The third and final installment of my April trilogy on Trump and tariffs. This one summarizes my discussions over the past week. (If you're short on time, scroll down for the headers and graphics.)
Your explanations make a lot of sense and your examples are easy to understand and to the point. All of which make me uncomfortable when I think about we as a nation are headed.
But let me make the case for being resentful of other countries who benefit from things America makes available at no cost to the world: safe sea lanes, a space-based navigation system and IT innovation, just as a few examples. That said, I am the first to admit we also take advantage of these things, but we support them financially when we pay taxes.
My major gripe about the current trading system is the manner in which the Chinese have stolen intellectual property.
My guess is that whatever benefits we provide in safe sea lanes, space-based navigation, and IT innovation (plus pharmaceuticals) we likely get back in multiples. Think of these as loss-leaders contributing to the enormous prosperity and relative peace we’ve enjoyed since WWII. (Bars give away free food so customers will buy expensive drinks and meals.)
The past 30 years has seen the greatest rise out of poverty in human history. Our gifts are heavily responsible. That rising income and wealth contributes to the sale of American goods and services and attracts investment capital for American business. In addition, populations experiencing rising prosperity are less likely to ensnare us in wars. A world where our tendrils are all over the place is a safer world for Americans to travel for business and pleasure. More wealth for us. Countries that depend upon our largesse are also more inclined to aid us in military and intelligence matters.
(For an analogy: One reason for Israel’s relative detente with Saudi Arabia and other Arab nations is their knowledge that their defense systems are loaded with Israeli technology for which there are no viable substitutes.)
No argument on China and IP being a problem. I’m just not of the belief that tariffs and trade barriers do much to combat that.
I'm not drawing a distinction between ensnare and engage. ... The EU and its predecessor organizations were founded to economically entangle Europe enough to discourage the wars that had engulfed the continent since Roman times. Casual empiricism would suggest that it has worked rather well. ... ... In theory, economic entanglement discourages war because of mutual costliness, stakeholder effects, and the development of communication and trust channels. ... ... There are caveats (e.g., WWI happened despite economic entanglements). ... ... Here are three papers that make this point--and which I have not read: [1] Oneal and Russett (1999): "The Kantian Peace" [2] Gartzke and Li (2003): "War, Peace, and the Invisible Hand" [3] Copeland (2014): "Economic Interdependence and War" These papers include caveats--including situations where economic integration can help provoke war.
with little in the way of consideration of the implications that, savings aside, a larger trade imbalance implies a larger budget deficit and thus a ballooning national debt. One of the most crucial economic challenges of our time, that we critically need to get a handle on, and we're deep on the wrong side of the equation.
Second, and related to it, the whole "foreign investment" thing, that you present as an Unequivocally Good Thing, really needs a more nuanced view. Yes, some amount of foreign investment is definitely good, but it's crucial to understand what that actually means: foreigners using the money we gave them to buy American assets.
Do that too much, and *you end up not owning your own country anymore.* The fact that we have to be afraid of China dumping US bonds in reaction to US policy shifts is a clear sign that we have already done that too much, and we desperately need to stop doing that and reverse it.
The mathematics of leverage are very interesting. The longer the lever, the more easily it can be used to move a large mass with a small amount of force. Our long lever was *time,* and we've spent decades filing it down shorter and shorter while also increasing the mass, and now it's a mountain big enough to crush us. Our lever is too short now, and the weight too great; the challenges we face simply cannot be dealt with through "business as usual." And I think that, on some level, the Trump Administration understands that.
— A trade deficit MIGHT track along with national debt. That is a popular hypothesis. But, thanks to the identities, that’s not necessarily the case. If an increase in government debt is offset by an increase in private savings or a decrease in private investment, then there need not be any impact on the trade balance.
— An increase in national debt is not a problem if national income is growing fast enough. For an analogy, I imagine that Elon Musk’s debt is a lot greater than mine—but it’s probably not much of a problem for him. Our problem, as much as anything, is policy that holds down real economic growth.
— I’ve never said that inward foreign investment is an Unequivocally Good Thing. I keep stressing that the national income identities are value-neutral. They are a means of organizing data and for exposing and preventing logically incoherent arguments. Once again, if the value of American capital grows faster than the inward capital flows, then we’re becoming LESS owned by foreigners as the foreign capital rolls in. That’s not necessarily the case, but it is certainly possible. If foreign investments in my company grow by 10% per year but the value of my firm grows by 20% per year, is there a problem?
— There is even an advantage of hostile powers holding U.S. investments. If push comes to shove, we can freeze Iranian assets in the U.S. or seize Nazi assets out west.
> For an analogy, I imagine that Elon Musk’s debt is a lot greater than mine—but it’s probably not much of a problem for him.
I disagree. Some of the things he's done to keep his net worth up, and thus keep his debt manageable, have gotten him in trouble, and some of the things that didn't get him in trouble very easily could have.
