Trade Wars


Trade and GDP growth after WWII

 1945 - 1982

US became more open since 1980.

Since 1945 and before 1982, the US experienced 7 recessions in 35 years, about once every five years.

 1982 -

Since 1982, the US had three recessions, about once a decade. US economy was much more volatile before 1982, but has since been growing at a much more stable rate.

 

Unemployment

In 1982 US unemployment peaked at about 11%, and has since declined especially after NAFTA (1994).

Trade Wars

1. Troyan War

 Trojan war


map of Europe

Trojan war was probably a trade war. It was supposedly waged by the Greeks over one woman, Helen, according to Homer, around 1250 BC, about the time of Moses' exodus from Egypt.

It is a Romantic story, but it is difficult to believe that a King would mobilize a thousand ships to get one woman. There may have been an economic motive; Apparently, Troy was a trading port. There were some trade between Mycenaeans and Trojans, and Troy was a major trading post as the people of Troas controlled the trade routes to the Black Sea.

The real motive of the Greeks to destroy Troy may have been to control the maritime trade in the Aegean Sea. In other words, Trojan War may have been a trade war.


Agamemnon's death mask,
Archeological Museum of Athens



Greek helmet, British Museum

 


Achilles and Patroclus, Altes Museum, Berlin

Abduction of Helen, Guido Reni 1631, Louvre Museum


A grinding stone used by Trojan women.

Alabaster figurines from Troy (Anatolia)

The Fourth Crusade (1202-1204)

 

Kingdom of Heaven (2005) describes the background and events of the third crusade. (some persons are fictional.)

First crusade (1095-1099): crusaders captured Jerusalem.

Second crusade (1145-1149): The French and German armies were defeated separately by the Turks.

The third crusade (1189-1192) resulted in a truce between King Richard and Saladin.

 The 4th Crusade

Blue mosque in Istanbul (as shown in Skyfall)

During the Middle Age, and thereafter, trade wars became more vicious. In the 13th century, there were two international trade centers in the West, Venice and Constantinople. (Italy then was not a nation state yet but was dominated by a few city states such as Venice, Rome and Florence) .

In 1202, 12,000 troops gathered in Venice, but they could pay only 51,000, not the full amount of 85,000 silver marks for the voyage to Cairo. (The intent was to conquer the Moslem controlled city of Jerusalem. Venetians constructed 50 war galleys and 200 ships for transportation. Nuovo Arsenale has not been built then, 1320 AD.) Enrico Dandolo, the founder of Venetian colonial empire, diverted the fourth crusaders to Constantinople, a rival trading center. Constantinople fell on April 12, 1204, and the fourth crusade ended then and there. Most of the crusaders returned home with the loots. The total amount of loots was estimated to be about 900,000 silver marks. Venice got the first pick, and Venetians brought the booties from Constantinople to Venice, which were used to embellish Basilica di San Marco. See Virtual History of Venice.

Basilica di San Marco, Venice.

Bronze horses looted from Constantinople, now in the Basilica.

Minneapolis Institute of Arts


 Today Only in recent years (post-World War II era) traders have become much more civilized. Modern trade wars are waged when governments erect tariffs and nontariff barriers (e.g., import quotas and voluntary export restraints). Aggrieved nations often file a complaint with a dispute settlement body of the WTO, against the importing countries that raise trade barriers. Representatives of the trading countries argue in a civilized manner and submit evidence to the WTO.

 

II. How Much China Loses from the Low Yuan Policy

 Is CM a trade policy? Currency manipulation is not yet treated as a protective instrument.
 US-China trade deficit: $318 billion in 2013.

In October 2011, the Senate passed the controversial currency bill, designed to punish the so-called "currency manipulators."

Low renminbi policy of China has been viewed as an attempt "to take unfair advantage" over its trading partners.

