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Why trade wars don’t work

Summary:
Yesterday, in a post on the “phase one” trade deal with China, I predicted: As new information comes out, I expect the deal to look even weaker, even more porous. And today we have confirmation: Donald Trump says China will spend billion a year for U.S. farm products as part of a “phase one” trade deal between the countries. But doubts are surfacing whether that’s even possible, bolstered by China’s reluctance to confirm the figure. . . . Prices for soybeans and hogs initially surged Friday as the deal was announced, but later retreated after Chinese officials said their imports would increase by “a notable margin,” but refused to be more specific. . . . Lighthizer suggested that the higher figure is aspirational. He told reporters Friday that China has agreed

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Yesterday, in a post on the “phase one” trade deal with China, I predicted:

As new information comes out, I expect the deal to look even weaker, even more porous.

And today we have confirmation:

Donald Trump says China will spend $50 billion a year for U.S. farm products as part of a “phase one” trade deal between the countries. But doubts are surfacing whether that’s even possible, bolstered by China’s reluctance to confirm the figure. . . .

Prices for soybeans and hogs initially surged Friday as the deal was announced, but later retreated after Chinese officials said their imports would increase by “a notable margin,” but refused to be more specific. . . .

Lighthizer suggested that the higher figure is aspirational. He told reporters Friday that China has agreed to raise its annual purchases of U.S. agricultural goods to $40 billion annually for the next two years and make its best efforts to reach $45 billion per year. Beijing agreed to specific benchmarks for individual commodities but those will be classified, he added. The goals will be re-examined after that, a U.S. trade official said. . . .

China won’t buy agricultural products from U.S. producers to meet the target if it can purchase them for less from competitors such as Brazil, the person said.

“Aspirational”?  Hmmm . . . . While I don’t doubt that China’s food purchases will increase substantially from the recent depressed levels, there is reason to doubt whether this will dramatically improve farm incomes:

Extra shipments to China could crowd out export customers in Europe and the rest of the world, forcing them to turn to Brazil for supplies in a mirror image of trade flows that occurred during the tariff war, said Richard Feltes, vice-president at RJ O’Brien, a commodities broker.

Mr Glauber said China’s commitments could draw scrutiny from other food exporting countries that may question “whether US products have been guaranteed preferential access” for tariff-rate quotas that are supposed to be applied on a most-favoured nation basis under global trade rules.

The basic problem is the “fungibility” of commodities. Our soybeans aren’t much different from Brazilian soybeans. When China reacted to the trade war by shunning our farm goods, we sent them elsewhere. Meanwhile, other exporters such as Brazil filled the gap. The net effect was almost zero; except for the extra transport costs as trade flows no longer were based on cost considerations.  Commodity prices are mostly set on global markets (with a few exceptions), based on global supply and demand.  Notice how US farm exports kept rising, even as China cut back in 2018:

Why trade wars don’t work

People in each country don’t materially change their food consumption during a trade war, and hence global food prices don’t change all that much. The effects are not zero (our farmers suffered some losses), but they were smaller than you might imagine. Trade wars don’t tend to work because combatants aren’t willing to make the hard choices that would have a major impact. President Trump is not willing to have a situation where consumers show up at Walmart and the shelves are empty of Chinese goods. Similarly, the Chinese are not willing to materially change the amount of calories they consume each day.

This is NOT to say that trade wars have no impact. They do. They distort the flow of goods to some extent, and both the US and the Chinese economy were (mildly) negatively impacted by the trade war. But the costs are not great enough for the Chinese to give in on the issues that are important to them, including their industrial policies toward SOEs and their ability to control their exchange rate.

Places like Cuba, North Korea, Iran and Venezuela have not caved in despite pretty severe sanctions from the US. Why would China surrender in response to comparatively minor sanctions?

President Trump is relatively “hawkish” (i.e. mercantilist), on trade issues.  If even his negotiations with China, Mexico, and Canada have produced only trivial results, what realistic prospect is there for an alternative to globalization?  As Margaret Thatcher used to say, “There is no alternative”.

Trump often claims that Boris Johnson is Britain’s Trump.  But Johnson has committed to negotiating free trade agreements with many different countries.  There are even rumors that Britain might try to join the TPP.  Trump could benefit from following Johnson’s lead on trade.

PS:  The current trade war is causing China to turn away from American tech products:

Tech spats between China and the US have encompassed smartphones and social media apps — and now the humble office keyboard.

This week’s news that Beijing has ordered all government offices and public institutions to remove foreign computer equipment and software within three years marked another example of “decoupling” between the two countries’ tech sectors.

And it’s not just the Chinese government; the private sector is also turning against US products:

However, if China’s PC industry follows recent trends in mobile and tablet markets, where local brands compete as evenly on aesthetics and power as their foreign premium-price rivals, then US groups will have cause to worry.

“There is already a patriotic shift in consumer electronics buying patterns due to the trade wars. You can see it in the tablet and smartphone markets now,” said Eric Smith, director of Connected Computing Devices at Strategy Analytics. “Local vendors like Huawei and Xiaomi are poised to take advantage of this.”

More reason to “just say no” when politicians call for America to get tough on trade.

Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment". In May 2012, Chicago Fed President Charles L. Evans became the first sitting member of the Federal Open Market Committee (FOMC) to endorse the idea.

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