The Rule of Law: China and the U.S.

The rule of law has been an essential and critical foundation of successful free market economies. It provides the certainty of property rights and contracts needed for entrepreneurs to risk their capital in business undertakings. But as our business and other activities cross borders, whose laws apply?

“Among the earliest examples of legal codes concerning maritime affairs is the Byzantine Lex Rhodia, promulgated between 600 and 800 C.E. to govern trade and navigation in the Mediterranean.” https://en.wikipedia.org/wiki/Law_of_the_sea  Leaping forward, international air travel, satellite communications, spectrum allocation for radio, TV, internet, and other telephonic transmission would be impossible without firm agreements among countries–the international rule of law.

Laws facilitate commerce–buying and selling–by establishing rules for doing so (e.g. contract enforcement rules) that are stable and applicable to all. They lower the costs and reduce the risks of trading. The United States Constitution recognizes the importance of this in the commerce clause of Article I Section 8, which is used to prevent individual states from taxing or otherwise interfering with interstate commerce. Achieving the same law-based freedom to trade across national borders is more difficult, requiring the negotiation of agreements and treaties that establish common rules between sovereign nations.

The World Trade Organization (WTO) develops and enforces the rule of law in the area of cross border trade. The difficulty of achieving global agreement on the rules of various aspects of trade is reflected in the fact that no new agreements have been reached since the establishment of the WTO (taking over the General Agreement of Trade and Tariffs) on January 1, 1995. “The WTO agreements cover goods, services and intellectual property. They spell out the principles of liberalization, and the permitted exceptions. They include individual countries’ commitments to lower customs tariffs and other trade barriers, and to open and keep open services markets. They set procedures for settling disputes.” the WTO – what is it?

China was admitted to the WTO as a developing country on December 11, 2001. Chinese officials immediately expressed the desire to understand and conform to the international rules required by the WTO and requested technical assistant from the IMF for doing so. In July of 2002, the IMF sent me to Beijing to review their needs with them.  They were particularly keen to have an American banking supervisor to advise them. I had a perfect candidate who was just finishing a two-year posting to Hong Kong. Everyone I spoke to in Beijing, as well as my Chinese colleagues at the IMF, stated that virtually all Chinese officials agreed on where China wanted to go–full liberalization according to WTO rules. They only differed with regard to how fast they thought they should move to get there.

Our condition was that our resident banking supervision advisor had to have his office located with the other Chinese banking supervisors and that he would have an open door. This was enthusiastically accepted by the Deputy Governor who apparently had not informed the Governor of these details. Unfortunately, when the Governor was presented the contract of his signature, he killed the arrangement. I was, however, able to enjoy wonderful tours of the Great Wall, the Forbidden City, and dine on the best Peking Duck I have ever had.  

An economically rising China is lifting millions of people out of poverty. We rightly welcome its newly productive economy contributing to increasing world output and living standards. The challenge is to square China’s authoritarian political regime with an international free market trading system. The vehicle has been the WTO and other international rule setting bodies that exist to harmonize diverse economies in the direction of freer and more open trade. The rules were being set by the dominant, largely free market economies that China wanted to join.

Beyond an American led WTO itself, the multilateral trade agreement that established the highest standards yet for tariff reduction and the incorporation of more modern trade issues such as non-trade barriers, services, protection of intellectual property, minimum labor standards, and dispute resolution (the rule of law cannot meaningfully exist without credible dispute resolution procedures) was the Trans-Pacific Partnership (TPP) negotiated between 2006 and 2015. The TPP agreement between Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, Vietnam, and the United States was announced on October 5, 2015.

Three days later, on October 8, I spoke in New York City at a seminar hosted by the Chinese Chamber of Commerce of New York on the internationalization of China’s currency, the renminbi. All of the talk by the Chinese attending was about the TPP. Why was China excluded? Could they join? My reply was that China would be very welcomed to join when they were able to meet the treaty’s conditions. TPP was another powerful magnet pulling China into the liberal international trading order.  