 Suppose US-China bilateral trade is balanced at 3 yuan per dollar, and that China pegs the exchange rate at 6 yuan per dollar in order to maintain a trade surpluse. As a result, China's trade surplus rises to $3 trillion in during the past 5 years. Suppose China continues this policy for another 5 years, and its trade surplus rises to $6 trillion during the next 5 years (by 2016).

 


At some point, China has to stop accumulating USD at high prices. When it does, RMB appreciates (and $ falls) to its equilibrium value (3 yuan per dollar). 

 China's International reserve asset

 


China's international reserve asset would rise to $6 trillion by assumption. China may purchase real estates, land or financial assets in America, but the total value of China's assets in America is still $6 trillion.
Cost  China would have paid $6 trillion × 6 yuan/$ = 36 trillion yuan. 
Value of China's assets in America Total value of dollar assets is $6 trillion (Interest rate is close to zero in the US), but its value now drops to $6 trillion  × 3 yuan/$ = 18 trillion yuan.
China's profit from Investment in America profit = Revenue (18 trillion yuan) - Cost (36 trillion yuan) = - 18 trillion yuan (or US profited $6 trillion).
 

Any more delay in using these surplus dollars will increase China's loss, as RMB can only rise further.

Investment is profitable only when the investors buy low and sell high.

China does just the opposite.

   

 

III. Arguments for Protection

 Problem Economic theory states that free trade is better than Autarky. In practice, no countries practice free trade policy.
Why protectionism?  A few arguments are valid, but most are faulty.
 Fallacy of Composition

"What is good for our industry is also good for the whole country."

Protect our industry, please. 

You can easily see how domestic industries might persuade the government to protect them from foreign competition. In presenting their case to the public and government, protectionists would not get very far if they were to argue in terms of their own private gains. Accordingly, most of their arguments assert that protection benefits the national interest.

In so many words, protectionists would argue that what is good for my industry is also good for the country. This constitutes a fallacy of composition. Protectionists usually appeal to the patriotism and nationalistic attitude of fellow citizens.

 

1 "Keep Money at Home" Argument

What The proponents of this argument claims that when domestic residents buy imported goods, the country gets the goods and the foreigners get the money. On the other hand, when the residents buy domestic goods, the country keeps both the goods and the money. Hence the country gets richer by preventing imports.
 "If you import foreign goods..."  
 "If imports are blocked..."

 

When domestic consumers buy goods from domestic firms, and hence money does not flow out of the country. Foreign exports only bring money into the home country, or so they argue.

 Why this argument is false

The sheer fallacy of this argument is rooted in the crude mercantilistic theory, which maintained that money is wealth itself.

Money paid for foreign imports must return sooner or later in the form of payments for imports or as investment in the US. Money has no ultimate redemption value except in the country of its issue.

 China's three options Suppose China does not want to spend the surplus on American goods. Then a surplus country (for example, China) has three options.

(i) China can pile up trade surpluses year after year and never spend them. In this case China never returns USD to buy imports from the US, and its trade surplus amounts to losing USD or donating to the US.

(ii) China can pile up USD and buy US Treasury bills for a long period (say ten years) and spend all its investment in a single year. In this case, the US would enjoy low prices for a decade but would face inflation in the year when China spends it all. (a) Due to inflation, the actual volume of goods China can purchase will be much smaller. (b) This option means China buys dollars at high price and sells at low price. According to Jin and Choi (2012) China lost about $140 billion since 2006.

(iii) China can use the surplus to buy American goods during the same year. This option would be the best way to protect the value of China's exports. True, China can use the surplus to invest in the US, but it would be more profitable for China to invest it in China, rather than in the US.

 Japan's mistake in the 1980s  Japan had been accumulating a huge bilateral trade surplus, which was used to buy assets in the US. Eventually, dollar depreciated and yen's value more than doubled in 1985. Accordingly, Japan's assets in the US lost more than half of their value (in yen).

