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.
Peter Navarro, director of the newly-established White House National Trade Council, gave a speech last week to the National Association for Business Economics, which he condensed into an opinion piece for the Wall Street Journal. The analytical errors and the fallacies portrayed as facts in that op-ed are so numerous that it is bewildering how a person with a Ph.D. in economics from Harvard University—and a potentially devastating amount of influence within the White House—could so fundamentally misunderstand basic tenets of introductory economics.
Almost every paragraph in the op-ed includes an error of fact or interpretation. I’ll focus on a few, deferring to others’ noble efforts (Phil Levy, Don Boudreaux, Linette Lopez) at wading through the rest of Navarro’s confused and misinformed diatribe.
Consider Navarro’s portrayal of the national income identify as an economic growth formula. He claims:
The economic argument that trade deficits matter begins with the observation that growth in real GDP depends on only four factors: consumption, government spending, business investment and net exports (the difference between exports and imports).
The sentence betrays a deep and troubling misunderstanding of the factors of economic growth. Real GDP growth (growth in the total value produced in the economy) depends on increases in the factors of production and increases in the productive use of those factors, which trade and specialization facilitate. What Navarro refers to as the drivers of growth are actually the channels that account for the disposition of our output – what we do with our output.
The national income identify is expressed as: Y=C + I + G + X – M. It tells us that our national output is either consumed by households (C); consumed by business as investment (I); consumed by government as public expenditures (G); or exported (X). Those are the only four channels that can account for the disposition of national output. We either consume our output as households, businesses and government or we export it.
Imports (M) are not a channel through which national output is disposed. We don’t import our output. But M appears in the identity and is subtracted because we consume – as C, I, and G – both domestically produced and imported goods and services. If we didn’t subtract M in the national income identity, we would overstate GDP by the value of our imports.
But Navarro believes – or wants the public to believe – that the national income identity is an economic growth formula or function, where Y (GDP) is the dependent variable, C,I,G, X, and M are the independent variables, and the minus sign in front of M means that imports are inversely related to (or detract from) GDP. That’s wrong and a Harvard Ph.D. economist should know that.
Reducing a trade deficit through tough, smart negotiations is a way to increase net exports—and boost the rate of economic growth.
The evidence is overwhelming – month after month, quarter after quarter, year after year – that the trade deficit and GDP rise and fall together. The largest annual decline in the trade deficit ever recorded was between 2008 and 2009, during the trough of the Great Recession. The largest annual increase in the trade deficit occurred between 1999 and 2000, when the economy grew by 4.7 percent – the strongest annual economic growth in the past 33 years.
When the economy grows, households, businesses, and government tend to spend more, and they spend more on both domestic and imported goods and services. When the economy contracts, there is less spending on both domestic and imported goods and services. For the past 42 straight years, the United States has registered trade deficits. In 40 or those 42 years, annual changes in the value of imports and the value of GDP moved in the same direction.
Navarro either believes, or would have the public believe, that imports detract from GDP and that our national security requires all of the gears of U.S. trade policy be put to the service of eliminating our trade deficit. This is a fool’s errand and a Harvard Ph.D. economist should know that.
Suppose America successfully negotiates a bilateral trade deal this year with Mexico in which Mexico agrees to buy more products from the U.S. that it now purchases from the rest of the world. This would show up in government data as an increase in U.S. exports, a lower trade deficit, and an increase in the growth of America’s GDP.
First, note the implication that Navarro expects U.S. trade agreements to include commitments by our trade partners to meet certain outcomes – “…Mexico agrees to buy more products from the U.S.” This kind of managed trade is unprecedented and utterly defies the purpose and spirit of trade liberalization. Trade agreements are intended to reduce barriers to competition, not to preempt competition by anointing the winners at the outset. But, okay, the administration believes it has a mandate to blow things up on the trade front.
But, here’s another problem with Navarro’s scenario. If Mexico agrees to buy from the United States some of what it now purchases from other countries (Navarro’s key to decreasing the bilateral trade deficit with Mexico), then won’t those other countries have fewer dollars with which to purchase U.S. exports? Wouldn’t that, all else equal, increase bilateral trade deficits or reduce bilateral surpluses the United States has with those other countries? Yes and yes. What Navarro is suggesting is a game of trade policy whack-a-mole. Bilateral trade accounting is utterly meaningless, and a Harvard Ph.D. economist should know that.