"The borrower is servant to the lender." When any reasonable alternative exists, the best course of action is to avoid going into debt, even if it means having to swallow the bitter pill of delayed gratification, because it avoids the even more bitter pill of payment schedules, compound interest, and loss of the freedom to act.
> If foreign investments in my company grow by 10% per year but the value of my firm grows by 20% per year, is there a problem?
The problem is Stein's Law. If you continue expecting 20% YOY growth, and acting on those expectations, sooner or later you're in for a rude awakening. You have a bad year, that growth you were counting on doesn't appear, and suddenly your company isn't yours anymore.
Delete Musk and substitute any other rich person of your choice. :)
I don’t agree that debt avoidance is a prime directive. Well-managed debt does a lot of good.
Don’t assume 20% growth YOY. :)
Herb Stein said “If something cannot go on forever, it will stop.” He didn’t say that nothing can go on forever. Ben Stein notes that people forget the second part of his Dad’s quote: “if it can’t go on forever it will stop. And if we never do anything that we can’t go on doing forever we will never do very much.”
Thank you for posting this collection of further comments on the implications of the algebra of foreign trade. I do have a couple of questions relating to these two posts.
1. Is it reasonable to read the identity X-M = (S-I) + (T-G) as "Net exports equals net investment inflows plus government surplus or deficit"?
2. Given that, it would seem to follow that reducing the government deficit should be effective
in reducing the trade deficit. Nobody seems to be talking about this, however.
3. In a world economy in a state of general equilibrium, is it possible to have positive net investment inflows? General equilibrium would imply that rates of return on investment should be essentially the same world-wide, wouldn't it? (Granted, in a world with so much interference with the market, general equilibrium is a bit fanciful, and, further granted, even an equilibrium economy would be subject to shocks due to inventions, wars, and natural disasters)
4. I don't think your point about income taxes is entirely well-taken. Congress passed an income tax to help fund the Civil War, which was finally ruled unconstitutional in 1896, if I remember correctly. I think it's more accurate to say that Congress resorted to tariffs for government financing because the Constitution had severely limited the power of the Feds to tax.
5. In one of the comments to your algebra post, you seemed to say that modern national income accounting was a product of the second world war. Did I read this correctly? If so, are there any historical accounts of this that you can recommend?
2) Lots of people talk about the connection between the government budget deficit and the current account (trade) balance. It’s called the twin deficits hypothesis: https://en.wikipedia.org/wiki/Twin_deficits_hypothesis
3) On your point #3, it’s likely that at any given time, some countries have greater growth possibilities and risk factors. So we can expect flows at any time. If nothing else, demographics will create flows. A country with lots of old people will have a very different saving and investment profile than a country with lots of young people. The U.S. has been on the good-place-to-invest list for most of its history.
4) As for the Civil War, the question is how much of U.S. income was detectable? (I don’t know.) Of course, the income tax that emerged under Wilson was supposed to hit only the wealthiest Americans—those whose income flows left a paper trail.
5) National Income Accounting began in earnest with the Great Depression but ramped up with WWII. Look up sources concerning Simon Kuznets. I’ll try to find a good source. For now, look for NIPA in Wikipedia. Here’s what Grok says:
“ ### Formalization (1940s): The Birth of NIPA
- World War II and GDP: The demands of wartime planning in the early 1940s accelerated the development of national accounts. Policymakers needed to know the economy’s capacity to support war production without causing inflation or shortages. Kuznets and the Commerce Department, working with economists like Milton Gilbert, expanded income-based measures to include product-based ones, leading to the concept of Gross National Product (GNP).
- 1947 Milestone: The NIPA as a formal, integrated system debuted in 1947, using a double-entry accounting framework to track both income and expenditure sides of the economy. This system introduced GDP as a central measure, calculated via three approaches: expenditure (consumption, investment, government spending, net exports), income (wages, profits, etc.), and production (value-added). The 1947 accounts were a breakthrough, providing a consistent, comprehensive snapshot of economic activity.
- Global Influence: The U.S. NIPA inspired international standards, notably the United Nations’ System of National Accounts (SNA), first published in 1953, which many countries adopted or adapted.
Thank you for your thoughtful responses to my questions. I did have something further I wanted to ask.
6. Following on your response to my question 3, it seems that trade imbalances act as an equilibrating measure in the global economy. Does this seem like a reasonable interpretation to you? If so, then casual tinkering with the terms of trade amounts to casual tinkering with the equilibration mechanism. Not generally recommended, I would think.
That's probably quite true. One of the interesting things about working in international finance in the 1980s was that whatever bad policy idea you wanted to discuss, some country was busy doing it, and you could point in that direction.
