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US President Donald Trump is more than an economist: He is a statesman who knows how to use the tariff and other instruments of economic power so as to make gains for America.

Early on, recognize that Trump uses the term “tariff” (that is, tariffs against the US) to mean all the taxes, regulations and conditions that foreign nations apply to the sale or use of goods and services that are in any way “American,” but are susceptible to any degree of foreign political control, including control by international entities like the World Trade Organization (WTO).

Also, realize that Trump is taking a tough initial bargaining – even threatening – position. No actual tariffs have been laid on.

Finally, recognize that the US president is unlikely really to think the old-time Big Steel industry of the mid-20th century, along with its vast army of well-paid workers, is coming back. He is threatening the profitability, even the very existence, of today’s non-American steel industry, in order to force foreign governments to be, in general, more US trade-friendly. He knows that a trade war between China and America would be destabilizing, not just in economic terms, but as a force to alter alliances and relationships all around the world.

Despite such sophisticated and politically sensitive behind-the-scenes thinking, Trump may have made a mistake of judgment when he introduced his proposals for new US tariffs, or possibly he is in error when he anticipates the full range of consequences that will follow from these proposals (remember it is only a proposal at this point).

But at this moment, because he has not yet revealed (and will likely not reveal) the complete story of his planned tariff moves, and because his tariff plan is dynamic, evolving and ongoing, no one can say if either his judgments are faulty or he has miscalculated his predictions. All we know now is that he has merely threatened to apply new tariffs on steel and aluminum originating in some, but not all, foreign places, and only after some of the governments in those targeted places refuse to make adjustments in tariffs they apply to incoming US goods.

We will detail Trump’s possible misjudgment later in the essay. For now, we will outline our understanding of what he understands quite well about trade.

Free trade: the blackboard version

What Trump knows better than many of his critics is that the completely free, two-nations, two-commodities, two-currencies, two-periods, before-and-after textbook diagram of international trade traditionally played out on the blackboard of every first-year economics class is a special case. That special case is a creature of limited assumptions, simplified motivations (mainly that the aim of trade policy is to maximize gains for all players, rather than national gains for the biggest player) and a-historic application.

The classroom example has little relevance when the nation-states, as well as trading partners, have global interests to advance and protect: interests that go well beyond, are independent of and even contrary to the calculus of private gains and losses experienced by direct trading players.

State traders are limited by their own histories, are sometimes desirous of helping or hurting competing political entities, are motivated by an interest in re-election or at least popular support from a vast array of foreign and domestic counter-parties having direct and indirect connections with the outcome of trading arrangements.

The prizes in the trade game being played include national prestige, possible redistribution of initial trade profits, political alienation of private benefits by way of taxation, economic support for “public goods and bads” like national defense, nation-building, cartelization, and even corruption. Any one of those “prizes” may be “paid for” with moves away from prim and proper “free trade”: indeed, the reason that real-world trade is never completely (or even nearly) free is that more than private economic profit/interest is at stake, and that the distribution of the “gains from trade,” both between trading partners, and within each national trader (for example US steelmakers may benefit, but steel users may lose).

We are economists. We know and respect the classroom model. We are also students of history, politics, national rivalries, cross-border intrigues, war, and peace. That list of factors is part of rational foreign policy. The list has always been entangled with deeply complicated foreign trade and investment policies: Trump is cooking those “ingredients” together in his real-world hot kitchen.

America and the rest of the world

He is informed by far more than a first-year understanding of how to get the rest of the world (ROW) to pay more attention to America’s claim on them in repayment for (according to Trump’s accounting) past and future political, social, up-till-now unpaid economic debts owed by ROW to America.

For example, American taxpayers paid the cost, via the Marshall Plan, of rebuilding ROW after World War II, and paid most of the cost of defeating the Soviet Union in the Cold War. Of course, that spending also benefitted America: The final result is that it is now the only superpower. But Trump nonetheless wants some payback.

Real-world considerations for political actors who designed tariff policy included, in times past, gathering a national fund (trade surplus) of foreign exchange (gold in the old days) adequate to pay mercenary armies.

Today, a trade deficit is possibly dangerous to the national interest because the deficit means the indebted nation owes the creditor nation a “mortgage” that is paid off (assuming the creditor won’t “continue to hold the mortgage” only by giving the creditor national assets.

In the case of the US, annual trade deficits along with other public and private purchases have built up the world’s largest net public and private external debt. In 2003, the total was US$862 billion. It is now $18.6 trillion, about $57,000 for each and every American person.  China’s comparable number is $1,100 per capita. In other words, to pay off America’s gross debt to ROW, each and every American person would give up $57,000 of his current wealth.

