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What’s in a Trade War?

November 15, 2018
It is almost impossible to open the news without reading about the intensifying US “Trade Wars.” Unfortunately, the coverage is often more sensationalist than substantive. Regardless of political perspective, the prevalence of sensationalist narratives undermines the ability of citizens and politicians alike to engage in productive discourse regarding the costs and benefits of trade. With the increasingly vitriolic dialogue swirling around the theme of trade and protectionism, it is worth taking a few minutes to review the basic theory underpinning trade policy.

The basic rationale for international trade is simple: without trade, national economies are limited to consuming only the goods and products that they can independently produce. Countries lacking in critical resources, agricultural potential, or constrained by size face critical scarcities; and countries with significant production potential are limited by the size of their domestic market. The competition over scarce resources in countries within which consumption exceeds production and the inability of producers to achieve efficient economies of scale in countries where production potential exceeds consumption result in high consumer prices and limited product selection across the board. Trade, therefore, enables each country to focus its production power into its strongest comparative sectors and import the remaining needed goods and services. Because producers are not constrained by the size of domestic markets, they are able to fully capitalize on economies of scale and, in the face of international competition, these producers are incentivized to produce at the most efficient and affordable levels possible. As a result, producers are rewarded for efficiency and consumers have access to a wide range of affordable products.

The challenge with trade is that the inefficient producers threatened by foreign competitors represent economic and employment losses. Anti-trade rhetoric, in the U.S. and abroad, often derives from a desire to preserve domestic producers, irrespective of the associated losses to consumers. Supporting domestic producers is a valid aspiration, and one we should continue to encourage. However, doing so at the expense of free trade is not a sustainable strategy. Protectionist policies limit competition, resulting in increased prices and limited incentive to improve. Rather than enabling domestic producers to attain a level of productivity at which they can compete effectively without government intervention, protectionist policies lead to stagnation within the protected industries. Meanwhile, consumers pay the price twice over: once at purchase and once at tax time. Moreover, because protected industries no longer have incentives to develop a competitive edge, a negative feedback loop supporting deficient companies is perpetuated.

Nonetheless, trade skeptics claim this is a cost that should be borne. While cumulatively larger, the benefits generated by open markets are typically reflected in small price improvements experienced by consumers across an entire industry. The losses, conversely, are often dramatic reductions in livelihoods felt by small segments of the population. At the heart of trade debates, therefore, is the crucial question: should the government’s priority be to achieve the greatest cumulative benefit or to protect the most vulnerable members of society?

This is the question around which most political narratives hinge. Both perspectives generate powerful emotional appeals that resonate with voters: iconic presentations of the American dream, technological progress, and consumerism juxtaposed against images of impoverished towns and laid off workers whose own American dreams have evaporated. But this narrative overlooks the fact that the losses policymakers aim to redress often cannot be fairly attributed to trade or are no longer mendable. The lost jobs that anti-trade advocates lament have been victims of automation to a far greater degree than trade. The U.S. steel industry, for instance, lost approximately 75 percent of its workforce between 1962 and 2005 without reducing shipment levels, according to a study conducted by Allan Collard-Wexler of Duke and Jan De Loecker of Princeton, who attributed this job loss to a new technology called the minimill.[1] Similarly, another analysis from Ball State University attributed roughly 13 percent of manufacturing job losses to trade and the rest to automation, finding that sectors such as apparel making were hit hardest by trade while computer and electronics manufacturing suffered losses from technological advances.[2]

Image: Productivity in the manufacturing sector, Source: BrookingsImage: Productivity in the manufacturing sector, Source: Brookings

If automation is the greater culprit, and most economists agree that it is, despite some claims that increasing product valuations in certain sectors unfairly obscure decreasing trade volumes in others, then most lost jobs are not coming back regardless of how many tariffs are applied or trade deals are abandoned.[3] Protectionism will simply increase the prices these out of work individuals will be forced to pay for goods.

Rather than withdrawing from the global market and hiding behind policies that have proven to be detrimental to long term growth, policymakers should divert funding from trade interference in industries that can no longer compete and allocate resources to support the domestic industries that are capable of competing effectively. Current vocational retraining programs are not able to sufficiently ameliorate the industry losses linked to automation and trade, but paying greater attention to improving and expanding these programs can yield greater dividends than attempting to claw back the industries and jobs that have already been lost.

