When the US stops trading internationally, it's time to worry
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All trade is good, even when it results in a deficit. This may be economics 101, but it is amazing how quickly it falls victim to contrary political thinking when international tensions run high.
As it happens, we don’t need to rely solely on economic theory to know the benefits of free trade. Just take the example of the United States, which has run current account deficits for the past 50 years or more, but has seen real GDP per capita more than double in that time.
It is no coincidence that this great leap forward in measured prosperity has coincided with a period of unprecedented globalisation.
There are, however, some important caveats. It used to be said that when politics and economics collide, it’s economics that in the end always wins.
Much of the time it’s true. You cannot buck the market, as Margaret Thatcher once said. Yet from a world economy perspective, borderless trade as an undisputed good really only holds its own in times of relative geopolitical stability, when countries and regions can be persuaded to trade with each other under broadly accepted rules and settlement procedures.
We are a very long way from that today.
A recent report by Capital Economics on the increasingly fractured state of the world economy put the point succinctly: “During the past decade, the global economy has transitioned out of an era in which globalisation was the key driver of economic and financial relationships into one shaped by geopolitics.
“Previously, most governments had believed that closer economic integration would promote long-term prosperity. Now, integration is seen as a source of risk and insecurity.”
The old orthodoxy on open borders is, in other words, either dead or dying. This change is perhaps the most significant shift in political thinking to have occurred in my working lifetime. Alarm over the impact of globalisation on society and national security is eclipsing belief in the efficiency gains and mutually enriching qualities of comparative advantage.
It’s a transformation that long predates the election of Donald Trump as US president in 2016, but few have more vocally championed and promoted the new politics than him.
At this stage, Trump’s economic plans for a second presidency – by this time next year, he may well again be president elect – are still sketchy, but there is one standout policy which he has already nailed to the mast.
This is to slap a universal tariff of 10pc on all imported goods. By doing so, Trump would be going way beyond the quite limited trade war he fought with China, and to a lesser extent the European Union, in his first presidency.
Indeed, this would be the most sweeping package of import duties to have been imposed by the US since the infamous Smoot Hawley Act of 1930.
The idea that Smoot Hawley caused the Great Depression has long since been debunked, but it certainly worsened an already dire economy, very considerably added to international tensions and was a major contributing factor in the political instability of the age. What Trump proposes is not nearly as big as Smoot Hawley, which added a further 20pc on average to already punishingly high import tariffs. But, as everyone knows, once the initial shots are fired in any trade war, it quickly escalates in beggar-thy-neighbour, tit-for-tax retaliation.
There is no knowing how an overtly protectionist US might pan out in today’s world. What we do know is that neither China nor Europe will take it lying down.
“Trade wars are good and easy to win,” Trump declared last time around. Neither claim turned out to be true. China and Europe responded in kind. Far from shrinking as it was supposed to, the trade deficit with China widened yet further.
Rather than stimulating domestic production by making imports more expensive, the main effect of the tariffs was simply to make things more expensive across the board. Trump’s trade war did little or nothing to “make America great again”.
Even so, Trump doesn’t seem to have learned his lesson. Nor does the American public, where the seductive appeal of protectionism seems to have grown in strength, rather than diminished, since Trump first dabbled in it.
When times are tough, free trade becomes particularly hard to defend. For many voters, the idea that employment at home is best protected by placing restrictions on foreign goods seems like simple common sense. Whether it be free movement of people or goods, voters are easily convinced that open borders undermine wages and jobs.
Not that Joe Biden can claim to be without sin on this front. Instinctively, Democrats have always been more protectionist than Republicans, and Biden is no exception.
Biden’s flagship policy, the misleadingly named Inflation Reduction Act, is a blatantly protectionist piece of legislation, even if delivered via $1 trillion (£800bn) worth of subsidies to American industry rather than the sledge hammer of import duties. In terms of seeing China as a security threat, and therefore not an economy to be trusted as a core supplier, he’s outbid even Trump.
Yet he does at least seem to acknowledge that there is a distinction to be made between free trade with allies, and free trade with potentially hostile regimes that don’t play by the rules. Trump, by contrast, has said he’ll slap the new tariff on all imports, allies alongside enemies.
In formulating this policy, the former president has relied heavily on two old muckers from his first term – Robert Lighthizer, a US trade representative under Trump, and Peter Navarro, a one-time economic adviser.
Like Trump, neither has repented, but have instead since doubled down on their economic illiteracy by insisting that only by bringing America’s trade flows back into balance can the nation be saved. Both have advocated a significant increase in tariffs to achieve this goal.
There is, admittedly, at least some economic justification for this way of thinking. In economic terms, the US is large and diverse enough to be a world unto itself. Provided competition remained free and open within its own borders, the US economy could easily sustain itself, and possibly even prosper, without recourse to international trade.
What is more, a 10pc tariff on all imported goods would raise a lot of money, possibly as much as $2.5 trillion over 10 years, according to estimates by the Committee for a Responsible Federal Budget. America would then become less reliant on inflows of foreign capital to finance the budget deficit. These flows are themselves just the flip side of the trade imbalance, which has to be paid for with inflows of foreign savings.
But it might also mean that the US would consume less and would therefore become a deflationary force on the world stage. Come to think of it, isn’t that sort of what happened in the 1930s? When America takes an isolationist path, it’s time to start worrying on multiple fronts.
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