- Global trade has become a political football
- Sluggish global economic activity and geopolitical tensions persist
- In the US, Trump in particular is talking tough but his ideas are myopic
- His opinion resonates with voters when economists are not making a good case
- Why not develop trade theory to span both macro and micro analysis?
By Stephen Pope
As the US presidential election charges forth into the final furlongs, the question of free trade
has been an ever-present issue on the campaign trail. No doubt it will loom large in the three televised debates.
Earlier this year, an academic paper from several economists, The China Shock: Learning from Labor Market Adjustment to Large Changes in Trade , found that between 1999 and 2011, the growth in US imports from China wiped out approximately 2.4 m American jobs. Of these, one million were in manufacturing. That number proved to be greater than most economists had estimated.
Trump has been stepping up the trade rhetoric against China. Photo: iStock
The paper pointed out that as import booms from Japan, Mexico and Asian “tigers” such as Indonesia, Malaysia and Taiwan penetrated the US, many cities and towns were able to adapt.
However, the case of China
was different. Here was a trading force that competed against the US, indeed the rest of the world, more completely than any economist or policymakers anticipated at the time or deduced for several years later.
General Administration of Customs
What happened with Chinese imports is an example of how much of the conventional wisdom about economics that held sway in the late 1990s, including the role of trade, technology and central banking, has been under attack and maybe at risk of completely unravelling.
Clinton, but mostly Trump, on the attack
Both presidential candidates in the US have challenged how much benefit the US has gained from 1994’s North American Free Trade Agreement (NAFTA), which boosted imports from Mexico. However, Donald Trump has been stepping up the rhetoric by bellowing out from the stump that since the mid 1990s the real culprit was China.
On certain issues, he may have a point. Much of the empirical evidence shows that there were many US factories that relocated their activities to Mexico in an attempt to match variable costs and hence prices with those from competing Chinese products.
Certainly, Trump has struck the more protectionist note on trade. He has appealed to an electoral base that wishes the world were like it was post-WWII, when the US was seen as the workshop of the world. He claims that the US is engaged in a trade war with China which it is losing and he is often seen proposing a trade crackdown on China that parallels the 1980’s Reagan trade barrier program against Japan. In contrast, Hillary Clinton is more forward-looking, recognising that the US can work higher along the value-added chain.
Supporting her approach is Dr Adam Posen, President of the Peterson Institute for International Economics. He likened Trump's approach to a mercantilist  stance that is blind to the changes in both the US and global economy over the past three decades. The US has shifted from a manufacturing to a services economy driven by ever-increasing global supply chains and a refinement of comparative advantages.
Posen has described Trump’s proposals as driven by a 1980s vision and an 1880s mentality.
Economics in question
A key tenant of modern economics is that if trading nations focus on the activities they do well when compared to the rest of the world, i.e. they exploit their comparative advantage, then free trade delivers beneficial results for all parties.
In terms of US trade with China, Americans have gained from low-cost imports and US companies have shifted production to activities higher up the value chain.
One can look back to the threat posed by Japan in the 1970s and 1980s and see that the US is a survivor and the most innovative economy in the world. Apple, Facebook, Google are leaders in their technical field.
In finance, Nomura and Industrial bank of Japan may have bought their way to the top of the new league tables in the 1980s, but their dominance did not last long and now US banks still dominate underwriting, securitisation and wealth management.
Industries in cities with broad manufacturing bases came under attack and yet motor manufacturing is still undertaken in the US, and where workers found that there was no space for them in automobiles they have switched their skills to aviation.
As an example look at Futuramic Tool and Engineering in Michigan. This was a former car parts supplier to the big players in Detroit. This placed them well down the supply chain with little value added. Now it has used its employees’ skill set in metallurgical engineering processes to provide highly detailed component parts for the aviation industry. In civil aircraft Boeing dominates with Airbus Industrie. US defence contractors such as MacDonnell Douglas, Lockheed Martin and General Dynamics are still the dominant global players in military aircraft.
