On Trade and Trump’s Tariffs – Part 3

Unless one is a hermit or is marooned on an uninhabited island, trade is what everyone does. Even children voluntarily trade cards, marbles, toys, etc., with other children. As grownups, we produce stuff to sell and that allows us to buy stuff that we consume but couldn’t produce. Most of us sell our labor in exchange for wages, and buy stuff we want. Even within a household exchange is ubiquitous even though it is not mediated using money.

If we couldn’t or wouldn’t trade, we’d be forced to consume only what we produce. That would be an all-round disaster; we’d all be desperately poor. Self-sufficiency is a recipe for poverty. Mohandas Gandhi was the prophet of the self-sufficiency religion, and we know how that worked out.

Trade is not a modern invention. Humans have been trading for at least ten thousand years, maybe more. But the impossible to comprehend enormous network of trade spanning the entire globe we all are embedded in is a modern creation not much older than a couple of centuries. Global trade and global prosperity are two sides of the same coin, as one would suspect from the concurrent rise of trade and prosperity in the recent past centuries.

Economics can be defined as that disciple which studies the nature, causes and consequences of trade. Since only humans trade, economics is in essence the study of humans as they go about exchanging stuff.

International trade is not in any sense fundamentally different from any other form of trade. Certainly international trade involves exchange across political borders but that fact does not invalidate the basic gains from voluntary trade. 

We need to keep in mind that nations don’t trade with each other even though we talk about, say, trade between the US and Canada. Individuals and groups of individuals (firms) within the US buy from and sell stuff to individuals and groups in Canada.

The international trade between Canada and the US will drop to zero in the unlikely event that Canada becomes the 51st state of the US even though there may not be a decrease in trade between the US and Canada.

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I’ve written a bit about Trump and Tariffs (part 1 and part 2.) This post is a continuation.

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Trade is good. Barriers to voluntary trade are bad. That’s the general statement of fact arrived at empirically and analytically, not some ideologically motivated prejudice. Taxes on trade are a barrier to trade. Therefore, as a first approximation, tariffs are bad because tariffs are taxes on imports. Any tax reduces the volume of trade regardless of whether it is domestic or international.

(We are talking about ordinary trade, not trade in harmful substances such as illegal drugs, even though a reasonable case can be made that the “war on drugs” is a cure worse than the disease.)

Various reasons are given for justifying tariffs, chief among them is “trade deficits.” It’s a simple idea: when the value of a country’s imports from another country exceeds the value of its exports, difference is a “trade deficit.” Therefore understanding trade deficits is important if one has to think clearly about tariffs. 

On March 12th, Scott Lincicome published a column titled “Things Everyone Should Know About Trade Deficits: They don’t hurt jobs or growth, aren’t trade or economic scoreboards, and can’t be fixed by tariffs.” That column could be behind a subscription wall. Here are the highlights.

• • • A Trade Deficit Is a Symptom, Not a Disease

. . . trade balances are trotted out to justify all sorts of protectionist trade policy—including today’s tariffs—on the grounds that persistent deficits are a disease killing both American jobs and growth and thus demanding strong government medicine. This common assertion, however, fails on the facts and the economics.

For starters, there’s little obvious connection between the U.S. trade balance and economic output (gross domestic product). . . . the relationship between higher trade surpluses (or smaller deficits) and higher GDP growth is practically nonexistent. Economist Don Boudreaux and former Sen. Phil Gramm . . . concluded that “[b]etween 1890 and 2024, it is impossible to find a statistically significant correlation between America’s trade balance and its economic growth.”

…  the trade deficit is driven not by trade policies but by nations’ overall levels of savings and spending (i.e., investment and consumption). National income—created by investment, production of goods and services, and exports—is used either to consume/invest or to save. Nations that, in the aggregate, spend more than they save will import more than they export (i.e., run a trade deficit), and their investors (or banks) will finance this consumption with capital from abroad. Trade surplus nations face the opposite situation. 

He goes on to write, 

“Tariffs can reduce both imports and exports, reducing a nation’s overall level of trade but leaving its trade balance unchanged in the long run”—a conclusion supported by research on dozens of different countries and the United States’ own experience during the first Trump term.

