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 Richmans' Trade and Taxes Blog

Tariffs to Balance Trade Do Not Violate Free Trade Policy
Raymond Richman, 8/20/2018

The media are all hyped up about trade wars. Where were they when the trade deficits showed up endlessly in the USA Gross Domestic Product accounts and slowed economic growth? They still do not mention them except to deride Pres. Trump when he mentions it. John Maynard Keynes, the famous economist, long a free trader, made an exception when depressed conditions existed in the markets for labor, writing that the trouble with free trade was the assumption “that if you throw men out of work in one direction you re-employ them in another. As soon as that link in the chain is broken the whole of the free trade argument breaks down.” He argued that labor would resist a cut in money wages. But they would accept a cut in real wages brought about as a result of rising import prices. However, he feared that the tariffs would become permanent. This problem is solved by imposing variable tariffs which diminish automatically as trade become balanced. We argue that balanced trade with rest of the world should be that appropriate goal.

Balanced trade is easy to achieve, not by tariffs on particular products, which invited counter measures by our trading partners but by scaled tariffs, single-country-variable tariffs, that work like devaluing a currency, the traditional method of achieving balanced trade. Our problem is with only a handful of countries. Countries that have huge chronic trade surpluses with the U.S. which in 2017 included China $ 375.6 billion, Japan $68.9 billion, the European Union $151.4 billion (including Germany $63.7 billion), and Mexico $70 billion. Balancing trade with those few countries would reduce our trade deficit over 80%.

Nearly all economists are strong advocates of free trade. That is a hangover from the decades before WWII when the U.S. was the leading trade surplus country. When the U.S. became the world’s leading debtor, economists did not change their outlook and were silent, with few exceptions like us, about the harm those deficits were doing to U.S. workers Economists have show that balanced trade is always beneficial for trade partners even when one’s partner is engaged in unfair trading practices. When a country has huge trade deficits with a few of its trading partners, economists cannot show that it benefits from trade with them.  

Unfortunately, the conditions for a free trade policy do not exist in the real world. No one should be in favor of free trade unless the following conditions are satisfied by the trading partners: a common currency and the absence of barriers to trade. Those conditions are imposed on the States by the U.S. Constitution. But they do not exists internationally. Tariffs, subsidies, quotas, and undervalued foreign exchange rates exist. Several countries have large chronic surpluses with the U.S. They acquire huge amounts of U.S. government and corporate debt, and often use the funds to acquired business assets in the U.S. The U.S. has a huge chronic trade deficit with the rest of the world, $795 billion in 2017.

The U.S. had chronic surpluses before 1970 and was the world’s leading creditor nation until chronic deficits converted it to the world’s leading debtor nation by the mid-1980s. After the GATT agreement of 1994 and the establishment of the World Trade Organization, the U.S. trade deficit exploded as the following table shows:

Net Exports and the Ratio of Net Exports to the GDP, 1994 to 2017

Year       Net           Net Expots                       Year        Net            Net exports     

             Exports    /GDP (%)                                          Exports      /GDP (%)                     

1994          -93            -1.27                                 2006         -771            -5.56                             

1996            -96           -1.19                                2007         -718            -4.86

1997          -102          -1.18                                 2008         -723            -4.91               

1998         -163           -1.79                                2009         -395            -2.74

1999        -257            -2.66                                2010         -513            -3.43

2000          -376          -3.66                                 2011         -580             -3.74

2001        -369            -3.47                                2012         -566             -3.50

2002          -426          -3.88                                2013         -492             -2.95            

2003          -504          -4.38                                2014         -510             -2.93                               

2004          -619          -5.04                                2015         -524             -2.89            

2005          -721          -5.51                                2016         -521             -2.80                            

                                                                                 2017         -524             -2.70

Source: Bureau of Economic Analysis of the Dept. of Commerce                                               

As one sees from the table, the 1994 Gatt agreement led to huge trade deficits for the United states. The last column of the table tells us that GDP was affected adversely by the trade deficits falling short of what should have been its balanced trade level by as much as 5.56 percent and was no doubt a contributing cause of the severity of the Great Recession of 2008-2009.

The U.S. can balance its trade as the Trump administration is doing by imposing tariffs on particular products of trade surplus countries. Unfortunately, this gives trading partners the opportunity to do likewise and causes trade wars. There is a policy that avoids trade wars, imposing single-country-variable tariffs that we proposed in the book Balanced Trade (Lexington Books, 2014), a tariff that applies to all goods and services imported from trade surplus country. The tariff rises as the trade deficit with a particular country rises as the trade deficit with a particular country increases and falls as trade moves toward balance. A trade war would increase the trade deficit and cause an increase in the variable tariff. The highest tariff would apply to China and much lower tariffs would apply to countries whose trade surpluses are much less. As we noted, about a half dozen countries account for more than 80 percent of the U.S. trade deficit are likely targets.

The variable tariff not only forces trade into balance but provides considerable revenue while it does its work. Countries could not retaliate as they are doing now in response to the administration’s imposition of the steel and aluminum tariff and countries that have nearly balanced trade or a trade deficit with the U.S. would not be affected. If countries did impose tariffs on selected products, it would increase the trade deficit and raise the variable tariff. When it comes to trade wars, the countries with large trade deficits will always be the winners.