 

2. Home Market Argument

What it says  This argument claims that "the domestic producers should have a home market for their products. By eliminating foreign imports, more jobs can be created."
 Why false

Farmers in the South should produce no more than than is needed to supply the home market (autarky).

The fallacy of this argument can be seen from noting that any shifts from imports to domestic production is offset by a contraction of the output in the export sector. The importing industry can increase its output only by attracting more resources from the export industry.

  This argument amounts to saying that we should not specialize in the commodities in which we have a comparative advantage.

   


3. Equalization of Costs Argument

 What it says

"We need to neutralize any advantage the foreign producers may have over the domestic producers, in lower taxes, or cheap labor."

"We need to equalize the costs of production between foreign and domestic producers." In this way, we level the playing field.

Some protectionists have favored the so-called the "scientific method of tariff making." This argument carries the spirit of fair competition. However, if costs of production are equalized by tariffs, then the very reason for international trade disappears.

  The logical consequence of this pseudo-scientific method is the elimination of trade between nations. This argument is totally fallacious, and is one of the most deceitful ever advanced in support of protection in the U.S.
 What is wrong? Problems: A close examination of this argument reveals many problems. Producers in any country have different costs for the same product. If the goal is to protect all domestic producers against all foreign producers, we must equalize the cost of the most efficient foreign producers and the cost of the least efficient domestic producers by adding a tariff. In this case, a relatively efficient domestic producer reaps above normal profit.

 How high a tariff?


Hawley and Smoot

 
 In practice

 Despite these objections, a tariff provision to equalize the costs of production were actually incorporated in the US Tariff Act of 1922 (Fordney-McCumber Act) and the Hawley Smoot Act of 1930 (t = 100%).

 Did HS cause the Great Depression?

 US exports of agricultural products declined from $7 billion in 1929 to $2.4 billion in 1932. US exports of iron and steel exports declined by 85% by 1932 due to retaliation by Canada.

4. National Security Argument

 What it says

"A nation dependent on foreign sources of supply is in a vulnerable position during a war."

This is a military or political argument, but it has economic implications.

Few people disagree with the need to maintain an adequate national defense. Even Adam Smith wrote in 1776 that "defense is more important than opulence."

Japanese people were trained to defend the country with bamboo spears (April 1945).

What is wrong

Likely to be abused by industries.

The problem is in defining the requirements of national defense. Otherwise, the national security argument can be used to justify complete self sufficiency or protection of any industry.

Since most producers consider their outputs are essential to the defense of their country, this argument is subject to abuse. In the US, manufacturers of peanuts, candles, thumbtacks, gloves, umbrellas, and many other sundry products of ordinary consumption goods have all asked for protection on the grounds of national security.

How future wars will be conducted

During the cold war, military experts were inclined to view future wars in terms of an all-out thermonuclear war, rather than in terms of potential production capacity. If there is a nuclear war, the potential production capacity has no value. Thus, maintaining adequate strength in a constant state of readiness, than in terms of potential production capacity is necessary.

In this case, protection of the so-called "strategic" industries can make no contribution. Moreover, the need for maintaining nuclear strike capability has declined since the end of the cold war in 1991.

The need for constant readiness for local or regional war and accuracy of hitting non-civilian targets is now more emphasized.

Environmental hazards

Nuclear and chemical weapons also pose enviromental hazards. These weapons become unstable over time and need to be dismantled later, a costly operation. (Remember Fukushima)

 subsidies are better

Direct subsidies are better policy tools than import restriction because they are more precise in their effects and less costly to the nation. 

Control exports

It is more important to control exports of goods that are strategically important to national security.

Military supplies used to aid an ally may fall into the hands of terrorists, or an ally today may turn into an enemy later (e.g., Afghanistan).

Cyber warfare: modern wars are becoming more complex. Nuclear wars are less likely, but cyber wars are surreptious and not easily detected.

