We live in a world at risk. That should be obvious to anyone who pays even a modicum of attention to the news.
Last week, Vladimir Putin was boasting that Russia had developed a new batch of “invincible” nuclear weapons that could foil any defensive system employed by the United States, cold war rhetoric to be sure.
There are a slew of other big risks that could, by extension, threaten the world economy. They include territorial disputes in the South China Sea, major cyber-attacks, war on the Korean Peninsula, an escalation of proxy conflicts in the Middle East, a big drop in oil prices, and the withdrawal of countries from the Eurozone.
Another threat emerged last week, which I hate to say, could be precipitated by the U.S. -- a full-blown trade war, the costs of which could be very, very bad.
Mind you, we’re not there yet. But we could be if things escalate, which is the nature of these conflicts.
A Simplistic View
It is obvious that President Donald Trump views trade in very simplistic terms as a win or lose proposition, disregarding the nuances that come with it. Most concerning was his statement on Twitter, one day after announcing tariffs of 25 percent on steel imports and 10 percent on aluminum imports, that “trade wars are good and easy to win.” History would show that is far from the case.
It should be noted that the tariffs in themselves are not signs of a trade war but could be a catalyst to spur one on if other countries choose to retaliate. Already, the tit-for-tat threats have emerged.
Electrolux, Europe's largest home appliance maker, said on Friday it would delay a planned $250 million investment in Tennessee in reaction to Trump’s announced tariffs. The European Union is now considering duties on U.S. imports worth about $3.5 billion if the White House pursues its plans.
“We will put tariffs on Harley-Davidson, on bourbon and on blue jeans — Levi’s,” European Commission President Jean-Claude Juncker said, according to Reuters news service. “We would like a reasonable relationship with the United States, but we cannot simply put our head in the sand.”
Trump naturally could not let that go unanswered and lashed out on Twitter Saturday, saying the U.S. may levy a 25 percent tax on cars exported from Europe.
My point is that trade skirmishes can snowball into an all-out trade war. And contrary to what the president may believe, there are no winners in that scenario.
A Consistent Message
Trump’s abruptly announced statement that he would go through with tariffs caught Washington and Wall Street off guard, with markets reeling as a result. But it is consistent with what the man has been saying since the 1980s -- that America is being “ripped off” by other countries, hurting U.S. jobs and factories.
In his bid for the presidency, Trump made the renegotiation of the North American Free Trade Agreement (NAFTA) a hallmark of his campaign, calling it “the single worst trade deal ever approved in this country.”
Signed into law by Democrat President Bill Clinton in 1993 with Republican support, NAFTA created a managed trade zone among Canada, Mexico, and the United States. In his third presidential debate with Democratic nominee Hillary Clinton, Trump said what he had been saying on the campaign trail:
“We’re going to renegotiate trade deals. We’re going to have free trade . . . But we have horrible deals. Our jobs are being taken out by the deal that her husband signed, NAFTA, one of the worst deals ever. Our jobs are being sucked out of our economy. You look at all of the places that I just left, you go to Pennsylvania, you go to Ohio
“. . . Our jobs have fled to Mexico and other places. We’re bringing our jobs back. I am going to renegotiate NAFTA. And if I can’t make a great deal—then we’re going to terminate NAFTA and we’re going to create new deals.”
Trump’s message resonated with American workers, which catapulted him, to the shock of many, into the White House. And now as president, he is acting on his perpetual belief to the consternation of most economists, who contend that such protectionist measures could damage economic growth worldwide.
Some NAFTA Progress
Believe it or not, some progress actually has been made in negotiations between the U.S., Canada and Mexico to rework NAFTA, a 24-year-old, $1.2 trillion treaty which Trump has threatened to walk away from unless major changes are made to benefit American interest.
In the latest (and seventh) round of negotiations which began last week in Mexico City, the three countries have agreed on regulatory best practices. With that done, on top of work on anti-corruption measures, rules for small- and medium-size businesses and for competition now done, it’s taken six months to complete four of the roughly 30 chapters likely to form the updated deal.
Rules of Origin Stumbling Block
And while nobody thinks these negotiations will end anytime soon (An eighth round of talks is being planned for Washington later this month), as long as the parties are at the table, well, progress is progress.
But there remain big hurdles ahead. Agreeing on new rules of origin for autos is just the latest. Under the current treaty, 62.5 percent of the net cost of a passenger car or light truck must originate in the NAFTA region to avoid tariffs.
Trump wants that threshold raised to 85 percent, and add a U.S.-specific requirement of 50 percent.
Again, reflecting his binary view on trade as win or lose, the president last week said the U.S. was probably losing $130 billion a year to Mexico. The U.S. 2017 trade deficit in goods with Mexico was $71.1 billion and $17.6 billion with Canada.
A False Assumption
Apparently, the president is under the belief that if trade deficits go down, economic output rises. Most economists say it doesn’t work that way. Having a trade deficit -- which happens when a country imports more than it exports -- reflects more about robust U.S. consumption than about unfair trade.
When calculating a country's Gross Domestic Product, it is true that economists will count a trade deficit as a negative, but that is more a matter of accounting. Most economists believe a trade deficit does not cause GDP to be smaller.
What they will also tell you that raising import taxes on goods (which is what tariffs are) can have all sorts of unintended consequences. Research by economists Nicholas Bloom, Mirko Draca, and John Van Reenen indicates that while exposure to Chinese competition did destroy U.S. jobs, it also forced U.S. companies to innovate faster and become more productive.
Erecting trade barriers and protecting domestic industry groups tends to inhibit innovation. In other words, the shielded companies get fat and lazy while consumers pay more for goods and services.
To be sure, corporate America was happy to see a reduction in the corporate tax rate from 35 percent to 21 percent. We have not seen a spate of new capital investment because of it yet, but it is still early. U.S. companies have also been quite happy with the Trump administration’s attitude toward reduced regulation.
But a trade war would be a bridge too far. Let’s hope we don’t go there.