Who is Peter Navarro?
Tyler Cowen linked to a paper by Peter Navarro, which discusses Trump’s economic plan. To put it simply, it’s a complete mess. Here are just a few examples:
Under WTO rules, any foreign company that manufactures domestically and exports goods to America (or elsewhere) receives a rebate on the VAT it has paid. This turns the VAT into an implicit export subsidy.
At the same time, the VAT is imposed on all goods that are imported and consumed domestically so that a product exported by the US to a VAT country is subject to the VAT. This turns the VAT into an implicit tariff on US exporters over and above the US corporate income taxes they must pay.
Thus, under the WTO system, American corporations suffer a “triple whammy”: foreign exports into the US market get VAT relief, US exports into foreign markets must pay the VAT, and US exporters get no relief on any US income taxes paid.
The practical effect of the WTO’s unequal treatment of America’s income tax system is to give our major trading partners a 15% to 25% unfair tax advantage in international transactions.
This is a very basic error. International economists almost universally agree that a VAT is neutral with respect to trade. An across the board 10% import tax, combined with a 10% export subsidy, offset each other, leaving no net impact on trade. Instead they convert the tax from a production tax to a consumption tax. But it’s a consumption tax that applies equally to all goods, whether made domestically, or imported. This is not even a tiny bit controversial.
In 2015, the US trade deficit in goods was a little under $800 billion while the US ran a surplus of about $300 billion in services. This left an overall deficit of around $500 billion.9 Reducing this “trade deficit drag” would increase GDP growth.
I suppose there might conceivably be some policy that would reduce the trade deficit and also increase growth, but I can’t imagine what it would be. Navarro’s confusion about the effect of VATs doesn’t inspire confidence that he knows either.
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.
Actually, eliminating the trade deficit would have no first order effect on wages. Any second order effects might lead to higher wages, but more likely wages would fall.
According to textbook theory, balanced trade among nations should be the long-term norm, and the chronic and massive trade deficits the US has sustained for over a decade simply should not exist. This textbook state of balanced trade would exist because freely floating currencies would effectively adjust differences in national domestic cost
structures to bring about balanced trade.
The problem, however, is that not all currencies freely float. Many are actively managed, and some are pegged to another currency or currency basket. This hybrid international monetary system makes it impossible for market forces to bring about balanced trade and thereby fairly distribute what the textbooks promise us will be the “gains from trade.”
A poster child for this problem is China and its narrowly pegged currency. In a world of freely floating currencies, the US dollar would weaken and the Chinese yuan would strengthen because the US runs a large trade deficit with China and the rest of the world.
Where does one start? No, China is not intervening to lower the value of the yuan; they are intervening to raise its value. And no, textbook theory does not say that exchange rates should adjust in the long run to balance trade in goods and services, unless long run means 1,000,000,000 years, in present value terms. But in that case the current US deficit presents no puzzle; it hasn’t lasted for a billion years.
Textbooks say that exchange rates should adjust in the short run to balance trade in goods, services and assets. Trade deficits (actually current account deficits) are caused by imbalances between domestic saving and domestic investment. Those can persist indefinitely. And currency “manipulation” (which is a meaningless concept) is completely beside the point. A country can have a laissez faire policy towards its currency, and still run deficits or surpluses for centuries.
Now let’s think about the broader Trump economic plan, how would that impact the saving/investment relationship? To make my point more clearly, I’ll compare his plan to Reagan’s, which has some similarities:
1. Reagan rebuilt the military and cut domestic spending. Trump promises to rebuild the military, and an increase infrastructure spending by more that twice the rate of Hillary’s already generous plan, and protect Social Security (perhaps even increase it?) and protect Medicare. Yes, there is the usual hand-waving about reducing waste, fraud, and abuse. But that requires a high level of expertise, and a candidate deeply immersed in the details of governance. Does that sound like Trump and his advisers? So I think it’s reasonable to assume that spending will be more expansionary than under Reagan.
