What Trump’s Trade Guru Doesn’t Get About Economics
President Donald Trump is reportedly considering promoting noted trade hawk Peter Navarro to the office of assistant to the president. This would be a significant move, and could signal Trump’s intentions for trade policy.
In a way, that’s good news. If Trump focuses on trade, where little of substance is likely to change, it could distract him from areas like health care and immigration where he could do more lasting damage. But Navarro’s promotion, and the protectionist agenda it’s likely to usher in, will probably not be very helpful for the U.S. economy.
First of all, Navarro has made at least one very basic mistake when talking about how trade affects the economy. He -- like many other people -- appears to believe that if trade deficits go down, economic output must rise. That’s false.
In accounting terms, exports add to gross domestic product, while imports leave it unchanged. U.S. GDP represents all the stuff that gets produced in the country -- exports are produced here and shipped overseas in exchange for foreign IOUs, while imports are consumed here in exchange for American IOUs. If you close the trade deficit purely by reducing imports, while leaving exports, consumption, investment and government spending the same, the economy doesn’t grow by even one dollar. But if you close the deficit by exporting more, while leaving everything else unchanged, the economy grows a lot.
You can see how mistaken the Navarro view of trade deficits is just by looking at a chart. Since the middle of the 1990s, the U.S. has run a big trade deficit:
During that time, there was one big drop in the deficit. It came during the Great Recession of 2009, when the economy was contracting. The much milder recession of 2001 also saw a decline. If your only data source was this chart, you might conclude that trade deficits actually cause faster economic growth -- the complete opposite of what Navarro thinks.
The reality is that neither simplistic view is true. No one really knows how trade deficits interact with economic growth, and in fact it’s probably different for different countries at different times. If imports compete with domestically produced goods, they could cause GDP to go down, but if they represent inputs into supply chains for domestic production, then cutting them off would hurt growth.
This is one big problem with the Navarro-Trump approach to trade policy -- it appears to revolve around tariffs, also known as import taxes. Navarro’s main policy idea is to raise import taxes on all kinds of goods. Trump has already slapped tariffs on solar panels and washing machines, and says he’ll do the same for aluminum and steel. But solar panels are important sources of electricity for U.S. manufacturers, and steel and aluminum are key inputs into many American-made goods. Making these more expensive could just hurt U.S. manufacturing. As for washing machines, American consumers might decide to buy these from domestic companies instead, raising U.S. output -- or they might decide to delay their purchases of new washing machines, or do without them entirely. The latter options would not raise economic growth.
Using tariffs to restore American competitiveness could easily backfire. If U.S. companies can hunker behind trade barriers and sell to a captive market, many will lose their edge. Research by economists Nicholas Bloom, Mirko Draca, and John Van Reenen has shown that while exposure to Chinese competition did destroy U.S. jobs, it also made U.S. businesses more productive, in part by forcing them to innovate faster. A 2007 study by Alla Lileeva and Daniel Trefler found that increased exposure to U.S. competition raised productivity at Canadian manufacturing plants. In fact, across a variety of countries, trade barriers seem to hold back productivity.
Lower productivity from protective tariffs wouldn’t just reduce efficiency -- it would hurt U.S. exports. Chinese companies selling their products to France, Brazil, Japan and India would have an easier time of it, as their U.S. rivals retreated into the cozy home market.
If the U.S. wants to close the trade deficit while increasing competitiveness, a better idea would be to forget about tariffs and promote U.S. exports abroad. Systematically helping and encouraging domestically focused companies to go out and compete in world markets could boost productivity and allow the U.S. to pay for more of its imports with goods and services rather than IOUs. Another idea would be to stop increasing the budget deficit, since government borrowing can also exacerbate trade deficits.
Hunkering down behind protective tariff walls and retreating from global competition might save a few jobs. But it would throw a big wrench into U.S. producers’ supply chains, reduce productivity growth, harm competitiveness, and make American consumers poorer. In the end, that would undermine economic growth, and could easily destroy more jobs than it rescued.
To contact the editor responsible for this story:
Mark Whitehouse at firstname.lastname@example.org