BUILDING TRADE WALLS: Holding China at Bay?

Trade is the mother of money. ~ Thomas Draxe (1613) 

Unfettered production and consumption of foreign-made goods – aka, “free-trade” – is so old school. Just ask Donald Trump.

Should we hop back to the old days of high tariffs, big customs duties and large quotas on foreign imports to make our country great again? Should we remember what the world was like after our Congress passed the Smoot-Hawley Tariff Act in 1930? Here’s a hint, it wasn’t that good.

Most economists and historians agree this Act, which significantly raised US tariffs to a level not seen in over the previous century on more than 20,000 types of imported goods, not only exacerbated the Great Depression but harmed the public’s economic prosperity due to higher prices. The Smoot-Hawley tariffs were ignominiously rescinded within five years after our major trading partners retaliated with their own increased tariffs on US exports.

But here we are with a president who is ready to roll the free-trade clock backwards by building “protective” tariff walls, not just his physical wall across our Mexican border.

International trade has been a quarrelsome series of policy debates (and much more) for at least the past 250 years. From an economic perspective, these disputes were formalized when Adam Smith stated in 1776 that free trade (trade not encumbered by tariffs or other protective barriers) was the basis of the wealth of nations. In the early 19th century David Ricardo, another British political economist, provided a notional rationale – his theory of comparative advantage – for determining which goods and services should be produced (and traded) to allow each trading nation to benefit from the trading. Unsurprisingly, these debates have continued and, as trade has greatly expanded, have become more consequential.

In our current age of globalization, there's a lot of international trade. It can be argued that the first "early modern age of globalization" in the West began in the 17th and 18th centuries (although inter-regional trade occurred since ancient times) with the development of the Portuguese, Spanish, Dutch and British empires. This early globalization certainly gained importance with the resultant increase in international trade, although its benefits were exclusively realized by the conquering Europeans.

Since the end of World War II the doctrine of trade liberalization – lowering or eliminating import tariffs, quotas and subsidies – has been publicly praised and followed by the majority of (already-developed) Western nations. These nations, with the strong support of many economists, have genuflected at the altar of free-trade. The creation of the World Bank, the International Monetary Fund and the General Agreement on Tariffs and Trade (the predecessor of the World Trade Organization - WTO) by 1950 was predicated on expanding post-war international free-trade across the planet. Virtually all contemporary nations have comported with this vision – that freer trade benefits everyone.

The WTO states that total world merchandise exports were $16.0 trillion in 2016, more than a 150% increase since 2000. The WTO now has 159 member countries, with 24 countries negotiating their WTO membership.

For more than 60 years US exports and imports have followed a bumpy but long-term increase as a share of our real (inflation-adjusted) GDP. This increase has happened as tariffs have been reduced and overall trade has grown.

The US and China are now the world’s largest traders. US exports represented 11.9% of our 2016 GDP, $1.45 trillion (T). Chinese exports represented 19.6% of its 2016 GDP, $2.10T. Germany wears the crown as the most intensive trading nation because its sizeable exports (ranked third-highest) represent an amazing 46.1% of its GDP. That’s a lot of Porsches, BMWs and Mercedes.

Let’s now consider China, the world’s largest exporting nation and Mr. Trump’s proclaimed nemesis. One analyst diplomatically characterizes the shifting US international trade priorities as a “protectionist crouch.” Others perceive it as a retreat from the leadership the US has provided for decades in the international economic community. Predictably, China sees Trump’s change in US policy as an opportunity and is very willing to assume more leadership in the world economy. Beijing is presenting itself as a benign alternative to the US in the international policy sphere. China’s rising geo-political influence has been caused by several reasons; the largest is its export-driven economic growth. Mr. Trump’s priority of building tariff walls specifically to protect domestic manufacturing jobs is simply policy icing on China’s expanding geo-political cake. For perspective, just 7.7% of the US labor force was in manufacturing in 2016.

