Trump and trade

The US president's trade policy is aimed at containing China, not abjuring free trade

With Brexit and the inauguration of the Donald Trump administration many are lamenting the prospective end of the postwar liberal international economic order. Most of these are concerned with foreign trade. But ironically, both the British desire to exit a protectionist trading block to move to unilateral free trade, as well as Mr Trump’s denouncing the current multilateral trade regime as leading to unfair trade are being put in the same box. I have already argued the case for unilateral free trade in my columns on Brexit, and it seems from the UK government’s recent statements as they launch the negotiations to exit the European Union (EU), that they want to move to free trade with the EU if it concurs. If not, whilst trading freely with the rest of the world they would trade under existing World Trade Organization rules with the EU.

But what about the Trump administration? As an advocate of free trade for most of my academic career, his attacks on free trade are deeply disturbing, as they go against the modern theory of trade and welfare and elementary national income accounting. Thus, his hope that protection will resurrect declining US industries is the opposite coin of the case which was made for protecting infant industries in developing countries. In both, the case for protection is ultimately based on some purported distortion in the workings of the domestic price mechanism which is best dealt with by attacking the distortion through appropriate domestic taxes and subsides. Protection is the worst policy to deal with the distortion as it causes many by-product distortions which could lead to even lower economic welfare. Whilst even the case for domestic subsidies to deal with the original domestic distortion is undermined if producers are rent seekers who will argue for all sorts of non-existent domestic distortions to get subsidies, also leading to a loss of economic welfare. Hence, as I have argued, the 19th century case for the joint adoption of free trade and laissez-faire still stands (“Free Trade and Laissez Faire: Has the Wheel Come Full Circle?”, The World Economy, 2003).

Similarly, the statements made by the US president and Peter Navarro, his trade advisor (“Why the White House Worries about Trade Deficits”, WSJ, March 5, 2017), that US’ trade deficits are economically damaging, and its trade policy should seek to eliminate them is economically illiterate. From national income accounting, a country’s deficit is by definition the imbalance between domestic savings and investment, and cannot be eliminated by trade policy. It is the other side of the coin of the capital account which records capital inflows which will be in surplus by an equivalent amount. This capital inflow is economically beneficial. Mr Navarro recognises this but argues the capital inflows allow the US government to finance undesirable fiscal deficits. Furthermore, it allows foreigners to own a growing share of US assets. This he notes could be benign, but he worries that “suppose the purchaser is a rapidly militarising strategic rival intent on world hegemony. It buys up America’s companies, technologies, farmland, food-supply chain and ultimately controls much of the US defense-industrial base.” He labels this as “conquest by purchase”, and this is the real target of his advocacy for protection. And who is the strategic rival? In his book (Death by China, Pearson, 2015), it is the People’s Republic. Is this a real danger or just a paranoid fantasy? 

Unfortunately, as I have argued in an earlier column (“China’s geopolitical resurgence”, December 20, 2013) this can no longer be looked upon as a fantasy with President Xi Jinping’s abandonment of Deng Xiaoping’s advice to hide its “peaceful rise”, and Mr Xi’s desire to fulfil the “Chinese Dream”. This is to reclaim its status as the wealthy powerful Middle Kingdom which was the Asian overlord with most of its neighbours being its vassals. This was destroyed after the 19th century Opium Wars and the “carving up of the Chinese melon” by Western powers. The West had hoped that Deng’s opening of China and integration into the global economy and the US-led liberal international economic order, would convert it into a prosperous, peaceful “trading state” like Germany and Japan. With its growing middle class, it would also become democratic. 

Illustration by Binay Sinha

But these hopes have been belied. As Edward Luttwak in The Rise of China vs. the Logic of Strategy has emphasised, China is reverting to its ancient assertive political habits of dealing with foreign “barbarians”. A major tool was “induced economic dependence”. This was developed after 140 years of protracted warfare with the formidable mounted nomad warriors, the Xiongnu, by the Western Han (206 BC-9 AD). The self-sufficient Xiongnu were made dependent on Han-produced goods, which were first supplied free as “unrequited tribute”, but were turned into “exchange for services rendered” as de facto vassals when the Han became stronger. This continues in Chinese foreign economic policy as noted in an earlier column (“China’s statist turn II: the ‘development bank’”, August 16, 2013), with the attempt to create the old Silk Route being the latest example.

Mr Luttwak also noted that from this tributary past the Han “also attribute superior cunning to themselves as compared to the non-Han world” considering Americans, though strong and violent “as specially naïve, but easily manipulated”. This has been resoundingly confirmed “as the Chinese watched with increasing incredulity the absence of any American attempt to impede [its] rise” instead contributing to its rapid economic growth, “without demanding anything resembling full reciprocity”.

But beginning with Mr Trump’s initial shot over the Chinese bow of taking a call from the Taiwanese president and suggesting he might reconsider the US acceptance of the “One China” policy, the US worm seems to be turning. It is in this context that Mr Trump’s “trade policy” is better seen as a strategy of confronting and containing China than abjuring free trade. Mr Navarro makes many recommendations on how the US might contain China in the future. They would shake up the multilateral trading system overseen by a seriously dysfunctional WTO — the subject of my next column.