Trade Shenanigans

International trade is always a contentious issue and one that is often not well understood. Some see the current structure as heavily biased toward particular multinational corporations and institutionalizing global inequality. Some others see it as a job destroyer in local communities and therefore something that cannot be good.

People wonder, is the WTO a good thing? Is NAFTA good for the United States? What about for Mexican workers who have yet to see any significant wage growth from so many years of openness?

In fact the Trump administration has taken on an openly protectionist agenda, withdrawing from the TPP, threatening to withdraw from NAFTA, and has moved to slap tariffs on foreign washing machines, solar cells and panels, and has also just outlined a tariff schedule to impose on foreign steel and aluminum imports, with Trump twitting characteristically that trade wars are good, and that they are easy to win.

In what follows a brief critique will be provided, and it will be highly simplified to keep it as short as possible, but hopefully the main insights will be caught and for the less informed, clarity will be improved.

The Free Trade Position

International trade, however it is construed, is a good thing. Fundamentally trade is an exchange relation being carried out among willing parties, the only difference being it is across national borders. Let's not lose sight of this.

But there are, quite naturally, questions that follow: how can we be sure of the safety or the quality of the foreign product? Shouldn't it matter if such a transaction harms domestic producers? What about national security issues? What about moral qualms about how those foreign imports get produced or/ and their impact on others?

These are perennial questions and answers that are provided often still get glossed over because some have their minds already made up, but I will try again...

Safety and Quality Considerations

In terms of product safety this true for imports as it is also true for domestically produced goods. Specific government agencies exist to monitor these things and if their scope has not been extended to include imports, they should. It is not like we would just be opening up to trade with other countries, at present a large volume of goods are imported into the US. Tariffs do not necessarily lead to zero imports, but actually they could even create perverse incentives for foreign producers now facing higher costs to seek to cut costs through unsavory production methods.

For quality considerations, it is not a new reality that we should expect to get what we pay for, but consumers should be free to make that choice. The issue here though is not keeping low quality foreign products out of the US, in the past VERs led to higher quality cars being imported into the US. Tariffs do not discourage low quality imports rather by stifling competition they encourage higher priced reduced quality production domestically.

Keeping Jobs and Bringing back Jobs

This is often the main issue, and it is the same both for explicit international trade and for its cousin - outsourcing. Starting from a situation where foreign imports of say steel are leading to reduced steel production and the closure of steel plants and laying off of steel workers, the argument is that a tariff on steel imports, by raising the price of those imports, allows domestic steel firms to keep selling at their now matched high price, so that steel workers retain their jobs.

This interesting reasoning seems to not ask important questions. Those who would have purchased steel at the lower import prices prior to the tariff, how has this tariff affected them? With steel, these are other US producers that need steel as an input in their production. With washing machines, these may be households, or laundromat owners. How are they affected by having to now pay higher prices for these products?

If other businesses face higher costs and cannot pass them on in the form of higher prices, then there will be job losses in those industries. If they are able to pass them on in the form of higher prices, we should expect reduced demand, and in tandem reduced production and job losses as well.

Restricting trade or outsourcing in the usual political rhetoric that it saves jobs or brings jobs back couldn't be further from the truth. For whatever visible jobs we see "saved", the resulting higher prices on products associated with these mean there are less visible layoffs that are happening because of reduced spending on other things, and in the aggregate the value of those will exceed the value of the jobs saved, because protectionist policies reallocate resources inefficiently. A brief explanation for this can be found in an introductory economics class.

Reports often focus on large number of jobs being lost from trade, but rarely on the jobs potentially created from having free trade. The latter is often chalked up to having come from technological innovations etc. But given this possible confounding of the source of gains, the important question should be what is happening to the level of employment in the US? What is happening to the labor force participation rate?

These are more accurate numbers to look at, since that tells us whether those losing jobs are readily finding other jobs, which is what the focus of policy should be on, rather than restricting trade or outsourcing.

National Security?

Raising the specter of a hostile world, the rise of Russia, China, and now North Korea as potential rivals to the US military might and dominance raises the question of whether there is need for tariffs on certain products in the interest of national security.

The argument is that absent these tariffs, we will come to rely on foreign production of these vital products and we will be ill-prepared to ramp up domestic production should we need to for the purposes of war or hostilities. It appears that seems to be the basis from the Chamber of Commerce for the steel and aluminum tariffs the Trump Administration plans to impose.

