There are many adjectives that could be used to describe Donald Trump. Probably the first that come to mind are uncouth and boorish, however from all accounts he can be charming in the face to face meeting, which indicates that two-faced is closer to the mark. That he is shrewd is beyond question, particularly in the sense of being media savvy, but, whether he is wise, is open to doubt. Often what sounds logical, fails the test when subjected to scrutiny.
Let us consider some of his proclamations and actions.
Trump imposes import tariffs is this wise?
The lessons of the 1930's, forgotten or never learnt. There is no winner in a trade war.
Firstly we must be aware that international trade in goods is in the main regulated by World Trade Organisation rules and the duties imposed by Trump run contrary to those rules. Arbitrary duties can only be applied when a country is guilty of dumping, selling goods to external markets at below the prices charged on it’s local market. This is usually difficult to prove, which is a drawback in WTO rules.
The idea of duties is to give a country’s local producers a level of protection against outside competition. Developing economies are granted greater latitude in this regard, as it is, a natural right of every country to firstly look after it’s own population and peoples jobs.
The effect of duties is complex, as it does not actually impose a cost on the exporting country, but rather on the importer therefore increasing prices in the importing country’s markets. This can result in an increase in local production over the long term, never in the short term! Business generally requires time to invest and increase output and usually we would expect to see results in two to three years, perhaps a little quicker on the fringes. However, it is most likely simply to see prices rise the local market, as business is unlikely to take the risk of investing on the basis of a protective duty, which could be dropped as easily as it was imposed.
Most countries protect their local markets by regulation rather than duties. To whit, the USA, EU, Japan and China. In all these countries regulation plays a bigger role than duties.
From an accounting point of view, duties will narrow the fiscal deficit (government deficit) but actually be negative to the population as a whole! If we look at this in the round, we see that, duties simply amount to a transfer from the local population to the government, or a tax on the people, and therefore results in a reduction of the spending power of the population, ultimately reducing business activity.
To the exporting country the duty imposed implies that the size of the market is likely to shrink, as a price increase, might have an impact on the affordability or desirability of the product. For example, a person might choose an alternative product because of the price increase.
From this we should see that the imposition of duties are unlikely to have the desired impact, and that short of substantial internal investment will only have an inflationary impact.
Now let us consider the claim that China is being unfair because it has a big trade surplus with the USA.
Firstly we need to understand price from an economic perspective.
Price = Labour + Interest + Rent + Profits + Tax.
While the individual company might not see this, as not all the components of a product are manufactured by itself, it is ultimately the sole equation for price. In terms of world trade, countries which possess minerals and raw materials required in the manufacturing process have a slight competitive advantage, but, largely mitigated against by the existence of ‘commodity markets’.
Trump complains that China forces technology transfer and is thus unfair to American companies. This may seem to be true, but is inevitable when the manufacturing process is moved to a foreign country. The question is therefore ‘Did China force companies to manufacture in China for access to the Chinese market?’ or ‘Did companies choose to manufacture in China, because of the need to reduce their cost to make their products affordable for the Chinese market?’
We only need to look at the relative costs of labour in the USA and China to correctly guess the answer!
The real problem arose out of companies choosing to close down their USA production and to export back into the USA from their Chinese production units, as a means of increasing their profits! This is further exaggerated by a flaw in the USA tax system whereby foreign profits are not taxed until the proceeds are transferred to the USA.
I assume that a certain amount of dumping as well as state subsidisation (against WTO rules) by the Chinese Government does take place but somehow doubt that this is the primary cause of the vast trade deficit incurred by the USA with China. I see rather that the profit motive of business will drive them toward choosing to manufacture in countries with the lowest cost equation, this is and has been the big driver of the USA trade deficit with China.
To say that China is unique in dumping is foolhardy, one only needs to look at pricing models of most multi-national companies to see that they all practise dumping based on ‘what the particular market can bare’.
State subsidy is far more insidious and takes many different forms, from tax incentives to exporters through to direct subsidisation or state loans to enterprises. In this regard with a large proportion of the Chinese primary industry being state owned there will always be an element of state subsidy in their output.
If you cast your eyes back to my price formula you will see I included tax as an item. Most economists do not, which, is partially why most economic models are incomplete and tend to give distortions when projected into the future.
Trump cuts USA taxes.
Tax relief is the most common form of subsidy, however, far more far reaching is the case where a country out of choice reduces it’s tax rates so low that they fail to recover the costs of government!
Consistently running a Fiscal deficit actually amounts to wholesale subsidisation of prices. It is my contention that this type of economic policy should be looked on as direct subsidy of prices in the world markets and should become grounds within the WTO for applying duties beyond those normally applied in terms of WTO rules. Obviously, short term deficits to counter some sort of trade cycle shock need to be viewed differently.
In the case of the USA there has been an ever growing Fiscal deficit ever since the presidency of Ronald Reagan! One might be inclined to forgiving this where the deficit is mainly being funded by the people of that country, as the risks are confined to that country. This has not been the case with the USA, where from being the ‘Banker’ of the Western world up until 1980 it has steadily become the debtor of the world, in net debt even to the world’s poorest nations!
While the fans of tax cuts claim that these result in increased tax takings, they have only been shown to result in increased deficits! If, indeed, the argument were true, what would happen if we reduced tax rates to 1% or even zero?
Trump’s tax cuts, while providing another short term stimulus to the USA economy will only increase the level of indebtedness of the USA. In the long term they will result in an even bigger shock to the world financial system than the 2007/2008 credit crunch, which had it’s roots in the economic policies of the USA and UK dating back to Reagan and Thatcher.
The USA trade position vis-à-vis the rest of the world can only change with local internal investment, no amount of protective duties will change that position, as duties can only serve to increase prices and reduce overall business activity! Foreign investment does not have the same impact as local investment because the profits from that investment move out of the country and therefore do not form part of the income of the country. This is not immediately apparent if we only look at GDP as an indicator of the health of an economy, but is self evident when we look at the total picture.
So much for Trump’s economic policies.
Other aspects of Donald Trump and his policies to follow ….