shouldn’t be constrained by the trade rules, and for supposing that Trump would ever read the New York Times.

April 19, 2018 1:00PM

US Only Country With Projected Rising Government Debt to GDP Ratio Through 2023

Where government debt is concerned, advanced economies should be fixing the roof while the sun shines. That’s the central message of a new IMF Fiscal Monitor entitled “Capitalizing on Good Times.”

The paper entails projections based on growth forecasts and budget plans of what will happen to deficits and debt across advanced economies. And the results for the United States are not pretty. In fact, as the chart below shows, the US is now the only advanced country projected to see a rising debt-to-GDP ratio in the coming 5 years.1

Debt to GDP

Now we have to take all this with a pinch of salt of course. For advanced economies as a whole the IMF says “the fiscal stance is expected to be mildly expansionary in 2018 and 2019, followed by gradual adjustment in outer years”. I’ll believe that when I see it. Governments around the world have a tendency to plan to be fiscally responsible in a few years’ time, without eventually delivering, and to be overoptimistic about their growth prospects (many of which, it’s worth noting, are much, much worse than the US).

But it is notable that the US is now the only country which is explicitly planning for larger budget deficits, and higher public debt to-GDP, over the next half decade. Hot on the heels of the CBO analysis last week, this report again shows just how unprecedented current US policy action (deliberately expanding borrowing via the tax and omnibus spending bills) and inaction (on entitlement spending) is given the favorable economic conditions.


1 The IMF uses a different definition of debt here – gross government debt – whereas figures usually reported in the media, and by the Congressional Budget Office related to public debt held by the public.
November 3, 2017 2:00PM

Lots for Economists to Like in the House GOP Tax Plan

Debating the implications of the GOP tax plan, most analysts speak past each other. That’s because there are 3 prisms through which changes can be assessed: the implications for efficiency and growth, the impact on the public finances, and the distributional impact across income groups.

The media tends to focus on the latter, but this is the least interesting. Distributional analysis tends to put the status quo on a pedestal (see how “progressive” sources now defend the state and local income tax deduction), tends to be static in its thinking, and in the case of this tax reform, ignores the potential for significant corporate income tax rate cuts to raise wages. Added to that, a lot of the results are simply not surprising. Given a large proportion of people do not pay income taxes, it is hardly shocking that their after-tax income doesn't increase following income tax rate cuts, though this can be influenced of course by credits.

As my colleague Chris Edwards has written before, the GOP open themselves up to these distributional critiques by talking about how their changes represent a “middle class tax cut” rather than focusing on the supply-side case for lowering marginal rates. As a result, this morning’s tax discussions on Twitter have been dominated by the sharing of blogs saying, in essence, that “the tax cut is actually a tax increase for much of the middle-class because the new credit is set to expire in 2022.” I am struggling to find blogs or comment pieces which used the same logic to explain why George W Bush’s temporary tax cuts weren’t really tax cuts at all, but hey, who expects consistency in politics!

On the efficiency and growth front, there is in fact lots to like in the House GOP plan. The changes to the income tax code stripped away a whole host of small deductions and made significant inroads into some big ones too (curtailing the mortgage interest deduction and eliminating the state and local income tax deduction), as well as abolishing the AMT. Of course, to make this politically palatable, the GOP near-doubled the standard deduction, expanded the child credit and added a new personal credit too. These will do little for growth, especially compared with purely lowering marginal rates, but they do help compensate losers from other changes.

The long-term consequence of the package of these reforms though (assuming they pass Congress without being further diluted) will be a combination of lower rates, fewer deductions and fewer people itemizing. This will significantly reduce deadweight costs associated with taxation. A key variable to watch out for to assess the broader economic impact of the income tax changes is the proportion of people who will face lower or higher marginal rates as a result of all the changes. One reason why this must be seen in the round is that linking tax thresholds to chained CPI rather than CPI will see slower threshold increases, meaning people being dragged into higher bands more quickly as nominal wages rise over time.

The most important policy goal was of course a large permanent cut in the corporate income tax rate, and this plan (if it passes) would achieve that. There is good reason to think this will raise the level of GDP and wages. Even though non-corporate businesses were already favored in the tax code once you include taxes on dividends, the GOP wanted to cut all business tax rates and broadly maintain differentials. They therefore introduced a new pass-through business tax rate at 25 percent. But this necessitates complex anti-avoidance rules to stop people restructuring their affairs to earn less wages and more business income.