Good question and excellent policy issue for DC to consider. I would argue, however, that tariffs and other trade barriers from the U.S. made us more dependent on foreign steel. Post WWII, we protected the hell out of the American steel industry. That left them with little motive to stay current on technology. Ultimately, our smoking, wheezing steel plants could not compete with foreign steelmakers, could no longer muster the political power to maintain the protection. I’m quite sure that whatever the answer is, it’s not tariffs.
One possibility is you subsidize a *small* local industry to keep the knowledge & skills developed and improving. In event of war or other disruption of sources you have the ability to quickly build and ramp up production. The small subsidized sector is simply a defense expenditure.
I’ve noted this before, the concern over trade deficits and tariffs miss an essential component of our economic health. Americans need jobs and work is important for the health of families. The best way to get to that end is reducing government intervention and red tape and reduce energy costs. Both are doable without tariffs. If we had lower cost energy, and more reliable electricity (see Spain) investment will organically arrive on our shores without any other effort. Even manufacturing will come back but with much more labor efficiency. As a non-economist I can see that but I suppose that is much too difficult for the political class.
I'm so glad! I used to tell my classes that the most important lesson I wanted them to take away from my class was that of skepticism. Don't trust what anyone says--including me. :)
I was told once that I should not take Trump's tariffs literally. I said they were written down as executive orders. If I can't take written executive orders literally, the word has lost all meaning.
The Chinese Communist Party is a classical Marxist-Leninist 'Vanguard Party,' the goal of which is to maintain the Party's monopoly on political power. The CCP modeled itself after the Soviet Communist Party, but the Chinese Communists have drawn lessons from the Soviet experience (especially Gorbachev) and have fortified this borrowed model in an effort to make sure they don't end up in 'the dustbin of history' like their Soviet counterparts. If the Soviet Union was substituted for China, would you still maintain your textbook analysis of trade relations? Is there any 'bad actor' in the world of geopolitics that would persuade you that this textbook analysis is inapplicable and irrelevant? Apparently not.
I always enjoy a good discussion, and people are often surprised by my responses to their questions. I lectured a couple of times in the Former Soviet Union and spent several years working for and with a noted authority on Soviet Union, Warsaw Pact, and People's Republic of China. So, it's a fascinating history and part of the world to me.
So, your first couple of sentences sounded interesting. But then, you descended into a opaque pseudo-question leading to a huffy presumption that you already know what I think about whatever point you thought you were making. If you care to clarify whatever it is that you were asking and wish to have an actual conversation, I'll happily engage.
China is reportedly providing satellite data that is being used by the Houthis to identify and carry out missile attacks on US and other ships in the Red Sea. Apart from economics, one of the topics you post on is Israel. China purchases oil from Iran, in violation of US sanctions, and who knows what other kinds of assistance China is providing to Iran, the leadership of which says they seek the destruction of Israel (the Houthis are one of Iran's proxy terrorist groups, so that's one example). Your posts on the topic of tariffs don't factor these kinds of national security and geopolitical concerns into its analysis of 'free trade' and 'globalization,' and I don't find it persuasive.
Great points. I agree with just about all of this. But I find tariffs to be a flaccid, ineffectual way to deal with these problems. That said, I can make an argument for tariffs against China on these grounds--and can nod respectfully when someone else makes that argument. But I cannot accept any argument that justifies President Trump's specific policy, which seems to say, "China is a bad actor. Therefore, we will slap gigantic and irrationally varied tariffs on every other country on Earth, with all sorts of odd carve-outs by industry and product." Summing up, one can logically argue for tariffs as punitive/preventative measures against a country like China, but I don't their effectiveness or accuracy of aim. But using tariffs in this way must be recognized as an economic cost--not a means of generating national wealth, as Trump and various Democrats have argued.
Chinese fashion company Shein is reportedly shutting down some of its garment factories thanks to the elimination of the 'de minimis loophole' for international shipments of all products coming from China. The video linked below documents Shein's blatant theft of intellectual property from US clothing designers. Does your analysis factor in the destruction of 'national wealth' due to widespread Chinese theft of intellectual property? https://www.youtube.com/watch?app=desktop&v=Pp_7rK7BJ5Q
I haven't gone into that level of detail, but I've said that I agree this a problem. My points were more general. (1) I doubt that broad tariffs are effective at dealing with most cross-border problems. (2) If you use tariffs or any other mechanism to deal with a cross-border problem, it had better be well-crafted, highly-targeted, and bearing clear rewards for good behavior and penalties for bad behavior. (3) Whatever legitimate concerns we have about China, slapping bizarre tariff rates on every country in the world is a poor strategy for dealing with it. (4) Effectively tearing up trade agreements that Trump 45 hammered out with countries is especially poor thinking (5) Assuming that the flow of goods is more important than flows of services or capital) is self-destructive, as is focus on specific industries only. (6) Whatever policies we wish to pursue, they are limited by the accounting identities I listed (and others); so, for example, it's futile to seek inward net capital flows AND trade deficit reduction simultaneously. The micro-details, such as the question you pose here, are interesting and important. But that's not my bailiwick; it's a matter of limited time.
