MANAGING FOREIGN TRADE
by W. Raymond Mills
Ideal Taxes Association Working Paper #2
Feb. 23, 2010
It is ironic that the man-on-the-street in any town in
The most effective way to reduce the size of the
Most American Economists believe:
Rather than spend time in the tedious task of listing all these myths and explain why they are wrong, a better alternative is simply to state the correct propositions that should be substituted for current conventional wisdom. The following propositions are introduced in context and defended in the following 7 chapters of this essay. These next 7 chapters would provide a good beginning for a new textbook, explaining to graduate students how to understand international trade.
1. The goods and services created by a domestic economy determine the wealth of nations.
2. The value of wealth created by the activity of the domestic economy is measured each year by Gross Domestic Product.
3. Trade increases Gross Domestic Product of a nation when Exports are equal to or larger than imports.
4. Equal Trade (exports equal to imports) is proposed as the ideal policy goal for each nation because that allows each nation to use trade to increase its Gross Domestic Product.
excess of exports over imports results in an increase of
dollar of increase in
3. Every dollar of imports in excess of exports requires a dollar of financial assets to be transferred from the deficit nation to the surplus nation.
a trade deficit reduces
5. Free trade fails as a policy goal because of the financial and productivity gains each nation can achieve by violating the prescription to open borders to all imports. Because free trade is an impossible to achieve goal and The World Trade Organization is founded on support for free trade, WTO activities are dominated by hypocrisy.
6. The manufacturing sector is the foundation on which a continuous supply of goods is sold in the international market resulting in sustaining the size of exports.
7. A sudden addition of wealth in a nation in the non-manufacturing sector of the economy, such as discovery of Gold or Oil or value increases in the stock market not matched by growth of production of manufactured goods, results in a decrease in the relative and sometimes in the actual size of the manufacturing sector of the economy.
8. An increase in wealth is a necessary condition for creating a trade deficit. It is not a sufficient condition. Open borders are also required for an increase in wealth to create a trade deficit.
membership in the World Trade Organization interferes with this proposed
Please read these 7 chapters if you are inclined to ignore
or dismiss any attempt to use legislative action to reduce the size of the
Part two of this document will set forth the contents of the law that should be passed to restrict imports and will provide justification and defense of that position. Part three of this paper will provide additional justification for the perspective and the solution proposed.
DOES TRADE CREATE WEALTH FOR A NATION? - #1
Adam Smith answered the above question with a resounding
“Yes” without any qualifications or conditions.
My answer is more nuanced. Trade
does create wealth for most nations participating. But the benefits from trade vary greatly
between nations. Nations with a large
trade deficit, like the
Adam Smith was unable to take advantage of the additional
knowledge of trade made possible by the invention of a means for measuring
Gross Domestic Product in each nation.
The National Accounts were invented in the
The following discussion is as clear and as simple as I can make it but some people find it impossible to tolerate formulae. To those I say, stick with it, the gain in insight is worth the trouble. By understanding how Gross Domestic Product is measured, we can see clearly how trade increases the wealth in a nation.
Gross Domestic Product = Consumption (both public and private) + Investment (both public and private) + Trade Balance (exports minus imports). The above version of this formula is different from the one most commonly used. The public component of both Consumption and Investment is usually separated out, added together and labeled “Government”. The version I use is simpler. It focuses attention on Consumption and Investment (congruent with my needs).
Consumption and Investment are not production, they are expenditures. They measure the value of goods and services when they are sold. How do we get from measurement of expenditures to estimates of the value of domestic production? Simple. If trade did not exist (no imports or exports), expenditures and production would be equal. We get the statistical equivalent of no trade when exports and imports are equal. When unbalanced (unequal) trade exists, we must add the value of the exports and subtract the value of the imports to get the value of the domestic expenditures that are equal to the value of domestic production. It is the size of domestic production that we seek.
This formula correctly estimates the value of domestic
production, even when unbalanced trade exists. We need to know more about how
the formula works. The formula will give
very different results, depending upon whether imports come into the nation and
displace existing production or whether they simply add to consumption and
investment. If they only impact
consumption and investment, not production, the harm they do to the domestic
economy would be limited to the financial assets transferred overseas to pay
for the excess of imports over exports.
If they replace domestic production, not only is current wealth reduced
(by paying for the excess of imports) but the capacity to generate future
wealth is reduced by the destruction of domestic goods production ability. Trade harms the
Suppose every dollar of goods imports into the
100% displacement. Original condition. (13,000 units of
Conditions after 100 units of imports are added that
displace 100 units of domestic production:
(12, 900 units of
Suppose 0% displacement.
Same original condition situation as above. After adding 100 units of imports that replace
no domestic production: (13,000
Displacement of 0% seems unlikely because of the substitution effect. Goods that are not perfect substitutes for the new import may nevertheless attract dollars from existing products. Small cars are not perfect substitutes for large cars. However, when the price of gasoline goes up, people buy small cars rather than large cars. When the price of gasoline goes up, people substitute public transit for automobile travel.
The first month a new import is accepted in the
The degree of displacement issue arises only when imports are less than exports. If imports and exports are equal, the loss of production created by imports that replace domestic production is made up for or cancelled by the extra production required to provide goods that will sell on the international market.