How? By transferring to ROW title to $57,000 worth of farms, factories, forests, and financial assets. ROW would, from that day forward, have a right to the earnings and dividends produced by those transferred producing assets.

Of course, the US does have some counterbalancing claims against ROW: amounting to about $10 trillion, leaving a net external US debt to ROW of more than $8 trillion.

OK, so to settle the net external (international) public and private debt, the average American person would have to give up to ROW persons “only” $25,000 worth of wealth.

The real significance of net external national debt is that the creditor countries (China in particular) have the financial power, and right, to demand that the Americans settle their debts by transferring ownership of assets now in American hands, and placing those assets (farms, factories, forests and financial claims) into (for example) Chinese hands and control.

It’s the numbers and consequent risks above that caused President Trump to tell the ROW that there is a new sheriff in town. Indeed, he is going to do the legal sheriff thing: He won’t repudiate US debt as some irresponsible nations have done. He is going to cut that debt down the honest way, by selling more American goods to ROW.

Not by collecting tariffs: The revenues would be pennies. He is focused on all the ways the American national wallet leaks dollars.

The US pays for ROW military preparedness. For example, only five of the 23 member nations in the North Atlantic Treaty Organization spend the 2% of gross domestic product they are treaty-bound to pay. (The US pays 3.6%, Canada pays 1%.) Trump’s total foreign-policy package (of which the tariff is a small but noisy part) is aimed at stopping that imbalance, which, if others paid their way, would reduce US overseas spending, and thus chip away at the accumulated US international debt.

That is, the Americans are, in a way not so different from the olden days of “mercantilist” (gold-build-up) international trade theory, currently “paying for foreign mercenary troops” and they are saying “no more.”

What are some other angles that make “big idea” sense of Trump’s new direction for US foreign trade, investment and “America first” overseas policy? Indeed, what are all the angles pursued by the entire spectrum of nations that use tariffs (positive and negative, taxes and subsidies) and other regulations affecting international flows of goods, investments and traded services, always in pursuit of a variety of national interests and concerns?

Tariffs of yesteryear

In 19th-century US history, protective tariffs and barriers to international capital allowed the “infant industries” of the United States to grow large enough to compete eventually with well-established foreign firms.

For example, the Mexican-American War, as well as the later Spanish-American War, fought with protected US steel, allowing for high-volume production of top-quality weapons, made possible the statehoods of California, New Mexico, Arizona, Texas and Nevada, to say nothing of territorial status for Puerto Rico, and an extension of US presence in the Pacific theater consisting of a port and eventual base in the Philippines, combined with ownership of the island of Guam in the Marianas chain and (only because of congressional squeamishness) forgone ownership of Cuba in the Atlantic.

Nobody lives by the rules of the free-trade model. Indeed, ROW has long been a strategic trader, while the US has been, relatively speaking, the advocate of free or freer trade. Trump is moving toward the ROW style of negotiating, much to the chagrin of ROW.

The Organization of the Petroleum Exporting Countries uses what is really a tariff on exports to keep the price of oil much higher than it would be under free trade: It makes the ROW much worse off, but OPEC likes it.

China has been charged with “dumping” steel and various other manufactured products (selling at less than the cost of production, using a negative tariff or subsidy) into world markets. Anti-Chinese players say “the plan” is to hollow out competing heavy industry in the buying nations, so as to set the stage for, perhaps, later price boosts, way above the cost of production.

It is likely the real Chinese intention, to the extent that such grand intentions actually work out, is to advance quickly the internal growth rate of key domestic industries, prior to the ability of Chinese consumers to buy, and ahead the capacity of China’s “up the food chain” industries to yet use the raw steel etc to feed local needs.

But whatever the motive, negative tariffs (subsidies) are part of the departure from free-trade classroom doctrine.

Manipulation of foreign investments is another commonplace “national interest” use for taxes, burdens, regulations, and barriers. For example, President Trump recently blocked Singaporean chipmaker Broadcom’s proposed $117 billion takeover of US high-tech firm Qualcomm: Trump cited problems with national security as his reason. Right or wrong, military needs are a universal factor not present in the classroom argument in favor of free trade.

China routinely limits the presence of US social-media services. Even during the relatively “free market” Stephen Harper administration in Canada, that Conservative government blocked the proposed $37 billion purchase by BHP Billiton (an Australian mining company) of the Potash Corporation of Saskatchewan. Canadian internal politics were blamed for this departure from classroom trade/investment openness.

