Has Trump really got the economics of trade all wrong?
One of the reasons for the crisis of liberal democracy and its institutions is complacency - over-reliance on old narratives and on liberal democracy's favourite experts. And so it goes that everybody seems to be in agreement that Donald Trump's trade policy is self-defeating, because every trade expert in the world seems to have placed their trust in studies that have shown this to be the case. We heard similar arguments during the Brexit debates.
Tyler Cowen, a US economist who is certainly no Trumpian, warns us that Trump's calculus in his trade wars with China might actually work. The economic literature, he writes, does not take into account the factors pertinent to this particular case. His criticism is not just confined to US/China trade relations. It would apply to a trade war between the US and the EU as well.
In the case of China, a trade war has several consequences apart from the raising the cost of imported Chinese goods in the US. The first is that production might shift from China to countries like Vietnam, which has lower labour costs than China and a free-trade deal with the US. The overall result would be an initial increase in cost to US consumers, followed by a fall in cost after a certain period. This is very similar to the argument made by Larry Kudlow, Trump's chief economic adviser, over the weekend. Cowen also makes the point that, if there is no US-China trade deal, multinationals will become more wary of investing in China. They are looking at the trade deal itself as justification for their commitment to invest.
And, as regards German cars, Cowen makes another important point that is often ignored in the debate. If a product has a large profit margin, like a Mercedes car, the cost of a tariffs will fall disproportionately on the producer, not on the consumer. This is so because Mercedes is more likely to accept lower profit margins than to try and pass higher prices through, given markets conditions.
We agree with Cowen's conclusion that it is humbug to argue that the US consumer is the one and only victim from a trade war. Shifts in production and cuts in profit margins mean that a larger share of the costs will be borne by the producers. In other words, we should consider Trump as dangerous, not as stupid.
We have been arguing as well that countries with extremely high trade surpluses, like Germany and China, are correspondingly vulnerable to trade tariffs, and that we should not rely on academic studies showing low tariffs to be a win-win proposition for everybody all of the time. We have made a similar argument in the case of Brexit, given the EU's large and persistent trade surplus with the UK. The impact of tariffs is highly complicated, and rarely captured by economic models that fail to take into account the specific nature of the concrete situation. In the UK, for example, it is not clear whether a 10% car tariff on both sides would end up shifting production into the country or out of the country.