Ultimately, Trump's tariffs are meant, more than anything else, as a shock to the post war economic system. We designed this system when we first decided that our potential allies against the Soviet Union required us to adopt an asymmetrical trade imbalance with them to facilitate their recovery, allowing or encouraging them to keep their tariffs and other protectionist measures high to facilitate their growing industries so they could afford to join us to bolster our political and military containment of the Soviets. Our economic disadvantage was thought to be worth it, as the Soviets were considered an existential threat to our nation, its system of government and those other nations which depended on us. The ultimate aim of the tariffs is not merely deficit reduction. Initially, that first part of this bargain was wildly successful, with Europe and Japan becoming very rich while keeping their barriers up to protect against our manufactured goods. However, once they were up on their feet, the barriers never came down, and later, with the very rapid growth of the extreme low wage, protectionist and wanton intellectual property stealing of our Chinese "frenemy", we are finally in a position where we have maneuvered ourselves into what seems to be a permanent economic disadvantage that has more serious implications for the health of our economic system than just a trade imbalance; it is much more serious than that.
By paying no heed to the nature of our economy - that we now are no longer able to produce here most of the basic materials and supplies that are required by even our present hollowed out manufacturing sector, or any future more healthy one, or supply our military with key components to create weapons for defense - we have become neutered. Things like steel, aluminum, rare earth minerals, heavy industry and capital production machines, and a vast array of most consumer goods - we can no longer make these in the numbers and/or quality that would be required if our competitors decided to withhold them for any number of reasons. And, no matter the illusion that a country can long prosper or defend itself if it no longer "makes things" but can only provide services to ourselves and trading partners. Furthermore, we have been arrogant and foolish enough to believe that our competitors who are outshining us now in manufacturing, somehow will not be able to sooner or later provide those same services themselves. Services, by definition serve something other than themselves - they have value only when they support the production of useful material things, which is the purpose for which they have been created.
This current predicament cannot long stand if we are to continue to be an independent nation able to provide a great economy for its citizens and a defense of its system and territory. Something had to be done, and Trump's tariffs, if not an economically efficient method of maintaining the equilibrium of the current world trading system, are a way to shock us out of our foolish lethargy and habit of "kicking the ball down the street" to avoid what needs to be done. If they move our trading partner to allow a more even playing field, to relieve us of the burden of being the world's only party to try to keep trading barriers low and neuter our own industry in the process, they will be the first step in a much needed change. They will have to be adjusted and maybe even largely eliminated, but that can only happen if our trading partners are somehow forced to accept that we can longer afford to forfeit the trade and the economic development that accompanies making not just ideas, but the things that ideas birth, alone on one way street. It's not 1946 any longer, and we have carried this weight too long already.
I was shocked to realize that the US could no longer build a nuclear power plant without the importation of numerous, substantial components. Even Canada could veto any new build in the USA.
Infamously, the UK has to nationalize its last steel ɓlast furnace to prevent closure by its Chiness owners.
As always there's a wise balance to be struck. Trump wants to renegotiate that balance. There's more to statesmenship than money.
I agree that all is not money. Decades ago, I worked for Don Patinkin, a great Israeli economist who had a long, sometimes bitter public argument with David ben Gurion over the PM's early policies. Ben Gurion wanted to spread Israeli towns fairly evenly across the Israeli landscape. Patinkin argued that it would more economically efficient for Israelis to huddle in a few big cities. Ben Gurion's interest was in strategic depth, so that invading armies couldn't just just roll through empty deserts on the way to 3 or 4 big cities--and so they couldn't drop 3 nukes and end Israel. While I was very fond of Patinkin, I believe ben Gurion was more correct.
In the present circumstances, I agree that actions must be taken with respect to China. I am deeply skeptical that anything in the April tariffs will have positive effects in these realms. In particular, hitting every single country on earth with weirdly designed tariffs is not a useful way to deal with China--and probably strengthens China's hand.
The U.S. relies on imported inputs for many reasons that will not be rectified by tariffs. In my interviews with Temple Grandin, she railed against American schools' abandonment of trades education (e.g., shop classes)--as we now have a dire shortage of people capable of performing the fine work that is essential for high technology. (She noted that animal facilities she worked with had to import all of their chips and other tech from the Netherlands because they didn't throw away shop classes.
I'm curious about your thoughts on the ongoing series here and on X (latest: https://x.com/tanvi_ratna/status/1915136356575305998?t=zLA9EN14wjEb4NEuIwARjg&s=19) by Tanvi Ratna.
Your explanations make a lot of sense and your examples are easy to understand and to the point. All of which make me uncomfortable when I think about we as a nation are headed.
But let me make the case for being resentful of other countries who benefit from things America makes available at no cost to the world: safe sea lanes, a space-based navigation system and IT innovation, just as a few examples. That said, I am the first to admit we also take advantage of these things, but we support them financially when we pay taxes.