A recent report from the Peterson Institute of International Economics (June 23, 2020) stated that: “The Trans-Pacific Partnership (TPP) was designed in 2016 to be almost China-proof, with stringent obligations requiring transparency and trade liberalization. As former US Trade Representative Michael Froman put it, Chinese participation would be welcomed only when China could meet TPP’s terms, which it was far from doing. The United States was not keeping China out; China was just not ready to come in.” “China and Trans Pacific Partnership-in or out”

Broadly speaking, the aim of the WTO is to increasingly move its member countries toward the freest trade possible with fair competition (a level playing field), thus promoting a more productive allocation of economic resources and lifting global incomes.  The organization is not without its problems. But rather than working to strengthen the WTO, President Trump turned to negotiating bilateral trade agreements and raising rather than lowering import tariffs. Clearly bilateral agreements are easier to conclude than are global or broad multilateral agreements. Trump focused on China and its large bilateral trade surplus with the U.S. out of the mistaken belief that its surplus (our deficit) was harmful to the U.S. and that reducing it would increase American jobs. “Who pays Uncle Sam’s deficits”

In one of his most short-sighted actions from a sadly long list, President Trump withdrew the U.S. from the TPP on January 23, 2017. In addition to tweaking a few existing trade agreements, such as the North American Free Trade Agreement (NAFTA) by incorporated many of the newer provisions of the TPP and the United States-Japan Trade Agreement and the United States-Japan Digital Trade Agreement, and imposing protective tariffs on solar panels, washing machines, steel and aluminum imports in the name of national security and “America First,” the Trump administration has focused its trade war bilaterally on China (with occasional pot shots at our friends in Europe and elsewhere).  “Trade Office fact-sheets and-annual-report”   A Brookings Institution study assessed the result of all of this for the American economy and workers as follows: “American firms and consumers paid the vast majority of the cost of Trump’s tariffs. While tariffs benefited some workers in import-competing industries, they hurt workers in sectors that rely on imported inputs and those in exporting industries facing retaliation from trade partners. Trump’s tariffs did not help the U.S. negotiate better trade agreements or significantly improve national security.”  “Did-Trump’s-tariffs-benefit-American-workers-and-national-security”

The remaining eleven countries that had signed the TPP agreed in January 2018 on a revised treaty they renamed the Comprehensive and Progressive Agreement for Trans-Pacific Partnership” (CPTPP).  CPTPP is substantially the same as TPP, but omits 20 provisions that had been of particular interest to the U.S. These provisions can be relatively easily restored should the U.S. choose to rejoin. “Trade and Globalization”

With the increasing power of Xi Jinping, China’s President and the General Secretary/Chairman of the Central Committee of the Chinese Communist Party (now for life), China has played an increasingly active role in the IMF, WB, WTO and other international bodies. In addition, it has launched several regional organizations that it leads (the Asian Infrastructure Investment Bank, the New Development Bank–BRICS, and the Belt and Road Initiative) “The Asian Infrastructure Investment Bank and the SDR”  Xi Jinping claimed that the AIIB would adhere to the highest international standards. But as President Trump and others have noted, there are a number of important areas in which China does not abide by the WTO rules. The policy question is what should be done about it.

The Cato Institution began a recent review of China’s trade practices as follows: “There is a growing bipartisan sentiment in Washington that Chinese trade practices are a problem, since these practices are unfair to American companies in a number of ways. But there is disagreement about the appropriate response. Can multilateral institutions be of use here? Or is unilateralism the only way?” Their conclusion is that the WTO and other multilateral institutions would be the most effective way of continuing to pull China into compliance with the international rule-based system. “Disciplining China’s trade practices at the WTO-how -WTO complaints can help”

President Trump has unilaterally gone the other way. He has blocked Huawei, the world’s leading seller of 5G technology and smartphones, from U.S. 5G mobile phone systems and urged our European allies to do the same because of Huawei’s links with the Chinese government. He is attempting to block the sales of U.S. and other non-Chinese manufacturers of the semiconductor chips used in Huawei and other Chinese products to China.  “A-brewing-US-China-tech-cold-war-rattles-the-semiconductor-industry”  He is trying to ban TikTok, WeChat and other popular Chinese products from U.S. markets and raising tariffs on an increasing number of Chinese products imported into the U.S. Some of these measures might be justified on national security grounds but some seem more protectionist of U.S. companies that are not otherwise competitive.

