Some, but much less than you might assume.
Let’s focus on the current trade dispute with China. I often read that Chinese exports to America represent only 3% of Chinese GDP. This is supposed to demonstrate that the US doesn’t have much leverage over China. The conclusion is correct, but the reasoning is flawed. That’s because 3% of GDP is huge. China would really, really hate to lose a foreign market equal to 3% of its GDP.
The correct arguments are very different:
1. A complete ban on Chinese exports to America would have an absolutely massive impact on the US economy. Think about the impact on American automakers that rely on Chinese components. Think about the impact on Walmart–what would they sell? Think about how long it would take for Apple to get Foxconn to recreate its massive Zhengzhou complex in some place like Vietnam or Indonesia. (Samsung would be smiling.) I could go on and on. The total loss of Chinese imports would devastate the US economy, and also cause a stock market crash. China knows this, and hence knows that at the end of the day its exports to America will still be roughly 3% of Chinese GDP. Any tariffs imposed by America will knock less that 10% off its exports, and probably more like 1%. And 1% of 3% of GDP really is a small number.
I do think the US has enough leverage to get some sort of symbolic win, some sort of deal where China agrees to crack down on piracy, and perhaps lower a few of its tariffs. Maybe allow a bit more US investment into its banking and insurance industries. (We’ve had such successes in the past.) But don’t forget that more US financial exports to China mean more Chinese manufacturing exports to America. I’m sure that unemployment steelworkers in West Virginia will be thrilled to hear that Steven Mnuchin is working hard to make sure that American financial firms get even richer, at their expense.
2. There is enormous misunderstanding in the media regarding the concept of “retaliation”. Pundits try to use game theory to figure out whether there will be a “tit-for-tat” trade war. Please, just stop wasting your time. There is always retaliation for trade barriers, regardless of what other governments do. That’s because the most fundamental principle of trade theory is that trade involves . . . trade. If we buy less from them, they will buy less from us. Always. Yes, it’s that simple. China is not giving us all these goods, we must pay for them with exports. If you think there is some sort of “deficit” then you have left something out.
Foreign individuals always “retaliate” when their home country exports less.
3. It is true that, in any given year, other countries may send us more stuff than we send to them. But the opposite will be equally true in other years. In the long run, trade balances out. Do less importing and you will equally reduce your exports. It’s also true that other countries may send us goods, and we may send them intangibles, like expertise, but that’s still “trade”.
4. Even though trade can be imbalanced in any given year, tariffs do not cause that imbalance to be “corrected.” Thus if the US imposes tariffs on China, it will not cause our deficit to change by any significant amount, because the deficit is caused by a saving/investment imbalance. More specifically, a trade deficit is domestic investment minus domestic saving.
5. The policies of the Trump administration will cause the trade deficit to become bigger, because his economic regime is somewhat anti-saving. Trump’s policies, particularly the ballooning budget deficit, will cause domestic saving to decline, and the trade deficit to get “worse”. I use scare quotes, as a larger trade deficit is not in any meaningful way worse than a smaller deficit. Indeed the trade deficit has already started to grow:
In fairness to Trump, although he will likely fail to reduce the trade deficit (especially the actual deficit–the measured deficit might fall a bit do to the effects of tax reform, which will encourage multinationals to re-label foreign production as domestic production), this “failure” will not actually be a problem. I believe it likely that Trump’s policies will lead to slightly faster RGDP growth, at least for a while (again, partly mismeasurement due to tax reform, but partly actual). Of course in the long run there will be a price to pay in terms of much higher taxes, and that will eventually slow growth.
To use the familiar metaphor, the Trump administration might be foolish enough to shoot off one of its small toes, but it won’t take a shotgun and amputate two of its own feet. And the Chinese know this. I’m often critical of Trump, but he does have one slightly positive quirk, an intense interest in how the stock market views his policies. That’s not a very good way of setting public policy (think clean air), but in this particular case it’s actually very helpful.
READER COMMENTS
Benoit Essiambre
Mar 27 2018 at 9:07pm
What would retaliation even look like? As someone outside the US, I hope that my government wouldn’t start shooting at our own feet in response. Better sit this one out and look at the weird spectacle from a safe distance. We can increase trade with other countries to fill voids from the collateral damage.
Don Boudreaux
Mar 28 2018 at 11:28am
Scott:
I love this post. It’s full of important and original insights. But I pick a nit. Although your claim that trade (or current-account) deficits are “caused by a saving/investment imbalance†is consistent with the conventional manner of describing such deficits, I believe that this conventional manner is highly misleading. I urge you to abandon it.
It’s true that when the U.S. runs a trade deficit during some month, the amount of investment that occurs in the U.S. during that month exceeds the amount saved by Americans during that month. It’s this difference that is conventionally called an “imbalance.†Yet what, exactly, is not in balance? I know of no principle of economics, of finance, or of accounting that suggests that something is ‘imbalanced’ if domestic citizens save less than foreigners. Just as Smith and Jones each might well be acting perfectly prudently with respect to each of their own interests even if Jones saves more than Smith, so, too, might Americans and non-Americans each, as groups, be acting perfectly prudently with respect to each of their own interests even if non-Americans save more than Americans.