The same is true in chemicals and pharmaceuticals. Akron, Ohio was the centre of the US tyre industry and yet despite overseas challenges the essence of that activity has created a local polymer industry that employs tens of thousands of workers. For medical care, the US firms of Pfizer Inc., Eli Lilly and Co., Merck and Co., Johnson and Johnson and Bristol-Meyers Squib are as good as any other world operator. Very few international clients are willing to put their total faith in Chinese medications following a large number of poor-quality, life-threatening scandals.
Of course the threat from China is significantly larger than that of Japan and certainly Mexico. The US and actually the world has never before encountered such a combination of sheer size of working-age population, low wages, government support, cheap currency and productivity gains.
Imports from China as a percentage of US GDP doubled within four years of China joining the World Trade Organization (WTO) in 2001. In contrast, Mexico took 12 years to do the same thing after NAFTA was approved and Japan took 11 years to do the same since unfettered trading with the US began in 1974.
In this heightened American political season, the spotlight is understandably on domestic losses rather than foreign benefits. One reason for this is the gains/losses of trade are sometimes seen as asymmetric or skewed.
Any benefit from lower prices tends to be distributed thinly over many beneficiaries. In contrast, the loss of jobs falls hardest on a smaller number of people that tend to be geographically concentrated. That is why the political classes that wish to feed upon fear are often seen most frequently and heard most loudly in the areas most blighted by economic dislocation. When it comes to scoring points on the subject of trade the political candidates are doing a better, if negative, job than we economists have so far.
That has to be because politicians, although addressing a broad audience, are hitting microeconomic buttons, e.g. “My friend, this affects you!”
In contrast, trade is generally seen as nestling in the fold of macroeconomics, where the costs and benefits are dealt with in aggregate. Maybe it is time for more work to be done on a firm by firm basis to see how trade theory and industrial economics can be married together.
As a very simple first stab, consider a firm that capitalises on a new innovation.
Source: Spotlight Education
A new innovative idea can radically alter the way in which production of an existing or perhaps a new product is undertaken. If it reduces production costs, then the initial impact is similar to a subsidy. However, it is not money given directly to firms by the government to encourage production in old flagging industries. That is just a costly short-term solution that usually ends in failure.
The effect of innovation is that as costs fall so the supply curve shifts vertically downwards by the amount of the cost saving. In such a case the new supply curve of the firm in question will be parallel to the original i.e. S to S1 in the chart above. Depending on elasticity of demand for the product in question, the effect is to reduce price and increase output.
The innovation has a generally symmetric benefit as the value of the innovation is AB in the chart above and yet the price the consumer pays does not fall by the full amount of the innovation's cost saving. Instead it falls from P, the old equilibrium to P1. Hence, although the innovation has reduced production costs, and hence the price charged to consumers, the producer gets some of the benefit in terms of extra revenue that they retain.
The boost to bottom line has two effects. At the macro aggregate it will lead to a boost in export revenue, which is a positive for the trade balance and GDP. The micro effect is to see the firm boost its profitability, which can either be distributed to shareholders and in turn boost its share price, or money can be directed toward medium-term investment in new productive capacity so increasing operational efficiency and employment.
Trade spurs innovation and wealth creation. Politicians who deny this need to be held accountable to do more to exercise the full weight of the WTO against dumping and product cheats and to encourage global entrepreneurs who are the source of real, lasting jobs and wealth creation.
“The China Shock: Learning from Labor Market Adjustment to Large Changes in Trade”
Autor, D.H., Dorn, D., Hanson, G.H.
NBER Working Paper No. 21906, © January 2016
Mercantilism was an economic theory and practice, dominant in Europe from the 16th to the 18th century. It promoted governmental regulation of a nation's economy for the purpose of augmenting state power at the expense of rival national powers.
Historically, such policies frequently led to war and also motivated colonial expansion.
— Edited by Susan McDonald