Address by Michael Stumo to the John William Pope and Jesse Helms Center Foundations

May 21, 2018

Address by Michael Stumo, CEO, the Coalition for a Prosperous America (CPA), to the John William Pope and Jesse Helms Center Foundations.

May 11, 2018, Raleigh, NC.

Foreign Policy, Trade, and Energy Challenges in the Age of Trump.

Trump and "The American System" of Economics that We have Forgotten

Alexander Hamilton was the father of the “American System” of economics. The American System is as important to world economic history as the Declaration of Independence and the US Constitution is to world political history. 

The press speaks of chaos in trade and wonder what is next. They speak of protectionism, isolationism. But the core fact is that the portion of the Trump trade team that is deemed nationalist is better referred to as Hamiltonians. We have forgotten and abandoned the economic system that made us great.

The American System is the proposition that the United States should seek strategic—not unconditional—integration with the rest of the world economy. This view dominated the US from its founding until FDR, who started the 20th Century free-trade era of the United States.

The American System, which I will discuss later, was adopted by Germany and the Asian industrial powers. It included tariffs to foster industry, to raise revenue to pay the expenses of government, and to raise revenue to directly support manufacturing. Subsidies were to encourage industry, support infrastructure, and grow the US into a manufacturing power independent of foreign powers—especially for defense. It also included a national bank with policies that promote the growth of productive enterprises rather than speculation. Today, for reasons I will discuss, it must also include management of a countries’ exchange rate.

Hamilton worried that Britain’s lead in manufacturing would remain entrenched, condemning the United States to being a producer of agricultural products and raw materials. In modern terms, he worried that the US would be a “banana republic.”

George Washington, in his first Address to Congress, said: “A free people… should promote such manufactories as tend to render them independent of others for essential, particularly military, supplies.”

Hamilton’s policies came down to a dozen or so key measures. Some of which were, in his own words: “Protecting duties.” (Tariffs.) “Prohibition of the exportation of the materials of manufactures.” (Export bans on key industrial inputs.) “Pecuniary bounties.” (Export subsidies, like those used by foreign nations gaming the system against us today.) “Premiums.” (Subsidies for key innovations; today, we would call them research and development tax credits.) “The exemption of the materials of manufactures from duty.” (Tariff exemptions for industrial inputs, so some other country can provide needed raw materials.) “Judicious regulations for the inspection of manufactured commodities.” (Regulation of product standards, like the USDA and FDA do today—and China doesn’t.)  “The facilitating of pecuniary remittances from place to place.” (A sophisticated financial system.) “The facilitating of the transportation of commodities.” (Good infrastructure.)

When the first Congress convened in 1789, the very second bill it adopted was a tariff act. This act was partly just for revenue, but it also declared that the tariff was “necessary for… the encouragement and protection of manufactures.”

The legitimacy of a tariff, aka “duties,” was explicitly written into the Constitution—Article I, Section 8 of which reads: “The Congress shall have power to lay and collect taxes, duties, imposts and excises.”

It was the intention of the Founders that taxation not go very much beyond that, for Article I, Section 9 reads: “No capitation, or other direct, tax shall be laid, unless in proportion to the census or enumeration herein before directed to be taken.”

Thomas Jefferson was initially a free trader and envisioned an agrarian economy. He opposed Hamilton on the issue of tariffs and industrial subsidies. But after the War of 1812 he changed his view: He said in 1816: “To be independent, for the comforts of life, we must fabricate them ourselves. Manufacturers are now as necessary to our independence as to our comfort.”

When Jefferson became president, he discontinued most of America’s internal taxes and relied on tariff revenue instead. In his second Inaugural Address, in 1805, he explained, “The remaining revenue on the consumption of foreign articles is paid cheerfully by those who can afford to add foreign luxuries to domestic comforts, being collected on our seaboard and frontiers only, and, incorporated with the transactions of our mercantile citizens, it may be the pleasure and pride of an American to ask, what farmer, what mechanic, what laborer, ever sees a tax gatherer of the United States?”

James Madison and James Monroe continued the American System, saw that it was working, and in 1821 Monroe said: “It may fairly be presumed that under the protection given to domestic manufactures by the existing laws, we shall become at no distant period a manufacturing country on an extensive scale.”

As to the theoretical arguments for free trade, he said: “Satisfied I am, whatever may be the abstract doctrine in favor of unrestricted commerce, that there are other strong reasons… which impose on us the obligation to cherish and sustain our manufactures.”

Karl Marx was also a free trade supporter, but only because of its destructive capacity.  He said in 1848: “The protective system in these days is conservative, while the free trade system works destructively. It breaks up old nationalities

and carries antagonism of proletariat and bourgeoisie to the uttermost point. In this revolutionary sense alone, gentlemen, I am in favor of free trade.”

