March 5, 2018 - On Thursday, March 1, President Trump once again shocked the world. He announced general tariffs on U.S. imports of steel and aluminum to the U.S. The proposed tariff on steel imports will be 25%, and that on aluminum imports 10%. They will apply to all countries.
"The response to President Trump's tariff announcement is chaotic," said an analyst at the New York Stock Exchange today. "No-one understands the focus." China, which many people expected to be the focus of President Trump's antagonistic trade policies, called his decision "remarkably stupid" and highlighted the risk to global trade, although it said that the impact on its own steel industry would be small. And the European Union threatened to respond with punitive tariffs on three iconic exports to the U.S.: Harley Davison motorcycles, bourbon whiskey and blue jeans.
But anyone who doesn't understand the focus hasn't been paying attention. As Commerce Secretary Wilbur Ross pointed out in an interview with CNN, President Trump is only doing what he said on the campaign trail that he would do. In fact, he is following practically to the letter the policy prescription laid out by Peter Navarro and Wilbur Ross (yes, the same person) in 2016.
The opening sentence of Navarro & Ross's economic policy paper from September 2016 says this: Donald Trump's economic plan proposes tax cuts, reduced regulation, lower energy costs, and eliminating America's chronic trade deficit.
Navarro and Ross are now senior advisers in the Trump administration. And their plan is now being enacted.
Three of the four pillars of Navarro & Ross's plan are already well under way. Shortly before Christmas, Congress approved a program of large and widespread tax cuts. And President Trump is systematically dismantling environmental programs and regulations, particularly those that inhibit hydrocarbon extraction and processing. The president has identified achieving "energy dominance" as a key objective for his administration.
Now, President Trump has embarked on the fourth pillar - eliminating the trade deficit.
Navarro & Ross blame America's persistent trade deficit for slow growth (my emphasis): The growth in any nation's gross domestic product (GDP) - and therefore its ability to create jobs and generate additional income and tax revenues - is driven by four factors: consumption growth, the growth in government spending, investment growth, and net exports. When net exports are negative, that is, when a country runs a trade deficit by importing more than it exports, this subtracts from growth.
This is mercantilist nonsense. Provided the exchange rate is free to adjust, as it is in the U.S., the trade balance is largely irrelevant for growth. Consumption growth can suck in imports, resulting in both a trade deficit and higher growth. Of course, growth founded on rising consumption can be unsustainable if it is associated with fast-rising debt, as it was prior to the 2008 financial crisis. A shock to income, such as a sudden spike in oil prices, can trigger widespread debt default and import collapse, resulting in a recession. There are therefore good reasons not to rely on consumption alone for growth. But it is simply not true that a trade deficit is necessarily a drag on growth.
Navarro & Ross also argue that a trade deficit reduces business investment (my emphasis): We focus on nonresidential fixed investment in this analysis because it specifically measures capital investment in new plant and equipment (and intellectual property).
To the extent unfavorable tax, trade, energy, and/or regulatory policies "push" capital investment offshore or discourage onshore investment, nonresidential fixed investment is reduced in the GDP equation, and this "offshoring drag" subtracts directly from GDP growth.
This is bizarre. In the national accounts, a current account deficit (of which a large proportion is trade) is necessarily balanced by a capital account surplus - which is inward investment. In other words, the U.S. imports capital. Some of that capital no doubt goes into poorly productive investment such as real estate - though even real estate investment creates jobs and incomes, not just in construction but in ancillary businesses such as furnishings. But it is simply not credible that there is no increase in business investment when America is running a capital surplus. I suspect the problem is that Navarro & Ross place a great deal of emphasis on offshoring by American companies, but completely ignore inward investment by foreign companies. So, for example, they complain about GM and Ford offshoring manufacturing to Mexico or China, but fail to mention that the German car manufacturers BMW, Volkswagen and Mercedes-Benz all manufacture cars in the U.S. If you cherry-pick your companies, you can prove that there is an abject failure of business investment even when there is evidently significant foreign inward investment in manufacturing as well as services.
But the fact that Navarro & Ross don't appear to understand how sectoral balances work, and have a decidedly skewed view of the U.S. manufacturing sector, is irrelevant. They have the President's ear. And they believe a trade deficit is bad news for economic growth and employment:These trade-related structural problems of the US economy have translated into slower growth, fewer jobs, and a rising public debt. For example, each additional point of real GDP growth translates into roughly 1.2 million jobs.10 When the US economy grows at a rate of only 1.9% annually instead of its historic norm of 3.5%, we create almost 2 million fewer jobs a year.
So they want to close America's persistent trade deficit. But what do they think is the key cause of that deficit?
In a word, cheating. Unfair trade practices by America's principal trade partners. They identify three main ones:
- currency manipulation
- mercantilist trade practices
- trade deals that disadvantage the U.S.
And they list the countries they think are principally involved in cheating the U.S.: Consider that roughly half of our trade deficit is with just six countries: Canada, China, Germany, Japan, Mexico and South Korea. If we look at the bilateral relationships of America with each of these countries, improvement in our trade balance is clearly achievable through some combination of increased exports and reduced imports, albeit after some tough, smart negotiations - an obvious Trump strength.
Those who were expecting Trump to impose specific tariffs on China for steel dumping, as the European Union has done, need to read Navarro & Ross's paper. Canada, not China, is the largest exporter of steel to the U.S., and Mexico is no.4. Other large exporters of steel to the U.S. include South Korea, Japan and Germany. All of these countries export more steel to the U.S. than China does. All of them feature on Navarro & Ross's list.
China is No. 4 on the list of the U.S.'s top sources of aluminium, but the top country is once again Canada.
These tariffs are clearly intended to influence the NAFTA renegotiation currently under way. Presumably this is President Trump's idea of "tough, smart negotiations." It remains to be seen what, if any, effect such an antagonistic stance will have, but I find it difficult to believe that it will be remotely helpful. Trade war appears to be on the menu.