During his election campaign, Donald Trump’s rhetoric was consistently anti-free trade. He threatened to impose tariffs on US imports from China and to renegotiate trade agreements such as the North American Free Trade Agreement (NAFTA). His argument for such policies is that they have led to enormous job losses in American industry. Indeed, this may explain some of his appeal to former ‘Rust Belt’ workers who have not been sharing in the ‘American Dream’.
The absence of the American Dream for enormous numbers of Americans is nothing new. Since the 1970s, median wages have been largely stagnant, while the so-called 1%, at the top of the scale, have done exceptionally well. This is reflected in rising income inequality. Among the 1%, one might include CEOs and many of those working in the financial sector.
So if Trump is as good as his word, will he enact protectionist policies, and will these restore more widespread prosperity among the poor and middle-class?
For mainstream economics, the case for free trade goes without saying. The law of ‘comparative advantage’ concludes that nations should specialise in the production of goods and services that they are relatively efficient at. Even if they are less efficient than other countries in everything, this should still lead to gains from international trade. Tariffs increase the cost of imports and lead to static welfare losses. Whether such imports are consumed directly, or provide inputs to particular industries, the increased costs will reduce welfare. Tariffs should therefore be avoided except under certain conditions determined in treaties overseen by the World Trade Organization (WTO).
In development economics, and particularly among its heterodox practitioners, there is a powerful argument, backed by historical experience and economic theory, that selective tariffs on imports can be part of an industrial policy which encourages certain key ‘infant industries’ to develop. During the post-war period, countries such as Japan, South Korea and Taiwan adopted such policies and many economists argue that this was key to their subsequent rapid growth.
Such industrial policies were not simply a matter of protecting domestic industry to create or preserve jobs. It was understood that industrialization was an imperative for successful development. Protection for the relevant sectors was conditional on improved performance, productivity growth and achieving international competitiveness so that such sectors could export onto the world market. The protection was therefore temporary and evolved with the economy.
Ha-Joon Chang has argued that industrial policies have not been confined to the ‘late developers’ mentioned above. All today’s rich countries used a variety of such policies to encourage industrial development. Chang also takes today’s global leaders and global institutions such as the IMF and World Bank to task for ignoring this historical evidence and for pushing free trade policies onto poorer nations. In the absence of some kind of industrial policy, it may be difficult for them to industrialize, diversify production, and develop rapidly enough to seriously reduce poverty.
But would selective protectionism help the US? After all, many of its industries are at the technological frontier and already dominant in world markets. They are hardly ‘infants’ that need to catch-up with international competitors.
In addition, the US has had its own form of industrial or technology policy for years. This relies not on protecting industries, more on public investment in research and development, particularly in the military-industrial complex. When it comes to national security, American governments have been happy to pour money into the development of new technology, which has later led to civilian applications. A good example of this is the technology behind smartphones, including the internet, GPS, touchscreens and voice activation software.
Trump is not proposing to protect technological leaders. Instead he wants to ‘make America great again’ in part by protecting industries which have lost out to lower-cost international competitors. However if protection is designed to reindustrialize middle America, it will need to be carefully managed to avoid the potential feather-bedding of uncompetitive firms. It will need to promote the international competitiveness of the relevant sectors. It should therefore be temporary and conditional on improved performance, so as to encourage not only job-creation but productivity growth and innovation. In the absence of the latter, which is essential to growth in countries which are already rich, jobs may be created or protected for a while, but the resulting inefficiencies will lead to welfare losses, rising over time.
There is also a macroeconomic element to the imposition of tariffs. The US is currently running a current account deficit, which includes a trade deficit (imports exceed exports). If the revenue from the tariffs is not spent by the government, then the effect of the resultant higher prices will be to reduce real household income and consumption and raise the national savings rate as the current account deficit falls. National savings will rise relative to investment, which is the same thing. This might provide a boost to aggregate demand in the short run, which could raise employment. In the longer term, and if maintained without complementary policies to promote competitiveness, the inefficiencies discussed above could come to dominate.
During the inter-war period of the 1930s, protectionism was a widespread response to the Great Depression and mass unemployment, although many have argued that the steep decline in international trade that resulted prolonged the Depression. As an example, the UK had rejoined the Gold Standard in the 1920s at a level for the pound which Keynes had argued was too high and uncompetitive. When the UK finally left it in 1931 by devaluing, cutting interest rates sharply, and imposing tariffs on imports, the economy grew rapidly. So tariffs imposed unilaterally might boost aggregate demand and growth for a while, but when other countries retaliate in similar fashion, world trade suffers and many countries are likely to lose the potential gains from its expansion.
Whether the Trump administration turns to protectionism or not, America could certainly do with more active welfare state and labour market policies, which should support structural change and the creation of new jobs in growing sectors. Structural change is inevitable under capitalism, as old industries decline or transform and new ones are created. The US could learn from the Scandinavian countries, where governments provide significant funding for job retraining and relocation, so that the unemployed are helped to find new work as the economy evolves.
There is a real danger that protectionist policies by the US could provoke a global trade war, as other countries retaliate in a beggar-thy-neighbour fashion. Of course, if all countries do it, there will be significant global losses so that, while some may benefit for a little while, most or all will lose in the longer run, probably unevenly, as international trade declines. This would be reminiscent of the 1930s, which ended in the disaster of global conflict.
In response to the Great Recession which began in 2008, governments responded on many fronts, and it seemed that the world would avoid another Great Depression. Since then, international cooperation has been found wanting, and growth has at best stagnated in the rich world. There has been a turn towards nationalism in the politics of many countries, and incumbent elites seem somewhat powerless to respond as globalization falters amidst the justified outcries that it has left so many behind.
What to do? It is early days in the US transition to a Trump presidency and the jury is out on how much of his policy rhetoric will be put into action.
Keynes would have called for a new Bretton Woods or a new Marshall Plan, which rested on US dominance in the West after World War II. It may be too early for that if the nationalist turn continues. But eventually a new balance will need to be found between the narrower domestic interests of each nation-state and the cooperation required by their global interdependencies. In the absence of a renewed commitment by the dominant global players to work together in the interests of the many and not the few, it may be some time until we are out of the woods.