Democrats tried to replace the tariff with an income tax as early as 1894. Republicans continued to support tariffs.

Liberal globalist Woodrow Wilson believed in outright free trade, and he reduced tariffs during his administration. He also installed the first income tax to replace tariff revenues.

But Calvin Coolidge raised tariffs again during the 1920’s—remember the roaring 20’s?  He said: “Our tariff enables us to pay American workmen the highest wages in the world. Before we get carried away with any visionary expectation of promoting the public welfare by a general avalanche of cheap goods from foreign sources, imported under a system, which, whatever it may be called, is in reality free trade, it will be well first to count the cost and realize just what such a proposal really means. I am for protection because it maintains American standards of living and business, for agriculture, industry, and labor.”

In the 1920s, tariffs were raised to an average of 40 percent on certain items that were produced here.

The “infamous” Smoot Hawley tariff of 1930 was enacted after the onset of the Great Depression. It raised tariffs up to pre-Wilsonian levels but below 1800’s levels. The Great Depression was a monetary crisis. Two-thirds of the drop in trade during the Depression happened before the tariff even came into effect, and only about one-third of our imports were even affected by it. (The rest were duty-free.) If tariff rates had caused the decline in trade, then imports of dutiable goods should have declined more than imports of duty-free goods. But when Smoot-Hawley went into effect in 1931, duty-free imports dropped 52 percent and dutiable imports only 51 percent.

Roosevelt’s globalist secretary of state Cordell Hull sold him on tariff cuts. The Democratic Congress transferred the power to set tariff rates to the State Department. Proponents called it “reciprocal trade.” Tariff rates were then negotiated on a country by country basis.

Tariff cuts, starting in 1934, were designed to build trade back up. It failed. It wasn’t until World War II that exports rose because of the war effort.

Tariffs continued to be lowered thereafter. President Truman said that US industry now dominates the world and need not fear low-priced foreign labor.  Eisenhower said “all problems of local industry pale into insignificance in relation to the world crisis.” So America became the only major market open to trade. All others were small, poor, socialist, or communist.

Friedrich List was a German economist with dual American citizenship who was a devotee of Hamilton and the American System in the 1800’s. He advocated for imposing tariffs on imported goods while supporting free trade of domestic goods among the German states, and believed the cost of a tariff should be seen as an investment in a nation's future productivity. “The result of a general free trade would not be a universal republic, but, on the contrary, a universal subjection of the less advanced nations to the predominant manufacturing, commercial and naval power.”

List argued that a society's well-being and its overall wealth are determined not by what the society can buy but by what it can make. His nationalist economic ideas helped the later-unified Germany become a major economic power.

Japan was influence by List. So was South Korea. Both were poor countries after major wars. They utilized a system of tariffs, industrial subsidies, and economic coordination to rebuild, along with exchange rate management to undervalue their currencies. They could have adopted free trade to allow their desperately poor citizens to buy cheap goods. But instead they focused upon building industry.

After Nixon took the US off the gold standard, the dollar value rose as nations and companies around the world bought dollars to conduct trade, as more and more trade was done in dollars.  All American goods and services then became more expensive in world markets.  Imports became cheaper. The beginning of our 43 year run of trade deficits started. Nixon was upset, directed his staff to fix the trade deficit, but they did not do so.

Japan and South Korea maintained their currencies at undervalued levels. In the 1980’s, Washington was concerned about Japan. President Reagan faced the largest trade deficit in US history. He and Secretary of State James Baker, in the Plaza Hotel in NYC, forced an agreement on Japan and West Germany to devalue the dollar and revalue the Yen and Deustche Mark. By 1991, trade was nearly balanced. Reagan signed the Trade and Competitive Act of 1988 which gave him Fast Track trade authority but also, for the first time, directed the Treasury Department to issue reports on nations that manipulate currency.

In 1994, the US signed NAFTA. China devalued its currency, the Renmimbi, by 40 percent. It also started its own Hamiltonian/List system in a particular, communist way. Beijing established five-year plans that targeted specific industries for growth, with the government actually owning most of these industries. 

China went from being a poor, starving nation that consumed more than it produced to one with supercharged investment and production. Consumption because an astoundingly small portion of GDP at 35 percent. Contrast that with 68 percent in the US and 63 percent in Germany.

The US continued its journey promoting unilateral low tariffs and consumption-based growth while taking pride in its strong dollar—which was caused by accelerating foreign capital inflows. America’s trade deficit continued to worsen.

