March 11, 2016
That is what Binyamin Appelbaum argued in a Upshot column with the headline, “on trade, Donald Trump breaks with 200 years of economic orthodoxy.” The piece points to Trump’s rhetoric in which he claims that other countries are taking advantage of the United States because they are running large trade surpluses with us.
It then turns to an old speech from Milton Friedman saying the opposite is true:
“’Economists have spoken with almost one voice for some 200 years,’ the economist Milton Friedman said in a 1978 speech. ‘The gain from foreign trade is what we import. What we export is the cost of getting those imports. And the proper objective for a nation, as Adam Smith put it, is to arrange things so we get as large a volume of imports as possible for as small a volume of exports as possible.’”
This is in fact the classic economics argument for the merits of trade, but there is an important assumption in the argument which is not mentioned. The assumption is that the trade deficit has no effect on the level of aggregate demand and output in the United States. In the standard economic view, if our annual trade deficit increases by $200 billion we will simply make up this demand elsewhere in the economy.
A combination of higher consumption, investment, and government spending will fully offset the $200 billion reduction in demand resulting from the rise in the trade deficit. This means that total demand in the economy will not change, nor will total employment. There could be some shift in employment, from the import competing industries to the industries that meet the new demand, but in the standard economics story of trade, overall unemployment is not a problem.
This view of trade is less tenable in an economy that faces a chronic shortfall of demand, as is the case in the United States. Most economists now recognize that advanced economies like those in the United States, Japan, and the European Union can have prolonged periods of inadequate demand (a.k.a. “secular stagnation”) leading to unemployment and underemployment.
Insofar as economies suffer from inadequate demand, Friedman’s comment does not make sense. If we import goods and services that we could have produced domestically it means a reduction in aggregate demand, and a loss of jobs.
Clearly this is the reality the United States faces at present. The trade deficit is running at an annual rate of more than $500 billion (@ 3.0 percent of GDP). This is demand that is creating jobs in other countries, not the United States. While it could in principle be offset by higher spending in the United States, like a big government infrastructure program which is not financed by taxes, as a practical matter fears over budget deficits prevent such responses. And, there is no mechanism that causes private sector spending to grow enough to fill the gap created by the trade deficit.
In this context, Trump is absolutely right to worry about a loss of jobs as a result of a trade deficit. He might be wrong to blame other countries or to imagine the cause is the incompetence of our trade negotiators (major U.S. companies like Walmart and GE benefit enormously from cheap imports), but the claim that a trade deficit is associated with lower output and employment is entirely consistent with modern macroeconomics.
It is also worth correcting the notion that the United States has been committed to a policy of free trade. While trade agreements have explicitly sought to lower barriers to manufactured goods thereby putting U.S. manufacturing workers in direct competition with low paid workers in Mexico, China, and other developing countries, they have maintained or even strengthened protections elsewhere.
For example, U.S. physicians earn on average twice as much as their counterparts in other wealthy countries. This is in large part due to the fact that foreign doctors cannot practice in the United States unless they have completed a U.S. residency program. Dentists enjoy similar protection. In order to practice in the United States a dentist must graduate from a U.S. dental school. (In the last few years, graduates of Canadian dental schools have also been allowed to practice.)
The article highlights a tariff on tires which apparently raised prices in the $40 billion tire market by 2.5 percent. In contrast, the market for physicians’ services is over $200 billion annually, with prices perhaps double what they would be in a free market. Nonetheless, the “free traders” never seem to pay attention to the protectionism in this market. The predicted and actual effect of this pattern of trade is to depress the wages of ordinary workers while increasing the wages for those at the top.
There are also areas where trade deals have quite explicitly increased protectionism and raised prices. All the trade deals the U.S. has negotiated in the last quarter century have sought to make copyright and patent protection stronger and longer. These forms of protectionism often raise the price of the affected products by 1000 percent or more above the free market price. The cost to the economy is enormous. In the case of prescription drugs the United States now spends over $400 billion annually on drugs that would likely cost less than $40 billion in a free market. (There are alternative mechanisms for financing the development of new drugs.)
In short, Trump is not at odds with modern economics in expressing a concern over the trade deficit. It is also wrong to claim the United States has been committed to a policy of free trade. It has been following a policy of selective protectionism which has the effect of redistributing income upward.
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