Monday, September 14, 2009

Government Failure: The Coming Trade War, or How to Shoot Your Own Foot for Dummies

The administration has chosen the path of war. In this case, the worst kind of war, the kind that hurts you as much as it hurts the "enemy": a trade war. Here's a post by Greg Mankiw on the subject, and here's an article from the magazine The Economist, which explains:

Although Barack Obama alarmed free traders last year with protectionist-sounding pronouncements on the campaign trail, such as one about the need to renegotiate NAFTA, optimists among them dismissed this as mere posturing designed to placate restive trade unions. Yet a decision by the White House to impose punitive tariffs (35% for the first year, falling by five percentage points a year, to 25% in the third year) on Chinese-made pneumatic tyres now raises serious doubts about Mr Obama’s commitment to free trade. ...

Poultry and tyres sound like small change in the context of the economic relationship between the two big economies. But Eswar Prasad, a professor of trade policy at Cornell University and a former head of the IMF’s China desk, argues that the American action and Chinese retaliation may presage “more protectionist measures to come from both sides”. He notes that China could retaliate much more broadly than by raising a few tariffs: it could, for example, supplement its implicit export subsidies, including an undervalued exchange rate, with more explicit measures to support its export industries and block imports. This could “easily ratchet up into a broader trade war and inflict economic damage on both countries”.

It's worse than that however. As you can learn from any good macroeconomics textbook (for example, Mankiw's "Brief Principles of Macroeconomics," pg. 314), sectoral anti-trade measures such as the ones being adopted by the current administration are incapable of eliminating trade deficits, since their effects are mostly, well, sectoral (what a surprise). Once the international macro channels finish doing their work, the consequences of such awkward policies can be summarized this way: (1) non-Chinese tire companies (and their unions) increase their gains in the American market (keep in mind that many of these companies and unions are European and Japanese); (2) all other American companies have losses in domestic and foreign markets; (3) Chinese tire companies have losses in the American market; and (4) all non-tire foreign companies, including Chinese companies, increase their gains in American markets. Notice that these self-defeating effects happen even if foreign countries decide to not retaliate!

In other words, the administration favors non-Chinese tire companies and workers at the cost of all other American companies and workers. Talk about shooting your own foot.

Some businesses and unions in America and around the world are probably happy with the new privileges granted by the American government. The rest of us should be angry, really angry. This is one good reason to study economics: at least you'll be able to recognize that when it comes to trade protectionism, even though they say they're shooting the "enemy," the real target is you.

PS: Here's McTeer's post on the same subject.

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