Trump vs. loose economics
BY GREGORY CLARK
FEB 15, 2017


Fashions change. From the miniskirt we moved to the drape dress. From obligatory neckties we now have cool-biz. And whatever happened to those loose socks?

Ditto for loose economic theories. My economics education began back in the days when protectionist polices were the norm. After all had not Germany and the United States relied heavily on such policies to create their industrial empires? And was not Japan already booming ahead because it protected its industries? The rationale then was as valid as it is now: Certain industries crucial to the industrial base should be protected to create the foundation for further industrial progress.

But somewhere along the line they discovered some industries were getting protection they did not deserve. Ugly trade wars were also breaking out. So a new generation of economists emerged armed with blackboards and diagrams that proved the universal merits of free trade. Only newly emerging industries — “infant industries” — could qualify for protection, we were told, grudgingly.

At the time the word “free” also had a political, anti-communist cachet. So soon it was not just trade that had to be freed, but currencies also. Before long “protectionism” was a dirty word, to be snarled at anyone, no doubt a “communist,” who sought even the minimal protection needed for an important industry to survive. Even the European Union’s move to protect and develop its own aviation industry — Airbus to compete with Boeing — had to be condemned even though the competition between the two has led to obvious benefits for the world aviation industry. Dogma has strange effects on people.

Now we see yet another fashion switch with U.S. President Trump complaining about currency manipulators and insisting on across-the-board protection for U.S. industries threatened by low-cost producers like China. And to some extent he could be right.

The currency of a developing nation is often undervalued relative to its production efficiency; Chinese production line assemblers can be as efficient or even more so than their U.S. equivalents, but at current exchange rates they will be paid only a fraction of the U.S. wage. There should be some mechanism — flat rate surcharges on cross-border transactions, for example — to allow advanced economies to avoid the damage caused by this imbalance. There should also be mechanisms to curb the harmful effects of the violent currency swings we see today.

Protectionism gets much of its bad name from the examples of weak economies trying to industrialize by massively protecting all import-competing industries. A vicious cycle gets under way. Costs rise across the economy. Exporting becomes even more difficult than before. Trade balances collapse. The currency has to be devalued. Costs rise even further across the economy as a result. Latin America — Argentina in the past and now Venezuela — is exhibit No. 1.

But it does not have to be that way. As I wrote on these pages earlier, Thailand relying on intelligent and highly targeted protectionism to force or encourage foreign, mainly Japanese, direct investment has come from nowhere to become a global exporter of vehicles.

Any other nation, even the so-called basket-case economies of Africa and the Middle East, could do the same. The only condition is for them to have a reasonably sized domestic market within their borders, combining with surrounding nations if needed. But the moment they try to do this the advanced nations begin the free trade rant that has kept these nations in their baskets for so long and with little chance of escape.

The U.S. under Ronald Reagan skillfully used the threat of quotas and surcharges to revive its domestic car and other industries under threat. Tokyo screamed protectionism. But it bowed to the inevitable and started to build its factories in the U.S. Today it is very glad it did that.

But if a nation wants to go the protectionist route, policies have to be carefully thought out and targeted. Australia is a pathetic example of how things can go wrong. It abandoned most of its low- and mid-tech industries under the free trade dogma that said people losing employment in industries hit by imports would automatically move to high-tech industries. Australia would become the Scandinavia of the South Pacific, exporting computers and other advanced gadgets to the rest of the world.

When that did not happen it decided it would rely on high automobile tariffs to become a car industry powerhouse. All it got was a range of inefficient producers struggling to survive and now whittled down to the point of extinction. To preserve at least some manufacturing employment it is now into massively subsidizing a nascent submarine industry. Meanwhile Japan by very slowly phasing out protection, even for low-tech industries, has given its industries time to evolve and expand. Toray and Teijin, once exclusively textile producers, are now major world producers of carbon fiber, for example.

The free traders also fail to realize the difference between protection for consumer and for producer goods. Tariffs on imported consumer goods act as little more than a tax on domestic consumers, hopefully to encourage or protect areas of the economy seen as important for employment, cultural or other reasons. Many taxes are imposed for much less worthy causes. Problems only arise when tariffs are imposed on producer goods since this raises costs across the economy, Latin American style.

Trump gets a bad rap for his dislike of trade blocs. Yet even here he may have a point. The North American Free Trade Association may have done wonders for the Mexican and Canadian car industries, but it has devastated Detroit. Meanwhile efficient, large-scale U.S. corn producers have crippled Mexico’s rural economy, and maybe encouraged the rural unemployed into the drug industry.

Trade liberalization is a worthy goal. But it should come about through carefully crafted bilateral deals rather than blunderbuss multilateral agreements where weak economies are thrown willy-nilly into competing with stronger economies — laid-back Greeks being forced to compete with disciplined Germans within the EU, for example. Here Trump with his anti-TPP hang-ups could come closer to the truth than the academics with their blackboards.