Image: iPhone value chain and production process, Source: The Wall Street JournalImage: iPhone value chain and production process, Source: The Wall Street Journal

The U.S. interest in international trade also spans beyond domestic factors. As global value chains have grown more robust, the economic gains of trade have disseminated widely. A 2011 study by Kenneth Kraemer, Greg Linden, and Jason Dedrick traced the value chain of Apple iPads and iPhones, showing that despite being manufactured in China, these products include components that are first imported to China from countries including South Korea, Japan, and Germany.[4] Tracing the suppliers and secondary services associated with each of these components further illustrates the expansive global footprint generated by a single “Chinese” import. As global value chains expand, more countries and individuals worldwide are brought into the production process, contributing and earning value at each stage. Trade, particularly via the rise of export-led growth in China, has been a leading cause of the severe reduction of global poverty levels, from 28.8% of the population living under 1.9 USD per day in 1999 to 10.9% in 2013.

This growth did not come without cost. An argument can be made that trade enables developed countries to outsource the negative externalities of production, such as pollution and high-risk, low-wage jobs, to poorer countries, while reaping consumer benefits. In light of the economic gains of trade, however, labor and environmental regulations addressing the costs of externalities are more appropriate remedies for mitigating such negative repercussions, not for blocking trade itself.

In response to those who present global trade gains as theft from the U.S.’s proverbial pocket, Kraemer, Linden, and Dedrick found that the largest share of value capture related to each product remained within the U.S. The alleged harm global trade has done to the U.S. has been repeatedly overstated through misrepresentations of trade statistics such as deficits which omit all trade related to services and fail to reflect the incremental value added to a product as components move across borders prior to the completion.

Even if one believes that U.S. policy should focus solely on domestic interests, the global ramifications of trade remain significant. Stanford economist Matthew Jackson has developed a model representing trade’s ability to link economies together and disincentivize military conflict.[5] His findings suggest that military alliances alone are not sufficient to stop nations from attacking one other but that the addition of multilateral economic trade increases stability and peace. Furthermore, widespread economic opportunity and stability lessens societal burdens many western states currently face. Polls have reported that limited economic opportunity often facilitate an increase in criminal and/or terrorist activity.

So, if trade is beneficial for importers, exporters, consumers, global stability, and the advantages of trade outweigh the associated disadvantages, does it follow that the U.S. should abandon all protectionist policies? Not exactly. Most of the arguments presented here unfortunately hinge on an invalid assumption that the US can make its decisions irrespective of the policies of other countries. Of course, this is not the case. Unilaterally relaxing U.S. protectionist policies and forcing American industries to compete with foreign counterparts benefitting from their own government support undermines the argument made for supporting free trade so as to prioritize global economic efficiency.

A counter argument can also be made that, while the theory supporting free trade is sound, an economic standpoint alone ignores other critical considerations. There are some products, which are so critical to our national interests that we should not allow ourselves to be reliant on external countries for their production, regardless of any resultant economic inefficiencies. Outsourcing the ability to feed citizens or defend borders, for instance, can be fairly recognized as a threat to national security. Products and services deemed essential to these objectives may therefore warrant barriers to trade.

The US should not immediately abandon all subsidies and tariffs. Rather, policymakers should maintain an awareness of the inherent advantages of a system that recognizes the benefits of free trade while seeking to shape policy that prioritizes domestic industries by helping them reach the level of international competition.

Student Blog Disclaimer
  • The views expressed on the Student Blog are the author’s opinions and don’t necessarily represent the Penn Wharton Public Policy Initiative’s strategies, recommendations, or opinions.

References

  [1]https://www.nytimes.com/2016/12/21/upshot/the-long-term-jobs-killer-is-not-china-its-automation.html

  [2]https://www.nytimes.com/2016/12/21/upshot/the-long-term-jobs-killer-is-not-china-its-automation.html

  [3]https://qz.com/1269172/the-epic-mistake-about-manufacturing-thats-cost-americans-millions-of-jobs/

  [4]http://pcic.merage.uci.edu/papers/2011/Value_iPad_iPhone.pdf

  [5]https://www.gsb.stanford.edu/insights/matthew-o-jackson-can-trade-prevent-war

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