Germany, known as the “sick man of Europe” in the 1990’s, replaced the Deutsche Mark with the Euro at an advantageous price. It then implemented the Hartz reforms to hold down wages while helping industry. Production and exports to peripheral Europe increased. But the German currency did not appreciate because it could not. Peripheral Europe’s industry was weakened, unemployment grew, their ability to absorb German goods lessened, so German banks engaged in a system of vendor finance to help them buy more German goods.

The Greek banking crisis came along, and both Spain and Italy have tremendous unemployment. But Germany has the largest trade surplus in the world. They increasingly export to the US, while peripheral Europe cannot absorb its overproduction.

The Great Recession happened. World trade took a dip. Just like the Great Depression. But no Smoot Hawley occurred. Just as in 1929, global trade declined because economic production declined.

Today, America runs a massive trade deficit with the world. President Trump’s trade team is focused on this deficit and the geopolitical aspects of trade. They are, in many ways, the new Hamiltonians. They are criticized by free traders for harming consumers and the global trading system. The debate has been renewed.

America has deindustrialized for 40 years. Global imbalances are a major problem, as G20 finance ministers have repeatedly and obliquely noted. The Treasury Department stated, in a report last month: “This historical imbalance—where one economy, or group of economies, does much of the net buying while others do much of the net selling—inevitably raises concerns about the sustainability of global economic momentum.”

Now, the trade surplus countries are Germany, Japan, South Korea, and China, along with smaller countries like Taiwan. They overproduce, underconsume, and excessively rely on US consumers for growth. They export their overcapacity and under-employment to us. 

Trade deficits destroy jobs. Some job losers get similar jobs, more get lower paid jobs, and many drop out of the workforce. Job quality has decreased as a higher proportion of monthly job creation is concentrated in low-wage and low-hour jobs.

We have deindustrialized. Only 12 percent of US GDP is in manufacturing. Manufacturing is a source of high-wage, full-time jobs, innovation, and productivity. Service sector jobs offer much less. Modern successful economies enjoy manufacturing as it double the share of their economy.

Dollar overvaluation explains much of the problem, as our goods are too high and imports are too cheap. The Treasury Department has noted that exchange rates show no signs of adjusting to eliminate imbalances. We can fix this problem unilaterally with the proposed Competitive Dollar for Jobs and Prosperity Act by preventing dollar overvaluation with a small variable charge on incoming foreign capital inflows. The result would be competitive dollar which spurs exports and jobs while reducing imports to balance trade over the long term.

China is a special case. Its state-capitalism model has been successful. They choose strategic industries and go after them with a dedication we’ve not seen before. The WTO system cannot handle it. China will be the next superpower, absent a correction.

The Trump Administration has imposed Section 232 tariffs on steel and aluminum for national security reasons. We thus join every major industrial nation in explicitly or implicitly treating these sectors as important for national or economic security.

The administration has called out China for breathtaking, systematic, and persistent theft of technology. Beijing uses forced technology transfer and hacking plus weaponizes incoming investment —which buys SS companies possessing important technology. $50 billion in tariffs are on the way. China refused to change, but rather threatened retaliation. President Trump then upped the ante to another $100 billion in tariffs.

Ironically, China is now challenging us in the WTO. U.S. Ambassador to the WTO Dennis Shea recently said, in Geneva, while defending against China's challenge:

“We have now entered the realm of Alice in Wonderland. White is black. Up is down. It is amazing to watch a country that is the world’s most protectionist, mercantilist economy position itself as the self-proclaimed defender of free trade and the global trading system. The WTO must avoid falling down this rabbit hole into a fantasy world, lest it lose all credibility.”Shea added, “The truth is, it is China that is the unilateralist, consistently acting in ways that undermine the global system of open and fair trade. Market access barriers too numerous to mention; forced technology transfers; intellectual property theft on an unprecedented scale; indigenous innovation policies and the Made in China 2025 program; discriminatory use of technical standards; massive government subsidies that have led to chronic overcapacity in key industrial sectors; and a highly restrictive foreign investment regime—these are the issues that should be on today’s agenda. If the WTO wishes to remain relevant, it must—with urgency—confront the havoc created by China’s state capitalism.”

We can expect these moves and countermoves to continue. The administration has not yet acted on exchange rates. As a result, the 2017 US trade balance worsened from 2016.

My organization, the Coalition for a Prosperous America, has developed an exchange rate solution which we are circulating in congress and the administration. We don’t yet know how seriously it will be taken.

The sum of all of this is that the free trade debate is not new. The US was not a free trade country when it grew to become the largest economy in the world. Modern industrial powers subsequently grew through their own version of the American system, not free trade.  No country grew from poverty to developed country status through free trade.

Reference: Shearer and Fletcher, "The Conservative Case Against Free Trade," (2012).

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