US Trade Policy: The Troika's Path is Cleared

The Trump Administration's trade policy intentions have been clear, and the resignation of Cohn removes a distraction and a fifth column globalist from its midst. The path for the heterodox trade Troika of Navarro, Ross, and Lighthizer is clear.  

When White House Communications Direct Hope Hiks left the Administration, some pundit quipped that there was no more Hope in the White House.  But the resignation of Cohn dashes whatever lingering hope there may have been, even at this late date, the Trump Administration can be turned from its mercantilist trade views. 

A paper written by Navarro and Ross in September 2016 (Scoring the Trump Economic Plan:  Trade, Regulatory, & Energy Policy Impacts) clearly lays out the strategy and rationale.  Simply put, the competitiveness of the US has been held back by the incentive structure of the tax code (ostensibly now addressed), the regulatory burden (rollback has come, though the judicial branch is checking such efforts), and by unfair trade practices abroad, which include undervalued currencies and illegal export subsidies.  

Traditionally, ideological divisions were understood as paramount; hardened by the Cold War and reinforced by the rise of Islamic fundamentalism.  Countering this was the pillars of the post-WWII institutions, like the GATT/WTO, IMF, World Bank, the UN that sought to build an international community and the rule of law, and foster a particularly American brand of globalism (what I argue in my recent book, Political Economy of Tomorrow, is the globalization of the Open Door policy).  

The Troika sees this as a mistake.  If Wilson's League of Nations was idealistic, then the post-WWII institutions must be more of the same.  The Troika offer a different brand of realism.  There is no international community.  There are lots of nations and they are always fighting for their national interest.  It is a permanent struggle for contingent gains.  In this worldview, inter-capitalist rivalries are just as important and economically significant if not more so, than the ideological struggles. 

Globalization is held responsible for the decline in manufacturing jobs, which are seen as crucial for middle-class economic security.  Ross and Navarro argue against claims that automation is responsible for the lion's share of the decline in manufacturing employment from 22% in 1977 to around 8% now.   They cite that fact that Germany and Japan have a larger share of employment in manufacturing than the US (20% and 17% respectively).  

Navarro and Ross write:  "According to textbook theory, balanced trade among nations should be the long-term norm, and the chronic and massive trade deficits the US has sustained over a decade simply should not exist.  This textbook state of balanced trade would exist because freely floating currencies would effectively adjust differences in national domestic costs structures and bring about balanced trade." 

It sounds reasonable, but the logic is flawed. Our understanding of the economy has progressed since the textbooks that Navarro and Ross read.  Specifically, since the early 1980s, a decade or so after Nixon delivered the coup de grace to Bretton Woods, capital mobility has increased markedly.  

In one week, the foreign exchange market sees the turnover that could finance trade for a year.  A price for foreign exchange that clears the goods market may not be sufficient to clear the market for capital.  That is to suggest that textbooks often offer students a simplified model to introduce the subject matter.  It is a beginning point, not the last word.  

Ross and Navarro are explicitly critical of countries that buy US Treasury bonds.  Let that sink in.  Countries with bilateral trade surpluses with the US, and this is not just China, but Japan and Germany who have accumulated Treasuries. Accumulation of Treasuries is a way to prevent their currencies from appreciating, which in effect, so the argument goes, blocks the "invisible hand" from working.  The US growth is weaker than it would otherwise be, and employment is lower.  To be sure, this view had already been represented in the Obama Administration, but the globalists had the upper hand.  

When it came to tax reform and the budget, the Trump Administration insisted upon dynamic scoring.  Lower taxes, went the argument, would boost growth and revenues.  However, when it comes to trade, a rather static model is used.  The response by other countries is not fully considered.  The risk of trade war is acknowledged but then quickly dismissed.  

Most importantly, Ross and Navarro argue that we are already in a trade war. "It is a war in which the American government has surrendered before engaging.  Unfair trade practices and policies of our competitors are overlooked or ignored...Our major trading partners are far more likely to cooperate with an America resolute about balancing trading than they are likely to provoke a trade war.  This is true for one very simple reason:  America's major trading partners are far more dependent on American markets than America is on their markets."