The other, final change of note is the welcome planned repeal of the estate tax. This will not set be fully implemented until 2024, however, by which time the political landscape may have changed significantly.

Overall then, critics of the plan were wrong to say this was just about tax cuts without reform. In fact, the plan was a lot bolder on making changes to deductions and the structure of the code than many expected. Sure, other less growth-oriented measures were included to compensate some of the losers from broader reform, but overall the tax code is made more coherent.

The real debate for conservative economists should be weighing these efficiency gains against the consequences for the public finances. The plan is projected to add $1.5 trillion to the debt over 10 years, but even this is predicated on full expensing and the new income tax credits expiring after 5 years, which is debatable to say the least. The problem is that absent spending cuts, net tax cuts ultimately become tax shifting, leading to higher taxes in future.

A few weeks ago, I wrote that tax cuts which raised borrowing were worth it if they were used to grease the wheels of pro-growth tax reform or if they were a precursor to restraining spending. The latter looks unlikely. Whether the specific tax changes the GOP have planned got enough “bang for the buck” from the extra borrowing is an open question. Certainly, the priorities as this develops into legislation must be to keep the most economically beneficial measures: the corporate rate cut, the marginal income tax rate cuts, and the elimination and constriction of deductions.

August 31, 2017 5:31PM

The Current Budget Crisis Illustrates James Buchanan’s Concerns About Politics

Nobel laureate James Buchanan has been in the news lately, especially because of a book that seeks to link his 7000 pages of economic writing to both Dixiecrat segregationists and Charles Koch's secret plan "to radically alter our government in ways that will be devastating to millions of people." The thesis of Democracy in Chains by Nancy MacLean is that public choice economics is a radical plan to "shackle the people's power," "to put democracy in chains." Oddly, she claims (without evidence), he set out on this project because he resented the Supreme Court’s decision in Brown v. Board of Education -- which of course used "undemocratic" means to overturn the democratic decisions of legislatures in various states.

Buchanan certainly was concerned with how to achieve justice, efficiency, and "prevention of discrimination against minorities" in the context of majority rule. Throughout his work he explored how to design constitutional rules to bring about optimal outcomes, including a balanced budget requirement, supermajorities, and constitutional protection of individual rights. He worried that both majorities and legislatures would be short-sighted, economically ignorant or inefficient, and indifferent to the imposition of burdens on others.

And today a Washington Post column by Dana Milbank illustrates one of the big problems that Buchanan sought to solve: the temptation of legislatures to spend money with little regard for what two of his students called "deficits, debt, and debasement." Looking outward from Hurricane Harvey to the upcoming congressional session, Milbank wrings his hands:

Harvey makes landfall in Washington as soon as next week, when President Trump is expected to ask for what could be tens of billions of dollars in storm relief. And paying for storm recovery — probably with few offsetting spending cuts — will be but the first blow to fiscal discipline in what looks to be a particularly active, and calamitous, spending season.

It's not just disaster relief. The Pentagon is hoping for tens of billions of additional dollars. And Republicans may pivot from "tax reform" to mere tax cuts. It's easier just to spend money and cut taxes than to reform the flood insurance program, make the tax system more efficient, and focus military spending on actual defense needs, much less to think about the national debt and the next generation.

Trump, who came to power promising to eliminate the $20 trillion debt, or at least to cut it in half, is poised to oversee an exponential increase in that debt. Republicans, who came to power with demands that Washington tackle the debt problem, could wind up doing at least as much damage to the nation’s finances as the Democrats did....

If the red ink rises according to worst-case forecasts, “we’re talking additions to the debt in the trillions,” Maya MacGuineas, president of the Committee for a Responsible Federal Budget, tells me. All from actions to be taken in the next few months. “It turns out the Republican-run Congress is not willing to make the hard choices,” she says. “It is a fiscal free-lunch mentality on all sides.”

We've heard a lot over the past few years about a "dysfunctional" Congress. Many critics mean that Congress doesn't pass enough laws. But this is the real dysfunction: a Congress that spends money with little thought to the future. The national debt doubled under President George W. Bush and doubled again under President Barack Obama. President Trump and the Republican Congress are just getting started, but the prospects don't look good.

