An even bigger China shock

By now many of us are familiar with the basic arguments for and against President Trump’s trade war with China. Over the past few decades, U.S. imports from China have surged. Several academic studies referred to this as a “China shock,” which adversely impacted a number of American regions that focus on manufacturing. At the same time, most economists believe that international trade benefits the United States as a whole. More recently, the Trump administration has made a big issue about our trade deficit.

While all of these events might seem related, on closer inspection there are a number of puzzles that have been widely overlooked.

{mosads}The biggest puzzle is what the Trump administration is trying to achieve with its trade war. Is it a move to pressure the Chinese to open up their economy, thus reducing barriers to U.S. trade and investment? Maybe, but it was precisely the opening of the Chinese economy that first created the “China shock.”

Indeed, China was no threat at all to U.S. firms when its economy was closed under the leadership of Chairman Mao. An even more open China would create an even bigger shock, resulting in even more economic dislocation in the Rust Belt. Presumably, Ohio manufacturing workers who supported candidate Trump were not hoping China would buy more Hollywood films and computer software, so that America could buy more auto parts from China.

Does the Trump administration see it this way? Probably not. Key trade advisor Peter Navarro and Secretary of Commerce Wilbur Ross hold highly unorthodox views on trade, accepted by very few professional economists—namely that a trade deficit reduces U.S. output and is largely caused by unfair trading practices by other countries.

Most economists believe that the U.S. trade deficit reflects our low saving rate, and that it does not reduce our output. If this conventional view is correct, then any successful attempt to get other countries to accept more of our imports will also result in America accepting more of their exports, leaving the overall trade balance largely unchanged.

Some defenders of Trump’s hardline tactics point to the possibility that they might lead to an agreement where we and our trading partners remove all of our tariffs. That might be a good outcome, but it’s an odd defense from an administration that has made a big issue of its opposition to free trade deals such as NAFTA.

Recent reports indicate that the Chinese are confused by the Trump administration’s negotiating tactics. They don’t seem to understand what the administration is specifically asking for, and after they believe they’ve reached a deal, the U.S. seems to change its mind.

Perhaps there is a split within the Trump administration — some may want a more protectionist America, while others prefer to use hardball tactics to advance a freer global trading system. One can find administration official comments to support either theory.  Trump has called the NAFTA agreement, which eliminated tariffs on trade between the United States, Canada and Mexico, the “worst trade deal ever made.” In contrast, he recently advocated eliminating all tariffs on trade between the United States and Europe.

In recent years, the average tariff rate in the United States, Canada, and Europe has been roughly 2 percent, which seems to conflict with the administration’s rather apocalyptic language describing the severe damage we are suffering from unfair trade practices. This creates a quandary: What sort of plausible trade war “win” could fix America’s huge trade imbalance? Perhaps this helps explain the administration’s difficulty in clearly defining its objectives with China.

The Eurozone has by far the world’s largest current account surplus, which is a more comprehensive measure of a trade balance, while the United States has by far the largest deficit. Because a current account deficit is also equal to the difference between domestic investment and domestic saving, the standard method for reducing a trade deficit is by boosting domestic saving and/or reducing domestic investment. To see why, consider what happens if we buy products from Germany but do not export any goods in return.  In that case, we exchange U.S. assets such as stocks and bonds for those German goods, which represents a net flow of German savings into the U.S. economy.

But Trump’s expansionary fiscal policy (deficit spending) is likely to dramatically reduce domestic saving, and over time he hopes to boost investment through corporate tax cuts and infrastructure projects. So it’s hard to see how these policies can do anything other than make the U.S. current account deficit even larger. 

There is too much focus on who is “winning” the various trade wars between the United States and our trading partners, and too little examination of what these trade wars are supposed to achieve. The most frequently cited objectives (like fewer foreign trade barriers against our exports) would help the average American but accelerate the pace of creative destruction in some parts of America’s industrial heartland. In addition, there is little evidence that our current strategy would do anything to reduce the overall trade deficit.

Scott Sumner is an emeritus professor of economics at Bentley University and director of the Program on Monetary Policy at the Mercatus Center at George Mason University.