We are basically forcing China to build its own alternative rules and approach to trade. It is even offering its own global tracking system in place of the GPS system the U.S. has given the world and they seem well along in dividing the World Wide Web and other Internet protocols into two worlds. https://www.voanews.com/east-asia-pacific/voa-news-china/chinas-rival-gps-navigation-carries-big-risks

A November 20, 2020 article by William Pesek highlights what Trump’s misguided trade war with China is producing: “On his presidential watch, Donald Trump did manage to make one thing great: economic cooperation within North Asia.

So chaotic and pernicious was the outgoing US president’s pivot away from Asia that China, Japan and South Korea are dropping the hatchet and joining hands. The unlikely union was formalized on November 15 with the signing of the 15-nation Regional Comprehensive Economic Partnership, or RCEP, free trade agreement.”  “US sidelined as China Korea and Japan unite”  The RCEP is a lighter more limited trade agreement than was the TPP (now the CPTPP) but it is led by China rather than the U.S.  Rather than converging to WTO standards it creates an alternative. 

“President Xi Jinping’s Friday [Nov 20, 2020] announcement of China’s intent to join the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP), a high-standard mega regional trade pact, has been seen as a bold move to reassure the world of the country’s continuing commitment to reform and opening-up.” “News analysis: an uphill task for China to negotiate CPTPP accession agreement”  While Xi Jinping’s strategy for China’s ascension is to take over the leadership in forging the rules for the international order more to the liking of his regime, China’s younger and upcoming managerial and entrepreneurial class, many of whom studied in the U.S. and Europe, have seen and liked the freer and more open capitalist societies. Their patriotism and commitment to a rising China is informed by the knowledge that freer and more open economies thrive more than centrally controlled ones.  We should not overlook their potential for returning China to a path of liberalization and integration with the liberal international order enjoyed by the rest of us.

Xi Jinping and his government’s goal is to retain power by delivering rapid economic growth, which allows and requires a vibrant private sector, while overseeing tight political control. One example is provided by its Social Credit System.  “China’s social credit system-mark of progress or threat to privacy?”  This requires a different set of rules for cross border trade than set out by the WTO. But many of China’s world traveling citizens see China’s successful rise in more closely embracing free market capitalism. We should incentivize the later view.

President Trump’s trade policies have damaged the world’s rule-based trading system and hurt the American economy while turning China in a different direction. President elect Biden has indicated his interest in rejoining the TPP. He should give it and the rebuilding of the WTO and other multilateral bodies high priority.

Is Huawei a Security Risk?

This question is quite beyond my technical competence to answer.  Even the experts disagree amongst themselves.  President Trump thinks it is too risky to use Huawei equipment and insists that Britain and our other allies not use Huawei equipment for building out their 5G telephone infrastructures. British Prime Minister Boris Johnson thinks its OK (plus it is available and cheaper than its potential future competitors) for many but not all uses.  President Trump, who likes to think he is protecting American jobs even though our economy is fully employed, was so angry at Johnson’s unwillingness to bow to his demands that he hung up on Johnson in their most recent phone conversation.  Johnson promptly cancelled his planned trip to the White House. Ukraine President, Volodymyr Zelensky, must be shaking his head in disbelief.

Trump has reason to be suspicious of foreign produced equipment following the recent disclosure that a CIA owned Swiss company, Crypto AG, sold encryption devises to 120 countries that enabled the U.S. and Germany to “easily break the codes that countries used to send encrypted messages.”  This went on for over 40 years allowing us to spy on our friends and foes alike. “National-security/cia-crypto-encryption-machines-espionage”

But these days security is much more sophisticated and wouldn’t allow such hardware to slip through undetected. On the other hand, the spying technology is more sophisticated too. Britain and other European countries are avoiding Huawei equipment for sensitive applications and using it for the rest. My point is not to join the debate over whether and where to use Huawei equipment but rather to argue that the more promising approach to convincing our friends of potential dangers (the more Adult approach, if I may) is to present our evidence and endeavor to convince them of our views. Trump’s approach, as in so many other areas, is to threaten and bully. “The-basis-of-American-world-leadership”

