To Donald Trump, trade is not an activity based on mutually beneficial exchange, but a zero-sum game where one party’s gain is automatically the other’s loss. From this perspective, he must see this $400 million gift as a rebate from a partner who has exploited the United States for far too long. 🙂

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It is counterintuitive to think that it might not be a good thing to pay lower prices. However, just because American consumers pay lower sticker prices does not mean that the United States as a whole is receiving more for less as a result of surplus countries subsidizing their manufacturing sector. The current U.S. debate on Chinese EVs illustrates this confusion. Some commentators argue that China’s subsidization of EV production is good for the world because it makes it cheaper to buy EVs, while others argue that Chinese subsidies hurt the U.S. economy and slow the climate transition by making it more difficult for non-Chinese producers to compete.

Although it is true that the sticker price for Chinese EVs is lower as a result of subsidization, this does not mean that it is ultimately China that bears the cost of this subsidy. Rather, because this surge in Chinese EV exports is not balanced by a surge in Chinese imports, U.S. producers are effectively funding these subsidies with lost income. These subsidies distort the production of EVs away from where it might be most efficient and may ultimately prevent EVs from being produced in a way that allows the world to collectively maximize its ability to produce goods needed for the climate transition.

In addition to this decline in manufacturing, the U.S. is being forced to find a way to accommodate the glut of excess savings that surplus countries have exported to the United States. In principle, this adjustment could take the form of either increased investment within the U.S. or a decrease in domestic savings. Evidence suggests that the excess savings imported into the United States has not caused an increase in investment, suggesting instead that the inflow of excess capital has decreased domestic savings.

In the United States, business investment is not constrained by the scarcity of capital but primarily by demand. Indeed, American businesses sit on substantial piles of liquid assets, amounting to $6.9 trillion—approximately 12 percent of their assets, even after engaging in substantial acquisitions and share buybacks.21 Since 1970, the liquid asset share of total assets held by American businesses has risen sharply (see Figure 4). In such a context, in which investable capital is abundant, the economy is unable to absorb excess capital as productive investment. As a result, excess capital from abroad crowds out domestic savings. Thus, although the United States should in theory have a high savings rate (because the U.S. has a high level of income inequality and the rich save more of their income than the poor), the United States in fact has a low savings rate at 19 percent compared with 27 percent for the world.

A number of mechanisms can cause foreign capital inflows to force down the U.S. savings rate. One of them is a rise in unemployment. As the emergence of a trade deficit forces U.S. imports to rise relative to exports, a portion of demand formerly directed toward domestic factories moves to foreign producers, without a compensating increase in demand from abroad for U.S.-produced goods and services. As a result, American producers are forced to lay off workers. Because workers must consume, regardless of their employment status, production falls faster than consumption, reducing the savings rate. Unemployed workers tend to have negative savings rates, as they must consume but typically have little to no income.

However, most studies on the impacts of trade deficits on the U.S. economy do not attribute a substantial decline in employment to the rise of globalization. This is because the U.S. government has compensated for the reduced demand experienced by domestic producers through mechanisms that still force a reduction in American savings. Washington has typically done this through one of two ways: expanding the fiscal deficit or lowering interest rates.

In expanding the deficit, the U.S. government takes on more debt to raise demand in the economy, which lowers domestic savings, accommodating the inflow of foreign savings. When the Federal Reserve lowers interest rates, this expands the money supply, encouraging banks to expand household debt, which households can then use to expand consumption. Because this increase in demand is again fueled by debt, it reduces savings. The combination of lower interest rates and high foreign demand for U.S. assets can also create real estate or stock market bubbles, which further encourages household debt by forcing U.S. households to pay inflated prices for assets.

Trade Intervention for Freer Trade – by Michael Pettis and Erica Hogan