With the election of The Donald as the next president of the United States the topic of global trade has come to the fore. Mr. Trump claims that global trade is bad for his country and, as a consequence, will torpedo the Trans-Pacific Partnership (TPP), a trade agreement involving 12 Pacific Rim countries (but excluding China). He also wants to rip up the North American Free Trade Agreement (NAFTA), throwing Mexican financial markets in disarray after his surprise victory. Trump threatens to impose import duties of 35% on Mexican goods and to erect a (physical) wall to keep cheap Mexican labour (as well as rapists and drugs traffickers) out of his, soon to be great again, country. And, of course, many of his arrows are pointed towards China, which he has labelled a currency manipulator by intervening in financial markets to keep the yuan artificially cheap. Trump wants to impose a 45% tariff on consumer goods imported from China.
Is global trade going off-track…?
Trump’s views on trade are rather outdated. Since the 90s, many products are tied into global supply chains. Thus, competitiveness should not be measured on a country-by-country basis as for many products this simply is irrelevant. For example, an Apple iPhone has about 1,800 components. Although the phones are “made” in China, many components are sourced from elsewhere, like displays from Japan, DRAM from Korea and Taiwan, batteries from Korea, NFC chips from the Netherlands, etc. Especially for high-value complex products, undoing global supply chains will take years and will be very costly. Also note that not all U.S. companies will benefit from protectionist measures. Some estimates put U.S. sourced components and services as a percentage of import value from Mexico before the goods are sent back north of the Rio Grande as high as 40%.
Furthermore, technology is probably a bigger threat to employment than offshoring. Robotics and artificial intelligence (or machine learning) already have transformed many manufacturing processes but are also expected to make inroads in areas like finance, healthcare and transportation. For example, banks are closing offices by the droves as people increasingly use internet to arrange their bank affairs and IT giants are working on self-driving cars, eventually making cab drivers obsolete (a bright prospect, getting rid of Amsterdam’s cabbies).
Imposition of tariffs is a double-edged sword. It may make some workers in protected industries better off but the cost is paid by consumers in the form of higher prices. As protectionism generally is bad news for Emerging Market economies, a logical consequence would be weaker currencies in those countries. The peso depreciated by 8% after Trump’s election victory, making Mexico even more competitive as exporter. Tariffs on Chinese and Mexican goods will make consumer goods in the U.S. more expensive and, through wage inflation, eventually U.S. exports dearer (to China, Mexico but possibly also to Europe). It is likely that China will impose retaliatory tariffs of its own, further denting U.S. exports. In the case of Mexico, many of its manufacturing plants actually are owned by U.S. corporations. These companies will bear some of the costs in the form of lower profits.
Spot the trade deficits…
If Trump believes that restricting trade is good for jobs, he could go one step further and impose tariffs on interstate trade within the U.S. This would address the migration of jobs from unionized rustbelt states (Pennsylvania, Ohio), whose voters he wants to please, to more liberal “right to work” states (Georgia, Texas). Would the U.S. as a whole really be better off? The answer, of course, is no. Free trade allows efficient allocation of resources by exploiting comparative advantages. This way productivity increases, which spurs economic growth. That is not to say that everybody wins, certainly not in the short term. Some companies will go bankrupt or have to downsize, resulting in job losses. Especially low-skilled labour tends to lose out unless retraining efforts are successful (another reason why nations should invest heavily in education, in our view). Some “losers” may have to be compensated by redistributive income policies. This is true for the U.S. but eventually also for China, which may lose jobs to cheaper countries, like Indonesia and Vietnam.
Mr. Trump has a point that trade must be fair. This mostly relates to China, however. China engages in dumping excess production in international markets (e.g. steel), infringing intellectual property rights and protecting its home market (by making M&A by foreign companies difficult). But it is already possible to address many of these issues without resorting to protectionist policies and, in any case, the U.S. itself is no stranger when it comes to devising protectionist measures.
At this moment, it is unclear whether Trump’s tweets convey upcoming policy initiatives or are just meant as entertainment. We assume that Trump and his crew understand the importance of trade. By reversing global trade and adopting a protectionist economic policy, Trump will hit U.S. voters where it matters most: in their wallet. That is bad economics, really bad…