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Free Trade vs. Balanced Trade
By Raymond Richman, Howard Richman, and Jesse Richman, 9/28/2016

During the 2016 presidential campaign, trade has become a major economic and voting issue. For decades both political parties, in general, and Hillary Clinton, in particular, have supported expansion of free trade through trade agreements that reduce tariff rates. In contrast, Donald Trump has upended that politics, seizing the Republican nomination with the promise to renegotiate trade agreements so that they balance trade.

As a result, the two alternatives in this year’s election are free trade vs. balanced trade. These are not necessary mutually exclusive. Indeed, there have been periods of world history in which trade has grown more free without getting out of balance. Especially notable were the 1840-1870 and the 1950-1997 periods. Those were the two golden ages of globalization in which tariff reductions around the world greatly benefited and integrated the world economy.

But the 1840-1870 period was followed by a period, much like the present, in which world trade became more and more unbalanced. The European countries were experiencing worsening trade deficits and eventually had to choose between free trade and balanced trade. Those that chose to balance their trade through tariffs resumed their economic growth, while those that stuck with free trade continued to stagnate (see Paul Bairoch's 1993 book, Economics & World History: Myths and Paradoxes). The United States faces a similar choice today.

The U.S. economic growth rate has followed the U.S. trade balance downward, as shown in the following graph:

The slow U.S. economic growth rate of the last 17 years is unprecedented. From 1999 through 2015, the average U.S. growth rate was just 2.1% per year, as compared with over 3% for almost every ten-year period during the previous five decades. And the first two quarters of 2016 (not shown on the chart) have been even lower -- just 0.8% and 1.1% growth. There are six primary reasons why trade deficits slow economic growth:

  1. They subtract from demand for American products. The negative trade balances since 1976, shown in blue in the graph above, have directly subtracted from each year’s GDP.
  2. Loss of manufacturing jobs. When imports exceed exports, there is a net loss of manufacturing jobs.
  3. Less investment in new factories. When foreign governments (with the help of their central banks) manipulate exchange rates to keep the dollar’s exchange rate high and their exchange rates low, they reduce incentives to invest in American factories.
  4. Less technological development. R&D is often related to current production and therefore needs to be near to factories. Also, “learning by doing” occurs in factories.
  5. Loss of economies of scale. As we lose factories, we lose economies of scale.
  6. Slower recoveries. Any stimulus leaks abroad as larger trade deficits.

The burden of the slower economic growth has fallen disproportionately upon America’s blue-collar middle class. They have lost highly-productive manufacturing jobs and have been forced to take less lucrative jobs in the service sector. This is a major reason why median U.S. family income, after subtracting for inflation, is lower today than it was in 1999.

The Problem of Mercantilism

Most of the problems of international trade are related to the fact that a number of countries have been running chronic trade surpluses which cause chronic trade deficits among their trading partners. They are following the mercantilist prescription of running trade surpluses in order to grow their economies more rapidly.

Almost all economists have decried mercantilism. For example, Adam Smith, the founder of modern economics with his 1776 magnum opus (An Inquiry into the Nature and Causes of the Wealth of Nations) called it a policy of “beggaring all their neighbors,” because mercantilists intend to grow at their trading partners’ expense.

The problem is that mercantilism works if trading partners tolerate it, as John Maynard Keynes, the founder of modern macro-economics pointed out in the chapter about mercantilism in his 1936 magnum opus (The General Theory of Employment, Interest and Money):

[A] favorable [trade] balance, provided it is not too large, will prove extremely stimulating; whilst an unfavorable balance may soon produce a state of persistent depression. (p. 338)

The governments of China and several other Asian countries have successfully grown their economies at U.S. expense by buying U.S. assets (stocks, bonds, or gold) while at the same time keeping out U.S. products through tariff and non-tariff trade barriers. They are following the classic recipe for mercantilism as laid out by University of Chicago economist Jacob Viner in 1948 and Chinese economist Heng-fu Zou in 1997. They are not the first countries to practice mercantilism successfully:

  1. England and France used mercantilism in the 1500s to replace Spain as the world’s primary economic and political powers.
  2. From 1865-1873, the U.S., Canada and Australia used mercantilism to grow rapidly at Europe’s expense.
  3. From 1924-1929, the U.S. and France used mercantilism to grow rapidly at British and German expense.

Mercantilism gives faster economic growth and increased political power to the trade surplus countries, but gives trade deficits, slower economic growth, and reduced political power to their trade-deficit victims. The correlation between trade balances and changes in political power are striking, as we demonstrated statistically in a recent conference paper.

Unfortunately, the majority of the American economic profession has completely ignored the growing research about the destructive nature of chronic trade deficits and about ways to combat them. For example, in their popular international economics textbooks, now in their tenth and eleventh editions, Paul Krugman (with his co-authors) and Dominick Salvatore never consider the causes of chronic trade deficits, and never offer remedies to those trade deficits.

The Business Economists

Fortunately, there are a growing number of respected economists who have been addressing the problem. Most are business economists, and thus in close touch with business managers and the problems that they are facing.