China’s growth from a poor, “lesser-developed country” 40 years ago began when Deng Xiaoping took power in 1978 and instituted significant economic reforms. China’s much heralded growth and development has been founded on government-led economic planning, large state-owned and subsidized enterprises in strategic industries, direct state control of capital markets, restrictive rules for any foreign manufacturer wanting to operate in China, and little concern for the traditional guidelines of free trade. Despite such centralized planning and obstructive trade policies, China gained membership into the WTO in 2001. China’s growth hasn’t relied very much on Adam Smith’s “invisible hand” of competitive market forces for its economic progress; it’s a centrally-planned economy with a dose of market interaction around the edges. The Communist Party of China describes its economic system as a “socialist market economy.”

China’s development into a more modern, industrialized economy via restrictive, non-free trade policy has an interesting parallel in US history. This history exposes the myth that we have always practiced free-trade throughout our economic development.

Several years after winning the Revolutionary War and freed from British control, Alexander Hamilton successfully argued before the first US Congress that our new nation should be protected from established, more developed countries like Britain, France and Spain. He coined the compelling phrase “infant industries” to claim that strong tariff protection was needed for our new nation. Congress agreed with his request. Domestic industries that benefited from tariff security included textiles and iron, and later steel. Some specialists believe this early, vigorous trade protectionism of our nascent industries allowed the American economy to be one of the fastest growing throughout the 19th century and into the early 20th century.

With this trade protection, revenues from US tariffs (also called customs duties) were a very large part of the federal government’s total revenues for over a century. Using high tariffs thus served two purposes, they helped protect our infant industries from foreign imports and they provided revenue to our federal government. It wasn’t until the 1913 passage of the 16th Amendment which legalized the federal government’s use of a personal and corporate income tax that customs duties’ fiscal importance began to wither.

The table below shows that customs duties accounted for at least 81% of the government’s total direct revenues from 1792 through 1850. Even in 1900, more than 100 years after protectionist tariffs were initiated by our government, customs duties accounted for over one-third of the government’s revenue. Notice the significant bump in federal customs duty revenues in 1930 because of passage of the Smoot-Hawley Tariff Act.

US Federal Government Revenue, 1792-1950 (millions $)

Year	Customs Duties & Fee Revenue	Total Direct Revenue (TDR)	Customs Duties Percent of TDR
1950	$407.0	$39,443.0	1%
1930*	$561.0	$4,830.2	12%
1920	$294.2	$7,380.4	4%
1900	$238.2	$669.6	35%
1850	$39.7	$49.1	81%
1800	$9.1	$11.1	82%
1792	$3.4	$3.7	92%

Source: usgovernmentrevenue.com *Smoot-Hawley Tariff Act passed.

Trade protectionism was very much alive and well during the initial industrialized growth of the US in the late 18th and the 19th century. This long period of US non-free trade policy is forgotten by most modern economists and politicians. Why should they remember; it’s now the age of globalization.

Many people say that the development of the US into the world’s macroeconomic power was because of a straight free-trade hit. But it’s not a hit, it’s a myth. It’s a myth that we’ve always used free-trade policies to achieve our greatness. We didn’t, as explained above. Ah, what a difference a century or so of growth based on protective “infant industries” tariffs followed by decades of freer-trade as a fully-developed nation makes.

For the past 65 years the US and many other nations have largely adhered to the free-trade faith of reducing tariffs on many goods and services. Significant and broadly beneficial bilateral and multilateral trade agreements have been implemented by the US with other trading partners. US free trade agreements include 20 bilateral free-trade agreements, the Tokyo Round, the Uruguay Round and the North American Free Trade Agreement (NAFTA). That is not to say that the US, or any nation, allows all foreign products to be imported with no tariff. Nope. The US International Trade Commission states that many agricultural products like sugar, cotton and vegetables, as well as live foxes, umbrellas, and nuclear reactors are subject to import tariffs.

It’s a different world now. Or is it? Is our blinkered, zero-sum micro-man leader Donald Trump returning to our forgotten olden days of uniformly high tariffs to battle specifically with China on the international trade stage? It seems so.

China has the second largest GDP in the world and, like the US, is a member of the Group of Twenty (G-20) nations. Nevertheless, its GDP per capita is $8,123 and not high enough to be ranked in the top 50 nations. Its investment- and export-led economic growth over the past 30 years has been impressive. Equally notable, the Chinese government had extensively raised literacy and life-expectancy levels, and reduced poverty. In 2017 its GDP growth slowed to 6.5%, the 16th highest in the world according to the World Bank. The US GDP growth for the last quarter of 2017 was 2.6%, less than half the Chinese growth rate.