Milbank, MacGuineas, and others who worry about the "fiscal free-lunch mentality" should read some Buchanan. As one scholar put it in a reflection on Buchanan's work, "Perhaps legislatures would do better if supermajorities were required whenever transfers to current recipients will burden future generations." Perhaps so. And perhaps constitutional guarantees of individual rights, judicial protection of those rights, and limits on the legislature's free-lunch mentality are all part of what Buchanan called the constitutional political economy of a free society.

August 16, 2017 2:24PM

Your Guide to the NAFTA Renegotiation

The North American Free Trade Agreement has been a source of controversy since well before its implementation in 1994.  It was the first trade agreement involving the United States and a “developing” country, so it raised concerns that a giant sucking sound from south of the border would hoover up U.S. investment and jobs.  Ross Perot, Pat Buchanan, and most Democratic presidential candidates beginning with John Kerry all lamented the imminent or unfolding devastation wrought by NAFTA.

Even though the U.S. manufacturing sector has continued to attract more investment than every other countries’ manufacturing sectors ever since NAFTA was implemented, and even though that implementation did not accelerate the trend of U.S. manufacturing job decline, which had been underway for 14 years since employment peaked at 19.4 million in 1979 (2.6 million decline between 1979 and 1993; 2.7 million decline between 1993 and 2007; 600,000 increase between 1993 and 1999), NAFTA became a symbol of corporate excess and a rallying cry for organized labor, environmental organizations, and other anti-business groups over the years.  It also made it nearly impossible for Democrats in Congress to support trade liberalization in the ensuing decades.

During the 2008 presidential election campaign, Democratic candidates John Edwards, Hillary Clinton, and Barack Obama all vowed to re-open NAFTA to make it less unfair for U.S. workers.  Within a few weeks of assuming office, President Obama let the president of Mexico and the prime minister of Canada know that he wasn’t about to follow through on his NAFTA pledges and risk disrupting North American production and supply chains that have enabled regional producers to compete more effectively against Asian and European rivals, while delivering better goods and services at more affordable prices to consumers.

Probably owing to the anti-trade agreement fervor that brewed during the debates over Trade Promotion Authority and the Trans-Pacific Partnership over the last few years, killing NAFTA (and the TPP) became a central plank in Donald Trump’s presidential campaign. Although, regrettably, he withdrew the United States from the TPP, Trump seems to have been talked off the ledge about jettisoning NAFTA , which (as of this morning) is being renegotiated.

As a guide to better understanding what’s on the table and what’s at stake, my colleagues Simon Lester, Inu Manak, and I produced this working paper: Negotiating NAFTA in the Era of Trump: Keeping the Trade Liberalization In and the Protectionism Out.

SOME FACTS FROM THE PAPER

  • When NAFTA came into force in January 1994, it was a groundbreaking achievement. It eliminated nearly all tariffs among three significant trading partners and achieved liberalization on a wide range of other issues (some of which had never before been included in trade agreements).
  • Total U.S. trade in goods and services with Canada and Mexico reached over $1 trillion in 2016, growing 125.2% in real terms since 1993.
  • NAFTA’s liberalization not only encouraged more trade, but more cross-border investment leading to deeper integration of production networks.  
  • On a historical cost basis, foreign direct investment in the United States from Canada increased from $40.4 billion in 1993 to $269 billion in 2015, and from Mexico it increased from $1.2 billion to $16.6 billion.
  • Today, 40 cents of every dollar of U.S. goods imports from Mexico and 25 cents of every dollar imported from Canada is U.S. value added (material, labor, and overhead contributed in the United States).

Still, the agreement can afford some updating to incorporate issues that were not included originally, to fix some of the flaws that have become evident over nearly a quarter of a century, and to reduce trade barriers in sectors that were originally untouched by liberalization.

NAFTA 2.0 SHOULD INCLUDE RULES ADDRESSING THE FOLLOWING ISSUES

E-Commerce

NAFTA was drafted in the pre-Internet era, when E-Commerce was virtually non-existent.  Since then, we have seen the growth of online product sales, the conversion of certain products into services delivered electronically, and the development of various online “platforms.”  E-Commerce is now a standard way of doing business for many companies, in both domestic and international trade.  The free flow of information is essential to free trade in electronic commerce, as well as to the industries for which data are crucial components of the product or service.  While governments have grappled with various responses to the growth of E-Commerce, trade policy has been slow in keeping pace with the changes.  But in recent years, U.S. trade negotiators have been making some progress on this issue. 

