by W. Raymond Mills
When two nations exchange goods and services of equal monetary value, several good things happen. Both nations increase domestic production to create the exports. The imports that come into the nation will either increase the value of domestic production (when the imports are inputs into domestic production) or they will increase the goods and services available to be consumed by families and individuals. Both outcomes increase the wealth and welfare of each nation.
On the other hand, unbalanced trade requires cash to move from one country to the other. This can lead to problems if the cash needed to complete the transaction becomes scarce in the trade deficit country. It can also cause problems for the trade deficit country because domestic production of goods and services are the source of national wealth, as Adam Smith said. Sending money overseas to pay for exports (net) means that domestic production has not kept pace with domestic consumption – a situation that weakens the wealth creating capacity of the trade deficit country. Unbalanced trade is a beggar-thy-neighbor activity. Each nation should seek to avoid become a habitual trade deficit country.
This common sense perspective is rejected by the powers that be in the U.S. Instead they support the competitor view that all trade is good trade and that U.S. policy should aim to increase the total of world trade, regardless of the balanced-unbalanced issue. This doctrine, which I call the conventional wisdom, began with a book, The Wealth of Nations, published by Adam Smith in 1776. Smith argued that if governments would just keep their hands off trade, the private sector would use trade to generate wealth and net benefits for all participants. This theory has been validated in the one place where it has been tried – in the United States of America. Trade between the various states must be free. The intellectual validity of the above proposition is irrelevant (in my opinion) because it cannot be applied where Adam Smith wanted it applied, to trade between sovereign nations. Experience has shown that ambitious nations produce governments that refuse to ignore the possibility of using governmental power to increase their exports and restrict their imports. Realists should expect nothing else. Japan followed this path to recovery from the devastation of WW II and other nations have followed her example. Free trade has never been tried in global trade. Despite years of experience with trade influenced by other governments, the U.S. continues to base trade policy on a dream rather than reality.
Support for free trade theory developed out of U.S. experience. Throughout the 100 years of the 20th Century, U.S. factories have been relocating from the northern part of the U.S. to other places where labor costs were lower and unions absent. That pattern began inside the U.S. but continued outside the borders of the country. Free trade assured the CEO’s of U.S. corporations that goods produced outside the U.S. could be sold in the U.S. Second, the U.S. emerged from WW II with superpower status in both military power and manufacturing capacity. The Cold War with Russia spurred the U.S. to use both trade and military alliances with other nations to counter the Russian ambitions. The U.S. could tolerate open borders to imports so long as our manufacturing prowess remained unchallenged. Free trade is a helpful doctrine when the most powerful manufacturing power in the world is seeking markets for its exports. Great Britain embraced Free Trade in 1838 when it was at the height of its power. The U.S. embraced Free Trade after WW II when it was at the height of its power. Third, U.S. economists have supported the free trade ideal for years, ever since the Smoot-Harley law in 1930 showed that protectionism imposed by the leading world power dried up world trade because other nations also adopted protectionism. Paul Krugman published the third edition of his influential text book, International Economics, in 1993. In it he argued for support for the doctrine of Free Trade because any effort by the Congress to interfere in world trade will inevitably result in the kind of political logrolling that protects dying industries and restrains the progress created by competition. He assumes that protectionism is the only alternative to free trade. His perspective would be undermined by a governmental program that preserves competition among domestic industries by placing equal restrictions on all imports.
The U.S. trade deficit cannot be ignored, despite the views of most international trade experts. It has existed for 36 years, peaking in the years of 2005 and 2006 when 36% of U.S. imports were paid for with cash. Also, in that same year 46% of goods imports into the U.S. were paid for with cash. Our trade with the 3 nations of China, Japan and Germany combed in that year require 72% of the payments for goods imports to be cash not offset by the value of our exports to those 3 nations combined. These numbers represent a peak year. During the ten years of 2002 to 2011, the U.S. sent 5.8 TRILLION overseas to pay for our imports in excess of exports. Those dollars can buy a lot of new machines to increase the efficiency of production in competitor nations. It also can help placate a restive population by increasing the quality and quantity of goods and services available to them. It can increase the capital reserves in other nations; it can increase the International Investment Position of other nations. But the important reality for the U.S. is that those dollars are used to pay workers and suppliers in other nations, not the U.S. Those dollars are part of the reason the Chinese economy has been growing so fast in the last decade.
U.S. trade deficit problem improved considerably between 2005 and 2011. By 2011 payments for imports in excess of exports had dropped to 21% of imports for all imports, 33% for goods imports and 65% for goods imported from China, Japan and Germany combined. The primary reason for this change is the financial meltdown of 2009 which hammered world trade for one year. Also, the low value of the dollar helped exports.
