In Defense of Free Trade

Reuters
October 12, 2019 Topic: economy Region: Americas Tags: EconomyTariffsTradeDonald TrumpChina

In Defense of Free Trade

Donald Trump's trade agenda has more potential drawbacks than benefits, and history shows that some of those are downright terrifying.

 

In other respects, Trump played a clearer, seemingly more principled, hand. When he walked out of the G7 meetings earlier this year, he told the other members that he would talk when they were ready to remove all tariffs, quotas and subsidies. Making such a statement to the leaders of the six other richest nations in the world—Japan, Germany, the United Kingdom, France, Italy and Canada—suggests perhaps that under all the noise Trump might aim at returning to the older U.S. policy of striving to erase trade impediments universally.

But even as Trump hints in this rather welcome direction, much else that he does contradicts such objectives. He could be saying that he prefers the elimination of all such barriers but as long as others remain unwilling he will fight for the best deal. Yet his position is hardly clear. That lack of clarity is more than just frustrating—it makes the give and take of negotiation all but impossible. Worse, it invites unhelpful responses as well as unintended and undesirable consequences.

 

For the second prong of this effort, the White House has concentrated on China. To bring Chinese misbehavior to heel, the Trump team has placed tariffs on Chinese imports to the United States and threatened more until Beijing bows on three major matters: 1) to import more from the United States, creating a less skewed balance of trade; 2) to have China cease cyber theft; and 3) to end Beijing’s insistence that every foreign business in China have a Chinese partner to which the foreign firm must reveal its commercial and technological secrets. Beijing has heard all this before. American presidents going back at least to Bill Clinton have made such demands and in turn received Beijing’s assurances—most recently and dramatically in a deal reached between Chinese president Xi Jinping and President Barack Obama.

Yet Beijing has always reneged. It is because of this past Chinese duplicity that the current negotiations have become so difficult. To guard against a repeat of such behavior, this White House demands that Beijing change its laws and that any deal include provisions allowing tariffs to snap back should China backslide. Beijing has rejected these demands, describing them as an affront to its sovereignty—something which China has always been sensitive about, but especially now with the troubles in Hong Kong.

The impasse has ignited a full-scale trade war. In late 2018, the White House placed 10 percent tariffs on an array of products coming to this country from China. The administration has threatened to up the rate on the levies to 25 percent and place them on a wider array of goods. China initially responded with similar levies on American goods coming into China. But since the United States sells China a lot less than China sells here, Beijing soon lost the ability to play the tit-for-tat tariff game with Washington, not the least because some 30 percent of the goods China imports from this country are components for its own exports, mostly of assembled computers and smartphones. Reflecting this constraint, China, in response to a recent round of White House threats, allowed the foreign exchange value of its currency, the yuan, to fall. By reducing the dollar price of Chinese goods this way, China has encouraged continued American sales by effectively relieving American buyers of the expense of the tariffs. The devaluation actually forces the Chinese sellers to bear that burden by denying them dollar amounts on sales equal to the amount the yuan has dropped and roughly to the extent that the tariffs have risen.

IN THIS standoff, the United States holds distinct economic advantages. Some 20 percent of China’s gross domestic product is tied up in exports, and fully one-quarter of China’s exports go to America, putting over 5 percent of China’s economy at risk in this trade dispute. In contrast, the United States depends on exports only for some 12 percent of its economic activity and less than 8 percent of them go to China, leaving only around 1 percent of America’s economy at risk in this matter. Not surprisingly, China’s economy has suffered a lot more than the United States’ in the dispute so far. Both foreign and Chinese firms have begun to decamp from China in order to avoid the American levies. Even the perennially upbeat and suspect Chinese government statistics admit the economic setback. In the second quarter, the most recent period for which statistics are available, they report that China’s real economy grew at its slowest rate since 1992. Export volumes have dropped some 4 percent in the past year and import volumes have fallen some 5 percent, indicating a drop in employment and consumer spending. Help wanted advertising has fallen. Ads for technology jobs have declined some 20 percent. Because of the economic hardship, China has cut back on overseas lending—so much so that flows for the first half of 2019 were one-quarter their size during the comparable time in 2017.