Again, that is unsubstantiated. While China does export steel to the US, so also to many political allies notably the Canada and Germany. In fact Chinese steel exports to the US are a very small fraction of total US steel imports. Brazil and Mexico are major exporters but it is not clear how they might pose a national security threat.

In any case, even if we needed to ramp up domestic production of steel and aluminum, domestic subsidies for that would be a lot less inefficient than the use of tariffs. This way steel importers still benefit, and domestic production is propped up by the government. This is true not just for steel or aluminum but any product that is deemed to be vital for national security.

Moral Qualms

This discussion also comes up perhaps more potently in the area of environmental considerations including global warming, but also in other social issues involving development, where child labor, worker rights and working conditions are involved.

The important question to be asked here is whether the imposition of a tariff or similar restriction does lead them to adopt more "humanitarian" production choices and work environments etc. This is interesting especially in light of the real world where advanced country hypocrisies are evident, with respect to say fossil fuel energy use.

Further, one argument some development specialists often point to is how even advanced economies initially had to resort to child labor in their development process. With no other alternatives for escaping poverty, it appears that those poor countries where child labor may be rampant may simply be a necessary transition phase.

Generally the prevalence of poor working conditions and violations of human rights in the work place and similar, are reflective of weak social, and political institutions in those countries, and the solution is not to impose tariffs on their products. Such could only possibly generate worse outcomes like encouraging child trafficking and drugs as desperately poor families look for income alternatives.

The Stagnant Wage Issue

Some studies have questioned the benefit of trade agreements and organizations such as NAFTA for workers more generally as the belief is that trade agreements as currently structured provides benefits for only large corporations. This is often the argument:

Businesses take advantage of cheaper resources abroad and produce goods which still get shipped back to the US and sold at fairly high prices, providing huge profits to corporations while wages remain stagnant. If wages were to rise, then more of those jobs requiring workers get shipped abroad.

Again, we would be barking up the wrong tree. Mistaking the result of market power for trade is what is more likely here. The presence of market power is something that standard economic theory tells us will lead to inefficient outcomes, and again, here is where policymakers should be focused. Identifying industries where there is market power and breaking it up, so that competition can exist in the industry. This should lead to wage growth.

The absence of wage growth is more an institutional problem then than it is the result of international trade.

Protectionism - all Shenanigans

The argument for US protectionist policies is sometimes cast in terms of retaliation for the unfair advantage provided by the other country. China, it is believed, provides through its industrial policy, incentives like export subsidies and others that essentially lower the cost of production or increase the profitability of their firms, so that they can export their products more cheaply to the US.

Is there really any country that does not do that? The US provides a lot of grants and incentives for many other industries to engage in what would be otherwise costly production. That the US cannot do that for every possible industry is simply the result of the fundamental scarcity problem, and well, neither can every country do that for all possible industries. So governments often pick and choose, and sometimes, if not most times, inefficiently.

If solar panel producing companies are looking for relief based on the infant industry argument that they are simply looking to find their feet but will be able to compete once they do so, then capital markets is where they should pitch their case and source for loans to cover their losses today, which when profitable in the future, they will be able to pay back. If these markets, which should be more experienced than the government in identifying future profitability are reluctant to lend to these firms, then there is no reason why the government should provide them with protection through tariffs.

Further, to label foreign cost advantages as dumping and to seek anti-dumping duties against these imports is simply to rob US consumers in order to pay select import competing producers. How ever these cost advantages come about need not be looked at as being predatory, it simply means we need to move resources toward some other production endeavor where we can either compete on cost or on superior productivity. That would be the American way.

A Final Word

The foregoing has not even touched on the bigger picture. Trade is a two way street. There is no such thing as winning a trade war. If you restrict imports, you in effect restrict exports. The markets will naturally ensure this through the reduction in US dollars held by foreigners.

However, countries do not wait for the markets to do this. They see the impact on their exporting firms and retaliate with tariffs as well on US exports into their countries. We do not need to go back to the 1930's Smoot and Hawley tariffs to understand this, we only need to look to the Bush era steel tariffs, the Obama era tire tariffs and the Mexican trucking debacle also during the Obama administration.

Free trade is good and should be encouraged. The objective of policymakers should be on how to strengthen domestic social, economic and political institutions to ensue that the gains from trade are more dispersed than concentrated, and to ensure that policies to facilitate efficient resource allocation are forward looking and incentive driven. That will allow for a faster adjustment to the impacts of trade and provide benefits across all segments of society.

#tradepolicy #tariffs #jobs #NAFTA #TPP