Explaining Trump’s Trade Policy: The Economics, Politics & History of Protectionism
By Ajay Sabharwal
On 5th February 2019, President Donald Trump, as a part of his second State of the Union address to the United States Congress, said:
“We are now making it clear to China that after years of targeting our industries, and stealing our intellectual property, the theft of American jobs and wealth has come to an end.
Therefore, we recently imposed tariffs on $250 billion of Chinese goods and now our treasury is receiving billions of dollars a month from a country that never gave us a dime. But I don’t blame China for taking advantage of us; I blame our leaders and representatives for allowing this travesty to happen.
But it must include real, structural change to end unfair trade practices, reduce our chronic trade deficit, and protect American jobs.
I am also asking you to pass the United States Reciprocal Trade Act, so that if another country places an unfair tariff on an American product, we can charge them the exact same tariff on the same product that they sell to us.
The e-commerce amendment was announced without consultation and its impact will ultimately harm the consumer. Amendments should involve a consultative process and preserve the value creation investors are contributing to the development of the emerging e-commerce sector in India. In a global services economy, of which India is an important partner, a free cross-border flow of data is essential.”
On 4th March 2019, it was reported that President Donald Trump had written to congressional leaders, providing notice of his intent to terminate the designation of India as a beneficiary developing country under the Generalized System of Preferences (GSP) programme.[1][2][3] Reuters quoted an excerpt from President Donald Trump’s letter, starting that he was taking such a step because after intensive engagement between the United States and the Government of India, he had determined that India has not assured the United States that it would provide equitable and reasonable access to the markets of India. [4]
India had been a beneficiary of the GSP programme of the United States, i.e. a certain number of products from India were being provided preferential duty-free entry into the United States. Such an exemption, as a part of the trade policy of the United States, was intended to spur exports from and economic growth in the beneficiary countries, most of which, just as India, were developing nations.
Such an action by the United States President does not come as a surprise. Donald Trump ran on a campaign opposing many free-trade agreements and has been criticizing the growing trade deficit since years before he declared his intention to run for the President of the United States. Some of his oldest tweets on the subject are reproduced below.
While there are scores of tweets from Donald Trump on this matter, his words alone will not help in the examination of the issue. The actions and the causes behind them must be understood.
The Economics (and Politics) of Trade Deficits
The economic and political incentives for pushing up tariffs cannot be overlooked. Donald Trump was elected on a platform opposing certain free trade agreements. Economist Peter Navarro’s appointment as the Director of the Office of Trade and Manufacturing Policy shows Trump’s seriousness in implementing his election promises. Peter Navarro has opposed the Trans-Pacific Partnership and North American Free Trade Agreement. Such a position concurs with the Trump’s position of balancing trade and creating jobs in the domestic market. The economic underpinnings of such a trade policy cannot be divorced from the political reality in America.
President Bill Clinton’s tenure in the Oval Office was unlike any other 20th century Democrat. He not only focused on deregulating the financial industry but also supported lowering trade barriers. Without a doubt, the intended consequences of such a policy were to favour the American consumer and by bringing in cheaper goods, keeping inflation low. The trade-off for such a policy was the shrinking incentives for producers that ensued in the outsourcing of manufacturing jobs. As the supply curve shifts outward, consumer surplus increases, which is only at the cost of the producer’s share.
Over the long term, the decreasing producer surplus results in lack of blue-collar job opportunities, which are in effect transferred to countries which have cheaper labour and can now export to America without the additional burden of high tariffs. While this works well for large multinational corporations and service providers, it is not as beneficial for local business, large or small. Needless to say, cheaper labour becomes a strong attraction for such businesses to counter international competition which can only be met with by increasing immigration into the US. This phenomenon across developed countries, including the United States, of high cost labour presents an alternative to businesses to ‘import’ cheaper labour from countries with lower per capita incomes, thus increasing their competitiveness with the more globalized businesses.
Thus, the local population opposed globalized trade that seemingly took away their jobs, whether or not they were replaced by immigrants in their country or workers outside. As manufacturing jobs were clustered in the mid-Northwest or the ‘Rust Belt’, the outsourcing of production to countries with cheaper labour, impacted these areas the most. By the time of the 2016 election, the workers who lost out as a result of trade agreements such as NAFTA, moved away from the political party they had supported traditionally — the Democrats. For the first time, in decades, these areas became swing states. Trump won their support on the assurance of redoing the trade deals, reviving manufacturing and as a result, getting back jobs in the region. Trump’s trade policy, like the ‘economic’ policy of any astute politician, is centered around his voters. He is providing incentives to companies to remain in or return to the United States, and by attempting to balance the trade balance, he is only looking at getting the surplus from the consumer to the producer, and by extension their employees. Thus, such policy, for the lack of a better word, is a means to create a favourable environment for hiring local blue collar workers, both in the Northern Midwest, and the rest of America.