Trade deficits exist because countries benefit from the corresponding trade surpluses. In 2011, trade between the U.S. and China, Japan and Germany resulted in the U.S. paying cash for 50% or more of their goods imports from each of those nations. By 2011, each of those nations had developed a competitive advantage over U.S. producers in some part of manufacturing industries to create their surplus. Statistics reported by the U.S. Census Bureau show that 90% of the U.S. goods trade deficit in the first half of the year 2012 in the U.S. was due to manufactured products only. The governments of each of these three nations have used their power to create the conditions favorable to their countries competitive advantage in manufactured products.
No trade deficit country has moved aggressively to use the power of their government to reduce the size of their trade deficit. No nation is more in need of this action than the U.S. The U.S. has been the world’s largest debtor nation for trade for decades. No law of nature or reason requires a trade deficit country to endure more than 36 years of a trade deficit. Each nation should defend its own interest – to take actions to preserve the nations’ ability to create wealth by domestic production.
The U.S. needs to develop a program (series of actions) that will reduce the size of our trade deficit with each of these three nations. In 2011, these three nations combined were responsible for 55% of our trade deficit in goods. That number can be reduced. If the merchandise trade deficit with the three nations can be reduced from 55% to 15% of the total U.S. goods trade deficit, the total cash paid for all imports from all nations (including services as well as goods) can be reduced to 6% of U.S. imports (if the other assumptions hold).
The numbers presented below show that a 290 billion reduction in the size of the goods imports from these three nations could result in a reduction of the total trade deficit in goods and services with all our trading partners of 407 billion (560 billion in 2011 versus 150 billion after implementation). Numbers for the year 2017 are, of course, a hypothetical possibility.
ASSUMPTIONS AND CALCULATIONS
1. The numeric increase in goods exports from the U.S. in the next 6 years will be one-half the size of the numeric increase in the years 2005-2011.
2. The ratio of goods exported from the U.S. to goods imported into the U.S. will grow by the same number of percentage points in the next 6 years as was experienced in the years 2005-2011.
3. The ratio of the goods and services exported from the U.S. to goods only exported from the U.S. will remain at 1.40.
4. The ratio of the goods and services imported into the U.S. to goods only imported into the U.S. will remain at 1.19.
5. The three nations as a group (China, Japan and Germany) will account for 15% of both imports and exports of goods into and out of the U.S. in the year 2017.
Calculations United States Trade To & From All Nations
Year Goods and Services Goods only (in Billions)
Exports Imports (Ratio)(Balance) Exports Imports (Ratio)(Balance)
2005 1,287 1,996 .64 -709 912 1,693 .54 -780
2011 2,103 2,663 .79 -560 1,497 2,236 .67 -738
2017 2,506 2,662 .94 -155 1,790 2,237 .80 -447
U.S. Exports to 3 Nations: U.S. Imports from 3 Nations Goods only (in Billions)
2005 Exports Imports (Ratio) Balance
· China, Japan & Germany Combined 131 466 .28 -335
As Share of Trade with All Nations 14% 28% 43%
· China, Japan & Germany Combined 219 626 .35 -407
As Share of Trade with All Nations 15% 28% 55%
· China, Japan & Germany Combined 268 336 .80 – 68
As Share of Trade with All Nations 15% 15% 15%
U.S. Goods Trade with Remainder Nations (Total – 3 Nations) (in Billions)
Exports Imports (Ratio) Balance
2005 781 1,227 .64 -446
2011 1,278 1,610 .79 -332
2017 1.522 1,902 .80 -380
Sources: U.S. Census Bureau, Foreign Trade Division, U.S. Trade in Goods and Services, 1960-2011, June 6, 2012; U.S. Census Bureau, Foreign Trade, Trade Highlights, Top Trading Partners
The above numbers represent an aspiration, a result I would like to see happen. It will not happen unless the U.S. changes current policy and practice re world trade. The actions needed are described below. The statistical result to be sought is present above.
The numbers in the above table assume that by the year 2017, the share of U.S. goods imports into the nation paid for by goods exports from the nation will be .80. That is a gain of .13 from the .67 share experienced in 2011. The second major assumption is that the share of imports into the nation proved by the combination of the three nations of China, Japan and Germany will be reduced to .15 by the year 2017. That number (.15) is the share of U.S. exports to the world purchased in the three nations in both 2005 and 2011 – and assumed for 2017. The .15 share for imports will be tough to achieve because the 2011 share is .28.
That kind of drop in imports from the three nations has never happened in the past and will not happen in the future absent a dramatic change in U.S. policy and practice.
The three nations are the focus of attention and action because trade with the rest of the world has already (by 2011) achieved the desirable ratio of 79% of goods imports paid for by exports (21% paid for by cash).
We need a program, a series of actions that can be implemented over time, to allow all parties involved to adjust slowly to the new reality.
This proposal assumes significant change. How can the U.S. government make that happen without a radical disruption of the world trading system?
First, implementation must proceed slowly. Secondly, the way must be prepared intellectually. Three propositions must be firmly establish.
