Tuesday, March 06, 2018

Tariffs: Trump's economic experiment

When my brothers and I were quite young, we heard that rhubarb leaves are poisonous.  We had rhubarb growing in our back yard, so on more than one occasion (usually when friends were over) we would each take a bite out of a rhubarb leaf to test whether it really would poison us.  Apparently this is well below the dose required for toxicity, and none of us noticed any effects.  (Perhaps some readers are now saying "Aha, that explains him!")

President Trump is engaging in a very interesting economic experiment.  It's sometimes said one cannot conduct economic experiments on a nationwide or worldwide level, but of course it is academic economists saying this about themselves, not about the president.  We are about to witness a grand experiment.  Tariffs are  poison, and Trump is about to prescribe a big dose.  OK, alleged to be poison, by us oddballs called economists.  Let's see who's right.

I've not yet read the details of the tariffs, other than that steel and aluminum will be particularly targeted, but apparently retaliations are already being considered elsewhere.  An economic experiment is about to get underway, and the results will be instructive. 

I will make some predictions.  The overall prediction -- the main experiment -- is that trade war will inflict real economic harm on America and Americans.  Some specifics:

1. There will be a series of tit-for-tat responses, in which tariffs will increase and trade war intensifies.  This isn't a forgone conclusion, and I think it's the weakest of my predictions.  Conceivably targeted nations could drop some of the trade restrictions and practices that Trump claims justify his tariffs.  I don't expect this, but it is certainly possible that trade war won't ensue, that the threat of U.S. tariffs will cause trade partners to increase their openness American exports. 

As Adam Smith put it in Wealth of Nations, "To judge whether such retaliations are likely to produce such an effect, does not, perhaps, belong so much to the science of a legislator, whose deliberations ought to be governed by general principles which are always the same, as to the skill of that insidious and crafty animal, vulgarly called a statesman or politician, whose councils are directed by the momentary fluctuations of affairs."  Trump claims expertise at the art of the deal; we'll see how insidious and crafty an animal we really have in Mr. Trump.

2. This will cause consumer prices to rise substantially in the United States, especially for lower end consumer goods, e.g. the sorts of things one buys at Walmart.  I'm reminded that Robert Reich lamented that low consumer prices at Walmart meant a lower standard of living for the bottom half.  I think that showed Reich to be an utter ignoramous, but now we'll have a test of his claim.

3. I expect capital inflows into the U.S. to plummet.  Somehow Trump supposes that foreign investment into the United States is good, and trade deficits bad.  Apparently Trump, his pseudo-economic advisor Peter Navarro, and all the other people who think this could make sense are unaware that there is no way to have net foreign investment in a country unless it runs a trade deficit.  The simplest balance of payments accounting shows this.  It's not a theory, it's basic accounting.

4. If net foreign capital inflow declines, I expect interest rates in the U.S. to rise. The national debt is already growing out of control; when the federal government must refinance its burgeoning debt at higher interest rates, this growth will accelerate.  Trump is playing with fire.  The debt problem is about to get much worse.

There are really three predictions here for economic harm in the United States: higher prices and lower living standards, lower investment and hence future productivity, and an acceleration of the national debt and risk of sovereign debt crisis.  I can make other observations of a more political nature.  Given DPRK's behavior, this seems an especially dumb time to hit South Korea with damaging tariffs.  Trade war has the potential to undo the economic gain from tax cuts and deregulation that was undercutting the chances of the Democrats to take over Congress.  (Memo to Trump: The dems are your enemies.  They will impeach you and destroy you if they ever get the chance.)  And I'm skeptical this tariff policy is really driven by "unfair" foreign practices.  I think it is pure mercantilist rent-seeking by the U.S. steel industry. 

This is not a good situation; it's a terrible one.  But enemies of economics  -- our enemies on both the left and the right -- have been yammering for far too long about how free trade is just dogma, that protectionism creates jobs and prosperity, that economists know nothing. Oh yeah?  Well I say (and 95% of economists say) that protectionism is poison.  So on with it, let's have a little empirical testing.

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