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How the US is busting myths and convention on trade

After decades spent promoting free trade and its benefits, we are now at a point where countries are debating who has benefitted the most.

The vast majority of economists the world over tout the benefits of free trade. It is the natural and optimal thing to do. We are also unanimous in our opinion that trade wars such as the one unleashed by the United States on China, the European Union and even Canada, lead to a reduction in economic well-being on all sides. Since countries don't roll over and play dead when tariffs are imposed on their exports, protectionism of this sort is met with retaliation, and the ratcheting continues, heightening anxiety, damaging relations and threatening a collapse of the world commercial order. There are no winners in this game. But which country loses the most depends on a host of factors.
Leaders of nations are not expected to be trained economists. In the case of the US, a president has at his beck and call some of the best minds in economics. So, it is hard to understand how the US president could have ignored conventional wisdom and discounted the fact that there is a lot more to one nation's dealings with another than just trade in goods. Like the 17th century mercantilists, who believed in maximising exports and minimising imports, Trump seemingly cannot abide trade deficits. But, merchandise trade in goods is only one aspect of a complex set of accounts that record transactions between nations called the balance of payments (BoP). The BoP considers not only of trade in goods but also trade in services as well as direct and portfolio investment between countries and other capital flows. Studying the entire BoP would have revealed some interesting details, such as the fact that while the US runs a trade deficit in goods, it in fact enjoys a surplus in services. Analogous to a company's balance sheet, the BoP consists of the current account and the capital account. The US current account has been in deficit for decades. But that has not affected the strength and stability of the US dollar. Why? Because of the inflow of foreign capital resulting in a surplus on the capital account. China, for example, invests a good portion of its huge foreign exchange reserves, the largest in the world, in US treasury bills and other debt.
The US has one of the lowest savings rates in the industrialised world. So where do funds for investment come from? From foreigners. This enables US investment and GDP to grow. A couple of hours spent with a few professional and proficient economists might have averted this situation.
There can be little doubt that the decision to impose tariffs will backfire badly on American consumers and producers. First of all, it should be patently obvious that the imposition of duties on imported goods does not reduce a trade deficit. Secondly, it is absurd, bordering on bizarre, to suggest that the tariffs collected at the border on imported goods will help pay off the US national debt as has been suggested by Trump.
Thirdly, and more importantly, before taking the drastic step of imposing across the board tariffs, a country needs to thoroughly investigate two critical factors. Do the imported goods (on which tariffs have been imposed) have effective and readily available substitutes? And what is likely to be the effect on consumption in the country imposing the tariffs to now higher prices for these imported goods - the responsiveness of demand to price changes or the price elasticity of the goods in question.
Take children's toys for example. These are nowadays mostly made in China. If the US were to impose tariffs on Chinese-made children's toys - i.e. almost all toys - parents would see a price rise in toy stores. Demand for toys is inelastic, meaning parents will still buy toys regardless of the price increase - after all, a child's birthday is priceless.
Will they be happy paying a higher price? Certainly not. Can they look for toys made in some other country? Doesn't exist. Who gets hurt here? The US consumer.
Meanwhile, on the Chinese side, China imports soybeans from the US. These soybeans are produced mainly in the states that ostensibly voted for Trump. The Chinese could impose tariffs on US soybeans making them more expensive in China. But Chinese importers have alternatives and can easily source soybeans from Brazil or some other country. Who gets hurt here? US soybean producers.
Further, in the case of the US and China, China can simply instruct (as in order) its citizens to boycott US products. Starbucks, McDonalds, Apple, GM, Boeing and a host of other American companies, whose products have ready alternatives available, could suffer considerable damage.
Before this totally unnecessary and inane tariff game began, the countries of the world met several times in various trade 'rounds' to reduce and even eliminate protectionism.
In 2016, the US had a weighted average tariff rate of 1.6 per cent, China was 3.5 per cent, the EU was less than 5 per cent and even India and Brazil, both highly protectionist in the past, had reduced their weighted averages to 6.3 and 8 per cent, respectively.
There were some quirky holdouts like Japan's utterly ludicrous 700 per cent tariff on imported rice (to protect a handful of rice farmers). The world was indeed moving towards free trade, the most potent instrument for reducing poverty and creating employment and wealth and advocated since the times of Adam Smith and David Ricardo.
And now we are regressing. Back to the dark ages of punitive tariffs, this time not to protect infant industries but to supposedly raise employment in an economy already at full employment (US) and for other opaque, obscure and unfathomable reasons. After decades spent promoting free trade and its benefits we are now at a point where countries look at lists of imported goods and decide what tariff percentage to impose in retaliation knowing fully well that either producers or consumers or both will be hurt by it. To paraphrase Shakespeare, it resembles a game played by idiots, full of sound and fury - signifying nothing.
Sanjay Modak is Chair, Graduate Programs & Research Dept and teaches economics at the Rochester Institute of Technology, Dubai.