Trump is not the first politician in the world, or even in the west, to support a protectionist trade policy. In fact the norm in the United States, for much of its existence had been the imposition of tariffs on most imported goods, for generating state revenue and bolstering the local industries. The first major Act, passed in the United States was The Tariff Act of 1789, which had two purposes as stated in Section I of the Act which reads as follows:
“Whereas it is necessary for that support of government, for the discharge of the debts of the United States, and the encouragement and protection of manufactures, that duties be laid on goods, wares and merchandise”
As per Alfred Eckes Jr., the Chairman of the U.S. International Trade Commission under President Reagan, from 1871 to 1913, “the average U.S. tariff on dutiable imports never fell below 38 percent [and the] gross national product (GNP) grew 4.3 percent annually, twice the pace in free trade Britain and well above the U.S. average in the 20th century.” [6]
It was during the Presidency of Woodrow Wilson that the United States lowered tariffs significantly and introduced direct taxation as the primary source of revenue generation for the State. The Sixteenth Amendment that was ratified in 1913 empowered the United States Congress to “lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.” While this was a turning point in the economic policy of the United States, with the simultaneous introduction of modern central banking, the more tangible changes came in the second half of the century. After the Second World War, the United States supported the General Agreement on Tariffs and Trade (GATT) and while the surplus started reducing after the GATT came into effect in 1949, it was not till the 1970s the United States started maintaining a trade deficit. After President Nixon took the United States out of the Gold Standard in 1971 and opened trade relations with the People’s Republic of China in 1972–73, the United States’ trade balance started tilting. Since 1975, the slide has continued with the United States trade deficit rising to $795 billion in 2017 with the most recent numbers showing it at $621 billion in 2018.[7]
Economists, since Adam Smith, have debated whether trade deficits are detrimental to a country and while the modern day consensus is in favour of trade deficits not causing any great harm to the importing nation, it is not without its critics. An alternative view to such a trade policy, as propagated by the Trump Administration has been directly or indirectly supported by some of his otherwise critics as well (long before Trump’s campaign started).
Warren Buffet has been advocating reducing the trade deficit for decades now. In 2006, he said that he expected the trade deficit to rise to $700 billion that year. He said, “That’s $2 billion a day. We are like a super rich family that owns a farm the size of Texas. You sell off a little bit of the farm and you don’t see it. Fifteen years ago, the U.S. had no trade deficit with China. Now it’s $200 billion. If we don’t change the course, the rest of the world could own $15 trillion of us. That’s pretty substantial. That’s equal to the value of all American stock.” [9]“That’s the big danger.” he added. He has voiced the same concerns in 2016 in an article for Fortune [10] and as recently as in 2018.
Though Buffet’s reasoning is not sound by itself, the conclusion may still be worthy of some consideration. While most economists argue that a rising and persistent trade deficit merely indicates consumer preferences over a long term and is no big threat, a deficit of such proportions can also amount to a substantial loss in employment, without dynamic structural changes to the economy. Significant technological changes can diminish such an adverse impact when they create new areas for employment opportunities and while this might be the case in innovative economies in the present day, it wasn’t always this way. Free trade, therefore, was not always the norm and the politics surrounding such an economic policy, cannot be divorced from it either. In fact, it was the politics in Early Modern Europe, just as in modern-day America (or any other sovereign country) that trumped economics.
The History of Economics and Politics
The Reformation gave rise to absolutist monarchies across Europe, wherein the Head of the State had complete and unrestricted possession of the instruments of government. There was no curtailment of the political prerogatives and privileges of the monarch whose authority on domestic and foreign policy issues was, for all practical purposes, unlimited. The levers of government in an absolute monarchy, just as in any other political systems, were instruments of direct or indirect rent-seeking. An economic policy that was most in sync with the progression of such a form of governance was mercantilism.