When exports and imports are equal, a large increase in imports means a large increase in exports and both changes together results in a large increase in Gross Domestic Product.
Given the original condition specified above, an addition of
1,000 imports and 1,000 exports will result in an increase of 1,000 units of
Gross Domestic Product and 1,000 of Consumption and Investment. [14,000
Our formula clearly shows that exports add to domestic
production and imports subtract from domestic production. Domestic production is obviously less when
goods are made overseas as compared to when goods are made in the
The following table shows how these influences have worked out recently.
Table 1. Exports and Imports as a share of Gross Domestic Product for four nations, 2006. (Goods only)(In billions of Current U.S. dollars)
Exports Imports Trade Percent of
Product Balance Equal Trade Total
Japan 4,366 647 579 + 68 + 13% + 2% + 15%
U. S. 13, 195 1,037 1,918 - 881 + 8% - 6.7% + 1%
Source: IMF for
Note: a) Exports and Imports for each nation are the total trade with the world.
b) % for equal trade is calculated, for
The smaller number of the two (exports and imports) measures
the amount of trade in each nation that can be said to be equal trade. Note that the positive trade balance shown
for the 3 nations is 446 billion while the negative trade balance for the
It is literally true that, by accepting more imports than
exports, the U.S. has been speeding up the economic growth of our trading
partners for as long as we have had a trade deficit (for 3 decades). That has harmed the
Equal trade adds to
The trade balance shows further disparity. In the
This discussion leads to both a moral and practical
question. Does the U.S. Congress and the
President have a moral obligation to the citizens of the
How about the
EQUAL TRADE VERSUS
Equal trade is presented here as a new idea, a proposed ideal, hopefully to be adopted by all nations. (Balanced trade is widely advocated for the world as a whole. This proposal
urges each individual nation to adopt equal trade as a goal. I assume this idea has been discussed before, I just do not know where). Free trade is an old idea (1776), also presented as an ideal to be adopted by all nations.
The first difference between the two ideals is that the
utility of equal trade, for any nation that adopts this ideal, is not dependent
upon how many other nations adopt the same ideal. If the
The utility of free trade ideal, for any adopter nation that
is not the leading manufacturing nation in the world, is totally dependent upon
what other nations do. If all nations
open their doors fully to imports, with no restrictions, this would maximize
the ability of each participating nation to specialize in producing those goods
in which they have a comparative advantage.
This extreme degree of specialization would maximize total world
production and each nation would maximize their
The reality is that all nations restrict imports, with the
possible exception of
Because exports add to
The World Trade Organization has become a place where
nations squabble with each other over who is deviating
the most from the free trade ideal. The
vision of every nation opening its door to imports without restrictions cannot
become a reality. It has not happened
and it will not happen, given the gains in
Trade had become an arena where nations compete with each
other for selling exports to the world.
The most successful nations in this competition are those who use their
government to encourage exports and discourage imports. Those nations who guide their action by the
free trade prescription fall behind in this competition (unless they have the
strongest most effective manufacturing sector in the world).
The proper trade policy for each nation is to seek to manage its trade so as to gain as much as possible from trade. This would encourage each nation that has a trade deficit to
adopt the goal of equal trade.
Comparative Advantage shows that each nation will gain from
trade, regardless of its productive efficiency, if it concentrates its
productive resources on that product for which it has a comparative advantage
The heavy use of models by the economics profession provides another reason to use equal trade as an ideal. Modeling is made easier by assuming equal trade. Simple trade models assume both equal trade and no unemployment. If the economics profession would switch to equal trade as an ideal that would make their models more congruent with the ideals they profess.
This material argues that the
SAVINGS - #3
National Savings is defined as that part of national production that is not consumed in the time interval (a year or a quarter of a year). It is left over, during this time period. In the year 2006, Gross Domestic Product was 13, 399 billion and Consumption was 11,416 billion (both public and private) resulting in a Savings of 1,983 billion. This is money that can be used in a subsequent time period or it can be stored. (The above description of National Savings is conventional wisdom, used by economists for years, but it is an example of careless labeling. It will be accepted as valid temporarily, for the purpose of understanding the causation issue. See the end of this discussion for a correct interpretation of what is left over after Consumption is subtracted from Gross Domestic Product).
The equation we are working with is
Some people (who are misguided) think that the level of
Savings (1,983) controls or determines the level of Investment minus the Trade
Deficit (2,752 – 769). This is the
direction of causation controversy. How
we decide the direction of causation in this equation is important. For if Savings controls the level of the
other two variables, and investment is controlled by the expenditures business
firms make on equipment, building and software, it would follow that the level
of the trade deficit is controlled by the level of Savings. That would mean that the
If, on the other hand, the trade balance is controlled by
the size of imports and exports, then the
The trade balance and investment are both calculated from numbers collected from businesses and Customs Agents. Savings, on the other hand, is derived from other numbers found in the equation. Numbers created by manipulating other numbers in an equation are called endogenous – dependent for their size on other numbers in the same equation. It seems reasonable to assume that the numbers used to determine the size of savings are in fact controlling the size of savings. How the numbers are created tells us which numbers are controlling.