My major gripe about the current trading system is the manner in which the Chinese have stolen intellectual property.
Thanks for the good words! Appreciate it.
My guess is that whatever benefits we provide in safe sea lanes, space-based navigation, and IT innovation (plus pharmaceuticals) we likely get back in multiples. Think of these as loss-leaders contributing to the enormous prosperity and relative peace we’ve enjoyed since WWII. (Bars give away free food so customers will buy expensive drinks and meals.)
The past 30 years has seen the greatest rise out of poverty in human history. Our gifts are heavily responsible. That rising income and wealth contributes to the sale of American goods and services and attracts investment capital for American business. In addition, populations experiencing rising prosperity are less likely to ensnare us in wars. A world where our tendrils are all over the place is a safer world for Americans to travel for business and pleasure. More wealth for us. Countries that depend upon our largesse are also more inclined to aid us in military and intelligence matters.
(For an analogy: One reason for Israel’s relative detente with Saudi Arabia and other Arab nations is their knowledge that their defense systems are loaded with Israeli technology for which there are no viable substitutes.)
No argument on China and IP being a problem. I’m just not of the belief that tariffs and trade barriers do much to combat that.
“ In addition, populations experiencing rising prosperity are less likely to ensnare us in wars.”
Is there empirical evidence for this? And is there a difference between “ensnare “ and “engage”?
I'm not drawing a distinction between ensnare and engage. ... The EU and its predecessor organizations were founded to economically entangle Europe enough to discourage the wars that had engulfed the continent since Roman times. Casual empiricism would suggest that it has worked rather well. ... ... In theory, economic entanglement discourages war because of mutual costliness, stakeholder effects, and the development of communication and trust channels. ... ... There are caveats (e.g., WWI happened despite economic entanglements). ... ... Here are three papers that make this point--and which I have not read: [1] Oneal and Russett (1999): "The Kantian Peace" [2] Gartzke and Li (2003): "War, Peace, and the Invisible Hand" [3] Copeland (2014): "Economic Interdependence and War" These papers include caveats--including situations where economic integration can help provoke war.
Bob, I respect the heck out of you, but I have to fundamentally disagree on a few points here.
First, in last week's column, you pointed out the identity:
[4] (X-M) ≡ (S-I)+(T-G)
(trade balance) ≡ (private saving balance) + (government budget balance)
with little in the way of consideration of the implications that, savings aside, a larger trade imbalance implies a larger budget deficit and thus a ballooning national debt. One of the most crucial economic challenges of our time, that we critically need to get a handle on, and we're deep on the wrong side of the equation.
Second, and related to it, the whole "foreign investment" thing, that you present as an Unequivocally Good Thing, really needs a more nuanced view. Yes, some amount of foreign investment is definitely good, but it's crucial to understand what that actually means: foreigners using the money we gave them to buy American assets.
Do that too much, and *you end up not owning your own country anymore.* The fact that we have to be afraid of China dumping US bonds in reaction to US policy shifts is a clear sign that we have already done that too much, and we desperately need to stop doing that and reverse it.
The mathematics of leverage are very interesting. The longer the lever, the more easily it can be used to move a large mass with a small amount of force. Our long lever was *time,* and we've spent decades filing it down shorter and shorter while also increasing the mass, and now it's a mountain big enough to crush us. Our lever is too short now, and the weight too great; the challenges we face simply cannot be dealt with through "business as usual." And I think that, on some level, the Trump Administration understands that.
Thanks, Bob. The respect is mutual.
— A trade deficit MIGHT track along with national debt. That is a popular hypothesis. But, thanks to the identities, that’s not necessarily the case. If an increase in government debt is offset by an increase in private savings or a decrease in private investment, then there need not be any impact on the trade balance.
— An increase in national debt is not a problem if national income is growing fast enough. For an analogy, I imagine that Elon Musk’s debt is a lot greater than mine—but it’s probably not much of a problem for him. Our problem, as much as anything, is policy that holds down real economic growth.
— I’ve never said that inward foreign investment is an Unequivocally Good Thing. I keep stressing that the national income identities are value-neutral. They are a means of organizing data and for exposing and preventing logically incoherent arguments. Once again, if the value of American capital grows faster than the inward capital flows, then we’re becoming LESS owned by foreigners as the foreign capital rolls in. That’s not necessarily the case, but it is certainly possible. If foreign investments in my company grow by 10% per year but the value of my firm grows by 20% per year, is there a problem?
— There is even an advantage of hostile powers holding U.S. investments. If push comes to shove, we can freeze Iranian assets in the U.S. or seize Nazi assets out west.
> For an analogy, I imagine that Elon Musk’s debt is a lot greater than mine—but it’s probably not much of a problem for him.
I disagree. Some of the things he's done to keep his net worth up, and thus keep his debt manageable, have gotten him in trouble, and some of the things that didn't get him in trouble very easily could have.