As a candidate, Mr. Trump denounced the “false song of globalism.” In his first week as president, he canceled US participation in the Trans-Pacific Partnership (TPP), a large regional trade deal with Japan, New Zealand and nine other pacific-rim countries that was initiated in 2005 to contain China. Mr. Trump has publically criticized Canada, China, Germany, Mexico and South Korea for exporting more to the US than they import from us. He is renegotiating trade pacts with Canada, Mexico and Europe to get a better deal for American workers. Mr. Trump has expressed a strong preference for bilateral trade agreements rather than larger, multilateral ones like NAFTA and the TPP.

Last month his administration decided to impose tariffs on imported washing machines and solar cells and modules from China, Malaysia and South Korea to help domestic firms’ workers. The tariffs’ overall effect on the US solar power industry will be to raise consumer prices of solar panels and also reduce employment by thousands of US workers. Also, the Trump administration started an investigation into claims that China has infringed on American intellectual property that could occasion investment restrictions or further tariffs.

On February 16, the Commerce Department recommended that the president impose substantial tariffs or quotas on imported steel and aluminum from China, Brazil, India, Hong Kong, Russia, South Korea, Venezuela and Vietnam to save American jobs. US auto makers complained that such trade restrictions will increase their costs and raise vehicle prices.

Mr. Trump dismissed objections to these trade measures, saying that the United States was considering tariffs, quotas or both. “You may have a higher price, but you have jobs.”

This quote typifies the president’s myopic view of raising tariffs on specific goods. The consequent price increases will directly affect millions of consumers (in this case of steel- and aluminum-using products like cars and trucks); the possible benefits are aimed at far, far fewer workers. Mr. Trump’s interest in building tariff walls scorns the historically high likelihood of other nations retaliating against these US tariffs with ones of their own, and filing formal complaints before the WTO.

In fact, America’s direct options for punishing China’s huge, worldwide increase in steel and aluminum exports are fairly limited. Why? Because the Obama administration already imposed a series of restrictions on Chinese steel imports in previous years; only 2% of American steel imports came straight from China in 2015. So, it may be media-worthy politics that possibly saves jobs (depending on how they’re counted), but ultimately it’s bad economics for consumers as prices will rise.

Protectionist tariffs certainly can serve useful economic purposes for developing nations, as they did for infant industries in the US well over a century and a half ago, and as they have more recently for Japan, South Korea and other Asian Tiger nations. But it’s been a very long time since we’ve been a nation of infant industries, despite the claims of domestic manufacturers. Erecting high tariffs to shield established industries (like US aluminum, steel, consumer appliances and agricultural products) in already-developed countries like ours at best only provides narrow, micro benefits and causes economic pain for the general consuming public.

Politically, the President’s retreat from our nation’s half-century record of trade liberalization seems to have boomeranged internationally and instead has provided China with an opening to fill the policy vacuum Mr. Trump created. Perhaps he recognized his mistake in building new trade walls – a very faint hope –when he offered a slightly different tune about trade at the January 26 Davos meeting saying, “America first does not mean America alone” and “America is open for business.” Did the listeners believe him? Doubtful, very doubtful. Just ask the Chinese, Canadian, Mexican and South Korean leaders whose businesses will be subject to higher US tariffs.

Mr. Trump’s foray into the dark, high-tariff past may provide ephemeral, slender benefits that will be paid by the consuming public’s much broader pain from higher-prices. If, somehow, we millions of consumers were to gain influence comparable to that of far narrower private interests, public decision-makers like our occluded president might support of our interests of broad choices and fair, low prices. Politicians like Mr. Trump always support these consumer interests in their campaign speeches but disdain them once elected to office. That’s why Thomas Draxe’s 405-year old quote remains relevant.