The conclusion is that the size of Savings depends upon the
size of the Trade Balance and Investments and not the other way around. It is also true to say that the size of
savings depends upon how wide the gap between Consumption and Gross Domestic
Compounding one error with another, some writers assume that the level of investment in a given time period is controlled by the level of savings in that same time period. The level of investments at any time period is controlled by investor’s decisions as to the likelihood of a good return on the investment. The money to pay for the investment in a given time period is assembled independently of the savings in that time period. After all, Savings, by definition, are not spent during the time period Savings is recorded. There can be no connection between the level of Savings in time period X and the level of spending for investments in time period X.
A further extension of this silly logic is to say that when savings is less than investment in a given equation, a trade deficit is necessary to provide the funds needed to fund investment. This is doubly silly: 1) Investment is not funded from funds created in the time interval of the investment and 2) A trade deficit does not increase the net financial position of the nation experiencing the trade deficit. Just the opposite. A trade deficit creates a net flow of financial funds from the deficit nation to the surplus nation.
An increase in financial assets in the trade surplus nation
is created when financial assets flow from the deficit nation to the surplus
nation in payment for goods and services.
The trade deficit nation gets more goods (worth 881 billion to the
The trade surplus nations prefer to exchange these dollars
for other financial instruments, such as U.S. Treasury certificates, stocks or
bonds or ownership of real estate or companies.
This flow of funds back to the
It is simply wrong to assert that a trade deficit provides funds to the trade deficit nation that can be used for any purpose, especially not to fund investment during the period the trade deficit is experienced. This issue has tangled the thinking of many economists.
“Oh what a tangled web we weave, when first we practice to deceive”.
The material covered in this post clears the way for the U.S. government to manipulate factors that influence the level of imports or exports without fear that savings or some other financial entity are controlling the level of imports and exports.
Note: The conventional wisdom as to what is left over after Consumption is subtracted from Gross Domestic Product is wrong. Subtracting Consumption from Gross Domestic Product allows us to separate current production into that part that serves the needs of the present versus that part of current production that serves the needs of the future. Investment is money spent today to increase future production ability and capacity. The trade balance shows deviation of current production from what is required to balance exports and imports. A positive deviation creates production knowledge and tools in the present that lay the foundation for future growth in domestic production. A negative deviation reduces the knowledge and tools existing in the present that can be used as a foundation for future growth in domestic production (compared to what is achieved with equal trade). The flow of money out to support a trade deficit and the flow of money in because of a trade surplus also impact the ability of an economy to produce in the future.
Everything in the formula for Gross Domestic Product is a form of production. No room is left for surplus money that is not used in production.
On the other hand, domestic production does create
additional wealth in the nation. Our problem
is that economists, thus far, have not devised a satisfactory way to measure
it. We know how much Net Wealth is added
to households during each quarter (Federal Reserve Board data). We do not know how to separate this total
gain into that part that is created by domestic production. . . . Table 5.1 in the National Accounts provides
estimates of Gross Savings. This number
is dominated by an accounting concept (Consumption of Fixed Capital) which is
an estimate of depreciation of fixed capital.
How that results in more stored wealth is not clear to me. Gross Savings in 2006 amounted to 2, 174
billion, a number which is 10% different from Savings as calculated above from
Summary thus far: 1. A trade deficit reduces the growth of an economy and its financial assets, compared to what would be achieved with equal trade. 2. The larger the trade total for each nation engaged in equal trade, the larger the contribution of trade to the growth of that nation’ economy. 3. The Free Trade ideal is torpedoed by the advantages nations gain from a trade surplus. 4. Expansion of National Savings (as conventionally defined) is not needed to reduce the trade deficit because the size of the trade balance (and investment) controls the size of savings. The trade balance also shows the contribution of current production to creating the knowledge and tools and money needed to expand future production.
Adam Smith saw the growth and spread of trade throughout the world as closely linked to the growth and spread of the industrial revolution throughout the world. Smith was very impressed by the increase in productivity in a factory that specialized in one particular product. But the size of the factory and the degree of specialization that could be achieved was limited by the size of the market that could be served. Smith recognized that free trade would expand the size of the market, thereby allowing for increased specialization which would create more goods and services for the entire world.
The expansion of productivity during the 19th
Century demonstrated the validity of his insight. Cotton producers and brokers in the
The primary reality about trade in Adam Smith’s world (near
the beginning of the industrial revolution) was the fact that industrialists
and brokers in England and France were persuading their respective legislators
to impose import duties on the specific product the domestic producers and
brokers had for sale, so as to benefit themselves, regardless of the effect on
the nation as a whole. One of the most important arguments used by domestic
manufacturers was that English import duties were necessary because of other
nations were restricting imports of English goods. Long lasting competition and hostility
Some would argue that manufacturing activities are no longer
necessary in the
Here are two answers to that point:
need to sell something to the rest of the world to pay for our imports. The
2. Service activities do not provide employment benefits comparable to manufacturing. Not only is manufacturing pay higher than service activities (generally, except for Finance and Insurance). We also find that manufacturing requires employment in other industries to produce the intermediate inputs needed by manufacturing industries. Also, manufacturing payrolls support many service activities. Mayors and other local officials fight with outrageous subsidies to try to entice manufacturing plants to locate in their district because of the spill-over benefits to the local area.