Under mercantilism, the King would have all barriers to local trade removed to create a unified home market, while at the same time imposing external tariffs to prohibit the import of goods that competed with local producers. Exports were encouraged and bringing in bullion was considered prudent and the basis of such a policy was the principle that there was a limited amount of wealth in the world and accumulation of bullion would make a country stronger.[11] To strengthen the economy, i.e. to promote exports, absolutist governments established trading companies that were granted monopoly charters to eliminate domestic competition and make foreign trade more viable.[12] [13]
With the monarch having absolute power in domestic affairs, foreign policy emerged as an important field of operation and projection of power and eventually acquired more importance than domestic policy.[14] This was certainly true of the larger empires, or countries with more hard power capacity, which after a certain point did not have to worry much about domestic integration and hence, could project their influence through the external affairs of the state. France, for example could prevail as a great power because of a higher degree of domestic integration, which in turn provided a stronger economic base, as compared to its neighbouring rivals.
As external trade was a large source of revenue, owing to the gold/bullion reserves arising from it, foreign trade itself became a driver of foreign policy. Not only did countries engage in regular trade wars by way of tariffs and control of seat routes, (as the British and the Dutch contested over the English Channel) foreign trade dominated policy to the extent that countries were willing to go to war to maintain trade supremacy. [15] The Anglo-Dutch Wars that lasted through the 17th and 18th centuries, [16] serve as a prime example of mercantilist policies resulting from a desire to wrest control of sea and trade routes leading to long and strenuous warfare.
European Great Powers also went to war to gain control of and preserve their colonial territories. Colonies fit well in the absolutist-mercantilist set-up as in effect they could only trade with their home country, i.e. the European absolutist monarchy. Such a process increased the trading clouts of the home merchants in and outside the country since these merchants enjoyed a quasi-monopoly over exotic goods such as tobacco and spices that these colonies produced.[17] [18] Colonies can be understood as an extension of the home market as well and thus, from a strategic point of view, the expansion of colonies, in the long term, among other things, meant an expansion of trade.
The establishment of these colonies required hard naval and military power. Native revolts were required to be crushed for trade with the colonies to be profitable. Apart from taking over native settlements in the new world, European powers fought each other to expand their respective colonial enterprises. The Seven Years’ War, for example, was fought between coalitions led by Britain and France between 1755 and 1764 to gain control over colonies in Louisiana, Florida and the Caribbean while territorial status quo was maintained in Europe.[19] [20]
The present day
The modern equivalent of such a set up can be seen in the relationship China shares with most African countries it invests in. While Africa is slowly becoming China’s China, in that it is take up the lower wage production, this is not divorced from China increasing its military presence in the region. The United States itself exerted its military or covert influence through the Cold War to prop up regimes favourable to its trade interests. Gun-boat diplomacy or projection of military power over minor regional players to accept the trade supremacy of the great power remains a constant. American presence in the Latin America serves as key example. In fact, in near absolute parallel to their early modern European counterparts, American trading companies were considered an extension of their home state. Petroleum and Military Industrial Companies still hold that kind of sway, especially in areas where the United States maintains a high military presence. While China and America will not directly lock horns in the modern scenario, they will, in a fashion similar to the European Great Powers in the 18th century, fight for control of smaller economies.
Since a strong political leader was essential for establishing a mercantilist system, the two systems flourished together. As the vested interests of merchants were arbitrary, it was required for decision makers to hold absolute and arbitrary powers to be able to act upon these interests. Since, the law functioned on the will of the king, the economic policies implemented were a mere extension of the relationship the domestic traders shared with their governments. Governments protected the business interests of the local merchants against foreign competition by imposing tariffs and while local producers and exporters reaped the benefits of such a policy. Needless to say, the King and Court got their hefty share.
Local businesses that gain from a protectionist economic policy are bound to put their economic clout behind Trump’s upcoming presidential campaign, but just like absolutist monarchs, Trump’s position is much stronger as compared the trading interests and his recent predecessors. This comes as a result of a certain degree of independence from local elites as much as it comes from the sheer audaciousness of the leader, akin to his early modern European counterparts. The bolder his steps, the more political leeway he will get to implement his policies. The madman theory can be altered to fit the requirements of an absolutist monarch or for the purposes of modern day America, the current President. The Head of State may seem unusual in the context of the last century, but in terms of his economic policy and the political demeanor that goes with it, seems quire the norm in the context of the four that preceded it.