State-Owned Enterprises

State-owned enterprises are commercial enterprises in which the state has majority ownership, controlling ownership, or the ability to appoint a majority of the board of directors. SOEs have become more prominent actors in the global economy in recent years. Concerns about trade distortions and unfair competition have grown, as SOEs that had previously operated almost exclusively within their own territories are increasingly engaged in international trade and cross-border investment. According to the Office of the U.S. Trade Representative, there was only one SOE on the list of the Fortune Global 50 largest companies in the world in 2000.  By 2015, there were close to a dozen.  The purpose of trade agreement rules on SOEs is to curtail their market distorting effects.

Regulatory Cooperation

Since NAFTA reduced almost all tariffs to zero, some of the largest remaining barriers to North American trade take the form of non-tariff barriers, or so-called “behind the border” measures. Differences in standards and regulations are frequently cited as key obstacles to trade, and many of these regulatory divergences are often the result of regulation occurring in domestic silos, without giving much thought to how those rules may impede trade.

Trade Facilitation

In broad terms, trade facilitation includes reforms aimed at improving the chain of administrative and physical procedures involved in the transport of goods and services across international borders. Countries with inadequate trade infrastructure, burdensome administrative processes, or limited competition in trade logistics services are less capable of benefiting from the opportunities of expanding global trade.  Like tariff cuts, improvements in trade facilitation procedures can help reduce the cost of trade and increase its flow. 

Dispute Settlement

The enforceability of the rules of a trade agreement is of great importance because if governments cannot be held to honor their commitments, the value of those commitments is significantly diminished. Inevitably, disputes arise over the meaning of the obligations in trade agreements. Typically, dispute settlement involves ad hoc panels of experts who hear claims from either governments or private actors, and then issue rulings on those claims. Essentially, these panels act as the judicial arm of the trading system.  If trade agreements are to be reliable and effective, they must include enforcement mechanisms. The degree of enforceability varies depending on the design of the particular system.  In this section of the working paper, we discuss how Chapters 20, 19, and 11 may be addressed in the NAFTA renegotiation.

Rules of Origin

Rules of Origin (RoO) establish the parameters used to determine whether an imported good “originates” within the region, thereby qualifying for the preferential treatment accorded under the agreement. Generally, a product is considered originating if it was wholly made within the region (in the countries party to the agreement), if it was significantly transformed within the region from imported materials and components, or if the relative value of originating materials and manufacturing performed in the region meets a specific threshold.

RoO are necessary components of preferential trade agreements. When products from different countries receive different tariff treatment, importers, exporters, and customs officials must have a way to determine which tariff rates apply.  Rules that permit greater use of non-originating inputs or broader definitions of what constitutes product transformation tend to be more trade liberalizing than more proscriptive rules, which impose greater restrictions on qualification for the agreement’s preferential tariff rates. In today’s globalized economy, strict rules of origin impede the evolution and operation of more efficient supply chains and can be used to privilege existing producers by limiting competition.

Canada’s Supply Management System

Canada’s supply management system for dairy, poultry, and eggs was excluded from NAFTA. The renegotiation offers an opportunity to bring these highly-protected sectors into the agreement, so as to increase market access for U.S. producers, but also to improve purchasing choices for Canadian consumers. For instance, Canada maintains a 270 percent tariff on milk, and the above-quota tariffs on cheese and butter can reach as high as 245 percent and 298 percent, respectively.

Softwood Lumber

The 35-year old lumber dispute between the United States and Canada must be resolved, somehow.  U.S. producers have long complained about Canadian land-management practices that, they claim, provided unfair subsidies to Canadian producers.  Three and a half decades of litigation, temporary supply management agreements, and, frankly, defiance of the trade rules by the U.S. government have strained trade relations and burdened U.S. lumber users and home buyers.  Whether an agreement can be reached within NAFTA is unclear – given that it probably would require the U.S. industry to disavow use of the antidumping and countervailing laws.