Examples

(i) Commercial aircraft producers such as Boeing were considering the production of engines for an aircraft in a third country at the time to avoid government regulations. But the plan was soon aborted by the surprise attack on Pearl Harbor.

(ii) Also, US Navy first ordered development of the dive bomber Hell Driver, Curtiss F8C in the 1930s. Ernst Udet, a German avaitor who fought in World War I visited the US and bought four dive bombers and shipped them to Germany. They then retroengineered and improved the designs. These effective dive bombers played a tactical role for Germany in the Battle of Britain. See Fact Index.

What is controlled now

Export Control Act 1949 required the denial of export licenses to items that contribute to military or economic potential of a communist bloc country. Before this act, scrap metals were exported to Japan and the Japanese used them to produce war materials to attack the United States.

Export Administration Act of 1969 eliminated "economic potential" criterion.

   

 

5. Infant Industry Argument

 What The infant industry argument asserts that "a new industry having a potential comparative advantage may not get started in a country unless it is given temporary protection against foreign competition. Protection gives local producers the time to improve their skills in production, management and marketing. Once competitive strength is built up, protection would be abandoned for free trade."
 Who?
The IIA argument was first initiated by Alexander Hamilton, the first secretary of the Treasury of the US. (His portrait appears in our $10 bills.) In his famous "Report on Manufacturers" in 1791, he urged the use of tariffs (i) to foster the growth of manufacturing, and (ii) to strengthen the American economy.

Government aid would expedite the growth of manufacturing. Government assistance is a temporary departure from the free trade doctrine, but it is a small price to pay for a speedy development of manufacturing.

 Problems Economists have long accepted the theoretical validity of IIA. However, we have raised many questions regarding the practical application.

It is not self-evident that an infant industry requires protection to get started. Many new enterprises are able to compete successfully with well established domestic companies. International competition is no different. If the long run outlook of an infant industry is so bright, there would be domestic entrepreneurs who would be willing to invest in that industry. If there are no domestic entrepreneurs, then the remedy is not protection, but state enterprises or foreign investment.

It is most difficult for the government to identify an industry that deserves infant industry protection. The search requires a careful study. In light of historical experience, the probability of a mistake is very high. One example is the US woolen/worsted industry. Started in the early years of the U.S. as an infant industry, it must still be protected against foreign competition. See Congressional Updates 2002 on apparel (copy). And it shows no signs of overcoming its comparative disadvantage.

The example also indicates that a mistake tends to become irreversible. Once a new industry is protected, the industry exerts a pressure not to remove protection even when it becomes competitive.

Temporary protection almost always turns into permanent protection.

Remedy: If a proper choice of an infant industry is made, the best way to promote that industry is direct subsidy. It has several advantages over tariffs. Subsidies are less likely to end up as permanent protection, because they require annual appropriations from government. Subsidies distort only production, not consumption. IIA argument does not apply to most industries in a developed nation such as the US.

 WTO rule

Today, tariff rates are governed by WTO. A country cannot unilaterally impose tariffs on imports from members of WTO. If it is groundless, the US is likely to be forced to rescind such tariffs, or suffer retaliation from other members.

   

6. Antidumping Argument

Is dumping harmful? Dumping is selling a product in an importing country at a price below that prevailing in the exporting country. Dumping may be harmful or beneficial to the importing country, depending on circumstances. Dumping is beneficial to the importing country, if it does not have domestic industry competing with the dumped product. Even if the importing country has a domestic industry, dumping is beneficial, since consumer surplus exceeds producer surplus. Dumping is a decline in the price of the importable.
Predatory dumping   Predatory dumping is harmful. "Some foreign firms prey on domestic producers. These predatory foreign firms cut prices to put a competing domestic industry out of business and to raise price afterwards."
 Remedy Impose antidumping duties when predatory dumping occurs.  
 Problem

It is difficult for government to distinguish permanent and predatory dumping. The latter is sporadic.

