Thursday, January 26, 2017

Trade Wars In The 21st Century: Faster, Bigger, Worse

By Nita Ghei
Real Clear Markets
January 26, 2017

With the announcement of withdrawal from the Trans Pacific Trade treaty, in one of President Trump’s first executive orders—following hard on a proposal for a 5 to 10 percent “border adjustable tax”—the new administration signaled that protectionism is the one campaign promise most likely to be kept. This resurgence of protectionist sentiment bears a marked resemblance to the United States at the turn of the 20th century; the federal government seems poised to repeat the same errors, despite the mountain of evidence on the gains accrued from lowering trade barriers following World War II. This is the first time since 1947 that the credible threat of a trade war is emerging.

If the major nations and trading blocs of the world choose to engage in “beggar my neighbor policies,” the poor in the United States and the rest of the world will bear a disproportionate share of the burden. Institutional changes, in the form of an array of regional trading arrangements and the World Trade Organization, could make a trade war swiftly much worse this time around.

The Smoot-Hawley Act of 1930 was the last legislation enacted in the United States to raise tariffs. It raised them from already punitive levels, set at an average of about 40 percent in 1922 by the Fordney-McCumber Act. European countries had already retaliated by imposing their own tariffs during the 1920s. In effect, the trade war was well on its way when Smoot-Hawley was enacted. That legislation both widened and deepened the trade war with its additional 20 percent tariff, as more and more countries put similar tariffs into place. International trade eventually fell by more than two-thirds between 1929 and 1932.

The trade war was certainly a contributing factor to the intensity of the Great Depression. With recognition of this fact, tariffs were cut in 1934. In further awareness of the dangers of trade wars, 23 countries signed the General Agreement on Tariffs and Trade in 1947. The GATT expanded in successive rounds, culminating the last successful Uruguay round in 1994, which created the World Trade Organization, and was signed by 123 countries. Tariffs and other trade barriers were lowered steadily across the globe between 1947 and 1994. Nations also signed a host of treaties creating regional trading blocs (for example, the European Union in western Europe, NAFTA in North America, and MERCOSUR in South America) and lowering trade barriers.

To the extent any proposed tax is now targeted at specific products or manufacturers, it could very well violate treaty obligations the United States assumed at the conclusion of the Uruguay round. The WTO, with its power to resolve disputes, was one of the most significant achievements of treaty. In the event the WTO finds that a member nation is in violation of treaty obligations, it could permit the other trading partner to impose a retaliatory tariff.

It’s fairly easy to imagine a scenario where several trading partners file a complaint against the United States in the WTO. It’s also easy to imagine where some other country or trading bloc decides to adopt a similar policy without going through the WTO, which could then trigger another complaint to the WTO. In effect, the combination of regional trading arrangements and the WTO could result in a more rapid escalation of a trade war than what happened in the last century and a consequent collapse of international trade flows.

The collapse in trade would hit the poorest countries, and the poor in the rich countries, harder. Poor countries have gained the most from lowering trade barriers and having access to markets. Poverty rates have plunged in countries that have opened their economies, including China, India, and Vietnam. Lower-income Americans also benefit from freer trade, with one large study estimating that access to goods from developing countries lowers prices of these largely basic consumer goods.

A collapse of trade would sharply limit, if not end, these gains. Higher tariffs benefit narrow industries and interest groups; the cost is borne by (often the poorest) consumers at large, many other producers, and by foreigners. All too often, these foreigners are poor and lack opportunities or resources to survive if their livelihood is lost in the event of a trade war.

The cost of raising tariffs is enormous. The purported benefits are illusory. American manufacturing is doing well. Both productivity and output are up. Raising tariffs is unlikely to result in more manufacturing jobs, because it is technological change, not trade, that has largely driven the changes in manufacturing. Increasing tariffs will not bring back those jobs. It might well cost many, many more.

Even without a trade war, simply withdrawing from ongoing regional trade negotiations with the hope of bilateral treaties is extremely inefficient. Regional arrangements, like the TPP are a poor third best alternative. In a perfect world there would be free trade without treaties. The second best option we have is a multilateral arrangement, such as the one achieved through the GATT. With the Doha round stalled, the world has fallen back to regional arrangements. Bilateral treaties are hopelessly expensive and inefficient, and far too vulnerable to being held by narrow special interests. TPP will go forward, but much of the expected benefits, particularly to the poorest country, Vietnam, will be lost. American consumers and businesses will also lose.

Protectionism benefits narrow special interest groups. Consumers everywhere lose. The worst case scenario is a trade war. Then, instead of continuing to seeing global poverty drop, the number of global poor may once again increase—a result that no one should wish.

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