Thirty-two percent of all the intermediate inputs used by
Finance and insurance were able to create enough profits in
2006 to replace the profits no longer provided by manufacturing firms. But these profits supported a very small
number of employees. The spill-over from
these profits to other jobs were not sufficient to sustain
Manufacturing employment in the
Manufactured goods are the main item exchanged among developed nations. Continuing participation in global trade requires a viable manufacturing sector.
The main, simple theme of this document, thus far, is that
In this section, I am going to attempt an explanation of the
primary reason why that happened and what it has done to the
The main reality is that the
During the period from 1994 – 1997, the wealth created by
the domestic economy was not illusory.
After 1997, the financial sector became the main source of wealth accumulation (if partly temporary and/or fictitious). The stock market became the place to get rich. Foreign capital poured in. Folks whose investments told them they had increased wealth went on a buying spree, including imports.
The bursting of the tech stock bubble decreased perceived
wealth but imports did not decline as much as wealth. The Federal Reserve Board dropped the Federal
Funds rate from 6% to 2% in the 12 months of 2001. This was the first recession in recent
history when consumer credit did not decline.
Consumers supported the
The domestic manufacturing sector never really recovered from the recession of 2001 and 2002. As the economy recovered in 2003 and 2004, manufacturing profits recovered partly, to a level of 20% of corporate profits during 2006-2008
The financial sector, meanwhile, was going great guns after 2004, piling up profits by the bushel. Again, foreigners were happy to buy the “instruments” the financial sector had for sale. The housing sector became the new means of getting “rich”.
The recent financial collapse shows that wealth accumulation based on speculation is not reliable.
Economists have recognized that a sudden increase in wealth
in a country is likely to reduce the domestic manufacturing sector. The new source of wealth attracts resources
away from manufacturing. This happens
because: a) Increased wealth causes the currency to appreciate, making imports
cheaper and exports more expensive: b) Increase wealth attracts domestic
resources to the new source of wealth, drying up investment in
manufacturing. Adam Smith gives us the
example of the importation of Gold from
This is called the Dutch Disease because the phenomenon was
described when the
The problem is that the new found wealth source may be temporary. Natural resources become depleted; finance booms become overheated and lead to a collapse of the wealth creation.
One option is to try to retrieve the financial sector since it was the most recent source of wealth creation. The other option is to try to revive the manufacturing sector, since it is the source of stable growth, not subject to booms and busts.
The Congress and the President have been led down the path of trying to retrieve the financial sector. A better option exists.
The whole point of this discussion is to encourage governmental focus on revival of the manufacturing sector. This will mean ceasing to pump money into the financial sector. Instead, reform trade policy so that balanced trade (and manufacturing) are supported by aggressive Federal government action.
(Other “stories” of what happened could be created. Go to the internet, IMF, and retrieve the
document “Global Imbalances : In Midstream?”,
HISTORY - #6
Immediately after WW II, the
After 1991, the
After 1997, imports into the
The U.S. Congress grew concerned with the growth of the
trade deficit after 1997. In October,
1998, the U.S. Congress established The U.S. Trade Deficit Review Commission
with the aim of understanding the trade deficit and providing the Congress with
recommendations of what, if anything, to do about it. The Republican members of the Commission
decided that nothing should be done to reduce the trade deficit because it was
an inevitable product of a rapidly growing economy. This conclusion is unreasonable, as Spock
would say. Rapid growth is a necessary but not sufficient condition. Open borders must be combined with rapid
growth to produce a large trade deficit.
By restricting imports,
The Commission recited the facts but they drew the wrong
inference from the facts because they took for granted continued open borders
The U.S. Chamber of Commerce has lobbied hard for Most
Favored Trade Status for
Multinational corporations with the parent company in the
The Japanese experience shows the important role that government can play in structuring a domestic economy to enable it to compete in global trade.
“In February 1985, one U.S. dollar traded on international
markets for 260 Japanese yen; in January 1988, a dollar was worth only 123 yen
(this is consistent with the above discussion of change in the value of the
dollar after 1985). This change had
effects that reached far beyond financial markets” (Krugman
and Obstfeld, International
Economics, 1993, page 6). Wage rates
After 2005, the slowly declining value of the dollar
gradually reduced the
HOW DID THREE NATIONS CREATE A TRADE SURPLUS? - #7
Each of the three nations (
The current Chinese government came into power with an
explicit promise to take power away from landlords and the warlords. The current Chinese government controls
everything of importance in
In all three nations, the national governments were the major actors managing trade to create the conditions which led to large exports.
PART TWO - THE SOLUTION
What we must learn from other nations is that the national government has an important role to play in creating the conditions under which foreign trade will benefit the nation.
The great natural advantage possessed by the
While equal trade is a good conceptual, clean-cut goal, the
A good practical goal for the
The recent history of the size of the
AVOIDING OBVIOUS PITFALLS - #9
The next background issue to be discussed is what NOT to do
when constructing a proposal or a program for reducing the size of the
This discussion should be preceded with the information that
experts in this field think that there is no way a
seen as a barrier..
In order to answer the nay-Sayers, the proposed solution must be carefully constructed. Below is a list of options to avoid.