I should let the interested reader read Lincicome’s column. Here I mention the subheading with a bit of excerpt. 

• • • A Trade Deficit Isn’t a ‘Drag on Growth’ 

. . . Even imported consumer goods can boost U.S. output. Companies tasked with moving or selling imported items—in wholesale trade, retail trade, and transportation and warehousing—generate trillions of dollars of additional U.S. economic output. By reducing retail prices, moreover, imports can free consumer dollars for spending on American goods and services. And, as already noted, dollars spent on imports quickly return to the United States as either investment in U.S. assets or purchases of exports, both of which contribute to economic growth.

• • • A Trade Deficit Doesn’t Reflect a ‘Loss of American Wealth’ or a ‘National Debt’

Excerpt:

It’s similarly wrong to assert—as our president often does—that the U.S. trade deficit represents a loss of wealth for the United States or some kind of national “debt.” For starters, this ignores that dollars we send abroad to foreigners buy us real goods and services that we value (or else we wouldn’t buy them), and that—as discussed above— those same dollars eventually return to the United States as investment in the U.S. private or public sector (by mostly unrelated people).

• • • Bilateral Trade Balances Are Utterly Meaningless

Another huge and common mistake is using bilateral trade balances—e.g. the U.S. trade deficit with China—as indicative of economic problems or as some sort of trade policy scorecard. (One misguided soul even went so far as to suggest recently that the U.S. “trade deficit with a country may serve as a proxy for the level of imbalance in trade policies and the level of reciprocal tariff.” Yikes.) 

Most basically, the world has more than two countries, so—just as my trade deficit with my grocery store tells us almost nothing about my overall financial position—a U.S. trade deficit with, say, Mexico tells us almost nothing about our own economy. 

Then Lincicome quotes a Cato essay as an example:

Let us imagine that the United States sells $100 billion of wheat to Saudi Arabia. Saudi Arabia sells $100 billion of oil to China. China sells $100 billion of consumer manufactures to the United States. If this is all the trade they do, each country will have balanced trade ($100 billion in exports and $100 billion in imports). But the United States will run a $100 billion trade deficit with China. Even if you’re worried about how trade balances might affect the US economy, that US-China trade deficit tells you nothing.

Here’s the concluding paragraph:

• • • Summing It All Up

So, trade deficits don’t hurt jobs or growth, aren’t trade or economic scoreboards (especially bilateral ones), and can’t be fixed by things like tariffs or subsidies. They’re not a drag on growth, and they don’t represent lost American wealth or a debt we must repay. Trade balances can tell us stuff about an economy—but much less about a nation’s trade policy and much more about its citizens spending and saving, as well as the economic and noneconomic forces affecting those millions of individual decisions. In the United States, much of the stuff our trade deficit reflects isn’t a problem and, in the case of our attractiveness as a global investment destination or the U.S. dollar’s importance in international commerce, is decidedly a good thing. And outside of a recession or the world ditching the dollar, government efforts to shrink the trade deficit will fail unless they fundamentally change Americans’ savings and investment decisions or unless Washington finally gets its fiscal house in order. Indeed, if policymakers and wonks—despite all the above—still feel compelled to reduce the U.S. trade deficit, eliminating our bloated federal deficits would be the most straightforward and benign way to do it.

Funny how none of the trade deficit worriers ever mention that.

Lincicome’s piece is an easy read. It is meant for the non-specialist. I wish that Trump’s advisors were not so compromised that they deny basic economic truths. I am afraid that Trump’s MAGA fan base, like Trump, is not economically literate. 

I think the best thing that Trump should have done is to remove all tariffs. Unilaterally. And by doing that, he’d usher in an age of global free trade. He’d have earned a place in history as a man who changed the world and not just one who attempted and failed to “Make America Great Again.”

You may ask, “What about imports from China? Shouldn’t the US government do something about bringing manufacturing back to the US?” First of all, US manufacturing is alive and well, even though US manufacturing jobs may be something that some people are worried about. Second, there are other instruments to deal with China. It’s pointless to impose tariffs on friendly countries like Canada, Mexico, India and the rest of the world.

More about that later.