It is not easy to determine when trade restrictions reflect genuine security concerns and when they are just another manifestation of Trump’s protectionist, central planning direction of our resources.  He has imposed and threatened to impose tariffs with abandon, inflicting harm on our own economy as well as the tariffs’ targets. “Trumps-recent-trade-moves-show-adversarial-approach-has-only-just-begun”  “The United States has also threatened duties of up to 100% on French goods, from champagne to handbags, because of a digital services tax that Washington says harms U.S. tech companies.”  “Trump-threatens-big-tariffs-on-car-imports-from-EU”  This use of tariffs has nothing to do with trade and violates WTO rules, which Trump seems to pay little attention to in any event.

While this type of bully approach might work sometimes, it is unsustainable in the long run.  Needless to say, world confidence in the U.S. to do the right thing has plummeted. While for now other countries bow to and follow orders from the U.S., not out of respect but out of fear of retaliation, they follow a strategic waiting game. They know that Trump will not always be in power. And after he is gone, the U.S. will no longer have allies but adversaries ready to bare their claws for revenge.  https://www”9-charts-on-how-the-world-sees-Trump”

 

 

 

The Sources of Prosperity

I am an economist so I can’t help writing about the virtues of trade in the (futile?) hope that what is obvious to economists might be better understood and appreciated by the general public. https://wcoats.blog/2016/12/22/save-trade/https://wcoats.blog/2017/01/06/the-liberal-international-order/,   https://wcoats.blog/2018/03/03/econ-101-trade-in-very-simple-terms/, https://wcoats.blog/2017/01/06/the-liberal-international-order/, https://wcoats.blog/2019/02/09/tariff-abuse/

So please bear with me one more time. If you join with ten, or a hundred, or a thousand others to cooperatively produce things, you can jointly produce much more than ten times, or one hundred or one thousand times as much as you could all produce individually as one person factories. But that huge increase in productivity and output is not possible unless you can sell your joint output to others for the many other things you need and want to consume that they produce. In short, none of this is possible without trade. The wider the area over which we can trade the greater are the possible gains in productivity from the specialization of labor and capital that a larger market makes possible. The American constitution recognized this when it prohibited restraints on trade between the states (across state lines).  The ultimate limit in the size of the market is given by the world itself.

But markets—the “places” or the arrangements through which trade deals (purchase and sales agreements) occur—require trust that deals will be honored.  The rule of law, which protects private property and the enforcement of contracts, provides the certainty needed for a manufacturer or other service provider to invest in the productive capacity and facilities needed to generate the promised supply of products that is the foundation of our relative affluence. When trade extends beyond national boundaries the rule of law takes the form of international agreements to rules of the game.  Bilateral, multilateral and global trade agreements establish the rule of law within their domains.  The World Trade Organization (WTO) was created to oversee this process. The astonishing skyrocketing of the standard of living of the average (even the poorest) earthling rest on, i.e. would not have been possible without, trade.

The uneven but persistent history of trade has seen the protection of less efficient and uncompetitive firms and industries reduced over time via trade agreements that reciprocally reduced the taxation of imports (i.e. tariffs).  Starting with President Trump’s misguided withdrawal from the Trans Pacific Partnership (TPP) trade liberalization has been thrown into reverse. Trump vs Adam Smith  TPP modernized and further liberalized existing trade agreements between the U.S. and a number of Pacific countries.  The agreement was to be between 12 Asian Pacific countries until the U.S. withdrew.  It would have provided a strong magnet to further draw China into the global system of rules for increasingly free trade. It was ultimately signed by 11 countries without the U.S. and renamed the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). The US withdrawal from the agreement was a serious mistake.