1. Reject secrecy and duplicity
Nations tend to seek some advantage for themselves from international trade. Many nations think that they must disguise their motives and their actions from their trading partners. Informal barriers to imports have become at least, perhaps more important, than formal barriers.
2. Reject discrimination by product
In the past, explicit trade barriers, such as tariffs or subsidies, have discriminated by individual product – steel, textiles, etc... That practice grew out of the wishes of domestic industrialists and traders. Individuals and firms sought to protect their own interests by urging the legislature to pass laws that restricted imports of the particular product they had to sell.
3. Reject the “Big Bang” approach
It would be a mistake to assume that the transition from current practice to a more balanced trading system can be accomplished overnight. Time is required to unwind existing trading relationships and establish new production locations consistent with the proposed new system.
This proposal is that restrictions on imports into the
It would also be a mistake to assume that the new system will be perfect as initially established. The Congress will retain the authority to modify the law as experience accumulates.
4. Reject treating all trading partners alike
Some of our trading partners already have a near equal
trading relationship with the
Limiting import restrictions to those nations who have the
largest trade surplus with the
5. Reject ignoring potential problems
We expect our trading partners that are subject to new restrictions
on imports into the
sales to the
to accept some or all exports from the
d. Stop buying U.S. Treasury bonds.
The solution proposed must be designed to support a ready response to likely retaliation efforts.
One of the dangers to be avoided is inflation. If our trading partners who are subject to
additional tariffs are able to increase the price of their products in the
6. Reject the assumption of a bumbling and powerless Federal government
Ability to establish the conditions under which legal
imports will be accepted in the country has long been recognized as the right
of every sovereign nation. The Federal
government can act reasonably and responsibly to reduce the size of the
What law should Congress examine and debate with the aim of
1. Assure Competition among Domestic Producers
Previous efforts to control the volume of imports into a nation have failed because they imposed separate tariffs on each product imported. This approach fails because it grants one firm or industry an advantage over other domestic producers and by this process reduces the ability of market competition to determine what is bought and sold ands thus firm success or failure. The tariffs imposed on each product are also irrational. They depend solely upon the political power of the various congressmen, each defending the interests of his constituents.
If tariffs on all imports are equal, the import products
that will be able to be sold in the
2. Gradual Implementation
The proposed legislation will establish a schedule of tariff increases in 4 month intervals. When the tariff rate reaches 40% (if it does) all scheduled increases will cease. A second recommendation is that tariff rate increases cease when the percent of goods imports not covered by exports declines to 23% (if it does).
The tariff rate will begin at 10% of the value of the goods and will increase by 5 percentage points each 4 months. The new rate of 10% will begin 4 months after the legislation is signed into law.
If this proposal ever comes to the Congress for debate, the discussion will extend over a period of months, perhaps years before a law is enacted. Business firms will have plenty of time to adjust production to the new law.
3. Tariffs for only five countries
Limiting the tariffs to only 5 countries will mean that most
of the nations of the world will escape coverage. Some nations will be able to increase imports
The five countries will be chosen on the basis of which
countries contributed most to the
The five countries, in order, are
Three of these countries are export oriented. That means they have arranged their laws and practices internally so as to produce a trade surplus with their trading partners.
Regardless of the reason for the trade surplus with the
The new law must include a requirement that every item
(good) imported into the
4. Limiting tariffs to manufactured goods
Increased employment and production in manufacturing in the
All manufacturing goods imported from all five nations will be assessed the same tariff.
5. Estimating Outcome
We can expect implementation of this proposal to reduce
imports from the five nations, to increase the cost of the imports they sell in
In the absence of a good basis for estimating, I will provide one calculation based on stated assumptions, without any expectation that this estimate will be accurate. Readers are welcome to substitute better assumptions and arrive at different conclusions.
Assume that the process continues until the tariff is 40% and that all the imports not received from these 5 nations, due to the tariff, are replaced either by domestic production or by imports from other nations. In addition, we will assume that we will split the difference between each of two options.
Using the numbers from 2006 as an example, we will assume
that those goods from the 5 nations that do sell in the
The price of the 542 billion of goods imports from the five
nations and sold in the
This seems like a puny result from a big change in approach
to trade. I cannot support the
proposition that the above calculations are reasonable. Whatever the results, a change in
If this proposed law
is enacted and implemented, it will supersede and make void all current
PART THREE - DISCUSSION
PREPARATIONS FOR DEFENSE - #11
None of the five nations are expected to be pleased with the
proposed law. How they will react is not
Smuggling will be attempted by individuals and groups other
than national governments. As the tariff
increases, the potential gains from smuggling increases. The inability of the
Drug smuggling is aided by the small size – large value characteristic of drugs. Some imports are similar to drugs, but most are larger and less valuable per weight.
2. Refuse to send
scarce and necessary imports to the
If the law is passed, the agency of the
3. Refuse to send any
imports to the
This would be an outcome to be hoped for. This would leave a big hole for
4. Refuse to accept
any exports from the
This would be a more serious matter. The
In 2008, 32% of
In 2008, 5.5% of our exports went to
5. Stop buying
The Federal Reserve Board and the Treasury Department have
demonstrated an amazing capacity to deal with liquidity problems in the banking
industry. Whatever the consequences of
less Treasury purchases by
5. Possible inflation
The new law should contain a provision providing the U.S.
