Here’s the real danger with Trump’s ‘Buy American’ agenda

  • Trump recently signed an executive order advocating a "Buy American" policy.
  • Trump went as far as calling Germans "very bad" because of their trade surplus with the U.S.
  • Here's why "Buy American" laws will lead to larger government deficits, a distortion of trade flows and higher prices for consumers.
Republican Presidential Candidate Donald Trump gives the thumbs
Getty Images

President Trump is pushing his "Buy American" agenda, going so far this week as to call Germans "very bad" because of their trade surplus with the U.S.

"See the millions of cars they sell in the U.S.? We will stop this," Trump reportedly said in a meeting with European leaders.

This came after the president recently signed an executive order advocating a "Buy American" policy.

The fundamental assumption behind this directive is that buying only goods produced in the United States will create a multitude of jobs and enhance the country's prosperity.

This may sound logical on the surface but it fails to acknowledge key features of the integrated global economy and the root causes of worker displacement. The imposition of "Buy American" laws will lead to larger government deficits, a distortion of trade flows and higher prices for consumers.

"'Buy American' has a certain ring to it, and will no doubt win over some of the electorate … What might sound best on Twitter may not be the soundest approach."

The primary aim of the "Buy American" part of the executive order is to maximize "the use of goods, products and materials produced in the United States." A number of free trade agreements and the World Trade Organization (WTO) limit the favoring of domestic providers in government contracting, but U.S. officials have been instructed to investigate the latitude available for them to turn inward. A report is due to the president in the fall.

One of the challenges in implanting rules of this kind is determining what qualifies as a domestic product. It is rare indeed to find something that is created exclusively from local content; more commonly, goods are the end result of global value chains (GVCs). GVCs are networks of production stages that span national borders. A GVC involves combining intermediate goods and services into products that are used at a subsequent stage of production.

A typical GVC consists of several steps, from conception to assembly to branding and marketing. Organizing production in this manner captures efficiencies from across the world.

Apple's iPhone is a classic example. It is designed in the United States, but uses parts supplied by different countries. It is assembled in China by a Taiwanese firm, and the final product is sold worldwide. As another example, the Ford Taurus is assembled in Chicago, but only 65 percent of its parts originate in the United States. Should these two well-known products be considered American?

According to the World Trade Organization, nearly 40 percent of all U.S. exports are the product of GVCs. Research analyzing selected factories across eight large economies shows that GVCs have expanded significantly.

There are relatively few products that are produced entirely in the United States. Food and services are two examples, but they constitute only a small percentage of U.S. gross domestic product (GDP).

Laws confining the purchase of goods and services to the national boundary contradict the basic tenet of a competitive free market economy that enables every firm, individual, or public agency to purchase goods and services offering the best combination of price and quality. More importantly, the free market arrangement enhances productivity.

The new executive order promises to affect the manner in which federal agencies purchase goods and services. The U.S. government spends nearly half a trillion dollars on contracted work each year. Firms place bids for construction, technology support and other services the government does not perform on its own.

Excluding sensitive defense-related work, both American and foreign firms are currently eligible to bid on these opportunities. Under the new order, only domestic firms will be eligible to win these contracts, potentially costing the taxpayer if revenues are channeled to firms/individuals that may not be the optimum choice.

The "Buy American" policy is a non-tariff trade restriction much like local content requirements (LCRs) designed to protect local industries and jobs. If America presses forward with this agenda, other countries can retaliate with LCRs that can range from requirements to purchase a certain percentage of domestic goods, use only local infrastructure to produce services and impose conditions on the way business is done. The U.S. could well be a net loser in this battle of barriers.

The Global Trade Alert group has identified that 343 LCRs have been implemented since the 2008 financial crisis. Research notes that LCRs largely have a net negative impact on trade flows and investment. The bottom line is that these protectionist measures are economically sub-optimal policies to shield jobs.

Furthermore, there is evidence that technology, not global sourcing, has contributed more to job losses in the United States over recent decades. The Buy American program will not diminish the march of automation.

"Buy American" has a certain ring to it, and will no doubt win over some of the electorate. But policymakers need to recognize this simple slogan obscures the more complicated realities of global sourcing, a system from which the United States benefits greatly. What might sound best on Twitter may not be the soundest approach.

Commentary by Carl Tannenbaum, the chief economist at Northern Trust, an investment-management firm. Prior to joining Northern Trust, Tannenbaum led a team at the Federal Reserve Bank of Chicago and served as the head of the entire Federal Reserve System's risk group in Washington for a year, working closely with Federal Reserve System governors and senior officials.

For more insight from CNBC contributors, follow @CNBCopinion on Twitter.