The United States as well as much of the rest of the world is beginning to pay the costs of Trump’s trade wars. In January of this year Deutsche Bank estimated that Trump’s trade wars have cost the U.S. stock market $5 trillion in forgone returns so far. Costs of trade war  “Bloomberg economists Dan Hanson and Tom Orlik have… concluded: If tariffs expand to cover all U.S.-China trade, and markets slump in response, global GDP will take a $600 billion hit in 2021, the year of peak impact.” US China trade war-economic fallout  “The import tariffs proposed by President Trump could wipe out the income gains provided by the Republican tax cuts for low- and middle-income earners, Jim Tankersley of The New York Times reported Monday.”  ”Trump-Tariffs-Could-Wipe-Out-Tax-Cuts-Most-Americans”

Are Trump’s import taxes old fashioned protectionism (protecting relatively inefficient domestic industries from foreign competition), a legitimate response to national security concerns, or a reflection of Trump’s “famed” negotiating style?

Protectionism

For starters Trump’s steel and aluminum tariffs of 25% and 10% respectively (following his earlier imposition of tariffs on solar panels of 30% and washing machines of 50%) are clearly protectionist and reflect an alarming over reach of executive authority. Using the “authority” given the President under Section 232 of the Trade Expansion Act of 1962, U.S. Department of Commerce found that imports of steel and aluminum “threaten to impair the national security” of the United States.  Canadian Prime Minister Justin Trudeau called the claim that reliance on Canadian steel could be considered a national security risk “absurd”.  Trump removed these tariffs on Canada and Mexico last month, but they remain in effect on our other friends (e.g., EU) and enemies. On several occasions Trump has threatened to raise tariffs on car’s imported from Europe on the same phony national security grounds.

The patters of trade that minimize costs of production and maximize labor productivity can be complex. While protecting a few inefficient American steel producers and their related jobs might be good for those few firms, it is bad for American consumers and the economy at large. Workers in less productive protected industries are thus not available to work in more productive activities. Moreover, more jobs were lost than saved as the result of high prices and lost sales by steel importing manufactures.  One study estimated that these tariffs could result in the loss of 146,000 jobs.[1]

Peterson Institute for International Economics study estimated that American businesses and consumers paid more than $900,000 a year for each job that was created or saved as a result of the Trump administration’s tariffs on steel and aluminum. The cost for each job saved as a result of the administration’s tariffs on washing machines was $815,000.[2]

National Security

The distinction between legitimate security concerns and protectionism is not always obvious. Trump’s approach is often more protectionist and bargaining chips than concerns for security.  An early indication of this was the U.S.’s treatment of ZTE Corp, China’s second largest telecoms gear maker.  In April 2018 the U.S. band U.S. companies from selling their products to ZTE in connection with its violation on U.S. restrictions on trade with Iran, Sudan, North Korea, Syria and Cuba.  “That means no Qualcomm chips or Android software for its phones, and no American chips or other components for its cellular gear.” NYT The company was effectively shut down and heading for bankruptcy when in early June of 2018 Trump ordered these restrictions lifted to save Chinese jobs!!  According to the NYT: “The Trump administration is pressuring China to make trade concessions. It may also need Beijing’s help to strike a deal with North Korea as Washington and Pyongyang plan a high-profile meeting on June 12 in Singapore.  Mr. Trump appears to be using ZTE’s punishment as a bargaining chip in negotiations with China, rather than a matter of law enforcement.” What is ZTE–A Chinese Geopolitical Pawn

Trump’s more recent banishment of Huawei, a Chinese tech company leading the world in 5G development, from the American market and efforts to convinces our once British and EU friends to do the same provides another example. In some applications security concerns when dealing with a Chinese company may be justified, but these areas are limited and Huawei has gone to great lengths to allay those concerns. “Google has been arguing that by stopping it from dealing with Huawei, the US risks creating two kinds of Android operating system: the genuine version and a hybrid one. The hybrid one is likely to have more bugs in it than the Google one, and so could put Huawei phones more at risk of being hacked, not least by China.”  “Google warns of US national security risk of Huawei ban” FT June 6, 2019

The Trump administration has expressed its anger with the refusal of many other countries to follow its lead thus incurring a diplomatic cost as well as the economic one of restricting access to the best and/or most cost-effective products. The dangers and potential damage of using trade threats for other objections are clearly express by seven former US Ambassadors to Mexico in a joint letter published June 5: Ex US Mexico Ambassadors-Tariffs would destroy partnership we built

Moreover, the US’s exploitation of the importance of the dollar as a reserve and payment currency in forcing its political agenda on the rest of the world has incentivized the EU, Russian, China and others to look for alternatives. As another example of the growing risks of relying on American markets, Alibaba, China’s national champion internet giant whose share are currently only listed on the New York Stock Exchange, will raise its next round of capital on the Hong Kong exchange.