1. Balanced trade is ideal trade because, in the long run, exports out must be near equal to imports in for all nations to insure that every nation gains a net benefit from trade (net benefit means the economy and the people are better off with trade than without trade).
2. Balanced trade will created unequal percentage increase in growth with the larger percentage increase stimulus to growth of GDP due to trade accruing to smaller nations.
3. It is the responsibility of each trade deficit nation to take actions to reduce their own trade deficit.
The actions proposed here should be delayed until the above three propositions are recognized as valid by bankers, economists and politicians all over the world.
Tariffs are the ideal weapon. They have been used for years by all nations to restrict imports. They have the advantage of being explicit. This makes the trading environment known rather than unknown. Western nations generally favor explicitness and honesty in all dealings, including trade. The U.S. should embrace this tradition.
Historically, tariffs have been answered with counter tariffs leading to a trade war which made both countries worse off. Historically, tariffs were imposed to satisfy a powerful political interest in the home country. Each imported product received a different tariff size reflecting the power of its advocate. Because of their origin, these tariffs had no intellectual justification. They were inefficient in that they usually defended dying industries. They harmed rather than benefited the general public of the home country, as Adam Smith argued so eloquently. Traditional protectionism, as described above, must be avoided.
The proposal is that every product manufactured in China, Japan and Germany will pay the same tariff rate. This insures that the products squeezed out of the import stream are those that are less competitive with alternative producers. Instead of favoring one domestic product over another, competition will be preserved throughout the global system. Those products that are available only from one of these three nations (and have no substitutes) will rise in price to offset the tariff. Limiting tariffs to those countries with a large trade surplus with the U.S. will retain the ability of other nations to enter the U.S. market. The handicaps applied to the three major nations will benefit producers in other countries as well as those in the U.S.
Prices will rise in the U.S. only after the three nations cease absorbing the increased costs by reducing profits and when all other nations and domestic producers cannot provide competitive substitutes for the handicapped goods. However, imports from the 3 nations will not decline until their products are priced out of the U.S. market. Domestic producers will fight for market share with the products of other nations. All nations that increase exports to the U.S. must also increase imports from the U.S. to avoid becoming the next nation added to the list of those nations handicapped by tariffs. This system is intended to expand over time to as many other nations as needed to reduce the size of the U.S. trade deficit.
The proposal is for tariffs to be temporally imposed on all goods manufactured in China, Japan and Germany until such time as the goods trade deficit with the three nations becomes less than 16% of the national trade deficit in goods (or when the value of the goods exports accepted from the U.S. becomes above 80% of the goods imports received from the three nations combined). Each of the three nations should be removed from the tariff system when they do their part in increasing the goods imports received from the U.S. relative to the goods exports they send to the U.S.
Implicit in this proposal is the idea that the U.S. should discard all other restrictions on imports. This scheme will succeed without this proposed gain in competiveness among domestic products but the gains will be greater with only this one tariff scheme.
The U. S. Congress should pass a law imposing a 10% tariff on all imports manufactured in China, Japan and Germany. This law will specify that the size of this tariff will increase by 5 percentage points at regular intervals (either 4 months or 6 months) until either the trade deficit with these 3 nations is reduced as described above or a cap in the tariff rate of 40% is reached.
The Congress will revise this system as needed, to remove or add nations to this scheme – or to change the tariff rates to meet new realities.
The Federal Reserve Board will be granted the authority to hold constant the size of the tariff at any time and for so long as inflation in the U.S. is a threat to the national economy.
This scheme is unlikely to produce a trade war because:
1. The proposed tariffs will end when U.S. trade nears a sensible goal.
2. The U.S. position is intellectually defensible.
3. Trade with other nations allows the U.S. to endure pressure from these three nations.
4. Exports to the three nations constitute only 15% of U.S. exports.
5. These three nations own trillions of dollars of U.S. Treasure notes. Selling a large quantity of these notes on the international market will depress the value of their remaining notes and will allow the U.S. to buy these notes at less than their face value. It would also decrease the value of the U.S. dollar, supporting sale of exports from the U.S. Using this money to acquire goods and services for sale in the U.S. will increase the market demand for goods and services produced or owned in the U.S. (a result Bernanke has been striving to achieve).
By way of summary; the three nations may mount some kind of resistance to the proposed actions, prices for goods may increase in the U.S… Set against these possible negative outcomes, production of manufactured goods may increase in the U.S., the trade deficit may be brought under control, the U.S. economy may be positioned to compete effectively in global trade, and trade surpluses may decrease throughout the world, positioning global trade to produce good results for all participating nations. The global trading system will be sustainable when it produces net benefits for all nations. Net benefits will be produced for all nations when every nation experiencing a long term trade deficit imitates the U.S. example.
December 19, 2012
W. Raymond Mills
6000 Riverside Dr. Apt. B-175
Dublin, OH 43017