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Why a Trade War Won’t Happen…But We Would Win If It Did

March 07, 2017

By Jeff Ferry, CPA Research Director 

There has been lots of talk of the danger of “trade wars” in newspapers in recent months. The Trade War Alarmists are likely wrong. 

 In a sense we already are in a trade war, because many of the largest nations we import from are using strategic trade policies to build their industrial, economic, and military strength at our expense. The U.S.has failed to respond.

But trade wars, in the sense of nations enacting specific protectionist measures in a tit-for-tat way, have rarely, if ever, happened in history. Ian Fletcher, author of Free Trade Doesn’t Work, described the mysterious, mythical non-existence of historical trade wars in his book and in a recent article in the Huffington Post. As Fletcher points out, despite free traders’ efforts to mangle the historical record and attribute the Great Depression to the tariffs of the Smoot-Hawley Act, economists from Milton Friedman to Ben Bernanke are agreed that the Great Depression was caused by financial and monetary developments, with trade and currency playing only a minor role. Indeed, the U.S. relied on protectionist policies in the crucial period of its industrial revolution from 1865 to 1929. “All four presidents on Mount Rushmore were protectionist,” Fletcher writes.

Yet even if a trade war materialized, the US would easily win. Since the 1970s, the U.S. economy has been like those old college friends in the movie who go to Las Vegas to spend millions of dollars they don’t have. We’ve run trade deficits for 41 years, and funded it all by selling bonds, real estate and other assets to foreigners.  As an economy, our drug of choice is overspending. We spend more than we produce and every time recession looms, the Fed or the government pulls another lever to make sure we can spend some more. Now the benefit of this sad state of affairs is the U.S. has become the consumer of choice for production (and overproduction) everywhere else in the world.

Overdependence on the U.S. consumer means that most other nations have far more to lose from a trade war than we do. As Commerce Secretary Wilbur Ross pointed out in his confirmation hearing testimony, China is America’s vendor. We have the power of being their largest customer. Globally, our “edge” is $502 billion annually, i.e. the value of last year’s trade deficit. That’s how much more we spend on foreign goods and services than foreigners spend on ours.

Other countries rely upon the US for export revenue much more than we rely upon them.  Figure 1 compares U.S. trade dependence between the U.S. and our top five trading counterparties. Our two NAFTA neighbors, Canada and Mexico, rely on us for exports worth more than 20% of their GDP! We rely on them to take exports worth less than 2% of our GDP.  Any effort by the U.S. government to restrict trade to those two countries could have a far larger impact on their economies than ours.

  

Fig1-cp.png

The dependence of China (our largest trading partner), Japan, and Germany, on our consumer market is five to ten times greater than our exposure to theirs. In a game of chicken, we should be glad we are us and not them.

The list goes on. You can see in Figure 2 that in each case, those countries’ dependence on the American market runs some five to 40 times greater than our dependence on them. All these countries have a large incentive to avoid a trade war and instead seek peaceful discussions as the U.S. moves to reduce its trade deficit.

 

FIg2-cp.png

 Let’s assume US officials sit down with their national representatives and say, “We are going to eliminate our trade deficit over a period of years.  We will use a range of tools to reduce our deficit, including tariffs, more aggressive legal actions at the WTO, or new currency regimes to address undervalued national currencies. This goal is not negotiable but the means of achieving it are.” They have every incentive to negotiate a friendly and peaceful solution that achieves our goals while giving them time to rebalance their over reliance upon our market.

They will know that even were all these actions implemented, the U.S. would still be a large consumer of their products. Can anybody doubt that if all these trade measures were effectively implemented, the U.S. would still be a huge consumer of made-in-China iPhones, made-in-Germany Mercedes, and made-in-Japan machine tools? Of course we would. And our trading partners understand that.

The lesson of history is that wars don’t happen when both sides understand who would win. Wars do happen when both sides think (or are deluded to think) that they can easily beat the other. Think of 1914, 1939, or Vietnam. But in this case, anybody can see who would win.

We’ve paid a huge price for our addiction to trade deficits in terms of industrial decline. But since those countries are now dependent on us, we can use that fact as leverage. It’s not only diplomatic fair game to exploit it; it’s also the obligation our elected officials have to the voters, their children and their grandchildren who want a prosperous future.


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  • Great article!