"The borrower is servant to the lender." When any reasonable alternative exists, the best course of action is to avoid going into debt, even if it means having to swallow the bitter pill of delayed gratification, because it avoids the even more bitter pill of payment schedules, compound interest, and loss of the freedom to act.
> If foreign investments in my company grow by 10% per year but the value of my firm grows by 20% per year, is there a problem?
The problem is Stein's Law. If you continue expecting 20% YOY growth, and acting on those expectations, sooner or later you're in for a rude awakening. You have a bad year, that growth you were counting on doesn't appear, and suddenly your company isn't yours anymore.
Delete Musk and substitute any other rich person of your choice. :)
I don’t agree that debt avoidance is a prime directive. Well-managed debt does a lot of good.
Don’t assume 20% growth YOY. :)
Herb Stein said “If something cannot go on forever, it will stop.” He didn’t say that nothing can go on forever. Ben Stein notes that people forget the second part of his Dad’s quote: “if it can’t go on forever it will stop. And if we never do anything that we can’t go on doing forever we will never do very much.”
Nailed it, Robert. Bottom line: voluntary exchange creates human flourishing; nothing else does.
Thank you for posting this collection of further comments on the implications of the algebra of foreign trade. I do have a couple of questions relating to these two posts.
1. Is it reasonable to read the identity X-M = (S-I) + (T-G) as "Net exports equals net investment inflows plus government surplus or deficit"?
2. Given that, it would seem to follow that reducing the government deficit should be effective
in reducing the trade deficit. Nobody seems to be talking about this, however.
3. In a world economy in a state of general equilibrium, is it possible to have positive net investment inflows? General equilibrium would imply that rates of return on investment should be essentially the same world-wide, wouldn't it? (Granted, in a world with so much interference with the market, general equilibrium is a bit fanciful, and, further granted, even an equilibrium economy would be subject to shocks due to inventions, wars, and natural disasters)
4. I don't think your point about income taxes is entirely well-taken. Congress passed an income tax to help fund the Civil War, which was finally ruled unconstitutional in 1896, if I remember correctly. I think it's more accurate to say that Congress resorted to tariffs for government financing because the Constitution had severely limited the power of the Feds to tax.
5. In one of the comments to your algebra post, you seemed to say that modern national income accounting was a product of the second world war. Did I read this correctly? If so, are there any historical accounts of this that you can recommend?
1) Yes.
2) Lots of people talk about the connection between the government budget deficit and the current account (trade) balance. It’s called the twin deficits hypothesis: https://en.wikipedia.org/wiki/Twin_deficits_hypothesis
3) On your point #3, it’s likely that at any given time, some countries have greater growth possibilities and risk factors. So we can expect flows at any time. If nothing else, demographics will create flows. A country with lots of old people will have a very different saving and investment profile than a country with lots of young people. The U.S. has been on the good-place-to-invest list for most of its history.
4) As for the Civil War, the question is how much of U.S. income was detectable? (I don’t know.) Of course, the income tax that emerged under Wilson was supposed to hit only the wealthiest Americans—those whose income flows left a paper trail.
5) National Income Accounting began in earnest with the Great Depression but ramped up with WWII. Look up sources concerning Simon Kuznets. I’ll try to find a good source. For now, look for NIPA in Wikipedia. Here’s what Grok says:
“ ### Formalization (1940s): The Birth of NIPA
- World War II and GDP: The demands of wartime planning in the early 1940s accelerated the development of national accounts. Policymakers needed to know the economy’s capacity to support war production without causing inflation or shortages. Kuznets and the Commerce Department, working with economists like Milton Gilbert, expanded income-based measures to include product-based ones, leading to the concept of Gross National Product (GNP).
- 1947 Milestone: The NIPA as a formal, integrated system debuted in 1947, using a double-entry accounting framework to track both income and expenditure sides of the economy. This system introduced GDP as a central measure, calculated via three approaches: expenditure (consumption, investment, government spending, net exports), income (wages, profits, etc.), and production (value-added). The 1947 accounts were a breakthrough, providing a consistent, comprehensive snapshot of economic activity.
- Global Influence: The U.S. NIPA inspired international standards, notably the United Nations’ System of National Accounts (SNA), first published in 1953, which many countries adopted or adapted.
Thank you for your thoughtful responses to my questions. I did have something further I wanted to ask.
6. Following on your response to my question 3, it seems that trade imbalances act as an equilibrating measure in the global economy. Does this seem like a reasonable interpretation to you? If so, then casual tinkering with the terms of trade amounts to casual tinkering with the equilibration mechanism. Not generally recommended, I would think.
That's probably quite true. One of the interesting things about working in international finance in the 1980s was that whatever bad policy idea you wanted to discuss, some country was busy doing it, and you could point in that direction.
