In Part 1 of this series of two articles, yesterday I examined the impact of President Trump’s economic program on the American economy. Today’s article discusses the impact of the Trump economic program on the rest of the world, and Australia in particular. The key danger is that Trump will further encourage a rise in protectionism, that will damage the foundations of the open economy that in the last seventy years has delivered the biggest rise in living standards in human history. However, continuing economic growth inevitably involves economic transformation, and maintaining support for the open economy will depend upon programs that better assist workers to adapt to structural adjustment pressures, from whatever source.
In the almost ten years since the Global Financial Crisis (GFC) economic recovery in the advanced economies has been very sluggish. This slow growth and the stagnation or even fall in household incomes has encouraged the rise of economic nationalism, as can be seen in the British vote for Brexit and the rise of mostly right-wing nationalist parties elsewhere in Europe. One response has been a rise in protectionism. During the last several years, the number of trade-limiting measures implemented by the G20 countries has more than quadrupled, while for the first time since World War II, the share of world trade to global GDP has been falling. Thus, the open global trading system was under some threat, even before Trump arrived on the scene.
Trump’s basic contention is that if a country’s exports to the US are growing faster than the US exports to that country, then that is proof that the US is being unfairly discriminated against. As I discussed in yesterday’s article this view is based on a fallacy. It fails to take account of the fact that we live in a multilateral trading system, and that the difference between a country’s total exports and its imports is determined by the difference between that country’s domestic savings and investment. This identity between a country’s trade gap and its savings gap is maintained by the real exchange rate changing as necessary, and we can expect the real exchange rate to rise in any country that seeks to introduce protectionist measures against its trading partners. This would of course nullify the objective of those protectionist measures, but there would be a lot of disruption and misallocation of resources. Indeed, this was exactly the experience during the Great Depression.
Nevertheless, one of Trump’s first acts after becoming President was to abrogate the Trans Pacific Partnership trade agreement, which of itself sent a bad signal to the world. In addition, Trump has now insisted that NAFTA be re-negotiated, so as to be less favourable to the other two signatories – Canada and Mexico. And while Trump’s threats of a penal tariff on Chinese manufactured imports have been toned down for now, in the hope of gaining Chinese support against the military threat posed by North Korea, those threatened tariff increases have not been taken off the table.
In what follows, I will draw on the work I cited yesterday by the Productivity Commission and McKibbin and Stoeckel to model the likely outcomes for the rest of the world if the US does increase its tariffs[i]. Two scenarios are presented. The first scenario assumes a 40 per cent increase in US tariffs on Chinese manufactured imports, but there is no response by any other countries. The second scenario assumes that each country imposes an extra 10 per cent tariff on imports from all other countries.
Interestingly a unilateral 40 per cent increase in US tariffs on Chinese manufactured goods, which provokes no further reaction, does not lead to any significant improvement in the US trade balance; principally because the imports from China are mainly replaced by (more expensive) imports from other countries. The effect on China though is significant with investment reduced by 1½ per cent relative to its baseline, which then leads to a drop in GDP relative to its baseline. The Chinese trade balance is however unaffected because the reduction in Chinese investment leads to more capital outflow than otherwise, and China’s real exchange rate then depreciates by 5 per cent below its baseline. In contrast, Mexico would be much more affected if the US introduced a 35 per cent tariff on Mexican imports as threatened. As much as 80 per cent of Mexican exports go to the US, and this 35 per cent tariff increase is projected to lower Mexican economic activity by about 10 per cent.
This picture changes dramatically for the worse if there were a trade war as depicted in scenario 2. When all countries raise tariffs, the modelling suggests that all countries then lose: in the year following the tariff increase, the US GDP is 1.3 per cent below its baseline; and the loss of output in Australia is similar; while Germany, China, and most of Asia, all have their real output lowered by three times or more the loss in the US and Australia. The biggest part of this loss comes from countries’ own actions, as investment declines in response to higher import prices and there are lower returns to capital as the price of capital goods increases relatively.
A key conclusion, which is reinforced by the modelling, is that it is the increase in a country’s own tariffs which causes most damage to its economy. Indeed, Australia recognised this almost thirty years ago, when it embarked on unilateral tariff cuts without seeking reciprocity. Obviously it should be in everyone’s interest to avoid a trade war – including the US. However, if the worst comes to the worst, and Trump does initiate a trade war, it would still be in Australia’s interests not to join in and retaliate.
Instead, in that case, the Productivity Commission suggests that Australia should seek to be part of a coalition of ‘like-minded’ countries that could agree to resist protectionist measures. The participants in the Regional Comprehensive Economic Partnership – including Australia, China, Japan, South Korea, India, New Zealand, and the ASEAN countries – could possibly form the basis of such a grouping. If these countries did no more than maintain their tariffs at current levels, the negative effect of higher protection elsewhere on Australia’s income would be largely offset, and further liberalisation of tariffs by this group of countries could increase economic activity in Australia by about 2.5 per cent – or about a year’s economic growth.
The conclusion is that it is critical to maintain support for free markets. But this support is more likely to be forthcoming if:
- Trade agreements are even-handed and rules-based
- Consultation processes are further improved
- More attention is given to the distribution of the benefits from trade and to the uneven costs of adjustment, and
- Australia’s training and other programs to facilitate adjustment are adequately funded, which is not the case at present.
While Australia should do better, it might also be noted that Australia’s handling of structural adjustment pressures has been much superior to American performance. Indeed, a comparative analysis of the impact of globalisation on the US and Australian economies has shown that while both economies were about equally exposed to globalisation pressures, unemployment rose much more in the US in response to globalisation[ii]. Thus, instead of blaming foreigners and resorting to protection, President Trump should really be seeking to improve America’s training and other programs that would allow America to better adapt to the inevitable changes from both new technology as well as from globalisation.
[i] For those who are interested the first study is reported in a Productivity Commission Research Paper, Rising protectionism: challenges, threats and opportunities for Australia (available on the Commission’s website); while the second study, Some Global Effects of President Trump’s Economic Program, is by two economists, McKibbin and Stoeckel, and is available at: https://cama.crawford.anu.edu.au/publication/cama-working-paper-series/11251/some-global-effects-president-trumps-economic-program
[ii] This analysis is contained in the book, Fair Share: Competing Claims and Australia’s Economic Future, by Stephen Bell and Michael Keating, to be published by MUP early next year.