Producers usually use this argument to achieve permanent protection.

Practice Antidumping duties are subject to WTO rules. When a country imposes duties in violation of WTO rules, the aggrieved nation is allowed to retaliate. (For example, President George Bush imposed a steel tariff on imported steel products in 2003 to protect the domestic steel industry, but subsequently rescinded it when it was deemed to be in violation of the WTO rules.
 US

Two-stage process.

(i) In the US, whether dumping has occurred or not is determined by the US Department of Commerce.

(ii) To receive antidumping duties, one also needs to show the extent of injury.

Injury is determined by the US International Trade Commission.

 US vs Foreign firms

The definitions of domestic and foreign firms are often blurred for multinational firms. Since they produce diverse products, one company may be treated as a domestic firm that deserve protection, while for another product it may be treated as a foreign firm. (American corportion = more than 50% ownership by Americans.)

In 1974, Smith-Corona charged Japan's Brother with dumping portable typewriers, but International Trade Commission ruled against it. Brother had 51% Japanese ownership, but incorporated in Delaware, hiring American workers.

In contrast, Smith-Corona had an American ownership, but their typewriters were produced throughout Asia. Which of the two is an American company that deserves protection of US government? In another case, Brother was considered an American firm which needs protection against unfair foreign competitors like Smith-Corona. Does ownership matter? (It rarely does!)

 

7. Reciprocity Argument

Reciprocity argument says

 

"The U.S. market is more open to imports than foreign markets. We need equal access to foreign markets."

Unless a foreign country grants equal access by lowering its tariffs to US goods, the U.S. should retaliate with higher protection against that country's goods.

 

The slogan that decorates US Department of Commerce.

 This argument is deceptive because it appears to support free trade. The purpose of reciprocity is to gain access to foreign markets comparable to that given to the foreign producers by the U.S.

This application will lead to higher U.S. protection and counter-retaliation by other countries.

 Problems  

What does "equal" or "comparable access" mean? How does one measure equal access? Traditional measures: tariffs and NTBs. Tariffs are already low, and hence inadequate to measure access. The proportion of markets covered by NTBs. By these standards, our market is not more open than others. The levels of NTBs are difficult to compare.

 

Equal access appears to be measured by U.S. trade deficit with a foreign country, Japan being the foremost in mind. This measure is however absurd.

The U.S. may have a trade deficit with one country, and at the same time it may experience a trade surplus with another country. If the U.S. maintains a trade surplus with EC countries, does this mean we are not giving them equal access to the U.S. market?

The imposition of new tariffs on countries not satisfying the equal access requirement would trigger counter-retaliation which would close markets for U.S. exporters. This is a result directly opposite to the intended purpose of opening the foreign markets.

 If one country has a large trade surplus vis-à-vis all other countries  This may be the result of undervaluation of its currency, e.g., Renminbi.
   

 


Optimal Tariff

          This argument has never been used by protectionists. The optimal tariff maximizes welfare of a large trading country which acts like a monopoly in trade. It is based on the naive assumption that trading partners do not retaliate. We are simply arguing that a large country can gain from a tariff if its trading partners do not retaliate. Economists are not arguing that US should restrict imports for this reason.

Maximize U[y1 + z1,y2 + z2], subject to F(y1,y2,L,K) = 0.

Use trade indifference curves.

Figure 3

Optimal Tariff:

An optimal ad valorem tariff for a large country is

to = 1/(η* - 1), where η* = - (Δz*1/Δp*1)(p*1/ z*1)

is the price elasticity of foreign import demand. (use Netscape only. Internet Explorer can't handle it)

Small Country

to = 0, because η* = infinity.

The foreign offer curve is a ray from the origin.

Figure 4

David Hume (1711-1776): In a gold standard, a mercantilist country piles up gold bullion, which stimulates inflation. Higher price of exports will reduce exports and increase imports. Thus, a trade surplus shrinks and disappears.