The officials note that six countries account for half of the US trade deficit:  Canada, China, Germany, Japan, Mexico and South Korea.   Navarro and Ross insist that the bilateral balances can be improved by increasing exports and reducing imports.  Note that most of the countries in this short list have trade and/or important military ties to the US. A broad definition of national security was apparently used to legitimate the steel and aluminum tariffs but not seemingly applied to the economic well-being of our allies.  

Some economists have questioned whether the US has the economic capacity to boost exports by a sufficient amount to close the deficit. About 1% of US companies export.  The goods deficit was about $75.3 bln in January and US manufacturing output and exports are near record levels.  

Manufacturing output has never been greater, but it is being achieved with fewer workers.  This is not a Sphinx-like riddle.  The answer is clear: productivity.   America's manufacturing sector is the most productive in the world.  Because it is productive, businesses can afford to pay employees higher wages than in many other countries.  

The same thing happened to our great-grandparents’ generation as the application of science and modern techniques freed people from the farm.  The farm jobs were not stolen by countries that have larger agriculture sectors, like India or China.  A similar transition to high value-added work that was experienced in agriculture is the most important driver for the decline in manufacturing jobs, which incidentally, appear to be falling around the world.  It has begun happening in parts of the service sector too.  

Lastly, we think there is a misunderstanding of the way the US commercial empire works and this misunderstanding is not limited to current officials.  The traditional approach to foreign policy was spheres of influence.  Wars were often fought as a country sought to increase its sphere of influence at the expense of another.  In the late 1800s, China was being carved up by the imperial powers of Europe and Japan.  Numerous concessions (spheres of influence) were granted.  Think of Hong Kong or the Bund District.  

As the new and rising power at the time, the US offered a revisionist view.  It challenged the fixed spheres of influence strategy with one based on variable shares of the world economy.  The variability was to be determined by economic prowess, not political concessions or war.   This was the logic that compelled the US to defend China's territorial integrity, for example. 

After WWII, American policymakers feared two things above all else.  A return to Great Depression economic conditions and the spread of Communism.  The solution to both fears was stronger world growth.  The US foreign direct investment strategy grew out of that.  The US dollar was strong, countries could rebuild and the US accepted discriminatory trade practices.  

To get around the protectionist walls, given the strong dollar, building plant and production abroad made sense.  It promoted growth and may have helped turn back Communism in Europe and elsewhere.  Under persistent pressure to allow the yen to appreciate and US protectionism (think "voluntary" export restrictions and orderly market agreements) Japanese autos and parts makers shifted production to the US in the 1980s and 1990s.  

We fully understand some of the recent arguments that emphasize various forms of tax arbitrage to explain globalization and direct investment.  We would share two observations.  First, the globalization of production is over-determined and technological advances in command, control, and communication were necessary as was the liberalization of capital beginning in the 1980s.  Second, it seems that the rise of US multinational companies took place first, and then their ability to influence legislation (regulator-capture model) to favor their activity was exerted.  

Officials point out asymmetries on individual tariffs.  It is true, but not a fair or complete assessment.  The overall tariff schedule is negotiated and tradeoffs are made, and initial conditions matter.  Re-opening discussions and negotiations is fair, but there are ways to do it that are effective and other ways that are less so.  

It takes two to tango, as they say, and it is true about trade wars as much as dancing.  How other countries respond to the new provocation is key now.  We suspect that aside from some symbolic action, most countries will seek to avoid a tit-for-tat approach.  Many officials we have spoken with in Asia and Europe seem more inclined to make some small concessions if necessary to the US and bide the time cautiously, apparently waiting for the change in the US political climate, which could come with the midterm elections in eight months.   In the meantime, like old Roman emperors demanding higher tribute from its colonies, the US is seen seeking to boost its share of distributional gains accrued through trade. 

 

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