Bargaining

But some of Trump’s threats of tariffs no doubt reflect his approach to a trade negotiation. While it is not the usual approach to a trade negotiation, in which the parties should be looking for win-win reductions in tariffs and other impediments to freer trade, it could occasionally work to achieve greater concessions from the other side than otherwise. There is really little evidence that it has, however. The renegotiated NAFTA, given the new name United States-Mexico-Canada Agreement or USMCA, is no better than a normal review and updating of the existing NAFTA would have been expected to produce. It incorporates most of the updated provisions of the TPP, as was expected. But Trump started the NAFT review and update, by tearing up the old agreement and threatening to revert to the bad old days. Trump’s threated 5% tariff on imports from Mexico if it doesn’t do more to reduce or deal with the flow of refugees across the US Mexican border seems to be a counter example of a threat that worked.

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Donald J. Trump‏Verified account @realDonaldTrump

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On June 10th, the United States will impose a 5% Tariff on all goods coming into our Country from Mexico, until such time as illegal migrants coming through Mexico, and into our Country, STOP. The Tariff will gradually increase until the Illegal Immigration problem is remedied,..

4:30 PM – 30 May 2019

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What if Trump doesn’t back down as China matches each of Trump’s escalations with new tariff increases of their own? Such a true trade war was not a necessary approach to the negotiations and could be terribly detrimental to both economies as well as those of our trading partners. Some of China’s behavior should be challenged. Its theft of intellectual property, state aid to some of its companies, and restrictions on foreign companies operating in China violate the spirit of the competitive deployment of resources to their most productive uses. But these criticisms are shared by most other countries (UK, EU, Japan, Korea, India, etc.). The US should negotiate with China together with these allies. It should use and strengthen the mechanisms of the World Trade Organization rather than ignoring and weakening it.

Even if Trump does backdown, as he generally has in the past, considerable damage has already been done that could take years to undo. The development of the cost saving, productivity enhancing global supply chains took time and were built with confidence in the rules that would apply—the rule of law. These very much included the maximum taxes (tariffs) and other regulations that would apply. The trust in that framework of rules has now been badly damaged.

Supply chains are already being restructured to reduce the risks of US policy shifts. While new arrangements may avoid or reduce these risks, they do so at the cost of efficiency.  Refusing to buy Russian booster rockets or Chinese semiconductors because of concerns that the Chinese or Russian government might exploit their companies’ products militarily or to steal our trade secrets, forces us into more expensive and/or inferior products and thus keeps us and the world poorer than otherwise. We had better be sure that the costs are necessary.

[1]  Timmons, Heather (March 5, 2018). “Five US jobs will be lost for every new one created by Trump’s steel tariffs”Quartz (publication).

[2] Long, Heather (2019). “Trump’s steel tariffs cost U.S. consumers $900,000 for every job created, experts say”The Washington Post.

Have we been taken advantage of?

For as long as I can remember I have purchased food and household items from Safeway, Giant, and Whole Foods without any of them buying anything from me. Was I taken advantage of? Of course not. I voluntarily gave up part of my hard earned income in exchange for something I wanted more. I gained and was made better off by being able to make these trades just as they profited from providing them. In fact, I don’t know and I don’t care what those stores did with the money I paid them. Much of it, of course, was used to buy the goods they put on their shelves for me to buy.

These trades (my income for their goods) would only become a problem if I spent more at Safeway, Giant, and Whole Foods than I earned selling my labor. To do so I would need to borrow money from someone and go into debt. That might be OK temporarily, but obviously not on a permanent basis. In the long run, my purchases (imports) can’t exceed my income (export of my labor).

