Mitchell’s Musings 6-25-2018 - The World: You’ve Heard of It?

23 Jun 2018 1:20 PM | Daniel Mitchell (Administrator)

Mitchell’s Musings 6-25-2018 - The World: You’ve Heard of It?


Daniel J.B. Mitchell


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Note: This will be the last of the regular weekly Mitchell’s Musings. The website for the Employment Policy Research Network - EPRN, while still linked to the larger LERA website, is no longer being supported technically. As a result, images such as charts no longer can be uploaded. Although past musings are also available on other sites, it has become complicated to keep the series going, hence the discontinuation.


One source for back issues is https://archive.org/details/@danieljbmitchell (and search there for musings). Another source is https://issuu.com/danieljbmitchell.

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From time to time, these musings have taken up the issue about balanced U.S. trade, which is said to be an objective of the Trump administration. The administration has been both imposing tariffs on various goods and threatening to do so, seemingly to pursue balanced trade. As with other pursuits of the administration, the actual goals and priorities are not clear. But balanced trade would bring about a net enlargement of jobs in the manufacturing sector (albeit not to anywhere near the proportions of the workforce back in the 1950s and 1960s).


In part because the administration’s goals are fuzzy, the reaction of the news media has been to call on pundits who then say things about international trade generally, but who tend to jump from issue to issue. There are warnings by pundits about trade wars that could develop, references to the Smoot-Hawley Tariff of 1930, and discussions about the benefits from trade (often taken from fading memories of Economic 1A). To the extent that references are made to the balanced trade issue, the discussion typically notes that protecting an ad hoc group of industries may benefit those industries (and their workers), but that their protection may harm other industries that are users of the protected products. The thrust of such commentary is that the effect of the tariffs on the U.S. balance of trade is “complicated” because opposing forces are set in motion.


A more sophisticated version of the “it’s complicated” commentary goes back to the national income identities. As you can find in any international economics textbook, at the end of the day S – I (must) = X – M, where S = Saving, I = Investment, X = exports, and M = Imports. The true reason, it is said, that American X – M is negative is because I > S. And since tariffs don’t directly change I or S, placing tariffs on particular industries such as steel or aluminum will not improve the overall trade balance even if we import less steel or aluminum. Some other industries will experience more imports to offset the steel and aluminum effects.


That observation, taken by itself, is largely true. (I say “largely” because raising the domestic prices of steel and aluminum could conceivably have some effect on S and I through various indirect channels.) But there tends to be a leap after that observation to the idea that there is NO trade policy that could be enacted that would have any effect on the U.S. trade balance, X – M. And that implication is incorrect.


As I have noted in prior musings and elsewhere, a policy advocated in the 1980s by financier Warren Buffett could bring about a zero trade balance. Essentially, the Buffett plan involves no tariffs or quotas or protection of particular industries. It does not involve singling out individual trading partners of the U.S. as trade villains. It does not involve pointless debates over whether currency values are being “manipulated.” The Buffett Plan is essentially a variation on the “cap-and-trade” approach that is sometimes applied in the case of anti-greenhouse gas programs.


Under the plan, any entity exporting one dollar’s worth of goods and services from the U.S. would earn a voucher entitling it to import one dollar’s worth of imports. There would be no imports allowed without the necessary vouchers. Exporters could either use their vouchers or sell them to importers. M could thus be no larger than X. Trade would be balanced. If you do the math, you will find that the actual exchange rate plus the cost of acquiring the voucher would be equivalent to that dollar exchange rate that would be needed to bring about balanced U.S. trade.


Various objections are typically raised. One is that having balanced trade isn’t necessarily a Good Thing. That is a valid point but off the mark. Perhaps the goal is wrongheaded. But that is a different issue from whether the Buffett plan could “work,” i.e., whether it would produce balanced trade. So the next line of attack is the S – I = X – M identity. Obviously, if X – M = 0, then S – I must also be 0. But what mechanism is there in the plan to bring about S = I? There is in fact no specified mechanism for S or I in the plan, but I will assert that nevertheless market and behavioral forces would be set in motion to ensure their equality.


I will further assert that we already know of an economy which has been constrained to have X – M = 0 and that has somehow been forced by that constraint to end up in a situation where S = I. The economy I have in mind is called “the world.” You’ve heard of it, no? So far, we have detected no life on other planets, not even microbes. As a result, we are constrained on Earth to have no trade with Mars or with any other non-terrestrial economy. Thus, for the world, the global trade balance is now, and has always been, constrained to be zero. Given that constraint, the world’s S must adjust to be equal to the world’s I. And the world’s I must adjust to be equal to the world’s S. Somehow, those adjustments happen! They have always happened! As Adam Smith might have said, an “invisible hand” brings about the equality.


While you are pondering that point, there is a secondary observation to be made. The criticism of the current policy of putting tariffs on particular products to bring about zero trade is largely correct, for reasons spelled out above. That criticism could also be applied to any trade deal that might be reached with a particular country, e.g., China, for much the same reasons. If the Trump administration really wants a zero U.S. trade balance, the Buffett tool for reaching that goal is available. So if the administration doesn’t use that tool, or some equivalent, the reason can only be because having a zero balance is not the real goal. You might then conclude that appearing to have that goal, rather than actually achieving it, is the true objective. And you would likely be right.

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Footnote:

[1] http://www.zocalopublicsquare.org/2017/01/09/cap-trade-solution-trade-dispute-china/ideas/nexus/

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