What happens in your view when China invades a country that no longer produces steel?
And China threatens all other steel-producing countries not to sell you any steel?
Good question and excellent policy issue for DC to consider. I would argue, however, that tariffs and other trade barriers from the U.S. made us more dependent on foreign steel. Post WWII, we protected the hell out of the American steel industry. That left them with little motive to stay current on technology. Ultimately, our smoking, wheezing steel plants could not compete with foreign steelmakers, could no longer muster the political power to maintain the protection. I’m quite sure that whatever the answer is, it’s not tariffs.
One possibility is you subsidize a *small* local industry to keep the knowledge & skills developed and improving. In event of war or other disruption of sources you have the ability to quickly build and ramp up production. The small subsidized sector is simply a defense expenditure.
We kind of did that in WWII.
I’ve noted this before, the concern over trade deficits and tariffs miss an essential component of our economic health. Americans need jobs and work is important for the health of families. The best way to get to that end is reducing government intervention and red tape and reduce energy costs. Both are doable without tariffs. If we had lower cost energy, and more reliable electricity (see Spain) investment will organically arrive on our shores without any other effort. Even manufacturing will come back but with much more labor efficiency. As a non-economist I can see that but I suppose that is much too difficult for the political class.
Mr. Graboyes always makes me think... and in the process, I always even learn stuff.
I'm so glad! I used to tell my classes that the most important lesson I wanted them to take away from my class was that of skepticism. Don't trust what anyone says--including me. :)
I was told once that I should not take Trump's tariffs literally. I said they were written down as executive orders. If I can't take written executive orders literally, the word has lost all meaning.
Another advantage of sales taxes over tariffs is that sales taxes are transparent to the buyers of finished goods.
The Chinese Communist Party is a classical Marxist-Leninist 'Vanguard Party,' the goal of which is to maintain the Party's monopoly on political power. The CCP modeled itself after the Soviet Communist Party, but the Chinese Communists have drawn lessons from the Soviet experience (especially Gorbachev) and have fortified this borrowed model in an effort to make sure they don't end up in 'the dustbin of history' like their Soviet counterparts. If the Soviet Union was substituted for China, would you still maintain your textbook analysis of trade relations? Is there any 'bad actor' in the world of geopolitics that would persuade you that this textbook analysis is inapplicable and irrelevant? Apparently not.
I always enjoy a good discussion, and people are often surprised by my responses to their questions. I lectured a couple of times in the Former Soviet Union and spent several years working for and with a noted authority on Soviet Union, Warsaw Pact, and People's Republic of China. So, it's a fascinating history and part of the world to me.
So, your first couple of sentences sounded interesting. But then, you descended into a opaque pseudo-question leading to a huffy presumption that you already know what I think about whatever point you thought you were making. If you care to clarify whatever it is that you were asking and wish to have an actual conversation, I'll happily engage.
China is reportedly providing satellite data that is being used by the Houthis to identify and carry out missile attacks on US and other ships in the Red Sea. Apart from economics, one of the topics you post on is Israel. China purchases oil from Iran, in violation of US sanctions, and who knows what other kinds of assistance China is providing to Iran, the leadership of which says they seek the destruction of Israel (the Houthis are one of Iran's proxy terrorist groups, so that's one example). Your posts on the topic of tariffs don't factor these kinds of national security and geopolitical concerns into its analysis of 'free trade' and 'globalization,' and I don't find it persuasive.
Great points. I agree with just about all of this. But I find tariffs to be a flaccid, ineffectual way to deal with these problems. That said, I can make an argument for tariffs against China on these grounds--and can nod respectfully when someone else makes that argument. But I cannot accept any argument that justifies President Trump's specific policy, which seems to say, "China is a bad actor. Therefore, we will slap gigantic and irrationally varied tariffs on every other country on Earth, with all sorts of odd carve-outs by industry and product." Summing up, one can logically argue for tariffs as punitive/preventative measures against a country like China, but I don't their effectiveness or accuracy of aim. But using tariffs in this way must be recognized as an economic cost--not a means of generating national wealth, as Trump and various Democrats have argued.
Chinese fashion company Shein is reportedly shutting down some of its garment factories thanks to the elimination of the 'de minimis loophole' for international shipments of all products coming from China. The video linked below documents Shein's blatant theft of intellectual property from US clothing designers. Does your analysis factor in the destruction of 'national wealth' due to widespread Chinese theft of intellectual property? https://www.youtube.com/watch?app=desktop&v=Pp_7rK7BJ5Q
I haven't gone into that level of detail, but I've said that I agree this a problem. My points were more general. (1) I doubt that broad tariffs are effective at dealing with most cross-border problems. (2) If you use tariffs or any other mechanism to deal with a cross-border problem, it had better be well-crafted, highly-targeted, and bearing clear rewards for good behavior and penalties for bad behavior. (3) Whatever legitimate concerns we have about China, slapping bizarre tariff rates on every country in the world is a poor strategy for dealing with it. (4) Effectively tearing up trade agreements that Trump 45 hammered out with countries is especially poor thinking (5) Assuming that the flow of goods is more important than flows of services or capital) is self-destructive, as is focus on specific industries only. (6) Whatever policies we wish to pursue, they are limited by the accounting identities I listed (and others); so, for example, it's futile to seek inward net capital flows AND trade deficit reduction simultaneously. The micro-details, such as the question you pose here, are interesting and important. But that's not my bailiwick; it's a matter of limited time.