Services

NAFTA was the first international trade agreement with significant commitments to liberalize trade in services, and one of the most prominent NAFTA disputes concerns the provision of trucking services in the United States by Mexican firms.  However, in the ensuing years, services liberalization in other trade agreements has evolved to include broader obligations covering more areas of trade, leaving NAFTA’s rules insufficient and outdated.  In the NAFTA renegotiation, there is as an opportunity to take a fresh look at services, such as legal, medical, and educational services, that are more easily traded across borders than was the case in the early 1990s. With growing concerns over the absence of sufficient competition in the provision of U.S. healthcare services, the United States could benefit by allowing more foreign competition in the medical services and health insurance markets.

NAFTA 2.0 SHOULD AVOID RULES ON THE FOLLOWING ISSUES

Trade Deficits

President Trump and members of his administration seem to believe that trade is a zero sum game played between Team USA and – in the case of NAFTA – Team Canada and Team Mexico.  They consider exports to be Team USA’s points, imports to be the foreigners’ points, and the trade account to be the scoreboard.  Since the United States runs a persistent deficit with Mexico (and an occasional deficit with Canada), they conclude that America is losing at trade.  And it’s losing because of poorly negotiated trade deals or outright cheating on the part of the foreign teams.

Secretary of Commerce Wilbur Ross and National Trade Council advisor Peter Navarro have suggested that our trade agreements should include some sort of trigger mechanism, so that if trade balance or some other objectives related to reducing deficits or increasing surpluses are not reached, the deal would be reopened and renegotiated.  That idea, frankly, is absurd.  What would motivate businesses to invest in cross-border relationships or to commit to capital investments if the terms of the underlying trade agreement were prone to such uncertainty and potential upheaval?

Moreover, the bilateral trade balance is not a measure of the success or failure of a trade agreement.  It is a meaningless statistic.  A better measure of the success of a trade agreement is its effect on total trade and investment, and its effect on economic growth.  By those metrics, NAFTA has been an unbridled success.  Furthermore, “despite” 41 straight years of registering annual trade deficits, the U.S. economy has grown significantly, in part because it has benefitted from the capital account surplus (foreign purchases of U.S. assets exceeding U.S. purchases of foreign assets) that goes along with a current account deficit.

The Trump administration’s obsession with trade deficits—especially bilateral trade deficits—is misguided.  The point of trade agreements is to reduce artificial impediments to trade and to provide greater certainty.  It would create vast uncertainty and be a serious mistake to push for any provisions in NAFTA that use the trade account as a trigger of some future action.

Border Taxes

Another problematic suggestion from the Trump trade team is that they would like to use trade agreements to take on the "border adjustment taxes" associated with value-added taxes used by many countries.  Trump advisors have expressed concerns over alleged advantages bestowed upon Mexican producers by way of the rebate of value-added taxes upon export and the assessment of taxes on U.S. products upon import.

A proper understanding of these border adjustment taxes is that their impact on trade is much more benign. The general understanding, according to WTO rules, is that value-added taxes are a consumption tax, similar, in nature, to a sales taxes, and thus a non-discriminatory application of such taxes to domestic and imported products is permitted.  Not that it would necessarily be a good idea, the U.S. government is free to adopt a similar VAT system with rebates upon export or some variation, such as a destination based cash flow tax, which was under consideration in Congress (although such a measure would, of course, have to be applied in a non-discriminatory way).  As of this writing, that controversial proposal seems to have been abandoned.

Regardless, this is not a NAFTA problem or a Mexico problem. Much of the world uses value-added taxes or some similar form of consumption taxes. If the U.S. government has concerns, it can address them at the WTO. There is a long history of disagreement over this issue in the GATT, and finding a way to raise it again at the WTO would not be out of line. Raising it in NAFTA, on the other hand, would be a pointless distraction.

Currency Manipulation

Another controversial issue the Trump administration is likely to press is currency manipulation. While economists are divided in their opinions about how to define currency manipulation and whether it constitutes an especially pernicious offense worthy of counteractions, even many of those who think currency manipulation should be discouraged are skeptical of the wisdom of including punitive provisions in trade agreements.  Even though Canada and Mexico do not generate much concern in the United States as likely currency manipulators, the Trump administration sees NAFTA as an opportunity to set a precedent for future agreements by crafting and incorporating such provisions without much resistance in this agreement.

China and Japan are the countries most often cited as the reasons for including currency manipulation provisions in trade agreements.  But we should be skeptical about the assumptions underlying the relationship between currency manipulation and trade flows.  Given that intermediate goods trade predominates total trade, as a result of the proliferation of global supply chains,  the relationship between currency values and trade is not straightforward.

