Trump’s trade war: A tale of the US grasshopper versus the Chinese ant

While there was always a possibility Donald Trump might impose steep tariffs on friends and competitors alike if voted to power, the common belief was that he was not serious about them, and that such Trumpian bluster was just his transactional style.

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Given the dystopia their continuation entail, there is still a distinct possibility that these tariffs might be abandoned once Trump achieves his real objectives, whatever these might be, before inflation kicks in and US demand as well as growth weaken. But there also appears to be a constituency in the US that believes if they cannot compete with China, as also Mexico, Canada and other countries with which it runs trade deficits, it is better to wreck globalization.

America seems to suffer from what Stephen Roach described as a “trade deficit disorder," induced by a macroeconomic imbalance—its deficit of savings—for which there is no bilateral fix. The deficit would just shift to other (higher-cost) producers.

Many believe it was the retaliatory steps and cascading effects of the US Smoot-Hawley tariffs that tipped what was originally a deep recession into the Great Depression of the 1930s, which provided the backdrop to World War II. Trump’s tariffs are reminiscent of those moves, although nobody is talking of another Great Depression—just yet—or a major conflagration.

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What is the case for these tariffs? Even if the strategy adopted is counterproductive, is the grievance —that the US runs wide deficits with partners that are gaming the system, through subsidies or exchange rate manipulation, and thereby depriving the US of domestic jobs—justified?

Cheap Chinese goods have raised living standards everywhere over the past three decades, despite growing unemployment and inequality, including in the US. The economic condition of Trump’s ‘Make America Great Again’ base would have been far worse without these cheap imports. The US has now decided to look the gift horse in the mouth, and, as China responds with its own measures, it’s unclear where this will take us.

The question is this: If China has a competitive advantage in consumer goods and other products, as a result of which others buy them, what principle of classical economic theory does this violate? According to theory, this maximizes human welfare.

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There are two arguments that are made to argue that classical Ricardian theory does not hold in the current circumstances.

First, if a country has a comparative advantage in virtually all high-value sectors, as China appears to, then either its currency is artificially pegged or significant fiscal subsidies are being provided. China has a huge surplus on the current account matched by huge deficit on the capital account. These surpluses are parked in US Treasuries, which prevents its currency from appreciating. And there is inadequate data to be sure if China has pegged its currency.

Second, if China captures global market share, in view of network externalities, its competitiveness could be self-sustaining—if it keeps innovating—even if subsidies are done away with, especially in oligopolistic sectors.

Arriving at a ‘fair’ exchange rate that would balance trade involves intricate calculations on which a consensus is very hard. This debate is ultimately geopolitical, couched in economic language. It is about who would be the dominant global power.

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The recent unpredictable behaviour of the US has eroded its soft power, making it increasingly unclear whether a US-led world order is better than one that is led by China. In the former, geopolitics would dominate; in the latter, economics. Many may now be constrained to choose the latter.

A commonsensical approach would be that if the Chinese and others are somehow internalizing costs and subsidizing the US by burdening their own populations, the beneficiary should just pocket this charity while focusing on sectors where it is competitive and increase savings to keep its trade deficit low.

The case for tariffs beyond raising some revenues and playing a limited role in the development of infant industries is dubious. Besides the classical argument of maximizing welfare, the Chinese are providing cheap consumer goods to the US and are willing to lend it money to buy them.

Martin Wolf illustrated this in FT through the fable of the ant and the grasshopper—instead of the grasshopper (the US) dying of hunger in winter because of a lack of savings, the ant (China) opens its granary to the grasshopper and lends it money to buy grain!

One could even argue that in earlier times, the grasshopper would have had to transfer gold to the ant to get grain. But what the ‘Chinese ant’ gets in exchange are really scraps of paper—US Treasuries, which can be printed at will.

Unlike gold, which will remain a store of value, the US can always renege on its debt through depreciation or other means, just as it is currently doing on long-standing trade agreements. It is Chinese consumers and taxpayers who pick up the tab for the current subsidies and future exchange rate risks, not American. One would, therefore, rather be the carefree grasshopper, whiling away the summer, than the thrifty ant slaving away!

The author is a retired Indian Administrative Service officer and former secretary, Prime Minister’s Economic Advisory Council.