Why the U.S. Wants Trade Deal Changes
Volume 18, Issue 3a
In this Market Update, you will learn:
- Why the U.S. trade deficit is currently a major political issue
- The effects of a trade deficit on the U.S. economy
- China’s recent history of economic policies that have affected the United States
- The likely outcome of trade negotiations
The United States has been attempting to renegotiate trade policies with many of its major trading partners, including Mexico, Canada, China, and much of Europe. This article will discuss why this is happening, what benefits can be obtained, and what is at risk.
The trade deficit is billed as the primary motivator for the U.S. to initiate trade discussions. The U.S. trade deficit is the difference between the value of goods and services we import relative to how much we export.
A trade deficit, while not necessarily bad, does bring a couple of concerns. First, the deficit must be financed either through use of savings or increased debt. In the U.S., we have been accumulating debt for decades, much of which has been financed by foreign governments purchasing our Treasury bonds. China is the largest investor in U.S. debt. This helps China further by supporting the value of the U.S. dollar, making Chinese products more attractively priced for U.S. consumers. For 2017 alone, the total U.S. trade deficit for goods and services was $566 billion, an increase of 12 percent over the prior year and the largest gap since 2008. The high debt balance, as well as the interest we pay on the debt, erodes our ability to spend on domestic programs and projects.
A second effect is that the U.S. could become too dependent on foreign manufacturing, thus losing skills, jobs, and eventually standard of living. The national security argument has also been brought up, especially with regard to China’s access to the technologies of U.S. firms doing business there. Speaking of intellectual property, one service that the U.S. is a net exporter of is higher education -– the tuition on foreign students in the U.S. is treated as an export.
History of U.S. trade imbalances
Trade imbalances are impacted by a host of factors such as growth rates of countries, savings rates, and currency valuations, making them imprecise gauges for the fairness of trade practices. Despite this imprecision, some observations can still be made.
Prior to 1980, trade deficits were largely non-existent in the U.S. Two events seem to have contributed to this change. The North American Free Trade Agreement (NAFTA) was signed in 1994 by Canada, Mexico, and the U.S. to encourage trilateral trade. Trade has increased, but the U.S. contends that our trade deficits with Mexico and Canada are a sign that the pact is not equally beneficial. Mexico had a protectionist economy for much of the post-World War II era up until the NAFTA agreement.
Also in 1994, China devalued its currency by 33 percent and pegged it to the dollar. That means China decided to maintain its currency's value in relation to the U.S. dollar at a fixed exchange rate.
In 2001, China was allowed to join the World Trade Organization in return for promises to adjust its currency regime and open its own markets to other countries. In following years, China’s huge trade surplus with the rest of the world again led to mounting pressure to amend its currency practices. In 2005, China devalued its currency by 2 percent and shifted to a “managed float” or “soft pegging” system. This was viewed as an improvement, but currency manipulations continued thereafter, resulting in a competitive advantage for China’s exports.
Despite huge growth in their consumer spending over the past 20 years, China represents our largest trade deficit in terms of dollars. On a per-capita basis (based on the size of the trading partner’s population), however, several countries outrank China.
Germany is the clear leader by this measure, followed by Mexico, Japan and Canada. Note the presence of our two NAFTA partners on that list.
The U.S. has implemented some tariffs already on products such as steel and aluminum, and is threatening to add more. Whether this is a negotiating tactic, an attempt to equalize trading, or both, remains to be seen. Economists generally agree that a free (or, open) market is best for the good of the whole, so the use of tariffs is largely frowned upon. The problem is that the current market is not all that open due to visible hurdles as well as covert manipulations.
For example, the European Union currently charges a 10 percent fee on imported vehicles, China has been charging a 25 percent tariff, while the United States charges 2.5 percent on imported cars.
Open trade is not the status quo. The fact that other countries are condemning the threat of tariffs may be because they are benefitting from the current arrangement.
The steel industry provides a more egregious example. China’s steel production grew sevenfold from 2000 to 2013, when it accounted for half of the global supply.
When a slowdown hit China in 2013, it flooded the global markets, causing steel prices to drop in half. Countries around the globe imposed anti-dumping tariffs, forcing China to cut domestic capacity.
At the same time, however, China provided hundreds of billions of dollars to support increased production at plants on foreign soil. One such plant in Serbia can now export tariff-free into the European Union.
A Chinese joint venture with a U.S. steel producer is now importing 300,000 tons from a Chinese funded plant in Indonesia, while the U.S. company’s production line sits idle. These foreign ventures would not be economically viable without subsidies from the Chinese government.
Currency manipulation is not isolated to China. Europe has been tinkering with currency manipulation since the 1970s.
The adoption of the euro by the European Union in 1999 has prevented the currency of weaker countries from declining, as a form of self-correcting mechanism.
This created the need for bailouts of Greece, Portugal, Ireland, and Spain after the financial crisis of 2009, and is causing political instability in countries such as Italy currently.
Open trade does not currently exist
The evidence indicates that open trade does not currently exist. If that is the case, can the current arrangement at least be considered “fair trade?” While America’s appetite for cheap consumer goods is part of the trade deficit equation, the efforts of the Chinese government to hold down the value of their currency and to subsidize some exporting industries have exacerbated the problem.
By threatening to apply higher tariffs, the U.S. is at least getting countries to the negotiating table. NAFTA was signed 24 years ago. Periodic discussions as economies evolve seem only prudent. With regard to China, a discussion of tariff trade-offs is not the answer, but merely a negotiating tactic. China has shown that they will not concede anything until forced, and even then, they will look for ways to circumvent the rules. This is the real long-term challenge, especially in the case of currency manipulation.
The worst-case scenario — a long-term, escalating trade war with multiple higher tariffs imposed by both sides — seems like a low probability. There is too much benefit to be had by both sides, but especially from the perspective of our trading partners. The stock market’s limited reaction to tariff talk headlines suggests that investors concur with this sentiment, but this can change by the day.
Most realistic outcome of trade negotiations
The most realistic outcome of the trade negotiations is modest improvements from the U.S. perspective and temporary agreements related to specific products. Utilizing strategic alliances with Canada and Europe to deal with China may have given the U.S. even more bargaining power, but these relations have been strained during trade talks.
The events going on now have the potential to shift the path of the U.S. and world trade for decades to come. The time to negotiate is when you have bargaining power. As the world’s largest economy, the U.S. appears to have plenty to gain in these negotiations. If the U.S. is not successful, however, our leadership position in world politics could be threatened at least in the near term.
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