Though China is in a more difficult spot economically, the United States is also vulnerable. Surveys of American businesses suggest that profits have already been hampered by the added costs of the 10 percent tariffs put in place late in 2018. Firm managers say that they can cope with that extra burden, but that the threatened 25 percent tariffs would cause a good deal more harm, even though the decline of the yuan’s foreign exchange value has reduced some of the strain on American buyers. More serious are reports out of Germany that its economy has weakened, perhaps even begun to shrink. There are many reasons why it would soften, but surely a contributor is the shortfall in Chinese economic activity. China, after all, is a major buyer of German products—or at least was. Weakness in the British economy, too, may stem at least in part from weakness in China, and by extension, economies elsewhere in Asia. This weakening in Europe will redound to the detriment of U.S. economic prospects.

Effectively what is happening as a result of this trade dispute resembles in some respects what happened with the dreaded Smoot-Hawley Act. Today’s matter is less grand than in the 1930s. Trump’s tariffs impose less of a burden on fewer goods and are aimed at only one country—not the rest of the world as the Smoot-Hawley tariffs were. Nor is the U.S. economy or the world’s economy in the otherwise weakened state that typified the 1930s. But the pattern currently developing resembles that horrible historic precedent and, for what it is worth, also is what economic theory would have predicted. Moreover, the longer the impasse between the United States and China persists, the more severe these adverse economic effects will become, as weakness in one place fosters weakness in another and the troubles build on themselves.

GIVEN THE high stakes involved, it would seem only prudent for the president to stop blustering and seek a resolution with Beijing. Will he? In this regard, the odds actually are not too bad. China would clearly like to get out from under the severe economic pressure it is already suffering. To be sure, China scotched the most recent round of negotiations by stepping back from what seemed to be a willingness to meet American demands. Perhaps Beijing believed Trump would accept less than he had demanded out of a desire to announce an agreement. If so, China’s negotiators miscalculated. When, however, the Americans held firm and rejected China’s weakened proposals, Beijing’s representatives, unlike 2018 when they cut off negotiations in response to Trump’s first round of tariffs, immediately reengaged. President Xi underscored this determination to continue talks with an extremely conciliatory approach to Trump throughout all the recent tensions. The embarrassing events in Hong Kong should, if anything, provide Beijing with an added incentive to get out from under the awkward and painful effects of the dispute with Washington.

Though the sovereignty issue remains a sticking point, no doubt exacerbated by events in Hong Kong, it would seem that if the White House could work out a diplomatic formula that allows Xi and company to save face on the sovereignty matter, Beijing would willingly offer stronger assurances on this county’s three objectives. A gesture from the White House on this score might not ensure resolution, but it would make it more likely and without either side having to climb down. More importantly, it would save the world economy from the destructive effects of a major trade war.

Prospects on the rest of this administration’s trade agenda, such as it seems, are both less clear and less likely to find any resolution. Trump has singled out the EU’s use of subsidies and quotas, especially in agricultural trade, where the United States would enjoy considerable advantages. Perhaps witnessing the U.S.-China dispute will predispose Europe to a more conciliatory stance. No doubt the White House is banking on this. Likewise, perhaps Brexit and incipient tensions between Paris and Berlin will weaken the EU’s former resolve to protect agriculture, which at base is mostly a French interest. But a standoff with Europe would also likely be more difficult for the United States than the one with China, which can hardly be described as a walk in the park. Because the balance of trade between the United States and Europe is less skewed than with China, Europe would have a much greater ability than China to engage in a tit-for-tat tariff competition should the White House proceed. The distribution of economic pain would also be more even, and come to the United States earlier.