A Bully in a China Shop?
It is a mystery what Donald Trump learned when he did his BA in economics at the University of Pennsylvania in the mid-1960s. The Ivy League college has a good economics reputation, but even had Trump been a top student – unlikely or he would trumpet it – his training in international economics would have been primitive by today’s standards (and it was only at bachelor level).
It is likely he would have been taught the Ricardian story of comparative advantage in which Portugal and England produced wine and cloth, and in which despite Portugal being more productive in both activities (i.e. it had an absolute advantage in both), it made sense for it to specialise in making wine and importing cloth (it had a ‘comparative advantage’ in wine). This notion of doing what you do relatively best as valued by exchange is integral common sense in economics.
However today’s international trade is very different from the inter-industry exchange which Ricardo was portraying. Much of it is intra-industry – that is, exchanging very similar products like cars for cars. Much of the trade is in components which get produced in various countries and assembled in a third, often after having crossed many borders. Much of today’s international trade is in services rather than the physical goods which dominated two hundred years ago (and which are hard to tariff).
It may not be simply ‘comparative advantage’. Many industries may have been located in a particular place by chance, but they are still there decades later because their experience and technological innovation gives them a ‘competitive advantage’. A further complication is the ‘economies of agglomeration’ which arise when production is cheaper because of this clustering of economic activity (typically in a larger city – it may be cheaper to do things in Auckland than in Akaroa).
The notion of comparative advantage still holds – do what you do well – but it now exists in a much more complicated environment. Adding to those complications, the standard undergraduate model would not have allowed for internationally footloose capital and technology – labour less so, but migration is still important – which means that industries can now relocate to cheaper sites. They produce paradoxes, like giant – trillion dollar – firms (like Apple) that do not produce anything but outsource the making of the product they design, manage and market to other businesses usually located in other countries.
You may be aware of these complexities and the nuances of behaviour they generate but is Trump? It is very difficult to understand the ‘trade war’ he is prosecuting in terms of the realities and intricacies of today’s international trade.
Perhaps ‘war’ is key to his thinking. Rather than using troops, he thinks he can get his way – America can get its way – by trade threats. War involves economic sacrifices; Trump seems to be aware he is expecting the US to make them when he accepts that there will be inflation as a result of his actions. Perhaps he hopes the threat of his tariff-troops will get him what he wants. (Although sometimes it is unclear what it is; remember the joke about Hitler who wanted ‘peace’ (it works better if you say it) – a piece of Canada, a piece of Greenland, a piece of Panama, a piece of Ukraine …)
My guess is that whatever happens, the Trump initiatives will dramatically change the global economy. Before explaining how, recall an earlier trade war.
The Smoot-Hawley Tariff Act of 1930 raised US tariffs on more than 20,000 imported goods. prompting retaliatory tariffs by many other countries. They were a major factor in the reduction of American exports and imports by two-thirds during the Great Depression, although they did not cause it. The event was so traumatic it would almost certainly have been mentioned in Trump’s international trade class, although he may not have been listening.
In the 1930s and 1960s US goods exports and imports made up about 3-5 percent of total production. Today the figure is more like 10-12 percent, so the impact of a Smoot-Hawley tariff war would be even greater.
Will we see a return to the 1930s trade wars. Hopefully not, although it may require considerable finesse to avoid one. I suppose it depends on how much Trump can get what he wants via bluster, how much he is willing to concede and how much the rest of the world stands up to him. Individually most countries are no match to the US, but there are blocks – like ASEAN and the EU – with collective clout. There are almost certainly already backroom conversations in train about collective responses.
That suggests that the effect of Trump will be to strengthen those blocks whether there is an actual war or just threats. Those outside the blocks will also be trying to work together. New Zealand on the periphery will find it particularly difficult. We will depend upon working with Australia but that country is trying to get a special deal with the US.
Were I a Chinese strategist I could not believe my luck. Sure, it is going to be difficult because of China’s production chains, including those with the US. But Trump has created a medium term opportunity for China to offer an alternative to a US-led global economy, strengthening its sphere of economic influence.
Businesses may take a different lesson, especially as they dislike the uncertainty which will be Trump’s heritage long after he has moved on. Can they rely on cross-country production chains as they used to? I shall not be surprised if there are changes to investment strategies, including postponements of investment decisions which will intensify any economic downturn.
Consumers may also respond, including those outside the US boycotting American products. In some cases – social media, fast food chains – it may not be so easy because there is no significant alternative. For others, we shall see.
Tesla cars face a further challenge. Trump’s tariffs may increase their US market, but Tesla may find it harder to sell elsewhere, as Chinese EVs push into third markets. In addition, it has a factory in China and sources some of its US components from elsewhere. (This is not Ricardo’s world.)
The world economy is not a china shop, although in the short term it could be greatly damaged by trade warfare or threat of war. In the medium-to-long term Trump’s bullying may be inadvertently hand over its leadership to China.