Much more fundamentally, though, is the fact that many of these foreign investments in the U.S. are entrepreneurial acts: these investment opportunities exist (and get funded) only because the opportunities for such investments in the U.S. are created by the foreigners who fund them. It is therefore not the case that such investments would have been funded by Americans if only we Americans had saved more. But describing trade deficits as “imbalances†gives the strong misimpression that these investment opportunities are somehow already out there and are funded by foreigners only because we Americans failed to save enough to fund them ourselves. This horribly mistaken notion – which is a never-ending source of fuel for protectionist policies that both you and I deplore – will never disappear if we stick with the convention of describing trade deficits as “imbalances†caused by, or that reflect, inadequate domestic savings.
Philo
Mar 28 2018 at 12:39pm
Perhaps Don Boudreaux is right, that the term ‘imbalance’ carries the negative connotation that something is wrong here. If so, Scott should have used a clearly neutral term, though it is hard to find a descriptive term (‘discrepancy’? ‘shortfall’?) that is entirely free from negative overtones. Perhaps the problem is more with the context than with the term itself: perhaps people feel that a nation *ought to* save enough to finance all domestic investment. (Really, no such principle is valid in general, though it may be true that saving in America is not as great as it should be.)
Let’s reword the offending phrase: “. . . the deficit is caused by the circumstance that domestic investment exceeds domestic saving.” (But some may view even this as suggesting off negativity!)
Philo
Mar 28 2018 at 12:51pm
Boudreaux’s other contribution is to point out that the entrepreneurial acts of foreign investors are likely to be different from the hypothetical entrepreneurial acts of hypothetical American investors who (hypothetically) had saved more than they actually did while, at the same time, the foreigners had refrained from investing in America. The relevance is obscure; for example, there seems to be no reason to expect the foreign investors’ entrepreneurial acts to be more prescient than those of the hypothetical American investors.
Don Boudreaux
Mar 28 2018 at 12:59pm
Philo: You are correct that “there seems to be no reason to expect the foreign investors’ entrepreneurial acts to be more prescient than those of the hypothetical American investors.” But my point does not turn on the existence of any difference in such prescience. My point is merely that many foreign investments in the U.S. are creative entrepreneurial acts – acts the particular forms of which might never occur to Americans. The existence of such acts carried out by non-Americans does not imply that Americans don’t have as many, or even more, such creative acts of entrepreneurship. As long as such acts, by foreigners and by Americans, occur disproportionately in the U.S., then the U.S. will likely run trade deficits. Entrepreneurial creativity, like capital, is not fixed in amount.
Gordon
Mar 28 2018 at 6:18pm
Scott and Don,
Off topic, but I was thinking it would be great if one or both of you would call out the Trump administration’s silliness over its outrage about trans-shipments via your blogs. Apparently, Trump, Wilbur Ross, and Peter Navarro cannot fathom why a country might both import and export a particular commodity at the same time. (Though I suspect if that commodity was gold they would have no objections.)
Scott Sumner
Mar 28 2018 at 11:22pm
Don, All good points, and I mostly agree. I guess I didn’t perceive that ‘imbalance’ had a negative connotation, although I’ll try to remember not to use that term in the future. (Unfortunately, given my bad memory I may slip up occasionally.)
On this point I slightly disagree:
“This horribly mistaken notion – which is a never-ending source of fuel for protectionist policies that both you and I deplore – will never disappear if we stick with the convention of describing trade deficits as “imbalances†caused by, or that reflect, inadequate domestic savings.”
I’d say that once people realize that trade deficits are caused by us saving less than we invest, they come to realize that tariffs would NOT solve the “problem”. (And yes, the scare quotes indicate that I don’t view it as a problem.)
Gordon. I’ll watch for that.
Amy Willis
Mar 29 2018 at 9:55am
@Gordon: Not sure if you caught this one, but it may be of interest, focused on Navarro specifically. http://www.econlib.org/econlog/archives/2018/03/the_danger_of_i.html
Gordon
Mar 29 2018 at 5:57pm
Thanks, Amy. I had not seen this post. I knew about Navarro’s ties to Nucor. And a few weeks ago, I saw an article in which Wilbur Ross was complaining bitterly about countries which imported steel from China while exporting steel to other countries. I’m guessing Ross never thought about why the US does that with oil (and soybeans if I’m not mistaken).
Bonnie
Mar 31 2018 at 7:54pm
The trade deficit graph is quite interesting, most notably the bounce that begins around the end of 2009 and the behavior changes that might entail.
Thanks for bringing it up.
In the past I’ve thought that your criticism of Trump was pretty intense. Though today, while reading your post my thought was that I am not positive that he or his trade negotiators would understand what would constitute “amputating their two feet with a shotgun.” I am really concerned about the potential for damage when they don’t seem to understand what it means to have a growth-rate inflation targeting regime as they go around slapping tariffs on things. There has to be a better way to deal trading partners without damaging ourselves as much or worse in a mindless game of rearranging the deckchairs on the Titanic.
To me, the term “trade deal” doesn’t seem to belong in the same sentence as “free trade”. But then again, perhaps I am rather simple-minded, thinking that “free trade” should be taken as literally as it sounds while Trump and big government should leave it alone if they want to do any good at all.
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