If only 50 percent of the value of a country’s exports is domestic content and labor (and the other 50 percent is foreign value), as is the approximate case with China, the impact of currency values on trade flows is mitigated.  This helps explain why, despite a 38 percent appreciation of the renminbi against the dollar between 2005 and 2013, the bilateral U.S. trade deficit with China didn’t decrease. Rather, it increased by 46 percent. 

Even if deemed desirable, crafting the right currency manipulation provision would be more difficult than the administration thinks.  There is vast disagreement among economists as to how to identify and measure the effects of currency manipulation. Meanwhile, U.S. government agencies have conflicting views about incorporating currency provisions in trade agreements.  While the Commerce Department—with its mission to protect U.S. industries in the global market place—might favor another weapon in its trade remedy arsenal, the Treasury Department, which has long held sway over financial and economic issues related to currency, is less inclined to take actions in currency markets to achieve trade objectives.

And while the Canadian and Mexican governments might not be overly concerned that their actions would be the targets of such provisions, they will certainly have their own opinions about whether and how such rules should be crafted. Thus, balancing domestic and international views on this issue will take time. If the Trump administration chooses to push this issue, the NAFTA renegotiation may not go as quickly as it wishes.

Buy America

Trump and his trade team have spent a lot of time promoting the idea of Buy America, and have criticized trade agreements that restrict the ability of the U.S. government to buy exclusively from Americans. In the leaked draft memo about NAFTA, it was suggested that the NAFTA renegotiation would provide more flexibility for such Buy America programs. What those pushing for expanded Buy America do not seem to realize is that this issue works both ways.

Cordoning off more of the estimated $1.7 trillion U.S. government procurement market to U.S. suppliers would mean higher price tags, fewer projects funded, and fewer people hired. In today’s globalized economy, where supply chains are transnational and direct investment crosses borders, finding products that meet the U.S.-made definition is no easy task, as many consist of components made in multiple countries. And by precluding foreign suppliers from bidding, any short-term increases in U.S. economic activity and jobs likely would be offset by lost export sales – and the jobs that go with them – on account of copycat protectionism abroad. If Americans are compelled by law to buy more U.S. product from U.S. firms, then the Canadians and Mexicans will insist on the same.

Buy America may sound good in a campaign speech or on a bumper sticker, but in practice it just means higher price tags for taxpayer funded projects and fewer opportunities for U.S. exporters.

July 11, 2017 9:22AM

In Just Six Minutes, Everything You Need to Know about Spending Caps

Back in April, I shared a new video from the Center for Freedom and Prosperity that explained how poor nations can become rich nations by following the recipe of small government and free markets.

Now CF&P has released another video. Narrated by Yamila Feccia from Argentina, it succinctly explains - using both theory and evidence - why spending caps are the most prudent and effective way of achieving good fiscal results.

[embed]https://www.youtube.com/watch?v=JZOwaIzW0xY[/embed]

Ms. Feccia covers all the important issues, but here are five points that are worth emphasizing.

  1. Demographics - Almost all developed nations have major long-run fiscal problems because welfare states will implode because of aging populations and falling birthrates (Ponzi schemes need an ever-growing number of new people to stay afloat).
  2. Golden Rule - If government spending grows slower than the private sector, that reduces the relative burden of government spending (the underlying disease) and also reduces red ink (the symptom of the underlying disease).

  3. Golden Rule Examples

    Success Stories - Simply stated, spending caps work. She lists the nations that have achieved very good results with multi-year periods of spending restraint. She points out that the U.S. made a lot of fiscal progress when GOPers aggressively fought Obama. And she shares the details about the very successful constitutional spending caps in Hong Kong and Switzerland.
  4. Better than Balanced Budget Amendments or Anti-Deficit Rules - The video explains why policies that try to target red ink are not very effective, mostly because tax revenues are very volatile.
  5. Even International Bureaucracies Agree - Remarkably, the International Monetary Fund (twice!), the European Central Bank, and the Organization for Economic Cooperation and Development (twice!) have acknowledged that spending caps are the most, if not only, effective fiscal rule.

I touch on some of these issues in one of my chapters in the Cato Handbook for Policymakers. The entire chapter is worth reading, in my humble opinion, but I want to share an excerpt echoing Point #4 that I just shared from Ms. Feccia's video.