Removing domestic economic regulations and increasing trade barriers accompanied with a foreign policy backing a ‘hawkish’ trade position appear to be hallmarks of a strong leader, who may not enjoy the support of the elites benefiting from an economic system that prevailed for decades. Even though there are no absolutist monarchs in the West, today, strong Heads of State, such as Trump seem to be the closest alternative. Akin to rivalries between erstwhile European great powers, America’s actions are only a natural response to the way the Chinese command structure economy operates. The American President is correct in suggesting that the Chinese are in gross violation of the trade and intellectual property laws, but at the same time, the state owned and quasi-private Chinese companies have the scales titled in their favour on other issues as well. Apart from enjoying strong financial banking from the state, these crony enterprises also have tacit political support. The dynamics of the relations between the trader and the monarch do not seem to have changed in China. The network of the American ‘free-trade’ economy, purely from a structural point of view, lacks the capacity to combat such a tower. (See: Niall Ferguson’s The Square and the Tower) Trump, it must not be forgotten, was elected to disrupt the system, and the changes he brings in, at least on this front will have some lasting permanence. If not for any other reason, at least for the fact that his political rivals on the extreme left of the Democrat Party, support a similar point of view, whether or nor for the same reasons. The likes of Alexandria Ocasio-Cortez and Bernie Sanders who enjoy strong support among millennial voters are in a strong position to dictate the agenda of the Democrat Party and have been doing so. (See: Green New Deal)
Getting back to mercantilism or protectionism, also understood as economic nationalism in the larger context, suits the agenda of a strong leader who invokes nationalist/loyalist sentiments while at the same time equating trade and commerce to a sense of national duty and pride. In a world where politics is driven by optics, economic nationalism seems to be making as much political sense in modern day America, (if not more) as it did in Early Modern/Late Medieval Europe.
As far as the trade-off between producers and consumers is concerned, it continues to perpetuate, at least in the long term, as a pattern consisting of a series of cycles in which, for a specific duration, one group is favoured and after a point when its benefits peak, government start favouring the other group. Here, producers must be taken to include the employers as well as employees. Saving and spending cycles would continue to go hand in hand with such a system and the current change in the United States trade paradigm continues to be just that — a seemingly revolutionary shift, which in the long term is merely a swing of the proverbial pendulum, from one direction to another.
President Donald Trump has been working towards raising tariffs on imports and creating domestic job opportunities. Even though the author is of the opinion that Presidents and their administrations cannot spur growth by themselves, unemployment has been on the decline. [21] However, does this mean the deficit has been curtailed? The answer to this question is a simple ‘no’. The American trade deficit in 2018 was $621 billion. The consequent question — ‘what then?’ requires a more detailed analysis of the American role in the context of the global economy.
Trade balances can be divided into various heads depending on what needs to be examined. One such distinction is that of manufactured and non-manufactured goods. While the trade balance for American manufactured goods has been negative since the turn of the millennium, it has gotten worse in the last few years, both in absolute terms and as a share of the GDP. While non-automotive capital goods such as machinery, aircraft and ships were in a surplus within the same time period, they have turned a negative balance as well. [22] The United States is a primarily only a net exporter of goods of the non-manufactured category, namely agriculture and food.
In layman language, the United States is effectively importing its computers, machinery electronics and even clothing and furniture from China. In return for these finished goods, China buys agricultural produce from the United States and the rest of the balance reads negative on the American side. Students of economic history from post-colonial nations would be reminded of a similar set-up wherein the colony sent in the raw materials whereas the mother/crown country exported the finished products to it. However, it would not be correct to term the United States as a colony of China, in the traditional sense. A key dynamic here is that the even though the United States does not (net) export value added finished products to China (or most of its other trading partners) the United States remains a net exporter of services. For a country, that derives 80 percent of its GDP from the services sector, the United States remains in a comfortable position at least in that it does not mirror the economic, political or technological standing of other erstwhile colonies. While the gross exports of services is as high as $828 billion, the net exports on amount to approximately $270 billion. Matched with a trade balance on goods standing at a negative $891 billion, these figures contribute to the $621 billion deficit in the trade balance of goods and services. The political and military standing of the United States and the demand for the dollar, make any adverse political situation unlikely. At worst, the Chinese will start accumulating assets in the United States but any investment in assets of strategic or political importance would be vetted thoroughly before it could have an unfavourable impact.