2. Trump promises deep tax cuts. How deep? The Tax Foundation says $2.6 trillion over 10 years. But the proposal he submitted to the Tax Foundation is not the proposal he is campaigning on, which calls for far deeper cuts. Whichever plan you use, I think it’s fair to say that the deficit will explode were Trump’s promises to be enacted (and perhaps under Hillary too, that’s a different issue.)
3. Like Reagan, Trump promises supply-side reforms, including lower marginal tax rates on income, as well as a big reduction in government regulation. This should lead to higher investment.
Reagan’s plan caused the trade deficit to increase sharply, and I’d expect the same under Trump’s plan. Recall that:
CA deficit = Domestic investment – domestic saving
Trump’s plan would (Navarro claims) boost domestic investment. It would certainly sharply reduce government saving. It seems reasonable to assume that domestic saving would also decline, pushing the current account deficit much higher. BTW, Reagan also had a few trade barriers against Japan, which did almost nothing to impact the size of the CA deficit.
To be fair, I do not view a larger CA deficit as a problem—it isn’t. Nor do I view higher investment as a problem. But I do worry about our fiscal policy, which seems likely to become increasingly irresponsible regardless of who is elected.
And yes, I do realize that actual policies often differ dramatically from proposals. This post is not a prediction about what will actually happen, but rather a comment on the quality of the advice Trump is receiving.
PS. The document says Navarro has a PhD in economics from Harvard.
Any excuse to show a Richardson building—magnificent.
Update: After posting this it occurred to me that I did not answer the question in the post title. Peter Navarro teaches at UC Irvine, and advises the Trump campaign on economic issues.
Sep 27 2016 at 11:20am
Good post but still…
Is there something glib about suggesting an economic region—the US—can sustain $500 billion a year in trade deficits, that there is a perpetual $500 billion a year free lunch to be had?
Are “capital flows” a polite way of saying that the United States is growing deeper in debt and/or is selling assets to foreigners?
Why are Australians and Canadians erecting barriers to foreign ownership of housing?
Sep 27 2016 at 12:06pm
Good discussion; but I would also point out to readers that imports appear to have a powerful disinflationary effect … so any trade restrictions would push inflation up and cause the Fed to increase interest rates … which would (probably) hurt growth.
Sep 27 2016 at 12:40pm
For those who don’t know, that’s Sever (pronounced SEE-ver) Hall, where most Harvard economics classes are held.
Sep 27 2016 at 2:39pm
B Cole, so some Chinese guy sells us a billion t-shirts for $1B and then buys a $1 Billion office building in Pasadena. This increases the trade deficit by $1B. $1B goes from the people buying the t-shirts to the guy who owned the office building. He now buys $1B worth of goods/services or invests the $1B (no other choice). Let’s say he builds two new $500M office buildings. A problem?
Sep 27 2016 at 2:48pm
This will cause the currency of such country to be almost 10% higher which is why this has almost no impact on trade.
Sep 27 2016 at 2:53pm
I’m inclined to say “Yes”, unless I have a fatal misunderstanding of trade deficits. I’m imagining the T. Boone Pickens oil/wealth transfer scenario: Assume the 500B was purely in barrels of oil from Saudi Arabia. If Americans then use the fuel in the form of value added services domestically (UPS, FedEx) in excess of 500B, then sure, why not?
My instincts tell me people think of the trade deficit exclusively in terms of end-user products like clothing, phones, or PlayStations where value add either isn’t there or easily perceived.
Sep 27 2016 at 2:57pm
Ben, You asked,
“Why are Australians and Canadians erecting barriers to foreign ownership of housing?”
There’s a lot of foolishness in the world.
The view that the CA deficit represents “debt” is a common misconception. Cliff has a good counterexample below. It’s trading stuff like buildings for t-shirts, except the buildings don’t leave the country.
Nick, Good point.
Cliff, Good example.