National-interest trade policy

Trade wars are sometimes not too distinct from real war. Cheap Cuban sugar, rum, cigars and even beach-front vacation weekends were denied to American consumers for many years, in order to make that Communist government pay for at some of the damage it did, especially during the years it was a puppet of the Soviet Union, to the general US interest in the Caribbean and the rest of the Western Hemisphere. Once again, the free-trade model is irrelevant to the usefulness (or not) of a real-world national-interest trade policy.

Prior to World War II, and going all the way back to Victorian times, Britain had a policy of “imperial preference,” or later “Commonwealth preference,” that set up a kind of free-trade group, headquartered in the UK, consisting of Canada, Australia, New Zealand and South Africa, that was transparently a system to limit the then rapid growth of the US as a world economic power. The Brits wanted to offset the US potential to threaten the importance of the British Empire.

Indeed, some historians say the UK trade and investment support for Canadian nationhood in 1867 (a moment when some Europeans feared the victorious armies of the US North might march north and create a three-ocean colossus) was another manifestation of national-interest economic policy aimed at harming a political, economic and social competitor. Also not on the blackboard.

Enter China

So, by now we have convinced you that Trump’s theory of international trade and his understanding of how to use the instruments of trade, tariffs, subsidies, and investment regulation in the advance of national interest is sophisticated and quite in line with historical traditions. But what could he be getting wrong? Or better yet, what might go contrary to his hope and expectation? China, that’s what.

By the way, we say “China” because the other possibilities (for organized, successful opposition to America’s change in policy) such as the European Union, the World Trade Organization, and the United Nations are at best (Woodrow) Wilsonian semi-utopian, treaty-based political institutions, without the deep roots or national purposefulness of real nation-states like the US or China.

To the extent that some of those international institutions have had brief success (none of them existed prior to World War II), that success has not been tested by the potentially far-reaching change in US willingness to put international stability ahead of America’s permanent domestic interest.

The situation is not so much trade theory as it is game theory. Trump’s model is of his superpower ganging up, one at a time, against an opposing line of squabbling, badly organized lesser powers, some of them quite trade-dependent (albeit rich: for example Germany), others indebted and vulnerable to anyone able to provide cheap credit (PIIGS, or Portugal, Italy, Ireland, Greece and Spain) or willing to sell out badly managed but “recoverable” national assets for dimes on the dollar.

In ROW (but within China’s sphere of influence), there are nations with promise, already on the road to near-full economic “adulthood”. The World Bank predicts these growth rates: the Philippians 6.9%, Laos 7%, Cambodia 6.9%, Myanmar 6.9%, Bhutan 6%.

Further afield, there are countries, interesting to China, with promise (Peru’s predicted rate is 3.7%: it has lots of gold, copper, zinc and lead). Panama will grow by 5.8% next year, says Bloomberg. Its money-machine, the Panama Canal, will be even more important as a facilitator of South American raw-materials exports to China.

All these counties now have links to the US. If they begin to worry about stability or generosity in their terms of trade with the Superpower, they may listen to a China, which has a long-run view and is willing to make long-run commitments.

Why would China make such promises? With the deep purpose of assuring, maintaining and even increasing its own internal growth rate, while making sure (again purely as an internal matter) that those parts of its domestic economy that are in need of “catch-up” will have the wherewithal needed for accelerated, equalizing development.

Any such ambitions on the part of China do not have to be classically imperial. They could and, should they come to be, will correctly be seen to be aimed at creating greater internal security and stability. But if it happens, it will be partly a consequence of American use of uncertainty (only tactical to be sure, but nonetheless unsettling to others) in its willingness to sacrifice American national interest in the name of international stability.

In conclusion, Trump’s actions are quite consistent with a “big idea” conception of trade, investment, tax, subsidy, and tariff theories. His thinking goes way past the simplified free-trade classroom case. He understands how to use foreign trade in a way that supports foreign policy and national interest.

His conception is subtle and complex, and not yet fully laid out. For example, it is already clear that any steel and aluminum tariff will not be uniform across nations or across rates.

But the very sophistication and studied complexity in his strategically vague plan may leave an opening for China to advance its own interests, possibly at the cost of at least some of America’s hoped-for gains.

Tom Velk and Jade Xiao

Tom Velk is a libertarian-leaning American economist who teaches and lives in Montreal, Canada. He is the chairman of the North American studies program at McGill University and a professor in that university's economics department. Jade Xiao is a McGill University graduate.

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