(One of) American Compass's horrible, terrible, no good, very bad ideas
The currencies, they are exchangin'
Recently, the nationalist conservative organization American Compass released their policy proposals, known as “Rebuilding American Capitalism.” In the section on globalization contained within the “Productive Markets” section, there are the following ideas:
Eliminate the Trade Deficit
Disentangle American Investment from China
Repudiate China’s Status as WTO Member and Trade Partner
Enforce Legal Constraints on Supply of Low-Wage Labor
Make All Jobs Ones That Americans Will Do
Of course, many of these are bad ideas, but the first one in particular defies the basic intuitions of macroeconomics to such a degree that I figured it was worth my time to explain why it just doesn’t work.
The primary proposed solution that American Compass has for the trade deficit is a “global tariff,” basically a uniform import duty on all goods from abroad. The idea is that this global tariff would increase up until the point where the US’s trade balance (that is, the difference between its exports and its imports) goes positive.
The argument behind this belief is that foreigners have gained more and more ownership of the United States economy as a result of running a current account deficit, which “future generations will pay for.” This is believed to be the cause of deindustrialization and the decline of manufacturing employment.
Regarding the last sentence, manufacturing employment peaked in the 1970s, well before the introduction of NAFTA or China’s accession to the WTO, and much of the decline in manufacturing employment is more attributable to automation rather than trade. However, this post isn’t dedicated to that, it’s dedicated to how trade balances and currency exchanges work.
The accounting equation for GDP is as follows:
GDP = Consumption + Investment + Government Spending + Exports - Imports
The reason imports are subtracted from the accounting identity is that imports are within consumption, but imports are not produced domestically. However, a lot of people have taken this to mean that imports are bad and that they “subtract” from standard of living. That is not true, imports are neutral with respect to GDP, but they aren’t neutral with respect to standard of living.
Suppose that, for instance, the United States was suddenly able to import double the value of everything that it currently imports, with domestic consumption alongside everything else remaining constant. GDP is not affected (domestic consumption remains the same), but now the average American has an increased standard of living because they are able to enjoy more foreign products.
The current account (which is the balance of trade in goods and services) is equal and opposite to the capital account (which essentially represents foreign investment) in the balance of payments. A current account deficit is equal to the capital account surplus; in this case, because the United States runs a current account deficit, this means Americans send dollars to foreigners, and Americans receive goods and services from foreigners.
Alternatively, from the point of view of foreigners, Americans satisfy their demand for dollars, in exchange for foreigners providing goods and services. What do foreigners do with these dollars? Invest in the United States’s economy — Toyota or Hyundai, for example, might build a factory. The current account deficit/capital account surplus is a sign of foreign confidence in the United States economy.
The way American Compass would put it, they believe that foreigners are nefariously taking over the United States’s economy in this process, but it is in fact the opposite. Foreigners are quite literally invested in the economy’s success through this process.
Now, suppose that we implement a giant universal tariff. Americans will consume fewer products from abroad — meaning that foreigners have fewer dollars. Because the US Dollar is a free-floating currency, assuming all else is equal, the price of dollars in foreign currency rises (since there are fewer dollars abroad). This means that the price of American exports also rises, so foreigners buy fewer exports.
While the quantity of imports fell, so too did the quantity of exports. And thus, the trade balance doesn’t change much at all. However, now we have made imports much more expensive, meaning consumers can’t spend as much in the domestic economy, so… yay?
Of course, this is all theoretical, but we must ask how this holds up in the real world. The best evidence we have is from the IMF, whose staff analyzed the effects of tariffs on the macroeconomy, and found the following, all consistent with what my basic explanation stated:
We find that tariff increases lead, in the medium term, to economically and statistically significant declines in domestic output and productivity. Tariff increases also result in more unemployment, higher inequality, and real exchange rate appreciation, but only small effects on the trade balance.
So, yeah, American Compass’s proposal for a global tariff is a bad idea. Tariffs are already regressive taxes on American consumers, so why make them more regressive for quite literally zero real gain?
