Trade War

Trade negotiation is inevitable, while trade wars are rare. Will today’s actions lead to a trade war? Much of the discussion of a looming trade war comes from those who emphasize that the US has a trade deficit with many countries. This means that we buy more from those countries than they buy from us. Thus, they have much more to risk in a trade war. We buy a lot from them and if we stop buying it will harm those countries mortally. 

There is nothing wrong with that logic except that it is incomplete. It focuses only on the bilateral relations between us and them. The bigger picture examines the importance of trade to the USA and its main trading partners. 

Let’s begin with a review of the countries that purportedly take advantage of us in the USA. President Trump’s goal is to reduce bilateral trade deficits. Below I list the biggest bilateral US trade deficits in billions of dollars in 2017:

            China             $375

            Mexico              71

            Japan                 69

            Germany           64

            Vietnam             38

            Ireland               38

            Italy                   32

            Malaysia            25

            India                  23

            South Korea      23

(Also among the top 15 countries are Thailand, Canada, Taiwan, France, and Switzerland.)

According to President Trump those countries are the “bad actors.” Notice that China holds a special distinction because the US trade deficit with that one country roughly equals the trade deficit with the next nine. China and the others, according to the logic discussed above, ought to cave soon because they sell so much to the USA. If we tax all that inflow to the US, it could hurt them a lot.

Let’s widen the story. Think about the importance of trade to these countries. The next table shows the total trade deficit of each country – the trade deficit of each country with the rest of the world. That deficit is presented as a percentage of each country’s GDP. Note that the corresponding number for the USA in 2017 was 2.8%.

           

            China             Surplus

            Mexico             1.4

            Japan                3.9

            Germany       Surplus

            Vietnam            6.2

            Ireland              0.9

            Italy                  1.4

            Malaysia           3.0

            India                 6.4

            S. Korea        Surplus

The point? These countries, except China, Germany, and South Korea, have trade deficits too.  How willing do you think they will be to making their deficits larger so that the US can have a smaller one?

Next, let’s turn to imports. If President Trump had his way, we wouldn’t import anything, except for maybe Cognac and a cigar or two. But he wants the bad actors to buy more from us. He wants them to import more. Below I report each country’s imports as a percentage of its GDP. US imports were 15% of GDP in 2017.

 China               18%

            Mexico            40

            Japan               15

            Germany         40

            Vietnam          99

            Ireland            88

            Italy                28

            Malaysia        64

            India               22

            South Korea   38

The point? These countries love imports even more than we do. But how much more can a country import when it already has a trade deficit? How much more of US exports can they consume?

It is nice to think that we are being taken advantage of by the rest of the world. But the larger truth is that many countries have trade deficits and already import a lot of goods and services. This reality is surely going to stiffen their backs as the US tries to solve its own trade problems by limiting imports to the US and raising exports to the rest of the world.

           

US Deficits in Goods Trade

Trade and protectionism are hot topics. At the root of the discussion is what has happened to the US as a trading partner. There is much to this debate and I won’t handle it all here today. Instead I focus on something that I think is central to the issue – the performance of US trade in goods.

International trade goes well beyond trade in goods. But as it turns out, a key part of what we consider to be problematic for the US is trade in goods. We trade services (like entertainment, transportation, shipping, and tourism) and we engage in a lot of international exchange with respect to financial and real assets (bonds, stocks, bank accounts) but we generally run surpluses in those trades. If we have a large and persistent trade deficit, it is mainly with respect to goods.

So I am back to playing with the data again this week. With trade figures there are choices to make. Much of what we refer to as trade is measured and captured in our balance of payments (BOP) account. There we find the Current Account and the Financial & Capital Accounts that contain information about exports, imports, and so on. These figures are always presented in nominal terms and thus measure changes in both quantity and price. Export and imports of goods and services are also published in our National Income Accounts (NIA) and those measures of trade are very compatible with the way Gross Domestic Product (GDP) is measured. The NIA accounts are presented in both real and nominal terms.

Yikes – too much information. Anyway, I decided to use the NIA measures since they are compatible with the way GDP is measured. I am using the nominal versions because they are somewhat more compatible with the BOP figures. I did a quick comparison of the real and nominal NIA measures and it didn’t change my overall conclusions. Whew. Where’s that JD?

The table at the bottom shows nominal NIA measures of US exports and imports of goods starting in 1964, the year I began studying Industrial Management at Georgia Tech and was introduced to chili dogs at the V in Atlanta. I present data for five years that are separated by 13 year-intervals because 13 is my favorite number (1964, 1977, 1990, 2003, and 2016). These 5 years bracket 1990 which is a demarcation point for the rise of globalization. This allows me to compare 26 pre-globalization years to 26 post-globalization years. Is this fun or what?