TRADING PLACES

Free trade is not based on utility, but on justice. ~ Edmund Burke

This weekend China’s President Xi Jinping is meeting with our president at his Mar-a-Lago resort. A key discussion topic will be trade between the 2 nations. This face-to-face meeting represents a substantial test for  Mr. Trump for several reasons. First, the US and China are the world’s 2 largest economies. Second, each man has very different perspectives on how to conduct international trade with each other, let alone the broader features of their economic and political firmaments and mutual interests. These challenges lead The Economist to cleverly christen this inaugural meeting Spar-a-Lago.

Our golfer-in-chief unfortunately will not be carting with Mr. Xi along his fairways, clubs at the ready. Officially, the Chinese government takes a sub-par view of golf, considering it a game for rich capitalists. Perhaps the 2 men can relax and create personal connection during a game of bocce ball instead?

They have plenty of trade issues to discuss. In 2016 the US exported $169.8 billion (B) of goods and services to China. We imported almost 3 times as much; $497.6B of imported goods and services from China. The US trade deficit with China isn’t recent. It has been negative for 31 years ever since Reagan was president, as shown in the figure below.

US-China Balance of Trade, 1985-2016 (10⁹ $)

Source: Economist.com, DOC/BEA

Overall, the current US balance of trade (BoT; exports minus imports) deficit with China is $309.8B. Mitigating the US-China trade deficit would be useful for us, depending on how it’s done. The president and Congress have power to change policies that can influence some but not all aspects of our BoT. During the past 3 years the appreciation of the US dollar relative to other key currencies like the Yuan and Euro – that neither the president nor Congress can effect – has not helped US exports.

Beyond the US and the Middle Kingdom, international trade anxieties are affecting other trading nations. The largest concern is that trade growth has slowed; the high-output growth engine of globalization-related trade has braked. As we already know, the political winds are shifting, causing international trade’s sails to luff in the doldrums of no supportive breezes. The World Trade Organization (WTO) expects that trade will remain “sluggish” and grew just 2.8% in 2016, like it did in 2015. Over the last decade, world trade growth has lagged world GDP growth. The world’s real GDP grew 3.0% in 2016. Average annual world real GDP growth between 2000 and 2016 was 3.0%; between 2000 and 2010 it was higher, 3.9%.

The post-WWII orthodoxy of increasing trade to improve nations’ growth and development is crumbling. Talk of tariffs and other protectionist policies is cresting these days, as individual nation’s economic growth has faltered and domestic-centered populism rises.

In addition to the general reduction in GDP growth mentioned above,  there are more specific reasons for this decrease in trade. First, growth of the BRICS (Brazil, Russia, India, China and South Africa) has slowed. These nations are the world’s largest emerging markets. Their collective economic growth has slowed from 9% in 2010 to about 4% in 2015. By 2015, 3 of the BRICS (China, Russia, and South Africa) had slower growth for at least 3 consecutive years and Brazil remains in a significant recession. Brazil’s GDP dropped 3.2% in 2016, it contracted 3.8% in 2015. Long-term growth expectations in these 5 key economies have been repeatedly downgraded since 2010. This lack of growth affects both our exports and imports. Second, imports into developing nations stagnated, growing only 0.2% in 2016, according to the WTO.

Mr. Trump has spewed several ill-considered actions for dealing with the threatening, hostile world he sees beyond our boundaries, including abolishing “unfair” trade agreements like the North American Free Trade Agreement (NAFTA), placing punitive tariffs on imports and restricting our borders.  

The pre-election Trumpian “action plan” included withdrawing from NAFTA that the candidate called “The worst trade deal maybe ever signed anywhere, but certainly ever signed in this country.” After becoming president, his extreme language has become less bellicose. Now he’s apparently willing to renegotiate, but hasn’t specified what that means; imagine our surprise. Time may tell.

In numerous public pronouncements the president has said he’s considering large tariffs on imports from countries like China and Mexico. Sometimes he’s mentioned a 45% tariff, other times a 10% tariff. Like all too many of his impulse-driven communications, they’re literally spread all over the map without substance. These specious ideas characterize his disjointed, no-dots-connected approach to creating policies that will hardly enhance our nation’s greatness. They’ll probably have the opposite effect. He seems oblivious to the likelihood that if he imposes tariffs on Chinese, Mexican and other nation’s imports these countries will retaliate with their own tariffs on our exports. In his fantasy world, US tariffs will only bring back low- and medium-skilled manufacturing employment; not higher prices on imported consumer goods and services, not curtailed exports from the ensuing trade war.