Federal Reserve Board with the power to delay indefinitely any scheduled
increase in tariff rates when that Board believes that an increase in the rate
at this time would lead to an unacceptable level of inflation in the
6. World public opinion
This proposal is different from the usual protectionist action in that it is based on a good motive – to restore the world trading system to a more sustainable exchange with fewer deficits and less surpluses. It will not punish any nation in that equal trade will continue to allow export oriented nations to continue to increase the size of their domestic economy by engaging in trade.
Balanced trade is widely advocated. Which nation will oppose moving the world trading system toward balance?
THE FUTURE - #12
Will this proposal die quickly or will it gain traction? No one knows. At the moment it has no well regarded sponsors or defenders. It does need to be tested by argumentation and public debate.
If it does gain traction and become the law of the land, the
law will be modified as experience accumulates.
Events as they unfold after the law is passed and the will of the
Congress will determine when and how the proposed law will be modified. Congress will be able to change this law any
time it wishes.
Change in the law must be carefully considered. For the law to achieve its purpose
(increasing the number of good jobs in the
Congress may wish to reconsider the criteria for choice of a
nation to be subject to the tariff, after a few years. The criterion used herein is sheer size of
the trade surplus a nation has with the
This law is intended not only to decrease the
If the proposed law is passed, every national trading
partner should aim to avoid excessive surplus with the
The smaller the
UNITED STATES CAN
From one perspective, reforming foreign trade should be easier than some other pressing problems (such as health care, federal debt or the financial sector) because reforming foreign trade disturbs fewer domestic pocket book interests.
There are however, intellectual issues blocking reform of foreign trade. Generations of economists have been taught, and continue to believe, that classical protectionism (discrimination by individual products) is the only alternative to free trade. Thus they support free trade because of the lack of a viable alternative.
This proposal for reducing the size of the
Because of their traditions, economists are expected to greet this invasion of their turf with suspicion and initial hostility, but they are rational people and this is a rational proposal, which should ultimately pass muster.
Equal trade is proposed as a goal to be substituted for the
current goal of free trade. A new tariff
regime is proposed, beginning at 10% of the value of the imported product, to begin
4 months after the law is passed and increasing by 5 percentage points each 4
months thereafter until a set goal is reached.
These tariffs will apply only to goods manufactured in the countries of
This proposal has a rationale – equal trade promises a more stable and longer lasting global trading system and it guarantees that all participating nations will benefit from trade. Those countries that can reduce their trade deficit most will benefit the most but all will benefit from equal trade. Equal trade will insure that current trade surplus countries will continue to benefit from participation in trade.
Care has been taken to alleviate the most likely fears and potential objections.
The adjustment proposed is radical conceptually (quite
different from present practice) but the change proposed is marginal. Imports will continue to arrive in the
Consumers who might fear price increases will be
reassured by the role assigned to the Federal Reserve Board – to delay tariff
increases when inflation threatens.
Also, a continued supply of imports into the
4. Possible retaliation by affected nations has been discouraged by excluding most nations from the tariffs, by recognizing that Mexico and Canada are essential allies, by beginning slowly, allowing the affected nations time to adjust and by providing a sensible rationale for the proposed change.
5. Firms with sunk investments in any of the 5 countries will be given months, perhaps years, to adjust their production locations to the new realities. If the time between tariff increases is too short (now 4 months), the time can be extended. A balance will be sought between concern for sunk investments and desire to get the benefits of better trade as soon as possible.
6. Elimination of tariffs applied separately to each individual product has removed a major objection to tariffs – namely, the argument that the use of tariffs will open the door to Congressional log-rolling to benefit their district.
7. Economists can continue to recognize and assert that free trade is an ideal that would maximize trade benefits to the world, if it could be implemented. However, they will be asked to agree that the ideal has proved to be a failure as a guide to any nation’s trade policy in the real world of competition among nations. Without 100% compliance among all trading partners or manufacturing dominance, adherence to the free trade ideal prevents a nation from gaining significant benefits from foreign trade. This proposal claims to be based on current realities. Economists will be asked to evaluate this proposal solely in terms of its likely consequences.
8. The five trading partners selected for imposition of tariffs were chosen
by statistical analysis. Our deficit creating trading partners have been
treated with respect. They have earned respect. They have succeeded in a competitive environment by taking advantage of the opportunities presented to them, as each leader of a nation should do. The hope is that they will recognize that world trade will become sustainable by reducing the size of trade deficits. And that reduction of trade deficits depends upon reduction of trade surpluses.
The fact that the size of the goods trade deficit relative to goods imports has decreased by 13 percentage points in the last 4 years argues that achievement of an additional improvement of 11 percentage points is possible.