One is Prof. Ralph Gomory, Research Professor at the Stern School of Business of New York University and former Director of Research at IBM. He is the co-author with Prof. William Baumol, distinguished former Professor of Economics at Princeton University, of a seminal work published in 2000. They modeled international trade in a world in which countries can acquire a “comparative advantage” by specializing in any industry in which they can obtain economies of scale. He now supports a system of import certificates to balance trade.

Another is Prof. Peter Morici at the Robert H. Smith School of Business of the University of Maryland. Earlier, he served as director of the Office of Economics at the U.S. International Trade Commission. He now supports a dollar-yuan conversion tax that would be applied to Chinese imports into the United States at a rate that would be adjusted to the rate of Chinese currency market interventions.

Yet another is Donald Trump’s chief economic advisor, Prof. Peter Navarro at the Paul Merage School of Business of the University of California-Irvine, who is on record with his view that the chronic trade deficits have cost a huge loss of American manufacturing jobs.

In Navarro’s 2011 book (Death by China), co-authored with Chinese-dissident Greg Autry, he noted that China is singly responsible for about half of the total U.S. trade deficit and a half percent reduction in the U.S. growth rate. His estimate is in line with our own estimate, based upon the above graph, that current U.S. trade deficits are cutting the annual U.S. growth rate by about 1%. Specifically, he wrote:

As for the actual impact our Chinese import dependence has had on America’s growth and unemployment rates, this, too, is mind-boggling. Over the past decade, our trade deficit with China has typically shaved off close to a half a point of GDP growth a year. While that might not seem like a large sum, it translates into a cumulative impact of millions of jobs that the American economy failed to create. (p. 69)
In his 2015 book (Crouching Tiger), he opposed Chinese currency manipulation and advocated countervailing duties against Chinese products. Like these economists, we have proposed a way to balance trade. In our 2014 book, we recommended that trade-deficit countries apply a single-country-variable tariff system, called the Scaled Tariff, upon the products of those trade-surplus countries with which they have significant trade deficits. The rate of the across-the-board tariff with each trade-surplus country would rise or fall depending upon whether our trade deficit with that country were increasing or decreasing. Navarro is aware that it will not be easy to take on Chinese mercantilism. In his 2008 book he wrote that the Chinese government has threatened to dump its more than one trillion dollars of U.S. government bonds gained by “recycling U.S. dollars gained from its export trade back to the United States.” He notes:
Through the currency manipulation process, China has accumulated over one trillion dollars worth of U.S. government bonds. Now anytime that U.S. politicians threaten to penalize China for its unfair trading practices, China routinely retaliates with threats of its “financial nuclear option.” Specifically, China threatens to destabilize the U.S. economy by dumping U.S. government bonds and dollars on world markets. (p. 8)

But Trump may have this threat covered. As part of his tax reform plan, he proposes a reduced tax rate on the approximately $2.5 trillion in profits parked overseas by U.S. corporations so that they can avoid paying the difference between foreign corporate tax rates and the higher U.S. tax rate. If an inflow of parked dollars is timed to coincide with sales by trade-surplus governments of U.S. assets, the two effects, moving in opposite directions, could cancel each other out.

The U.S. trade deficits have become an important political issue. The choice this election is between free trade and balanced trade. Trump, a businessman, and his chief economic advisor, a respected business economist, have put together a plan to balance trade.

If they succeed, they will significantly increase the U.S. annual economic growth rate, restore the blue-collar middle class, and begin the process of restoring U.S. economic and political power. If Hillary Clinton wins, the American economic decline, shown in red in the above graph, will likely continue.

--

Raymond Richman is Professor Emeritus in Public and International Affairs at the University of Pittsburgh. His economics dissertation advisor was Milton Friedman at the University of Chicago. The Richmans co-authored the 2014 book Balanced Trade published by Lexington Books, and the 2008 book Trading Away Our Future published by Ideal Taxes Association.

To read another version of this commentary, go to: http://www.americanthinker.com/articles/2016/09/free_trade_vs_balanced_trade.html




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    Wikipedia:

  • [An] extensive argument for balanced trade, and a program to achieve balanced trade is presented in Trading Away Our Future, by Raymond Richman, Howard Richman and Jesse Richman. “A minimum standard for ensuring that trade does benefit all is that trade should be relatively in balance.” [Balanced Trade entry]

    Journal of Economic Literature:

  • [Trading Away Our Future] Examines the costs and benefits of U.S. trade and tax policies. Discusses why trade deficits matter; root of the trade deficit; the “ostrich” and “eagles” attitudes; how to balance trade; taxation of capital gains; the real estate tax; the corporate income tax; solving the low savings problem; how to protect one’s assets; and a program for a strong America....

    Atlantic Economic Journal:

  • In Trading Away Our Future   Richman ... advocates the immediate adoption of a set of public policy proposal designed to reduce the trade deficit and increase domestic savings.... the set of public policy proposals is a wake-up call... [February 17, 2009 review by T.H. Cate]