American companies that have used China and Mexico as a production base would struggle to revamp their supply chains. If US firms brought production back home to escape the tariffs, prices would increase dramatically and take considerable time to set up. As a consequence of much higher tariffs, Goldman Sachs estimates that the cost of producing clothing domestically would increase by over 40% and smartphones by over 35%. None of these consequences seems to concern Mr. Trump.

His muddled, myopic mind doesn’t see any connection between exports and imports. They are completely separate from each other, not mutually bound by trade agreements and economic reality.

The president seems equally unaware that the ultimate objective of bilateral and multilateral trade agreements is to benefit every signatory and that the negotiations to reach agreement will always involve trade-offs that need to be recognized and made. Trade agreements are founded on the world being a positive-sum game, where each party can gain. Should trade agreements be reviewed and modified over time? Surely, but Mr. Trump’s world view is at best zero-sum.

That zero-sum concept is not supported by historical facts. For example, under NAFTA US farmers – who most likely voted for Trump in large numbers – have exported significant amounts of corn and other ag commodities. In 2016 these farmers sold 13.8 million metric tons of corn to Mexico. Corn exports to Mexico have increased 5.5% every year since NAFTA was implemented in 1994. Mexico has said if the US walks away from NAFTA or imposes tariffs on Mexican goods, it will buy corn from other exporters including Argentina, not the US. How are you going to explain that in Dubuque or Omaha Mr. President?

Then there’s Trump’s Wall. Building the Wall along the US-Mexican border was a prominent specter in Trump’s candidacy. When mentioned in his campaign speeches, it wasn’t a question of if, but how tall and how long it would be – and, of course, that Mexico would pay for it. The Wall was only one piece of Mr. Trump’s actions to close our borders.

Other pieces include his disastrous 2-part orders to stop people from 8 (then 7) principally Muslim nations as well as other visa-holders from entering the US. To date, federal courts have fortunately taught Mr. Trump that his actions are subject to court interpretation; despite his protests (which themselves were cause for public astonishment and distain).

But back to The Wall. The total length of the US-Mexico border is 1,989 miles. It’s been difficult for anyone outside the White House to get specific information about Mr. Trump’s plan for the Wall. Until Jan. 20, Mr. Trump's border wall existed only as campaign rhetoric not supported by a real plan for building or paying for it. Its length and height depended on to whom and where he was talking. Now that he’s president, a plan appears to be arising. In mid-March the Department of Homeland Security (DHS) issued a request that stipulated the wall must be 30ft high, look good from the US side and be hard to climb or cut through. It must take at least 1 hour to cut through. The request apparently didn’t state how long the wall should be. Irony abounds beyond walls because some of the firms that may submit bids are minority-owned, Hispanic companies.  

Others have speculated that the Wall could be up to one-half of the border’s length, with natural barriers such as the Rio Grande River taking up the rest of the length. Guestimated costs range from $12 to $21 billion. The President’s draft budget, which was sent to Congress last month and generated scathing reviews, indicates only about $2.9 billion is now earmarked for the Wall — most of which will come from sizeable cuts to key agencies within the DHS, like the Coast Guard. Oh, will the bill eventually be sent to Mexican President Enrique Peña Nieto, as Mr. Trump proclaimed dozens of times? Nope, he was just kidding in trolling for votes. US taxpayers appear to be on the hook, which is no laughing matter at all.

The president’s international trade policies are quixotic at best; they are misdirected and inconsistent. It’s hard to see such policies as the product of reasoned, competent, coordinated analysis. This goes beyond just trade. Such concern was reflected in a recent column by David Brooks where he stated, “Trump’s greatest achievements are in the field of ignorance. … It’s not so much that he isn’t well informed; it’s that he is prodigiously learned in the sort of knowledge that doesn’t accord with the facts of our current dimension.” Trading places with Mr. Trump would involve more than relocating to 1600 Pennsylvania Avenue. Fasten your seat belts and resist.