Trump on trade war with China: “When you’re already $500 Billion DOWN, you can’t lose!”

President Donald Trump
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President Donald Trump

On Monday, the Trump administration announced tariffs on about $50 billion worth of imported goods from China, aiming to punish the country for alleged violations of American intellectual property. The Chinese clapped back Tuesday with retaliatory tariffs on about 106 categories of American products, including soybeans, cars, and whiskey.

Stock market futures plunged overnight, leading the Dow to open Wednesday morning down 450 points. But Trump was ready to go with a pair of reassuring tweets indicating that either there would be no trade war or else maybe trade wars are good.

This reflects a view that Trump has consistently maintained in his personal rhetoric and that has been reflected in the official documents put out by some of the members of his trade team — trade deficits are per se bad, reducing them induces prosperity mechanically, and so there is no downside to a trade war with a country with whom the United States runs a large trade deficit.

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One big question hanging over Trump even since the campaign has been whether this is something he really believes and is prepared to act on as president, since it happens to be totally wrong. And while so far nothing Trump has actually done on trade is all that significant in the grand scheme of things, perpetually making policy on the basis of a total misunderstanding of the issue is potentially quite dangerous.

Trump's theory of trade is wrong

Commerce Secretary Wilbur Ross and trade adviser Peter Navarro were the co-authors of an important policy paper the Trump campaign put out during the election season that mostly focused on trade issues.

Unfortunately, the paper's discussion of trade was incredibly shoddy. George Mason University's Scott Sumner describes it as "a complete mess," which, if anything, is too kind. When Adam Davidson profiled Navarro for the New Yorker, he wrote that even when he asked Navarro to help him out, he couldn't find a single other economist who fully agreed with him on trade and China. Which is about what you would expect, since the Ross-Navarro trade policy analysis is based on a mistake that would get you flunked out of an AP economics class.

"When net exports are negative," Ross and Navarro write, "that is, when a country runs a trade deficit by importing more than it exports, this subtracts from growth."

They believe that, therefore, we can boost growth by curtailing imports:

To score the benefits of eliminating trade deficit drag, we don't need any complex computer model. We simply add up most (if not all) of the tax revenues and capital expenditures that would be gained if the trade deficit were eliminated. We have modeled only the impacts of implicit profits and wages, not any other economic aspect of the increased activity.

Trump proposes eliminating America's $500 billion trade deficit through a combination of increased exports and reduced imports. Again assuming labor is 44 percent of GDP, eliminating the deficit would result in $220 billion of additional wages. This additional wage income would be taxed at an effective rate of 28 percent (including trust taxes), yielding additional tax revenues of $61.6 billion.

Reading this, you might wonder why it is that in the real world, economists actually do try to develop complex computer models of the economy. The answer is that the alternative method Ross and Navarro are proposing doesn't even remotely work.

A simple sanity check

Here's a quick way to tell that something has gone wrong with the Ross-Navarro argument. Last year, the United States imported $180 billion worth of petroleum products — oil and such.

According to Ross and Navarro, if the United States made it illegal to import oil, thus wiping $180 billion off the trade deficit, our GDP would rise by $180 billion. With labor constituting 44 percent of GDP, that would mean about $80 billion worth of higher wages for American workers. So why doesn't Congress take this simple, easy step to boost growth and create jobs?

Well, because it's ridiculous.

What would actually happen is that gasoline would become much more expensive, consumers would need to cut back spending on non-gasoline items, businesses would face a higher cost structure, and the overall economy would slow down with inflation-adjusted incomes falling. Modeling the precise impact of a total shutdown of oil imports is hard (hence the computer models). But we know from experience that the directional impact of sharp disruptions in the supply of imported oil, and it's not at all what Ross and Navarro say it would be.

Ross and Navarro made a subtle but basic error

Here is the issue.

Gross domestic product (GDP) is meant to measure the dollar value of everything produced in the United States. To calculate GDP, you take everything the government purchases (G for government purchases), then add everything households purchase (C for consumption), then add everything businesses buy but don't sell to customers (I for investment). That gives you a picture of everything that was bought in America. But then you need to adjust for the fact that Americans buy some foreign-made stuff (imports) and sell some stuff to foreigners (exports) — so you add that together and get net exports (NX), which need to be added or subtracted from the total.

That's written down as an equation: GDP = G + C + I + NX.

But this is an accounting procedure, not a causal theory. The accounting procedure says that government purchases are an element of GDP — higher G means higher GDP, and absolutely everyone agrees on that. But whether increasing government spending will boost or harm the economy is obviously a hot topic of political debate. A sensible high-level take would be "it depends." It matters what you spend the money on; it matters how you raise the revenue and what the larger economic situation is.

The net exports situation is just the same. If America's net exports grow because America becomes a fashionable tourist destination and sales of Boeing airplanes surge, then that will boost the economy. But if America's net exports grow because new Trump-imposed taxes cause the price of imported goods to surge, then the economy is going to shrink.

It is reasonably common for people to make the kind of mistake that Ross and Navarro are making here, which is why professors generally make it a point of emphasis when introducing the GDP concept to students. Why a credentialed economist would do it in a policy paper for a presidential candidate is another matter.

Trump's trade message is total nonsense

The Democratic Party has long been divided on questions of trade policy. Bill Clinton's administration pushed for NAFTA and Chinese accession to the World Trade Organization over the objections of labor unions. Barack Obama's administration pushed for the Trans-Pacific Partnership, again over the objections of labor unions, this time joined by many public health groups.

Over time, the coalition of left-wing skeptics of the prevailing trade policy regime has developed an increasingly sophisticated critique:

  • Modern trade deals are largely more about encouraging foreign countries to adopt regulatory changes that are friendly to Hollywood and American drug companies than about reducing trade barriers.
  • Investor-state dispute settlement mechanisms undermine democratic control over regulatory policy and the legal system.
  • Trade deals subject less educated American workers to foreign competition while leaving credentialed professionals protected in a way that skews the income distribution.
  • Last but by no means least, standard economic theory predicts that increased trade will grow the economy but hurt some specific social classes. And the US has failed over the past quarter-century to adequately grow the welfare state to ensure that trade policy is a win-win.

Because political life is full of dreary reductive binaries, many left-of-center people who are generally strongly critical of Trump have been inclined to praise his criticisms of US trade policy. It is important, however, to understand that Trump is not in any way offering any version of the most sophisticated criticisms of America's approach to global trade. Not just in his rallies and off-the-cuff remarks but in his policy papers prepared by PhD economists, he is appealing to the idea that arbitrary restrictions on the sale of foreign-made goods will mechanically boost the American economy.

There is no empirical or theoretical basis for this view, which is why no president of either party has ever attempted to make it the centerpiece of his national economic strategy. It's just wrong. It's the kind of thing you might come up with if you were a wealthy landlord and reality television personality who ran for president on a whim without learning anything about issues or public policy.