In A Trade War, The Enemy Is Us

From Taxpolicycenter.com

Walt Kelly’s comic strip character Pogo said: “We have met the enemy and he is us.” It seems a particularly apt metaphor for the true effects of President Trump’s trade wars. Ostensibly, his targets are China, Canada, and the members of the European Union (EU). But the real conflict in a trade war is not among countries. Rather, it is among different groups within countries that either benefit from or are hurt by trade restrictions.

There is an additional wrinkle with Trump’s trade wars. In today’s world, most American business and most American consumers could end up losers.

Let’s consider a simple example. Suppose there are only two countries in the world, the United States and China. The US sells food to China and buys clothing from China. Through trade, the US can consume more of both food and clothing by trading with China than if it does not.  That’s because the labor and capital the US uses to produce food to sell to China in exchange for clothing is less than the labor and capital the US would use to produce its own clothing. And the same is true for China’s production of clothing that is sold to the US in exchange for food.  Thus, trade benefits both countries in the aggregate.

But trade does not benefit everyone within each country. If US workers who make clothes cannot become agricultural workers at the same wage or if it takes more capital per worker to produce food than to make clothes, then trade may reduce compensation of US clothing workers, while it enriches US farmers and owners of capital. At the same time, trade could raise incomes of Chinese clothing workers at the expense of Chinese farmers.

This explains why selected groups in each country may support trade restrictions.  (In this example, both US manufacturing workers and Chinese farmers may want to be protected from global competition.)

This example of course is highly over-simplified for a world with many countries, numerous trade deficits and surpluses, and complex global supply chains.  Most trade now takes place among intermediate goods, not final consumer goods, so that import restrictions may impose direct harm on some workers producing goods in competition with imports instead of helping them. And because of this, it is sometimes difficult to identify the ultimate winners and losers from the changed trade patterns caused by new tariffs. 

But the basic principle remains unchanged. In an economy with flexible exchange rates and where monetary policies is designed to maintain demand to keep most people employed, trade policies have little or no effect on total employment. But they can substantially change the composition of output, leading to gains in employment and income in some industries and losses in others. 

Almost all economists dislike trade barriers because they prevent countries from specializing in the production of goods and services at which they are relatively more efficient, thereby lowering average living standards in all countries. And by the standard economists’ arguments, new US tariffs will reduce overall US output and consumption even if other countries do not retaliate.  By responding – predictably - with tariffs and other barriers of their own, other countries are further suppressing trade and making matters worse.

But in today’s multilateral trading world, a unilateral withdrawal by the United States from trade agreements may do us even more harm than if it simply led to higher trade barriers worldwide. Instead, as the recent EU-Japan trade deal suggests, the US tariffs may encourage other countries to strengthen their own trade ties while they impose retaliatory actions against the United States alone. This would place US exporters at a competitive disadvantage with foreign producers of the same products and lead to a general discounting of the value of US-produced goods in global markets. If that happens, there may end up being few winners in the United States. Or none at all.

To sum up, trade wars are generally about the division of income and wealth within countries instead of between countries.  But if this trade war ends up leaving the United States outside of a world trading system, it may end up more like many real wars – with no winners at all.

From Taxpolicycenter.com