Via FFWiley.com,

Worried that recent U.S.–China trade dialog sounds like a Mayweather–McGregor promotional tour? Concerned that we might be headed for a repeat of the Great Depression era’s race-to-the-bottom tariff wars? Or, maybe you’re relieved that diplomats are no longer being diplomatic? Maybe you think it’s about time Washington stood up for American jobs?

However you feel, we suggest stepping back to review your armchair-policymaker options. In particular, we recommend answering two questions, as in the table below: 

trade article aug 2017 table 1

We explain our mapping one quadrant at a time, starting with the lower-right (LR).

LR—Free trade is good, and it’s okay to run huge deficits. The lower-right claims the mainstream core of both major parties. Sure, mainstream politicians sometimes hop into the other quadrants, but usually for show. When the public isn’t paying attention, they normally hop right back. But they don’t pursue the pure free trade that many economists would like to see. All countries protect their businesses from foreign competition, and we’re obliged to do the same. What passes for free trade is a parade of bilateral and multilateral agreements that gradually knock down barriers. Whether you support those agreements depends largely on your comfort with 1) the political and often crony-capitalistic process involved, and 2) the skills of our trade negotiators. (You don’t think pundits actually read the agreements, do you?) But those factors depend, in turn, on your comfort with large trade deficits. By embracing the status quo, mainstream politicians signal that they support free(-er) trade and that they don’t mind that America imports way more than she exports.

 

LL—Free trade is bad, but deficits aren’t the issue. The lower-left bubbled up especially in 1999 and the early 2000s, when noisy protesters interrupted gatherings of the World Trade Organization (WTO). But protesters didn’t shout “Make America Great,” and they didn’t complain much about the unemployment rate in, say, Michigan. They focused more on working conditions in, say, Shenzhen. Although a diverse group, its core appeared to be anti-capitalist and especially anti the notion that developed nations force capitalism on the rest of the world.

 

UL—Trade needs to be less free, and largely because our deficits are killing us. Ten or fifteen years ago, the upper-left included much of Middle America and a few rogue politicians. Today it includes even more of Middle America and even more rogue politicians. And you may have noticed that the rogues have more power than they used to have. They’ve pulled the mainstream upward and leftward, to a degree. But let’s face it, they’re still rogues.

 

UR—Trade should be more free, but without allowing deficits to grow so large. We call the upper-right “home,” although we’re not entirely happy with our home. It lacks the lower-right’s authority, the lower-left’s energy, and the upper-left’s voice. Nonetheless, we suspect there are more like us—those who prefer the upper-right to the alternatives. That’s partly because we know people who see things as we do, but we’ve also noticed a change in the public debate. Certain pundits have started pointing out the downside to chronic trade deficits (often citing recent research but maybe also thanks to the rogues?), and without abandoning their support for free trade.

But the UR quadrant begs the question: How do you simultaneously constrain deficits and knock down trade barriers? We claim an answer in the table below (you might recognize a thinly disguised version of Warren Buffet’s proposal for import certificates), alongside policies to match the other three quadrants.

trade article aug 2017 table 2

Tweaking Warren Buffet’s Import Certificates proposal

As noted above, we modeled our UR-quadrant policies after Buffet’s certificates. But we use the term import credits. (Who needs a paper certificate?) Also, our rationale for the approach is different than Buffett’s rationale, as we’ll explain shortly. First, here’s our version of how it might work:

  • Businesses submit their exports to a recordkeeping system (or possibly a blockchain) that assigns credits (ICs) for the verified dollar amounts of those exports.
  • When businesses import, customs agents debit their IC balances.
  • Should an importer’s balance fall below some negative threshold, it faces penalties.
  • Businesses are left on their own to trade the ICs, although using the recordkeeping system (or blockchain) to record transactions.
  • Policymakers can uniformly debit importers for less than the dollar amounts of their imports, thereby assigning a non-zero cap to the overall trade deficit.

In other words, exporters receive ICs that they then sell to importers. Exporters earn extra revenue (encouraging exports), importers incur additional costs (discouraging imports), and policymakers constrain the deficit. One of the attractions to the approach, in our opinion, is that it can supersede traditional protectionism. After constraining the deficit, freer trade wouldn’t carry the same risk of domestic businesses being crushed en masse by predatory trade practices. We’d be in a better position to reduce tariffs, subsidies, and other protectionist policies that sacrifice competition while rewarding special-interest politics.

That said, our solution converts the overall deficit to a public policy decision while still leaving doors open for politicking. For those reasons, it doesn’t score points with free-market economists. For it to gain acceptance, free-market thought leaders would need to change their positions on the meaning of large trade deficits. They would need to jump from the lower-right to the upper-right, lending the upper-right some authority. And there’s not much chance of that happening. Attitudes about trade restrictions are a bit like anchovies—you either like them or they disgust you, and you’re not likely to wake up one day and switch from one camp to the other. Switching camps may even require turning your back on patrons, followers, and a portion of your published works. What’s more, we’ve been verbally bashing our trading partners as much today as ever before, and yet import credits rarely enter the discussion.

Nonetheless, we’ll play the Lloyd role in Dumb and Dumber (“So you’re telling me there’s a chance!”) and say our piece.

As above, we’re not pushing Buffet’s rationale for constraining the trade deficit. He points out that foreign countries accumulate American assets by selling more to us than they buy from us. He then predicts that foreigners will eventually dump their American bonds and acquire American land instead, which he calls colonization “by purchase rather than conquest.” That’s an interesting idea, but it seems overblown to us.

Beware the double slam

We’re not as concerned about “colonization” as we are of what exactly happens when deficits drain dollars from our real economy and then recycle them back to our financial economy. The dollars that leave our real economy carry significant opportunity costs. If those dollars were used to buy American goods and services, they would boost profits, create jobs, and lift wages. When the same dollars flow overseas instead, profits, jobs, and wages suffer.

And how about the equal amount of dollars that flow into our financial economy, as foreigners purchase American assets with the money they’ve accumulated? In the best case, foreigners use their dollars to invest directly in America, hiring local workers and injecting money back into our real economy. We shouldn’t be bothered by foreign direct investment—notwithstanding Buffet’s argument—nor should portfolio investment bother us if the proceeds are used to build capital and create jobs.

So what exactly is it that should bother us?

The problem is that most of the dollars that trade-surplus nations accumulate are then lent back to us to finance either public spending or private consumption. That’s the piece that pundits who back pure free trade tend to gloss over, often appealing to the theory of comparative advantage. But it’s not an advantage that separates foreign savers from our spenders, it’s an attitude. In place of comparative advantage, we should think of our trade deficit as vendor finance. The vendors are the trade-surplus nations that build savings as we accrue debt, thereby financing our habit of spending more than we bring in. Vendor finance helps us kick the can down the road, making our economy more vulnerable to financial, debt, and fiscal crises. It might also amplify the business cycle.

In other words, we get slammed by the trade-deficit dollars that depart our real economy (lower business revenues, fewer jobs, weaker personal income) and then slammed again on the rebound when those dollars reenter our financial economy (overspending, vulnerability to crises, economic volatility). That’s the risk of running large, chronic deficits—a vicious double slam. Imagine stepping into a knock-out punch and then, as you fall, banging your head against the canvas.

The double slam explains our affinity for the upper-right quadrant in the tables above. We think free trade is generally good, but it’s not okay to run large deficits. Therefore, we see drawbacks to both mainstream thinking and traditional protectionism. Which brings us back to the question we began with: Where in the foreign trade debate do you belong? Which of the quadrants do you like best?

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