Debunking the Obama trade policy

Ignore the ‘Chinese Takeover’ theory of international trade

In the previous article, I tried to explain the core logic behind why trade is mutually beneficial, and not a “competition” as the Obama Administration has been describing it. At some level, many non-economists seem to accept the argument I offered, but retain some lingering doubt. They concede that free trade is beneficial (or is at least necessary to avoid some greater loss) but they still cannot shake the feeling that trade must have winners and losers. After all, isn’t our growing trade deficit with China evidence that we are being “beaten?”

Our trade balance is a concern, but not a scorecard. When we run persistent trade deficits with China, it is not a sign of economic superiority or inferiority, but instead merely the effect of the United States consuming more than it produces and China producing more than it consumes. There are reasons to be worried that we are exchanging a higher standard of living later for a higher standard of living now, but we are not “losing” jobs or losing productivity or any other such nonsense when we run a trade deficit.

It is worth repeating: A nation is not a corporation. For one, the effects of “trade” are far smaller for a nation than they are for its corporate analogue — Ford, after all, exports nearly 100 percent of its output, that is to say, the fraction of Ford vehicles consumed by Ford employees is vanishingly small. But most importantly, a nation cannot fail in the same sense that a corporation can. A corporation can vanish because its workers can migrate entirely to other companies. It ceases to exist because all of its “citizens” voluntarily decide to leave.

The United States does not face the same prospect — even if China were to grow at an extraordinary rate, even to the point where it had a higher per-capita income than the United States, most American citizens would still elect to remain in their home country. As other nations grow, we may lose political rank or watch the balance of military power shift, but otherwise our national standard of living will remain untouched. Because there will always be workers, a nation cannot “lose” like a business can — it may be dissatisfied with its own economic performance (which is in turn, as argued previously, is determined almost entirely by its own productivity), but there is no realistic way in which a country can go out of business — even if it did, and every last American citizen voluntarily decided to emigrate to another country, would we really consider that a loss, or even attribute the cause to economic factors? No competitiveness advocate is claiming we should bar our citizens from leaving the country; we would find it abhorrent to prevent our own citizens from finding greener pastures elsewhere.

It is important to remember that whenever we run a trade deficit, in effect what is really happening is that we are taking goods from other nations in exchange for scrip that we call “dollars.” Out in the rest of the world, the dollars may be used as a medium of exchange and become involved in transactions unrelated to the United States (i.e. China may exchange the dollars to Europe in exchange for goods), but ultimately they are just paper and can only be redeemed for real, useful items by returning them to the United States.

The scrip that China has amassed, should we choose to honor it, entitles it to a (relatively small) fraction of our future output. Even if they chose to redeem their coupons for productive resources of the United States, such as factories and machines and other capital (this is often the great fear of mercantilists), it would be relatively easy to reconstitute our capital stocks by shifting American workers from producing consumer goods to producing capital goods. In fact, to the extent that such an outcome is likely, the free market is already allocating such workers — to the extent that we trust the free market hypothesis, our economy is already performing the adjustments necessary to start producing what we expect our trade partners to ask for on the timetable that they are expected to ask for it.

Of course, information is imperfect (much like the free market hypothesis) and it is possible for the markets to misjudge when and for what the rest of the world will demand from the United States. This could make the reorientation of our economy sudden and unexpected — what economists like to call a “hard landing.” It is valid to concern ourselves with the size of our trade deficit because of this potential risk, and there are some serious economists who would advocate taking measures to mitigate this risk — but this is fundamentally a different argument than what competitiveness advocates are claiming, and even on its face is not especially compelling. If we consider the free market incapable of properly assessing the future demand of Chinese consumers, why then would we trust it to properly assess the future demand of American consumers? In some sense, the argument that we need active government intervention to mitigate the risk of a hard trade landing is similar to the argument that the government should actively manage markets for, say, hotdogs, lest hotdog companies underestimate the future American appetite for hotdogs and are later forced to make wild and undignified expansions in their hotdog producing capacity.

The takeaway message from the trade deficit must be this: Our past borrowing from China entitles them to future repayment. In the future, our roles must eventually reverse, with Americans saving more and laboring to provide China with goods and services. Over time, exchange rates will adjust, discouraging Americans from purchasing Chinese products and encouraging Chinese to invest in American enterprises. But nothing else should be read into the trade deficit than this future prospect of consuming less and saving more. China cannot “own” America or acquire it like some successful company buys out a rival.

This is the second in a three-part series by Keith Yost on trade myths. Part one appeared in the Opinion section of the March 16, 2010 issue of The Tech.