In Trump’s US and closer to home, decision-makers don’t understand how the global economy really worksby David Henig / January 4, 2019 / Leave a comment
US trade is really quite simple in the eyes of President Trump. As he said in March 2018, “we as a nation lost $817bn dollars on trade. That’s ridiculous and it’s unacceptable.” A trade deficit is bad, and such a big trade deficit particularly bad. Tariffs are the answer, and in this way domestic industries will be protected and the trade deficit will go down.
Trump said in December 2018: “I am a Tariff Man. When people or countries come in to raid the great wealth of our nation, I want them to pay for the privilege of doing so.”
Though it’s unlikely that anyone would use the same language as Trump in the UK, you could extend the argument to UK-EU trade. The UK has a trade deficit with the EU, and therefore the single market is biased against us, but they need us more than we need them. Our trade surplus with countries outside the EU shows why it makes good sense to leave.
All very straightforward, but unfortunately all completely incorrect. Trade deficits, the balance between goods and services exported and imported, are not inherently good or bad. The figure President Trump cited was the only the deficit for goods, ignoring the approximately $250bn surplus the US has in services trade. Tariffs on the other hand impose extra costs and reduce choice for consumers, and are economically inefficient. Increasing them does not necessarily reduce trade deficits, as the US has seen, with its trade deficit increasing in 2018 despite the imposition of various new tariffs.
When discussing the trade deficit it is vital we consider the other related variables, most significantly, inward investment, which is the balance for a trade deficit. Put simply, a country’s trade deficit is offset by the inward flow of capital, which allows the continued operation of such a deficit. Some have suggested we should think of a deficit in a developed country as meaning foreign investors subsidising domestic consumption. Which doesn’t sound like a raid on the wealth of a nation.
Were the suppliers of the capital to lose confidence in a country, as we saw for example in the Asian financial crisis of 1997, then a trade deficit becomes a real issue. In this situation we typically see a currency devaluation and inflation, making acquiring imports more expensive, and exports more competitive. In this way there is a correction, though at a considerable short-term cost.
The US has run a trade deficit since 1982, the UK since 1984, and there is little sign of investors losing confidence. There is however another question that could be asked of a trade deficit, which is whether this inevitably leads to a greater percentage of the country in effect being owed to foreign investors. Clearly debts must always be paid, but in both the UK and US this works both ways, we have a large stock of inward investment, but equally significant investments in other countries (for example for the US inward stock of FDI is valued at over $4trn, but the value of US holdings abroad over $5trn).
In a world where a significant percentage of world trade is within individual companies, a more significant question is whether we need new measures in place of longstanding metrics such as the trade deficit. Take for example the case of Apple devices assembled in China for a US company using Intellectual Property from a number of other countries. When an iphone is sold in the US this counts towards the US deficit with China, but there will also be a number of capital flows associated with the transaction. Even products that are physically produced and consumed in one country may impact the trade deficit, for example in the way that Amazon is structured in Europe where UK sales come through a subsidiary of a Luxembourg company. Add in the sheer volume of capital flows associated with the financial sector, for example, and it is not surprising that both the US and UK think we run a trade surplus with each other.
One of the stranger effects of Brexit and the election of President Trump has been to reveal that we know rather less about the functioning of our economy than is healthy. The last 20 years have seen the rise of global value chains and intra-company trade, linked to the growth of multinationals easily able to navigate the complexities of different regulatory systems. Until 2016 the focus of much trade policy effort was removing barriers to trade, notably in terms of tackling non-tariff barriers. In theory this should particularly aid smaller companies unable to invest in navigating differing rules, while strengthening global supply chains.
We are now trying to understand the impact of increased barriers, whether through increased US tariffs or the UK leaving an integrated international market. We don’t know enough to understand this fully, not least given how much will be down to the decisions of the global players. In this complex situation it is understandable that many are turning their thoughts to apparently simpler times, essentially the 1970s and before, in seeking solutions such as public ownership, leaving a trading bloc, or imposing new tariffs. It is doubtful though that such solutions can bring back large manufacturing plants or better high streets. Perhaps what is really needed is to find new measures—especially given existing ones, such as that of the trade deficit or surplus, mean so little.