The top of the table presents US imports and exports in billions of dollars. Nominal GDP, also in the table, went from about $6 trillion in 1990 to almost $19 trillion in 2016. Some of that increase is because of price increases – with the rest from quantities. But GDP is not the point today – though it gives you a benchmark as to how much the size of the overall economy changed over those 52 years. Goods exports went from $403 billion in 1990 to almost $1.5 trillion in 2016. Imports increased too – from $508 billion to about $2.2 trillion. The net imports (imports minus exports) was $105 billion in 1990 and increased to $778 billion in 2016.

If I stopped right now many of you would have an aha moment. What you would see is the following post-globalization experience: US imports of goods outran our exports of goods and the trade deficit in goods increased dramatically. There are no smoke or mirrors here. This is the kind of information that supports the popular idea that globalization has not been good for the US and that there might be unfairness working against us – be it so-called free trade agreements or cheating or whatever.

But let’s not stop there. In the second part of the chart we display trade in goods as a percent of GDP. In 1964 goods exports were 3.9% of GDP. By 2016 goods exports accounted for twice the share of the economy at 7.8%. But notice that the pre-globalization gain of 2.8 percentage points (from 3.9% to 6.7% of GDP) compared to the 1.1 percentage point gain in the post-globalization years. That is, exports gained as a share of the economy much more before- compared to after-globalization. What about imports? Imports of goods increased 2.7 points before globalization and then 3.4 points post-globalization.

It is true that imports of goods picked up its pace after globalization while exports did the opposite. But notice also that much of those changes came in the 13 years after 1990. During the time from 1990 to 2003, exports fell as a share of GDP while imports rose dramatically. But then in the most recent 13 years we see that reversing as the share of exports increased at more that twice the pace of goods imports.

What can we say?

First, goods trade – both exports and imports were rising as a share of the economy for 52 years – both before and after globalization began accelerating in 1990.

Second, when we compare the data before 1990 with what happened afterward you can see much bigger increases in imports of goods relative to exports.

Third, if we look closer at the data since 1990 we see that most of the advantage of imported goods peaked by 2003 and has reversed since.

What does all this mean? For one thing it means that this is a pretty rich stew with a lot of vegetables. If we combine these numbers with the numbers from last week’s blog post we wonder if some of these trade results have something to do with the fact that so many countries have been narrowing the economic gaps between them and the US.

The 1990s were a time when many countries decided to open-up and use trade as a development tool. These countries wanted to rebuild and become more competitive and many were very successful as we saw in this blog last week. As incomes across the world grew, so did their appetites for goods and the growth of US exports of goods verifies this. But as their incomes grew they also became stronger competitors to the US and our goods imports rose as well.

Since so many countries were starting from very low incomes and poor productivity it made sense for the US to make special compensations or to ignore remaining protections in these countries. US citizens gained many of the benefits as more goods were available to them at lower prices. Lower prices gave US residents more dollars to spend and these people redirected some of these surpluses to US companies and created millions of jobs. The GDP data below show remarkable growth in our economy as some jobs declined while other expanded. 

There are some who think that the US can use its own arsenal of protectionist policies to preserve and restore jobs in the US. But that thinking is short-sighted. Despite catching up many countries still retain much lower incomes and a distinct price advantage that goes with it. Protecting US citizens from low prices on low-skilled goods makes no sense. It’s like sticking a finger in the dyke. What makes more sense is to recognize that the world has changed and that developing countries need to protect their own industries and workers less. Let’s not raise the worldwide level of protection – let’s lower it. 

But what about all those US workers in firms and industries that cannot compete? The answer is pretty simple in principle. Protecting these workers is only a temporary measure so long as the American worker makes $50k per year and foreign competitors make half or less. What makes sense is to encourage other countries to keep catching up with our incomes – and to find ways to better train and retrain our workers to fit better into US advantages in education, science, technology, entertainment, communications, and so on. The data below suggest that the export/import issue started turning in 2003. Perhaps we can keep that alive in the next 13 years following 2016.

Billions of Dollars	1964		1977	1990	2003	2016
Nominal GDP		686	2,086	5,980	11,511	18,625
Exports of Goods		27	128	403	741	1,446
Imports of Goods		40	153	508	1,296	2,224
Net Imports		13	24	105	555	778
As  Percent of GDP		1964	1977	1990	2003	2016
Exports of Goods		3.9	6.2	6.7	6.4	7.8
Imports of  Goods		5.8	7.3	8.5	11.3	11.9
Net Imports		1.9	1.2	1.8	4.8	4.2
Source BEA.gov

Lesson 1. International Trade Ignorance

Those of you who can count will recognize that my last lesson was Lesson 16 and therefore you were expecting Lesson 17 this time. Unfortunately I checked the records and I never had a Lesson 1. I started with 2. Sheesh. So I am naming today’s main plate Lesson 1.