More than a decade ago, I acquired the 1994 version of the
classic textbook on trade titled “International
Economics” by Paul Krugman and Maurice Obstfeld. This book
provided the basis for understanding both international trade and what was
taught to undergraduates about international trade. I wanted to learn what the economics profession
has to say about the
I was encouraged to encounter, on page 2, a chart showing
the spread between imports and exports that developed in the
This sentence was all this textbook had to say about the
I found myself at odds with this book throughout. For me, the central question is a normative one – what should governments do about foreign trade? Should they try to increase the volume of world trade? Should they concentrate on managing trade so as to get the most benefit for their country from world trade? Or should they take no stand on world trade as it affects their nation – be a bystander, ignore what trade is doing to their country and their economy? This is the practical question I thought should be central to
Apparently, the economic profession does not focus instruction of students on heated controversies or on practical guidance for governments but instead provides instruction in models, ways of looking at trade, that provide the tools students need to be able to think like an economists.
But I had no interest in a career as an economist. I wanted to know what should be done about an obvious serious pressing problem.
The central question for me, trying to use the ideas in the
textbook, was what do the models provided tell me about the
The instruction focused on two abstractions – supply and demand curves. The instruction showed the various use and conclusions that can be drawn from supply and demand curves. But the connection between reality and these graphs remained uncertain. There must not be a simple way to know exactly how supply and demand curves should look to represent different conditions in the real world.
I learn, from another source that: “Demand and supply relations in a market can be statistically estimated from price, quantity, and other data with sufficient information in the model. This can be done with simultaneous-equation methods of estimation in econometrics. Such methods allow solving for the model-relevant "structural coefficients," the estimated algebraic counterparts of the theory”. But this text did not solve the problem of how to translate the knowledge gained form econometric models to tell us what the slope of these curves should be in specific situations.
My skepticism about theusefullness of these models was reinforced when the discussion turned to the important issue of the gains from trade experineced by nations. This book said that the welfare effect of trade on a nation depends upon the price of exports divided by the price of imports. I could not get a clear answer as to whether this is unit price that is being measured or price times quantity. I inferred that this is unit price, not price multiplied by the number of units. If this inference is correct, this is a mistake. The welfare effects of trade are the total costs of exports minus the total cost of imports, our familiar trade balance which is a trade deficit when the balance is negative. Price per unit is of minor importance. If terms of trade gains are unimportant, the welfare gains argument based on unit price is undermined.
This focus on unit price enables the authors to show that
the declines in price for the
The model developed in Chapter 5, The Standard Trading Model was a disappointment because it did not deal with a world in which trade deficit and trade surplus are important. Instead, it talked as if the gap between imports and exports can be ignored when discussing the welfare effect of trade.
The lines drawn on a chart to represent change in price due to change in supply and demand are purely hypothetical. No evidence is presented that the lines as drawn represent reality. A chart of this type shows that a tariff is undesirable because it raises the price in the country imposing the tariff producing distortion in both production and consumption. Distortion from what? How do we know that the existing price does not itself produce distortions from a perfect free trade environment? A reductio-ad-absurdum argument would say that this chart shows that anything less than perfection (free trade as idealized – all countries opening their borders to all imports) is less than perfect. Deviation from an idealized state that cannot be realized (for reasons discussed in Chapter 2) is irrelevant to me.
My version of a proper cost-benefit analysis of trade would
begin with the consumer faced with a choice between two objects – say cars, for
example. The foreign made car costs 10%
more than the domestic product but the consumer would be willing to pay 20%
more for the foreign made car – he thinks it is that much better than the
domestic car. The domestic consumer gets
a 10% gain in consumer surplus by purchasing the foreign car. The domestic produced car that is not sold
This does not justify raising tariff on foreign automobiles. Tariffs on individual products are counter productive. It does show that the textbook cost-benefit analysis, which ignores the effect of consumer choice on domestic production, is short sighted.
The only alternative to free trade, in this text, is protectionism. “If the gains from trade is the most important theoretical concept in international economics, the seemingly eternal battle between free trade and protection is its most important policy theme”. Protectionism is not defined in this book, so far as I can tell. The subsequent discussion is all about protectionism as it has existed historical – tariffs or restraint on imports imposed on each good separately. Protectionism means discrimination by product, if we limit the definition to what is discussed in this text.
This limitation ignores the possibility of discrimination by
some other category. Warren Buffett proposed use of import certificates to restrain
imports into the
My proposal in this text – to impose tariffs by country rather than product – is another option that does not rely upon discrimination by product.
The authors are not interested in discussing alternatives to free trade. They want to use the failure of classical protectionism to bolster the case for free trade. Their ploy will not sell. Other alternatives to free trade can be imagined that are not classical protectionism.
My textbook did not take the trade deficit seriously, contrary to the statement in the introduction. The trade deficit is not discussed in the initial section which focuses on exports and imports. The trade deficit issue is deferred to the financial section and is discussed in terms of the Current Account balance. That placement of the issue avoids the confrontation with the issues raised in this document. Not all issues can be avoided. The last two sentences in the Balance of Payments chapter are as follows: “Unfortunately for the United States, most of its foreign borrowing over the 1980s financed government budget deficits rather than investment, as we saw in the last Case Study. Future generations of U.S. citizens therefore will face a real burden in repaying the resulting foreign debt”.
This statement should (in my mind) have been followed with a recognition that trade deficits are dangerous for the U.S. in the current circumstance and should be avoided. Instead, we find a discussion of what nations tend to do rather than what they should do. That neutralizes the issue. Perhaps I expect too much from a textbook.