Coda
The United States will thus, continue to be a net importer for the foreseeable future, will not have much of a political impact as a result, and will not start accumulating foreign currencies in reserve and the consumption/demand is not likely to fall in the foreseeable future (unless the Federal Reserve orchestrates a rescission in time for the 2020 election). Even a recession would not drop consumption in the United States to a point that erases such large deficit. What then could be the ultimate goal of Trump’s posturing with countries such as China? The answer lies in The Art of the Deal. In the current scenario, China has more skin in the game when compared to America as it has more to lose out of the equation. America, on the other hand, as a trading nation, only stands to gain by an alternation of the current trade agreements it has with its trading partners across the world. Unlike political commentators on mainstream media that understand neither negotiation strategy nor elementary game theory, Trump is a seasoned negotiator and deal maker. He understands that it would not be possible for the United States to overturn its entire trade balance; however, strong posturing in that direction can at least get him favourable leverage over China (and other trading partners) in negotiating trade agreements. That has been Trump’s call from day one. He says that his predecessor was that the trade deals were not favourable to the United States and he intends to renegotiate the position. The Madman theory, or Nixon going to China, fits well with Trump’s posturing on trade. His endgame, on the proverbial 4D chess board, isn’t actually to make the United States a net exporter. He realizes that the United States lacks that capacity. However, getting better deals will be a winner for President Trump both to bolster domestic businesses and to gain political mileage. Akin to an absolutist monarch, his chest-thumping is projection of power external to the domestic affairs, but the positive impact, even if only in terms of optics would serve Trump, the politician well. As far the American trade deficit is concerned, at least for foreseeable future, and till the rest of the world is more in need of the services rendered by Americans than they are in need of goods from the rest of the world, it cannot be done away with. The words of a famous American rock band can be used to summarize the situation rather succinctly:
And in the master’s chambers,
They gathered for the feast
They stab it with their steely knives,
But they just can’t kill the beast.
Author’s biases
The author is a supporter of fiscal prudence by governments and reduction of unessential economic regulation.
References
[1] https://in.reuters.com/article/usa-trade-india/exclusive-u-s-considers-withdrawal-of-zero-tariffs-for-india-sources-idINKCN1PX0ZI
[2] https://in.reuters.com/article/usa-trade-india/trump-moves-to-scrap-trade-privilege-for-india-delhi-plays-down-impact-idINKCN1QM003
[3] https://timesofindia.indiatimes.com/business/india-business/trump-informs-congress-about-intent-to-terminate-gsp-designation-of-india-turkey/articleshow/68263146.cms
[4] https://in.reuters.com/article/usa-trade-india/trump-moves-to-scrap-trade-privilege-for-india-delhi-plays-down-impact-idINKCN1QM003
[5] Original source mentioned in the image. Image accessed from Wikipedia.
[6] https://wikimili.com/en/Foreign_trade_of_the_United_States
[7] https://www.census.gov/foreign-trade/statistics/historical/gands.pdf
[8]https://upload.wikimedia.org/wikipedia/commons/c/c1/US_Trade_Balance_from_1960.svg Data Source: https://www.census.gov/foreign-trade/statistics/historical/gands.pdf
[9] http://www.freerepublic.com/focus/f-news/1560201/posts
[10] http://fortune.com/2016/04/29/warren-buffett-foreign-trade/
[11] Perry Anderson, Lineages of the Absolutist State, 1974, p.35
[12] Douglas Irwin, Mercantilism as Strategic Trade Policy: The Anglo-Dutch Rivalry for the East India Trade, Journal of Political Economy, 1991: 1296–1314.
[13] Kenneth R Andwers, Trade, Plunder and Settlement: Maritime Enterprise and the Genesis of the British Empire, 1480–1630, 1985, pp. 256–260
[14] Richard Bonney, Political Change in France Under Richelieu and Mazarin, 1624–1661. p. 440
[15] Perry Anderson, Lineages of the Absolutist State, 1974. pp. 441, 449
[16] J.R. Jones, The Anglo-Dutch Wars of the Seventeenth Century. pp. 9–15
[17] Kenneth R Andwers, Trade, Plunder and Settlement: Maritime Enterprise and the Genesis of the British Empire, 1480–1630, 1985, pp. 3–4, 43–45.
[18] Hugh Thomas, Rivers of Gold: The Rise of the Spanish Empire, from Columbus to Magellan, 2005, pp. 327–330, 474–476
[19] Fred Anderson, Crucible of War: The Seven Years’ War and the Fate of Empire in British North America, 1754–1766, 2001, pp. 158–160, 453–457, 497–498
[20] Daniel A. Baugh, The Global Seven Years War 1754–1763: Britain and France in a Great Power Contest, 2011, pp. 639–645
[21] https://www.bls.gov/news.release/pdf/empsit.pdf
[22] https://www.bloomberg.com/opinion/articles/2019-03-14/trump-has-to-understand-trade-deficit-before-he-reduces-it