There’s a very practical reason to focus on capping long-run spending rather than trying to balance the budget every year. Simply stated, the “business cycle” makes the latter very difficult. ...when a recession occurs and revenues drop, a balanced-budget mandate requires politicians to make dramatic changes at a time when they are especially reluctant to either raise taxes or impose spending restraint. Then, when the economy is enjoying strong growth and producing lots of tax revenue, a balanced-budget requirement doesn’t impose much restraint on spending. All of which creates an unfortunate cycle. Politicians spend a lot of money during the good years, creating expectations of more and more money for various interest groups. When a recession occurs, the politicians suddenly have to slam on the brakes. But even if they actually cut spending, it is rarely reduced to the level it was when the economy began its upswing. Moreover, politicians often raise taxes as part of these efforts to comply with anti-deficit rules. When the recession ends and revenues begin to rise again, the process starts over—this time from a higher base of spending and with a bigger tax burden. Over the long run, these cycles create a ratchet effect, with the burden of government spending always reaching new plateaus.

It's not that I want to belabor this point, but the bottom line is that it is very difficult to amend a country's constitution (at least in the United States, but presumably in other nations as well).

So if there's going to be a major campaign to put a fiscal rule in a constitution, then I think it should be one that actually achieves the goal. And whether people want to address the economically important goal of spending restraint or the symbolically important goal of fiscal balance, what should matter is that a spending cap is the effective way of getting there.

May 23, 2017 1:34PM

The Five Most Important Takeaways from Trump’s Budget

It's both amusing and frustrating to observe the reaction to President Trump's budget.

I'm amused that it is generating wild-eyed hysterics from interest groups who want us to believe the world is about to end.

But I'm frustrated because I'm reminded of the terribly dishonest way that budgets are debated and discussed in Washington. Simply stated, almost everyone starts with a "baseline" of big, pre-determined annual spending increases and they whine and wail about "cuts" if spending doesn't climb as fast as previously assumed.

Here are the three most important things to understand about what the President has proposed.

First, the budget isn't being cut. Indeed, Trump is proposing that federal spending increase from $4.06 trillion this year to $5.71 trillion in 2027.

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Second, government spending will grow by an average of almost 3.5 percent per year over the next 10 years.

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Third, because the private economy is projected to grow by an average of about 5 percent per year (in nominal terms), Trump's budget complies with the Golden Rule of fiscal policy.

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Now that we've established a few basic facts, let's shift to analysis.

From a libertarian perspective, you can argue that Trump's budget is a big disappointment. Why isn't he proposing to get rid of the Department of Housing and Urban Development? What about shutting down the Department of Education? Or the Department of Energy? How about the Department of Agriculture, or Department of Transportation?

And why is he leaving Social Security basically untouched when taxpayers and retirees would both be better off with a system of personal retirement accounts? And why is Medicare not being fundamentally reformed when the program is an ever-expanding budgetary burden?

In other words, if you want the federal government to reflect the vision of America's Founders, the Trump budget is rather disappointing. It's far from a Liberland-style dream.

But for those who prefer to see the glass as half-full, here are a couple of additional takeaways from the budget.

Fourth, as I wrote yesterday, there is real Medicaid reform that will restore federalism and save money.

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Fifth, domestic discretionary spending will be curtailed.

But not just curtailed. Spending in the future for this category will actually be lower if Trump's budget is approved. In other words, a genuine rather than fake budget cut.

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I'll close with my standard caveat that it's easy to put good ideas (or bad ideas) in a budget. The real test is whether an Administration will devote the energy necessary to move fiscal reforms through Congress.

Based on how Trump was defeated in the battle over the final spending bill for the current fiscal year, there are good reasons to be worried that good reforms in his budget won't be implemented. Simply stated, if Trump isn't willing to use his veto power, Congress will probably ignore his proposals.

P.S. You may have noticed that I didn't include any discussion of deficits and debt. And I also didn't address the Administration's assertion that the budget will be balanced in 10 years if Trump's budget is approved. That's because a fixation on red ink is a distraction. What really matters is whether the burden of spending is falling relative to the private sector's output. In other words, the entire focus should be on policies that generate spending restraint and policies that facilitate private sector growth. If those two goals are achieved, the burden of red ink is sure to fall. Whether it happens fast enough to balance the budget in 2027 is of little concern.