If you change my name to the United States and the names of Safeway, Giant, and Whole Foods to China, Japan and Germany (not necessarily in that order) nothing in this story changes fundamentally. Americans benefit from our purchases of Chinese goods and it doesn’t matter what they do with the money we paid to them (net of what they purchased from us—i.e., their trade surplus and our trade deficit). As I have explained in the following article, what they (all of them collectively) are largely doing with our money (our net global trade deficit) is finance our profligate government. https://nationalinterest.org/feature/who-pays-uncle-sams-deficits-26417

For some reason President Trump has trouble understanding these simple facts. He is upset by our trade deficit with China and Germany and others that his profligate, indebted government has caused. If the federal government balanced its budget (actually being at the top of the current business cycle it should be running a surplus in order to balance over the cycle), what would China and Germany do with their surplus of dollars? Rather than buying U.S. treasury securities, they might invest in the U.S. economy contributing to faster economic growth in the U.S. They might also choose to buy more goods and services from the U.S. thus reducing their dollar surpluses. In all likelihood they would do some of each. Given the resulting adjustments in their demand for dollars, the exchange rates of the dollar for Euros and RMB would adjust to produce the desired reduction in their surpluses.

Attacking China with tariffs and demanding a reduction in their trade surplus with the U.S. is counterproductive and wrong headed. But it does not follow that China is playing by the rules (WTO rules that we should be trying to strengthen rather than weaken). The EU, Japan, Canada, Mexico and others share this assessment and Trump would be much smarter to seek their cooperation in pressuring China to behave better rather than attacking them with tariffs and tariff threats as well. With the recent agreement with Jean-Claude Juncker, head of the European Commission, to deescalate the trade war with the EU and resume the negotiations over further trade liberalization started a few years ago (TTIP), perhaps Trump is changing tactics in a more promising direction. This should include concluding the updating of NAFTA and rejoining the TPP now the CPATPP.  We should all hope so.

Richard Rahn makes similar arguments in his Washington Times article today: https://www.washingtontimes.com/news/2018/jul/30/the-united-states-is-doing-better-than-it-did-duri/

Trump and interest rates

There seems to be no norm or conventional wisdom that President Trump is not willing to overturn. Following Fed Chairman Powell’s congressional testimony Tuesday in which he confirmed the Fed’s intention to continue its gradual increase in its policy interest rate, Trump said: “I don’t like all of this work that we’re putting into the economy and then I see rates going up.”  The statement is wrong on multiple accounts.

The economy is now fully employed and interest rates probably should have been returned to normal some time ago.  The alarming current and projected fiscal deficits of the federal government will force interest rates and trade deficits still higher.  This is Trump’s fault– not Powell’s.  “Who pays uncle Sam’s deficits?”  The major policies threatening to undermine the economic boost from tax and regulatory reforms are Trump’s trade policies (pulling out of the Trans Pacific Partnership, stalling and threatening U.S. withdrawal from NAFTA, Steel and Aluminum tariffs (taxes) on our friends in Canada, Mexico and the EU, and a deepening trade war with China).  Leaving the TPP  Resisting the interest rate increases needed to keep inflation at 2% would increase the most regressive tax around (inflation).

But Presidential interference in implementing monetary policy, as is now being undertaken by President Erdoğan in Turkey, violates a long established principle and practice of central bank independence.  Historically, inflation, which falls heaviest on the poor and undermines economic efficiency and growth, has resulted primarily from governments turning to their central banks for financing in misguided and ultimately futile efforts to keep interest rates (government borrowing costs) low.

President Trump can save the economic benefits of his tax and regulatory reforms by rejoining the TPP, rapidly concluding amendments to NAFTA that improve productive efficiency and fairness, dropping the steel and aluminum tariffs, ending the trade war with China, joining with the EU, Canada, Japan and others to bring China into compliance with the rules of a strengthened WTO, and establishing a fiscal budget surplus primarily through entitlement reform.

