President Trump’s proposed tariffs have attracted almost universal criticism, both in Europe and America, from commentators of all political persuasions and from economists. The spectre of protectionism, the retreat behind tariff walls, and the demise of international free trade looms large and threatens the prosperity of all countries, America included and perhaps America most of all. Such is the stupidity, pig-headedness and economic illiteracy of Trump.
The standard economic analysis is simple: protecting inefficient industries may preserve jobs in those industries, at least in the short run, but the economic gain is more than outweighed by increased costs, uncompetitiveness and job losses in the rest of the economy, which now pays increased prices for the products of these inefficient industries. When this effect is multiplied worldwide, as tit-for-tat retaliation takes effect, the economic cost is colossal.
Of course, this is all true; but commentators who brandish Ricardo’s doctrine of comparative costs (the original economic justification of free trade), according to which countries are better off if they specialise in the sectors in which they have comparative cost advantage (let England produce cloth, Portugal wine, and the two can be exchanged to mutual advantage), forget that the system only works if countries trade at the correct rate of exchange. What is this rate of exchange? It is the rate at which the value of imports and exports is equalised. There is no need to fix this rate of exchange: the market will see to it. If it is too high for country A, then imports will exceed exports, the demand for foreign currency (to pay for those imports) will exceed supply (earnings from exports), and the currency will depreciate until equilibrium is restored. Such is the beauty of markets.
But what if country A (let us call it America) runs a persistent trade deficit with country B (let us call it China)? What if exchange rate equilibrium is not restored to correct the trade imbalance because China, as a deliberate act of policy, for political reasons, maintains an undervalued currency and uses the vast dollar reserves it builds up to buy up assets overseas, including in America? The problem is obvious, and the game is changed.
Some would blame American industry for being relatively inefficient. But the whole purpose of international trade is to enable countries to trade to mutual advantage regardless of their relative productivities and costs. Indeed, Ricardo notes that even if country A has lower productivity in all sectors than country B, it still better off under international trade so long as it specialises in those sectors in which it is relatively least inefficient. There is no economic reason for persistent trade imbalances to arise at all.
Trump’s policy pronouncements might be ill-thought-out in their practical detail and stand in need of correction by his advisors, but he has grasped a crucial point about international trade that has escaped idealistic economists armed with theoretical models: the current terms on which trade is conducted with China are bad for America!
Would that we in Britain might wake up to this. Why does China have a seemingly inexhaustible stock of capital to invest in our industries, our property, and national assets, whereas we have next to none and are wholly dependent on foreign investment – i.e. on flogging off our assets? Because China runs a huge trade surplus and we run a huge trade deficit. The great game is afoot; but their game is long, while ours is short.