No, Trump's Tariff Wouldn't Crash The Economy

Hillary Clinton has been accusing Donald Trump of having economic plans that would crash the U.S. economy.

There's a NY Times story about the underlying economic analysis here. (Google the article title and enter via Google if you're not a subscriber to the Times's paywall.)

The underlying report from Moody's Analytics, a mainstream economics firm, is here. The lead author is Mark Zandi, who used to advise Sen. John McCain and Barack Obama, so its presumed bias is anti-Trump. He has also endorsed the Trans-Pacific Partnership, the economic models in support of which have been shown to be wrong.

The report concerns three big issues: taxes, immigration, and foreign trade. Now the first two aren't my area of expertise, so I'll leave any arguments about them to the experts. But the third is, so let me explain why I think these guys have it wrong.

Before we begin, it's necessary to get clear on the fact that, frankly, a lot of what Mr. Trump says is obviously just campaign rhetoric. So no, we shouldn't take literally the idea of a 45 percent tariff on Chinese goods, which the candidate has proposed.

Does this make The Donald a liar? Well, let's remember that when Pres. Obama was running against Hillary Clinton in the Democratic primaries in 2008, he touted a version of heath reform that was supposedly superior because it lacked the individual mandate to buy insurance. That was obviously a nice piece of campaigning (he won) but was a) the precise opposite of what Obama did in office, and b) an obviously impossible proposal given the structure of healthcare reform. So this is basically par for the course in politics. I wish it were otherwise, but there it is.

And don't even get me started on Hillary's rhetoric.

So the correct interpretation of Trump's tough words on trade is, "I'm going to impose a get-tough policy," not any particular tariff level. The president can't set tariffs on his own, and (as Trump has said in other contexts) the 45 percent proposal may just be a negotiating stance designed to bring Beijing to heel. (His actual proposal was for a 45 percent tariff until China lets its currency float freely on international markets, which tends to support this interpretation.)

Moody's interpretation of the 45 percent proposal (even if one grants the unlikely premise that it should be taken literally) is also unacceptably crude. They write:

The U.S. imports nearly $500 billion in goods a year from China, and another almost $300 billion from Mexico, accounting for approximately 35 percent of total U.S. non-petroleum goods imports... Slapping a 45 percent tariff on Chinese imports and 35 percent on non-petroleum Mexican imports thus increases overall goods import prices by approximately 15 percent. This in turn lifts overall U.S. consumer prices by almost three percent at its peak...

For one thing, they're ignoring the basic economic concept of elasticity. In a nutshell, prices wouldn't respond in a linear fashion as described. Profit margins would get compressed, domestic competitors and other foreign nations would move in, and prices wouldn't move by the amount of the tariff. (The report perfunctorily mentions these issues, but its math doesn't appear to take them into account.)

For another, they're forgetting that a tariff offsets other taxes. So if tariff revenue finances, say, a cut in income tax (Trump has indeed proposed one), then the net cost to consumers is zeroed out (pace secondary effects).

So no, a tariff is not necessarily inflationary. And in an economic environment where inflation is so low that central banks are unable to cut interest rates because they can't go (more than a crumb) below zero, else people would hoard cash, worrying about inflation is not especially rational right now anyway.

Just so you know, I'm not the only one pooh-poohing the idea that Trump's tariff would bring disaster. The liberal Nobelist Paul Krugman wrote this,

Yes, I know there's a Moody's study claiming that Trumponomics would be a yuuge job destroyer, but I really don't know where they got that result; the best guess seems to be that they're assuming that former spending on imports just goes away, which is not a good assumption.

Note that this is coming from someone who doesn't seem to take the upside to Trump's proposed policies very seriously; he's just not that frightened of the (in his view, small) downside.

More importantly, the Moody's report doesn't pay any attention to the economic benefits of relocating production to the U.S. A nation that runs a chronic trade deficit, as we do, is eschewing domestic production in favor of letting foreigners produce for it in exchange for a) debt and b) sale of existing assets. Producing for ourselves instead would, by basic economic definitions, be an increase in U.S. GDP.

Since our trade deficit is around $500 billion a year, this is not a minor issue. (Anyone who's still buying into the "trade deficits don't matter / aren't real money" delusion, let's go over that one more time.)

Zeroing out the U.S. trade deficit would also reduce unemployment. Or, more likely, bring back people who have dropped out of the labor force entirely - a huge problem that has enabled us to have nominally low unemployment numbers because people who aren't looking for work aren't counted. This, in turn, would increase Federal tax revenue as people started paying income tax again, and reduce the cost of unemployment benefits. So it's a very virtuous cycle.

The Moody's report makes a number of really odd assumptions. For example,

But although Mr. Trump is uncomfortable with NAFTA and the WTO-based trade relationship with China, it is assumed that they are not materially changed.

Now I can't tell you exactly what changes a President Trump would make, but it's pretty obvious that a) he wants these agreements changed, and b) because NAFTA and the WTO are treaty obligations, which the U.S. negotiated in the first place, the U.S. can renegotiate them. The obvious goal would be to end the practice of U.S. trade obligations being tools to prop open American markets for foreigners while they give us only nominal, not real, access in return.

How much traction against the trade deficit could a President Trump get? Well, since the U.S. hasn't even been seriously trying to control its trade deficit in decades, the short answer is: definitely something.

How much would depend on what policies were used. Some of the best policies are things that Trump probably knows about, but can't talk about because they're politically unpalatable. For example, if the U.S. introduced a 15% border-adjustable Value-Added Tax like other developed nations have, this would a) provide big leverage against the trade deficit, and b) be absolutely, impeccably WTO-compliant, so none of the deficit-racking usual suspects (China, Japan, Germany) could do a thing about it. Such a tax could, of course, be used to finance a cut in income tax, so it could not be a net tax increase at all. But it's still a tax, so probably toxic to Republican voters, although a national consumption tax has recently been becoming more acceptable to Republicans stymied in other avenues of tax reform.

Is Trump crazy to think he can negotiate better deals for the U.S. with foreign nations? I'm not going to offer an opinion on whether his vaunted negotiating skills will translate from Celebrity Apprentice to summitry vs. China, but I'm not the only person to have noted (like liberal economist Dean Baker below) that:

Anyhow, it would make perfect sense to negotiate a path for a higher valued yuan. At the negotiating table it would be perfectly reasonable to threaten various forms of retaliation as pressure, including tariffs.

So net-net, I can't guarantee that Trump would be able to successfully pull off a major reform of America's ongoing "free" trade disaster, but he would be the first president in decades pushing in the right direction and no, he's not visibly setting us up for disaster.