Evaluating the U.S. trade deficit with China and other nations

International Trade & Finance

China is the second-largest trading partner of the United States after Canada (Census.gov, 2009). This trading relationship has fundamentally altered the economies of both countries, as well as the shape of global trade itself. The nature of the trade is based heavily on the U.S. importation of low-priced Chinese goods from a wide variety of sectors. This has created a massive trade deficit between the U.S. And China, a situation exacerbated by historically low U.S. savings rates and historically high Chinese savings rates, along with the peg of the yuan to the dollar. There are calls, however, for this trade to be curtailed somewhat. Trade between the U.S. And China has resulted in a massive transfer of wealth across the Pacific. This has in turn had many negative consequences for the U.S. economy, including hundreds of thousands of lost jobs in manufacturing. U.S. firms complain that the cost of doing business is so low, that they could not compete even they paid their workers nothing. This raises the question, is protectionism warranted, to protect U.S. economic interests? It is fanciful to enact protectionist measures in tough times, and indeed this trend is increasing as the result of the global financial crisis (Evenett, 2009). However, this trend is wrong headed. This paper will show that protectionism hurts economies, even the workers the measures are designed to protect.

Ricardo

The foundation of international trade theory derives from David Ricardo's 1817 book On the Principles of Political Economy and Taxation. In this work, Ricardo outlined the theory of comparative advantage. All things being equal, he argued, nations benefit from producing the goods in which they have a comparative advantage, not an absolute advantage, and then trading those goods freely among each other. When illustrated, comparative advantage shows that the total output of the two nations combined is higher than if they only produced the goods in which they had an absolute advantage (NetMBA, 2007).

The Ricardo example was simple, devoid of taxes, to show the impacts of such trade without any barriers. From it has flowed our current model of international trade that has emphasized the removal of trade barriers. The massive uptick in trade between the U.S. And China, for example, began as a result of the removal of barriers between the two nations. The ascension of China into the World Trade Organization has further allowed the two countries to build trade linkages.

Protectionism

There are many arguments in favor of protectionism. These include national security interests, the infant industry argument and for the protection of jobs. U.S.-China trade, for example, has cost the American manufacturing industry hundreds of thousands of jobs. The cost for an hour of Chinese labor is substantially lower than for an hour of American labor. Land is relatively cheap in China compared to the United States. China backs their industries with low interest loans from their banks, and protects them from the adverse affects of currency inflation by wildly distorting the market for the yuan.

Thus, that the Chinese economy is growing at the expense of manufacturing jobs in America and other western countries is a point of policy of the Chinese government, and is evident in many of its tactics and economic development strategies. The approach of the United States is typically to promote free trade, a reflection of Ricardian values.

Protectionism in the context of the U.S. trade relationship with China is to protect the nation from the adverse impacts of trade with China. There are positive impacts as well, though. Trade with China functions in the way that Ricardo predicted it would, raising the combined production of the two countries to the betterment of both. Access to low-cost Chinese goods has held U.S. inflation in check, even during economic boom times.

Cultural Values

The debate about increasing protectionism in the U.S. boils down to a clash of cultural values. In the natural course of international trade, there will be those who suffer and those who benefit. International markets are amoral. Trade is conducted between nations with the intent of raising the standard of living for both, but this is on aggregate, not universally. As a result, jobs losses in some sectors, particularly those where the U.S. does not have comparative advantage, are inevitable. To enact protectionist measures to stem those job losses will have three negative impacts.

The first is retaliatory trade measures. Tariffs and other protectionist measures tend to go hand in hand. If a country protects its industries, nations that trade with that country will do the same. This is the classic Smoot-Hawley scenario. To protect American jobs during the Depression, the Smooth-Hawley Act was signed, bringing heavy tariffs to protect U.S. workers. However, the major trading partners in Canada and Europe retaliated against these measures by protecting their markets from American goods. The impacts on the U.S. economy were devastating, as export markets disappeared overnight and domestic consumption remained unstimulated (U.S. Department of State, no date).

The second impact of protectionism is that it represents a distortion in the markets. If the free market determines that those jobs are no longer sustainable, protectionism will not change that. The cost of sustaining those jobs will simply get higher, as those jobs become increasingly unsustainable. Distorting markets creates inefficiencies and the potential for market failure. By contrast, the removal of trade barriers promotes market efficiency.

The third impact of protectionism is that it breeds complacency. Industries that are protected have little incentive to compete better. They innovate at a slower pace, are less efficient, and invest less on improving their capabilities. Protecting industries ultimately harms them in the long run.

Conclusion

Protectionism does help to protect some American jobs, in the short-term. However, it costs more jobs than it saves. Free trade stimulates the economy and creates jobs in other areas, that can offset the impact of lost jobs in some sectors. While this is no comfort for the workers who are suffering the impacts of trade with China, it is not the goal of a capitalist government to provide lifetime employment in one's field of choice. If the nation as a whole benefits from the removal of trade barriers, then that is the course that the government should take.