As The Wall Street Journal notes, “Mr. Trump and his advisers see the U.S. goods trade deficit as an indicator of U.S. economic weakness.”
Yes, they do. But why? As the graph clearly shows, the real gross output of U.S. manufacturing rises when the goods trade deficit (both measured in 2009 dollars) is also rising. When trade deficits fall, so does U.S. manufacturing. Sinking industries need fewer imported parts and materials, and their unemployed workers can’t afford imports.
Measured in 2009 dollars, the goods trade deficit fell from $863.4 billion in 2006 to $525.2 billion in 2009. Peter Navarro, the President’s liberal protectionist trade adviser, would apparently call that good news. The rest of us called it The Great Recession.
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.
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.
Interest groups in the United States have focused on the possibility of including provisions in trade agreements with the intent of countering currency manipulation. The concern is that another country may choose to reduce the value of its currency relative to the U.S. dollar in order to encourage its businesses to export more goods to the United States. Such currency realignment also would tend to make it more expensive for the devaluing nation to import products from this country.
It’s true that an adjustment in currency exchange rates – regardless of the reason for the adjustment – can have an effect on trade flows. U.S. industries that export to foreign customers, or compete with imported goods in the domestic marketplace, understandably would prefer that currency relationships not become skewed against their commercial interests. Currency stability improves the business climate by making it easier to build long-term relationships with customers and suppliers.
However, currency exchange rates have fluctuated throughout recorded history. Sometimes those changes may be driven by a government’s conscious desire to devalue its currency. More often the variability in exchange rates reflects fundamental economic realities. Economies that experience growing productivity and rising prosperity should not be surprised to find that market pressures cause their currencies to strengthen. The reverse is true for countries that are growing slowly or not at all.
A shift in exchange rates changes a country’s “terms of trade,” which is a term used by economists to describe the ratio of a country’s export prices to its import prices. From a U.S. perspective, if another country sets its currency at an artificially low level relative to the dollar, the U.S. terms of trade will improve. The United States will be able to obtain a greater value of imports for the same value of exports. Exporting the same number of airplanes and soybeans as before will pay for the importation of larger quantities of shoes, coffee, and automobiles.
Earlier this month in Bali, WTO ministers reached agreement on a set of negotiating issues known as “trade facilitation,” which deal mostly with customs reform and related measures to reduce the time and cost of transporting goods and services across borders. If removing tariffs is akin to turning on a water spigot full blast, trade facilitation is the act of untangling and straightening out the attached hose. A kinked hose impedes the flow as an administratively “thick” border impedes trade.
This paper, which I wrote a few years ago, describes the importance of trade facilitation reforms to economic growth, and explains why subjecting such self‐help reforms to negotiation – instead of just undertaking them as a matter of surviving in a competitive global economy – would only delay the process of removing inefficiencies. Five years after the paper was written and 12 years after multilateral negotiations were launched in Doha, a deal was reached obligating governments to reform and streamline their customs procedures, with technical and financial assistance provided by the wealthy to the developing countries. As I wrote yesterday, this is small relative to the overall Doha Round agenda and relative to what might have been accomplished over these past 12 years in the absence of Doha (i.e., without adhering to the pretensions that our own domestic barriers to foreign commerce are assets to be dispensed with only if foreigners dispense of theirs). But perhaps nobody has been more gifted at exposing the absurdity of administrative trade barriers with pithy wit and grace than the 19th century French classical liberal business and economics writer Frederic Bastiat. Around 1850, Bastiat made a case for trade facilitation that can scarcely be improved:
Between Paris and Brussels obstacles of many kinds exist. First of all, there is distance, which entails loss of time, and we must either submit to this ourselves, or pay another to submit to it. Then come rivers, marshes, accidents, bad roads, which are so many difficulties to be surmounted. We succeed in building bridges, in forming roads, and making them smoother by pavements, iron rails, etc. But all this is costly, and the commodity must be made to bear the cost. Then there are robbers who infest the roads, and a body of police must be kept up, etc. Now, among these obstacles there is one which we have ourselves set up, and at no little cost, too, between Brussels and Paris. There are men who lie in ambuscade along the frontier, armed to the teeth, and whose business it is to throw difficulties in the way of transporting merchandise from the one country to the other. They are called Customhouse officers, and they act in precisely the same way as ruts and bad roads.
Congratulations, negotiators, for agreeing to remove the kinks from your hoses.