This lesson is about international trade. International trade is a lot like pho, the Vietnamese soup. A lot of people really like it but almost no one knows how to prepare it. Otherwise Campbell’s would have canned it already. We're similarly ignorant about international trade. When my fifth grade teacher called me ignorant, I was very hurt. But later I realized it did not mean I was terminally stupid – only that I didn’t know very much. I was willing to go with that.

I fear that our President-Elect is a bit ignorant about international trade. I also fear that he will read this post and ask me to be Secretary of Doggie Bags, but the truth is that most of us are ignorant about international trade. So no insult is intended.

One of my professors once talked about international trade in terms of the tail that wagged the dog. Unless you have a really small dog with an unusually large tail, you expect the dog to wag its tail. So saying international trade is like the the tail wagging the dog ought to have your ears perked and your tail wagging.

What my professor meant is that there used to be a day when trade pretty much meant one thing – countries selling goods to each other. "Goods" implies a tangible, e.g. a manufactured product or an agricultural product. You can imagine a time when much of world trade was coal or corn or clothing or cars. Countries loved to export goods because it expanded their ability to sell. The more they sold, the more incomes and employment grew.

So exporting goods was really cool. It was the big dog. You were the coolest kid on the continent if you could export your goods to other countries. That’s what many people think is what international trade is all about. Exports of goods! In 2015, the US exported $1.5 trillion of goods. Go team.

The interesting thing about an export of goods is that a bunch of foreign currency comes into world markets to pay for your goods. What do we do with all those foreign currencies? They are pretty but papering your walls with it can only go so far. Then some bright bulb thought, "Hey, with all this foreign money, maybe I could buy things from other countries!" So export countries would use the foreign currency to buy goods from other countries. Imports go hand in hand with exports. And more important, imported goods can really help your country – especially if you import things that help you to be happier and more productive.

So exports of goods imply imports. While exports have an important role for national goals, imports of goods are also part of that equation. If a country imported only Twinkies, then maybe you might want to rethink the value of the imports. But countries often import vital things they can’t get at home.

Nowadays most of the world has discovered services. Services are intangibles which essentially disappear once they are consumed. A float down the Rhine might cost you $20k but on your way home all you have left are some nice memories and the JD bottle you stole from your room fridge. Travel, tourism, entertainment, communications, utilities, healthcare, etc. are services. In the US today, about 70% of what we spend goes for services. So whatever I wrote above about goods adheres equally to services. Services exports augment a nation’s output and employment; services imports fill in what we don’t or shouldn’t make ourselves. In 2015, US services exports were $743 billion.

When people subtract national imports from exports, they are doing a legitimate operation. For example, if exports are less than imports of goods and services, we call that negative number a trade deficit. That causes frowns. We don’t like deficits. But in reality the negative number is telling you only one thing directly – currency going out exceeded currency coming in. What this negative number tells you – for example, a deficit of goods and services of $500 billion in 2015 – is that $500 billion did not return to the US via imports of goods and services. So what? It does NOT tell you that the US is in a half-billion dollar hole. In fact, what we know is that the nation got benefits from the exports AND it got benefits from the imports. Adding them together, we got about $5 trillion of benefits to the country in 2015.

I see you are tiring. Give me 10 burpees. The best part is coming.

What we have left out of all this is a huge part of trade call financial stuff. Okay, there is a more technical term but for now remember that the trade deficit left $500 billion of dollars around the world that people did not want to use for US goods and services. 

Notwithstanding wallpaper, foreigners who hold all those dollars can use that money and more if they want to buy financial stuff in the USA. They can open up an account  at the IU Credit Union. They can buy corporate or government bonds. They can buy shares of Apple or shares of an index fund. They can also acquire or merge with Apple or the Crosstown Barber Shop.

Wow. And they are not limited by that $500 billion left over from the trade deficit. They can invest all they want. And I don’t have to convince you that when foreigners buy US assets, it is a good thing. It is good because US firms find it easier and less costly to raise capital for investment. It is good because it lowers US interest rates. It is good because it can infuse the latest technology and innovations into American companies.

In 2015, foreigners increased their ownership of US companies (what we call foreign direct investment or FDI) by around $350 billion dollars. That’s not how much they owned – that’s how much they INCREASED their ownership in that one year. They increased FDI by around the same amount in 2014. In those two years, foreigners increased their ownership of portfolios in America by about $736 billion. Money is gushing into the USA. Between this portfolio investment and the FDI, we are talking about an increase of dollars buying US assets of more than $1.4 trillion.

Here’s the point: Trade includes cross border transactions of goods, services, foreign direct investment, portfolio investment, and more. Anyone who focuses on one of these to the exclusion of the rest is not telling you the full story. International trade is great for the USA. Yes, we have a trade deficit. But we also have a pile of very valuable imports of goods and services flowing in and a waterfall of the world’s savings wanting to invest here. Anyone who suggests that we should jeopardize the latter so as to remediate the trade deficit in goods is not understanding the meaning of international trade.