MICHAEL KEATING.-Trump’s fantasies and trade realities.

Jan 3, 2020

Trump’s trade war with China cannot and has not succeeded. But Trump risks doing major damage to the rules-based global trading system and the future of the world economy.

A year ago President Trump embarked upon a trade war with China. Trump’s immediate objective has been to reduce US imports from China and thus reduce Chinese competition and the US trade deficit. According to Trump, the large US trade deficit with China could only have been caused by China’s cheating, and that deficit is in turn a measure of how much China is taking an unfair advantage of America.

Now a year later it is timely to see how those trade numbers have reacted to the increase in tariffs imposed initially by Trump, but then also in retaliation by China.

First, the US trade deficit has not fallen. Instead the current account deficit on the US balance of payments is larger than ever – an expected 2.5 per cent of GDP in 2019, compared to 2.4 per cent in 2018 and 2.3 per cent in 2017.

Although the trade deficit with China has fallen by about $10 bn., US domestic demand has not fallen and with the US economy already operating at full capacity, the US demand for Chinese imports has instead been diverted to other countries. The net impact has been that the US trade deficit with the rest of the world has increased in the last year by more than enough to offset the fall in the reduction in the trade deficit with China.

This increase in the US current account deficit is not what Trump expected, but it shouldn’t have surprised anyone who understands basic economic and trade realities.

The fact is that a country’s overall current account deficit on its balance of payments is identically equal to the gap between what it earns and what it spends – that is its savings deficit, or the amount that it then needs to borrow from foreigners. And in the case of the US, this gap is growing because of Trump’s lax fiscal policies, with the general government financial deficit increasing from 4.3 per cent in 2017, to 6.7 per cent in 2018 and an expected 7.0 per cent in 2019. Thus, despite Trump’s delusions, the reality is that the US trade deficit will never come down, so long as the US is providing tax cuts that its Budget cannot afford.

Furthermore, given this identity between the current account deficit and the US savings deficit, tariff increases cannot reduce a trade deficit. Instead, it is likely that the exchange rate will react to offset any increase in tariffs, so long as the savings deficit remains unchanged.

Accordingly, as expected, we find the second piece of economic reality is that the Chinese yuan has depreciated by 6 per cent against the dollar since the trade war began. Trump might wish to interpret that currency depreciation as an indication of Chinese currency manipulation, but there is no evidence of any such manipulation. Instead, this depreciation of the yuan relative to the dollar is a normal response by a free market to any increase in tariffs when there is no change in the domestic savings deficit.

The third fact is that Chinese exports have continued to increase at a rapid rate over the last year. Although exports to the US have fallen by about 8 per cent in the twelve months to October 2019, China has diverted its exports elsewhere, and its total share of global exports has increased marginally compared to the previous twelve months. In addition, China’s overall trade surplus is estimated to be about a quarter bigger in 2019 than in 2018; although this increased trade surplus is partly because of a slow-down in Chinese domestic demand.

Overall Assessment

The domestic economies of neither China nor America have been greatly impacted directly by their trade war. Instead, China has increased its exports elsewhere, and the US has increased its imports from other countries. But the net result has not been any diminution in their respective trade balances, and really we should not have expected any other outcome.

Trump of course claims that he has extracted major concessions from the Chinese so that in future they will have to compete on a fairer basis with America. This claim about past and future Chinese behaviour is however debateable.

First, few details have been provided yet of what has been agreed with the Chinese and so we cannot judge what they have conceded, if anything much. What we do know is that the US claims that:

· much of China’s success has depended upon the theft of intellectual property, but given China’s lead in advanced technology such as 5G one wonders what difference any concessions here will make, and

· China has forced foreign firms to hand over their R&D, but it is questionable how reprehensible those demands are. In Australia’s case, for example, the evidence suggests that we have been too reticent in demanding that foreign-owned firms do more of their R&D in Australia, and this has affected our rate of innovation and technological progress.

Second, it is highly likely that any concessions that China has made, will come at a cost to other countries. For example, it is reported that China has agreed to a large increase in agricultural imports from the US, but this increase will probably mean a reduction in competing imports from Australia and other agricultural exporters who compete with the US.

All that leaves me wondering about the acumen of the US policy makers and especially their chief, President Trump. Trump keeps telling us what a genius he is as a negotiator, but as I have argued above, the US is delusional if it thinks that it can change its trade deficit by changing trade arrangements.

The experience of the last twelve months has reminded us that so long as the US has a savings gap, it will have a commensurate trade deficit. Even if Trump succeeds in reducing the US trade deficit with China, it is likely to be offset by an increase in the US trade deficit with other countries. Equally, China is likely to maintain its trade surplus by increasing that surplus with other countries, if its trade is diverted from the US.

In short, Trump’s policies have not and will not lead to any improvement in international trade imbalances. Instead, Trump has orchestrated a major disruption of the rules-based global trading system and increased uncertainty, that is now believed by the IMF and OECD to be affecting investment and future economic prospects. But, at the same time, Trump has not changed significantly the US demand for imports and the competition that American manufacturers are experiencing.

Nor can it be expected that protectionist policies, such as those adopted by President Trump, will ever succeed in making an economy more competitive. The only way to restore US competitiveness is, as Australia recognised in the 1980s, to:

1. embark on a program of micro-economic reform which will reduce costs and redirect resources to where the country has its greatest comparative advantage, and

2. rebalance macroeconomic policy to rely less on domestic demand and more on foreign demand.

Michael Keating is a former Head of the Departments of Prime Minister & Cabinet, Finance, and Employment & Industrial Relations. He is presently a Visiting Fellow at the Australian National University.

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