The flow of funds from the U.S. to other nations does result in resources owned by foreigners which have been used to acquire much U.S. Treasury debt. The funds were made available by a trade deficit. But they could not have been used to purchase Treasury debt had the U.S. government been continuously living with a balanced budget. Trade provided the means. U.S. Treasury provided the opportunity. Freedom to use the acquired dollars as they see fit allowed foreign nations to stockpile U.S. financial assets in their Reserve Funds. These assets allowed China to pay for a large stimulus package that built need infrastructure. It also allows China to control the exchange value of their currency, insuring continued trade surplus for China.
The hidden harm that a trade deficit does to an industrialized nation is elimination of some of the productive capacity in the manufacturing sector. This harm is more important than the financial bind. If the U.S. possesses productive capacity to enable it to sell products in the international market, the financial loss can be replaced. Without a growing ability to export, the U.S. economy will have great difficulty repaying debts. This textbook ignored this reality.
In summary, my textbook focuses on models which are idealized versions of reality. The discussion that follows the presentation confronts the question of the utility of the models by showing how and when they are applicable to real world situations, sometimes. But this discussion is missing when the all important issue of the welfare effect of trade are discussed or when cost-benefit is discussed. Even when the utility question is admitted, the discussion is uneven – sometimes convincing, often not. This textbook failed my test. It did not provide a clear understanding of why the U.S. has a trade deficit, what are the consequences of a trade deficit and what could be done to move toward a more desirable state of affairs.
I hope more modern textbooks will avoid some of these
problems. The data for this version
ended around 1991 – the year when the
My preference would be to have a textbook begin as this essay began – with a discussion of Gross Domestic Product and the role that trade plays in creating Gross Domestic Product. Trade is a macroeconomic level event. The discussion should concentrate on nations productive output first so as to understand what trade does to expand domestic production.
Adam Smith established the importance of markets in creating wealth in a nation, in motivating entrepreneurs, in allocating use of scarce resources, in assisting the development of specialization of productive activities.
Because trade expands the size of the market that can be served by one firm or one factory, trade increases wealth by increasing specialization. Specialization is one way to increase productivity per man hour.
Everything Smith says about trade and markets is accurate,
so long as the trade is within one nation.
Internal trade played a major role in assisting the growth of the
Smith said one good thing about foreign trade – that is was not necessary to achieve a trade surplus in order to benefit from trade (a proposition supported by Table One in Chapter One of this essay). But he made a mistake when the he provided arguments to support the proposition that a trade deficit is harmless and should be ignored. These arguments are unpersuasive. Their quality is shown by the fact that they are not repeated by modern defenders of Free Trade.
The first 2 chapters of this essay provides evidence that a trade deficit reduces both the financial assets in a nation and the size of Gross Domestic Product below what would be achieved with equal trade.
The logical next step after showing that equal trade will
allow a nation to profit from trade and to expand their Gross Domestic Product
via trade, is to argue that equal trade is the desirable trade policy goal for
each nation because it prevents the beggar-thy-neighbor strategy.. Smith rejected that option. I think I know why. He was consumed by the loss of productivity
Besides which, free trade, if enacted by
all nations, would elevate the productivity level of each nation that
participated in the trading system.
He ignored the fact that free trade opens the possibility of trade
surpluses and trade deficits – I think because he knew that
Smith railed against “Mercantilism”. The part of his argument that was correct was that a trade surplus is not necessary to benefit from trade and that piling up wealth in a nation due to a trade surplus is not needed to benefit from trade. He was wrong in so far as he implied that a trade surplus would not benefit a nation (I am not sure he went this far. If he did, he was wrong).
Smith used a logical fallacy to sell his vision of Free Trade. “All commerce that is carried on betwixt two countries must necessarily be advantageous to both” and therefore “all duties, customs, and excise [on imports] should be abolished, and free commerce and liberty of exchange should be allowed with all nations”. Another famous quote is “What is prudence in the conduct of every family can scare be folly in that of a great nation”.
What is true for an individual member of a nation is not
necessarily true for the nation as a whole.
To assume to the contrary, as Smith does, is called the Fallacy of
Composition. Many instances exist where
an action will benefit one member of a group but will harm the group as a
whole. Running for the exit in a crowded
theater when a fire breaks out is an off cited example. I used the example of an individual in the
Foreign trade is normally carried on between private firms and individuals living in different nations. It is correct to assume that trade would not exist unless both parties to the trade expected to benefit from the transaction. But individual benefits do not always translate into group benefits. These individual transactions have implications for the wealth and size of the Gross Domestic Product of each nation. A trade deficit is not a characteristic of an individual trade. A trade deficit is a characteristic of a group of trades summarized. Trade deficits should be examined in terms of their impact on the nation as a whole.
The present consumer is reduced to a non-factor or a
secondary factor in this discussion.
However, correcting a trade deficit has long term benefits for future
consumers. This perspective says that
the well being of future consumers (since they are more numerous) takes
precedence over the preferences of current consumers. The marginal impact on current consumers is
less corrosive than the long-terms enfeebling of the
To repeat a previous point, Free Trade served
CASTING A WIDER
At the end of the year 2009, the
Other failures of his policy occurred long after he left
office. The collapse of the