Ultimately, Trump's tariffs are meant, more than anything else, as a shock to the post war economic system. We designed this system when we first decided that our potential allies against the Soviet Union required us to adopt an asymmetrical trade imbalance with them to facilitate their recovery, allowing or encouraging them to keep their tariffs and other protectionist measures high to facilitate their growing industries so they could afford to join us to bolster our political and military containment of the Soviets. Our economic disadvantage was thought to be worth it, as the Soviets were considered an existential threat to our nation, its system of government and those other nations which depended on us. The ultimate aim of the tariffs is not merely deficit reduction. Initially, that first part of this bargain was wildly successful, with Europe and Japan becoming very rich while keeping their barriers up to protect against our manufactured goods. However, once they were up on their feet, the barriers never came down, and later, with the very rapid growth of the extreme low wage, protectionist and wanton intellectual property stealing of our Chinese "frenemy", we are finally in a position where we have maneuvered ourselves into what seems to be a permanent economic disadvantage that has more serious implications for the health of our economic system than just a trade imbalance; it is much more serious than that.
By paying no heed to the nature of our economy - that we now are no longer able to produce here most of the basic materials and supplies that are required by even our present hollowed out manufacturing sector, or any future more healthy one, or supply our military with key components to create weapons for defense - we have become neutered. Things like steel, aluminum, rare earth minerals, heavy industry and capital production machines, and a vast array of most consumer goods - we can no longer make these in the numbers and/or quality that would be required if our competitors decided to withhold them for any number of reasons. And, no matter the illusion that a country can long prosper or defend itself if it no longer "makes things" but can only provide services to ourselves and trading partners. Furthermore, we have been arrogant and foolish enough to believe that our competitors who are outshining us now in manufacturing, somehow will not be able to sooner or later provide those same services themselves. Services, by definition serve something other than themselves - they have value only when they support the production of useful material things, which is the purpose for which they have been created.
This current predicament cannot long stand if we are to continue to be an independent nation able to provide a great economy for its citizens and a defense of its system and territory. Something had to be done, and Trump's tariffs, if not an economically efficient method of maintaining the equilibrium of the current world trading system, are a way to shock us out of our foolish lethargy and habit of "kicking the ball down the street" to avoid what needs to be done. If they move our trading partner to allow a more even playing field, to relieve us of the burden of being the world's only party to try to keep trading barriers low and neuter our own industry in the process, they will be the first step in a much needed change. They will have to be adjusted and maybe even largely eliminated, but that can only happen if our trading partners are somehow forced to accept that we can longer afford to forfeit the trade and the economic development that accompanies making not just ideas, but the things that ideas birth, alone on one way street. It's not 1946 any longer, and we have carried this weight too long already.
I was shocked to realize that the US could no longer build a nuclear power plant without the importation of numerous, substantial components. Even Canada could veto any new build in the USA.
Infamously, the UK has to nationalize its last steel ɓlast furnace to prevent closure by its Chiness owners.
As always there's a wise balance to be struck. Trump wants to renegotiate that balance. There's more to statesmenship than money.
I agree that all is not money. Decades ago, I worked for Don Patinkin, a great Israeli economist who had a long, sometimes bitter public argument with David ben Gurion over the PM's early policies. Ben Gurion wanted to spread Israeli towns fairly evenly across the Israeli landscape. Patinkin argued that it would more economically efficient for Israelis to huddle in a few big cities. Ben Gurion's interest was in strategic depth, so that invading armies couldn't just just roll through empty deserts on the way to 3 or 4 big cities--and so they couldn't drop 3 nukes and end Israel. While I was very fond of Patinkin, I believe ben Gurion was more correct.
In the present circumstances, I agree that actions must be taken with respect to China. I am deeply skeptical that anything in the April tariffs will have positive effects in these realms. In particular, hitting every single country on earth with weirdly designed tariffs is not a useful way to deal with China--and probably strengthens China's hand.
The U.S. relies on imported inputs for many reasons that will not be rectified by tariffs. In my interviews with Temple Grandin, she railed against American schools' abandonment of trades education (e.g., shop classes)--as we now have a dire shortage of people capable of performing the fine work that is essential for high technology. (She noted that animal facilities she worked with had to import all of their chips and other tech from the Netherlands because they didn't throw away shop classes.
This is a great series. Thanks for the insights.