Sep 27 2016 at 2:59pm
Richard, That’s right.
Sep 27 2016 at 3:36pm
Scott / Richard A.,
apologies for my rustiness in intl trade econ but does the result of 10% higher exchange rate assume zero net capital flows across countries? Or what are the assumptions / math leading to that result?
Sep 27 2016 at 6:40pm
This is why I said almost 10% higher. The higher currency exchange rate would lead to more capital outflow and less inflow preventing the currency to appreciate fully by 10%.
Sep 27 2016 at 10:08pm
Cliff, ChacoKevy and Scott Sumner:
Who sez the practice of orthodox macroeconomics is a dismal science?
Residents of the U.S. can consume $500 billion more in goods and services than they produce (thanks to imports), and in perpetuity! And never with an economic consequence or comeuppance!
Life is good!
In fact, the only consequences of perpetual trade deficits are positive, as offshore holders of US cash will return the cash as “capital flows” into the United States!
If true, why not shoot for $1 trillion a year in trade deficits?
Side question: If foreigners own the bulk of prime residential land in the US, and Americans work as butlers and maids and call girls, or clean toilets in the Waldorf for wealthy foreign tourists, is that a negative result, or from the globalist perspective is that a wash?
True, the US is such a large country, that foreign domination seems unlikely, but certainly Third World populaces have chafed under the prospects of wealthy foreign domination. I concede, the political power that comes with economic power may not extend to foreign ownership of US assets.
And smarter American can also work in a Mandarin class of accountants and lawyers real estate brokers and trade specialists, as minions for wealthy internationalists.
But is this really good regional economic development for the US? $500 billion a year in net imports in perpetuity?
What regional economic development model proposes perpetual deficits?
Side note #2: Okay, let us say Americans save more. Then, it is true, US-cash holding foreigners would have less debt securities to buy.
They would have to buy more US assets, such as hotels.
Of course, in that case, the foreigner would have perpetual claim on rents.
Dudes, the case for running perpetual and large trade deficits is just not that solid….
Sep 28 2016 at 1:16am
Cliff, I think it is the long term, skillwise, that people are worried about.
Assume your CA deficit gets continuously balanced by a capital surplus for a long time. Imagine the effect it has on your people and the skills they choose to develop, on the margin. Instead of choosing to make or create something for the world, they will choose to either become a rentier or schmooze/seduce a rentier. This is one of the ideas that came up in discussions of Tyler Cowen’s “average is over” book, in which being a “courtier” for one of the few people productive enough to sell to the world economy was mentioned as a possible work choice for the not-so-gifted.
It is not an economic choice, it may be purely a psychological / aesthetic choice, but a lot of fairly smart people like Buffett and Munger worry about it.
This is not a pure speculation. Examples follow.
1. Look at the work ethics of ethnic Saudis and extrapolate that. What happens to them when the oil is over?
2. The movement of icelanders from fishing to finance – caused a fair bit of tumult when the GFC hit.
Sep 28 2016 at 5:20am
The VAT and trade claim is one that drives me up the wall. It’s entirely nonsense. But at least we know where Trump is getting it from now, from Navarro.
Sep 28 2016 at 10:28am
–“Residents of the U.S. can consume $500 billion more in goods and services than they produce (thanks to imports), and in perpetuity! And never with an economic consequence or comeuppance!”–
People say similar things about the national debt. As long as the nominal economy continues growing, a mild deficit (current account or budget) can be easily sustained indefinitely.
Moreover, despite chronic current account deficits leading to a negative net international position, the US continues to earn more on assets it owns abroad than it pays out to foreigners who own American assets (at least through 2014).
I’m in my early 30s. The U.S. has been running current account deficits for pretty much my entire life, and despite this, real median family income is up 35%, real GDP per capita has risen 67% and U.S. real household net worth per capita has risen 136%.
