Trump is going to war for the wrong reasons

From my office window I can see the single lane at the end of a motorway, usually filled with a queue of slowly moving cars. The conventional wisdom is that it should be two-laned to remove the blockage, but that does not look beyond the tunnel to the end where there the road meets a major junction with traffic lights. Were the lanes to be doubled without improving the junction, the same number of cars would go through it and there would still be a queue.

Identifying a problem but not seeing its interdependence with other problems is a common error in much public policy discussion. That is one of the advantages of a good economics training; you are taught to see the world holistically. OK, some economists may not see the world holistically enough – for instance, paying insufficient attention to resource depletion and the environment, But that is their failure, not the subject’s, as is evident when even critics use the economics frame.

I am long past the point of bothering to assess Donald Trump’s erratic public interventions, but one of his arguments justifying a trade war is widely held by the conventional wisdom too, and it is no more effective than double-laning the road below me. He has got the world into the conflict for the wrong reasons and like the military wars other presidents have got the US into, it wont be won with a triumphant victory.

Strictly, we are not in the actual trade war yet but in a phoney war which is building up to the whole ugly show. Businesses have seen it coming and taken measures to ameliorate it – like speeding up shipping and increasing inventory behind the border. These are but short-term measures; eventually the stocks run down, prices are increased, contracts renegotiated, workers laid off and plant closed.

I have to mention this because the commentaries written before the declaration often give the impression of a huge destruction soon. Instead, things will whimper along, which can be worse because it will take time for the stupidity of the declaration to sink in and the damage will accumulate. (Commentators made the same mistake over Brexit.)

Military strategists tell us you have to go to war with clear and achievable objectives. I should not be surprised if Trump would get a zero out of ten on this measure. Perhaps a little more, in that the Chinese economy has some unacceptable trade practices which may be addressed. But that does not explain the inclusion of Canada, the EU, Japan and Mexico in the confrontation (nor the exclusion of Australia but the inclusion of New Zealand).

Trump says he is concerned about unfair trading practices. (Congratulations Australia, you dont appear to do them; what are we doing wrong?) Typically, he assesses the unfairness by the size of the deficit in goods traded between two economies. But while pairs of  countries may be in bilateral imbalance, one needs to look at all the trading relations; that you are in a deficit with your supermarket does not prove they are treating you unfairly. (And what about those countries which are in deficit to the US? Is the US surplus evidence that America is treating them unfairly?)

Trump’s measure is also flawed because it ignores trade in services. The unpleasant row he is having with Ottawa is based on the fact that Canada exports more goods to America than it imports from it. For services it is the other way around. In total, the balance favours the US. Is Trump arguing the American service economy treats the Canadians unfairly?

It is true that the US runs a deficit on all its goods and service transactions with the rest of the world (another name is the ‘current account balance’). But before you break into tears at the injustice, think about the whole of the transport system and not just the one road.

A current account imbalance reflects an internal imbalance. It tells us that Americans are spending more (on consumption and investment) than they are producing. To cover this production deficit (or over-consumption) the US imports more goods and services than it exports. To pay for the extra imports it has to borrow offshore, including allowing foreign direct investment and selling off assets.

So it is not that the world is unfair to America, it is that Americans are not saving enough to fund their domestic investment by themselves. The evidence is they have a  current account deficit.

This may be a good thing, It is argued that New Zealand should run a current account deficit so that we can invest in activities we cannot afford to fund, with the downside that we will have to reduce consumption in the future to service the debt. Hopefully, any investment will lift incomes sufficiently to pay for itself in the long run.

There are all sorts of caveats, but it is not a crazy strategy. It would be crazy to borrow offshore for consumption purposes (except temporarily in an extreme emergency like a major earthquake). I am afraid during the big housing speculation boom a few years back that was exactly what we were doing.

The extent to which America is borrowing offshore for consumption rather than investment need not detain us. The point here is that if Trump thinks the US current account deficit is a problem, discouraging imports will have zero effect unless America produces more and/or consumes less. If it does not, the economy will find some other way of importing more (and exporting less) to cover the over-consumption.

For if Trump thinks the current account deficit is the problem then he has to attend to the internal imbalance. This seems unlikely given that he recently approved a huge tax cut which will increase the internal imbalance further because government dis-saving will increase without an offsetting increase in net private saving.

I am not sure whether the uncovered American tax cuts will put a bigger strain on the world economy (an earlier one led to the GFC) than the trade war. I am sure we can do without either.

Comments (1)

by Katharine Moody on July 23, 2018
Katharine Moody

This is the kind of result that will look good to the electorate;

And may of course translate into domestic inflation - also not an unwelcome metric.

Who could guess what his rationale is but I suspect he generally plays to short term numbers - and if the numbers don't change, he changes tack.


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