OK, they weren’t supposed to start the trade war until I got back from vacation. And I really have too many kilometres to cover and hills to climb to weigh in on a regular basis or at great length. But since I’m currently sitting in an outdoor cafe with my coffee and croissant, I thought I might take a few minutes to address two misconceptions that, I believe, are colouring discussion of the trade conflict.
By the way, I don’t mean President Donald Trump’s misconceptions. As far as I can tell, he isn’t getting a single thing about trade policy right. He doesn’t know how tariffs work, or who pays them. He doesn’t understand what bilateral trade imbalances mean, or what causes them.
He has a zero-sum view of trade that flies in the face of everything we’ve learnt over the past two centuries. And to the (small) extent that he is making any coherent demands on China, they’re demands China can’t/won’t meet.
But Trump’s critics, while vastly more accurate than he is, also, I think, get a few things wrong, or at least overstate some risks while understating others. On one side, the short-run costs of trade war tend to be overstated. On the other, the long-term consequences of what’s happening are bigger than most people seem to realise.
In the short run, a tariff is a tax. Period. The macroeconomic consequences of a tariff should therefore be seen as comparable to the macroeconomic consequences of any tax increase.
True, this tax increase is more regressive than, say, a tax on high incomes, or a wealth tax. This means it falls on people who will be forced to cut their spending, and is therefore likely to have a bigger negative bang per buck than the positive bang for buck from the 2017 tax cut. But we’re still talking, at least so far, about a tax hike that is only a fraction of a per cent of GDP.
This means it’s hard to justify claims that the trade war, at least what’s currently in the pipeline, will cause a global recession.
If the trade war expands not just to all imports from China but to imports from Europe and other parts of the world, we could get this up to a contractionary fiscal policy of a couple of points of GDP; $200 billion (Dh734.6 billion) here, $200 billion there, and soon you’re talking about real money. And that certainly could happen: Trump imagines that he’s winning, and might well move on from China to European cars and so on.
But we’re not there yet.
But doesn’t the prospect of foreign retaliation change the picture? Actually, what foreign retaliation does is prevent tariffs from being bad than an ordinary tax increase. When a large country like the US imposes tariffs, one effect — if we don’t face foreign retaliation — is a rise in the price of US exports, either though a rise in the dollar or by drawing resources away from export to import-competing sectors.
This price rise is, other things equal, a gain for America (although not for export-oriented sectors like agriculture). And this “terms of trade” effect can mitigate or even reverse the overall losses as tariffs distort the economy.
If (when) foreigners retaliate, however, the terms of trade effect goes away, and we’re back to tariffs just being a tax on domestic consumers. Maybe the larger point here is that there tends to be a certain amount of mysticism about trade policy, because the fact that it’s global and touches on one of the most famous insights in economics — the theory of comparative advantage — gives it an amount of mind space somewhat disproportionate to its actual economic importance.
Yes, trade policy is important; but in terms of strict economics it’s not more important than health policy, or fiscal policy, or policy in general.
I say this, by the way, as someone whose career as a professional economist was based mainly on research into international trade and finance. In general, people who actually work on these issues tend to assign them less importance than those who haven’t studied them closely.
All of this, however, is only about the strict economics of a trade war, which may be the least important aspect of what’s happening. For trade policy isn’t just about economics. It’s also about democracy and peace.
Trump’s trade war should correspondingly be seen as part and parcel of his embrace of foreign dictators, lack of respect for our allies, and evident contempt for democracy, at home as well as abroad.
But wait, you say: China is neither an ally nor a democracy, and it is in many ways a bad actor in world trade. Isn’t there a reasonable case for confronting China over its economic practices?
Yes, there is — or there would be if the tariffs on Chinese products were an isolated story, or better yet if Trump were assembling an alliance of nations to confront objectionable Chinese policies. But in fact Trump has been waging trade war against almost everyone, although at lower intensity. When you’re imposing tariffs on imports of Canadian steel, on the ludicrous pretence that they endanger national security, and are threatening to do the same to German autos, you’re not building a strategic coalition to deal with a misbehaving China. What you’re doing, instead, is tearing down what’s left of the Pax Americana.
Wasn’t this inevitable in any case? I don’t think so. True, US economic dominance has been eroding over time, not because we’re getting poorer, but because the rest of the world is getting richer. But there was reason to hope that a relatively peaceable international order could be sustained by an alliance of democratic powers.
In fact, until a few years ago it seemed to me that we were seeing exactly that taking place for the world trading system, which was transitioning from largely benign US hegemony to a comparably benign co-dominion by the US and the EU.
At this point, however, things look a lot bleaker. It’s not just Trump. And it’s not even just Trump plus Brexit. The Europeans are also turning out to be a big disappointment. But where the Europeans are weak, Trump is malign. He’s working actively to make the world a more dangerous, less democratic place, with trade war just one manifestation of that drive.
And the eventual negative consequences for America and the world will be much bigger than anything we can capture with economic modelling of the effects of tariffs.