–“If true, why not shoot for $1 trillion a year in trade deficits?”–
We shouldn’t shoot for $1 trillion trade deficits or any particular value. The point is not that a $500 billion deficit is better than $0, only that it doesn’t really matter. The U.S. should stabilize NGDP growth and do what it can to ensure a competitive business environment. Some reforms I favor probably would reduce the trade deficit somewhat, (e.g. shift taxation away from business and saving and towards consumption) but that’s a side effect and not the overall goal.
Sep 28 2016 at 11:49am
The example leaves out that the people buying the t-shirts now buy $1B less of new U.S. office buildings or U.S. goods and services, offsetting what the seller of the $1B building does with his proceeds. One way to understand the situation is to suppose that the guy selling the $1B office building to the Chinese is also the one buying the $1B of t-shirts from the Chinese. There is no money left to buy 2 new buildings or anything else. Net impact: the U.S. has sold a building to the Chinese in return for t-shirts.
Sep 28 2016 at 12:48pm
Doesn’t ChacoKevy’s example persuade you that this can indeed be true? If we import $500 billion in oil every year, and turn it into products that are worth much more to us than $500 billion (say $1 trillion), why can’t that be done in perpetuity?
For example, if you needed bolts to attach an engine of a Lexus to its body, couldn’t you get them from a foreign country in “perpetuity”? After all, without those bolts the separate Lexus engine and Lexus body are worth thousands of dollars less. So you’re adding thousands of dollars of value just by getting maybe $5 worth of bolts. Isn’t that a good deal, and something that can be done in “perpetuity”?
P.S. I put “perpetuity” in quotation marks, because maybe after a couple hundred years of buying $5 of bolts per year from that country, you sell a Lexus to that country, and turn your trade deficit into a trade surplus. And anybody who is worried about the implications of some policy on the economies of countries 100+ years in the future is being foolish, because we can’t know what economies are going to be like 100+ years in the future.
Sep 28 2016 at 3:35pm
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Sep 28 2016 at 3:35pm
Federico, It’s really just an example of the legal incidence of a tax not mattering. A VAT is a consumption tax, with the same impact as a consumption tax implemented some other way. Don’t overthink the issue.
Ben, You said:
“Residents of the U.S. can consume $500 billion more in goods and services than they produce”
That’s not what it means, read my earlier reply. A CA deficit does not mean we are consuming more than we produce. (A lot of people suffer from that misconception.)
Prakash, It might be worth worrying about declining labor force participation, but that doesn’t have anything to do with CA deficits.
David, You said:
“Net impact: the U.S. has sold a building to the Chinese in return for t-shirts.”
And the problem with that is?
Sep 28 2016 at 3:37pm
progrolibeeral, I thinks Mundell and Fleming are approximately correct, at least in terms of first order effects.
Sep 28 2016 at 4:15pm
“Net impact: the U.S. has sold a building to the Chinese in return for t-shirts.”
And the problem with that is?
Too many Americans employed in skilled construction trades and too few employed in t-shirt factories. Duh.
Sep 28 2016 at 6:18pm
“And the problem with that is?”
The layman’s reply would be that you can’t sell the building a second time, and you can’t build a new one with the T-shirts you received in exchange, so your consumption is outstripping your production — and that cannot go on indefinitely.
Sep 28 2016 at 8:06pm
I submit a nation that runs a perpetual and large trade deficit faces the prospect of becoming a renter rather than a rentier.
Sep 29 2016 at 5:25am
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Sep 29 2016 at 10:52am
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Sep 29 2016 at 4:13pm
Ricardo, You also can’t sell the same t-shirts twice. But you can build new t-shirts, and new buildings.
I honestly think lots of people are just confused on this stuff.
Ben, Instead of “submitting” ideas, tell me what’s wrong with my criticism of your assertion that a CA deficit means you are consuming more than you produce.
Sep 29 2016 at 7:15pm
You don’t have to talk about theory here, real actual data shows that nations who trade freely do better than those who do not.
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