Econ 101: Trade deficits

Responding to critics of the administration’s proposed steel and aluminum tariffs, Commerce Secretary Wilbur Ross stated on CNBC: “I think this is scare tactics by the people who want the status quo, the people who have given away jobs in this country, who’ve left us with an enormous trade deficit and one that’s growing. [The trade deficit] grew again last year, and if we don’t do something, it will keep growing and keep destroying American jobs.” “Wilbur-Ross’s-star-rises-as-trump-imposes-tariffs”

Though the forces determining our trade deficits have many moving parts, it is not that complicated to explain why everything in the above statement is wrong. In this note I explain why:

  • Our trade deficits are caused more by U.S. government fiscal deficits than by the mercantilist export promotion policies of China, Japan, and Germany;
  • Mercantilist policies that subsidize exports and restrict imports don’t cost American jobs but rather reallocate workers and capital to less productive jobs that lower our standard of living; and
  • Challenging mercantilist policies using the tools and provisions of the WTO and other trade agreements better serves our long run interests than unilaterally imposing tariffs and inciting trade wars.

To understand the relationship between our fiscal deficit and trade balance, it is essential to understand the macro level relationship of our trade deficit to the other broad categories of our national income and expenditures. So take a deep breath as I explain the national income identities through which I will explore that relationship.

The economy’s total domestic output, known as Gross Domestic Product (GDP), can be broken into the broad components of our output/income that reflect how that income is spent. I understand how a little math can discourage some from reading further, but this is necessary and I hope you will indulge me. Starting with the components of expenditures:

GDP = C –M + I + G + X, or GDP = C + I + G + (X-M)

Where:
C = household consumption expenditures / personal consumption expenditures
I = gross private domestic investment
G = government consumption and gross investment expenditures
X = gross exports of goods and services
M = gross imports of goods and services

C-M is household consumption of domestically made goods and services, while M is household consumption of foreign made goods and services. If we subtract M from X (foreign expenditures on domestically made goods and services) we have the famous trade balance. When we buy more foreign goods and services than foreigners buy of our output, i.e., when X-M is negative, we have a trade deficit. As discussed further below, it is important to note that the trade balance (deficit or surplus) is between the U.S. and the rest of the world. Bilateral deficits or surpluses with individual countries are irrelevant.

But another way of breaking up total output (and thus income) is into how households allocate it:

GDP = C + T + S

Where:

T = household tax payments (personal and corporate income taxes plus sales taxes)

S = household saving

These two equations each provide definitions of the same quantity (GDP) and thus can be set equal to each other. This enables us to arrive at a useful formulation of the trade deficit:

C + I + G + (X-M) = C + T + S, or M-X = I-S + G-T;

The relationships in the identity can be described in several ways. Our fiscal deficit (G-T) must be financed by domestic net saving, i.e. a negative I-S, or by foreigners (M-X), i.e. a trade deficit or a mix of the two. Government finances its deficits by selling treasury securities domestically or abroad. If they are purchased domestically, residents must save more for that purpose or investors must borrow less from existing saving. If a fiscal deficit doesn’t crowd out private investment or increase private domestic saving (e.g., if I-S = 0) then it must be financed by foreigners who get the dollars with which to buy U.S. treasure securities by selling their goods and services to us in excess of what they buy from us, i.e., a trade deficit.

The above relationships are derived from definitions. They are tautologies. If the government’s spending exceeds its tax revenue it must borrow the difference from someone: a diversion of spending that would have financed investment (crowding out), a reduction in consumption (i.e., increase in saving), or an increase in the share of consumption spent abroad (increase in imports) giving foreigners the dollars they lend to the U.S. government. The interesting part—the underlying economics—is how markets bring about these results (usually a mix of all three).

When the government increases its need to borrow, other things equal, the increase in the supply of treasury securities relative to the existing demand for them increases the interest rate the government must pay. Higher interest rates generally encourage more saving and discourage investment. If we have no trade deficit (X-M = 0 so that G-T = S-T), the government’s deficit (G-T) must be financed by net saving (S-T). Depending on how much of the net saving comes from an increase in saving and how much from a decrease in investment, government deficits are bad for investment and economic growth in the long run (abstracting from countercyclical budget deficits and surpluses meant to offset cyclical swings in aggregate demand).

However, much of our fiscal deficits have been financed by foreigners (predominantly China and Germany) through their trade surpluses and our trade deficits. The market produces this result because the higher interest rates on U.S. treasury securities (and until now their perceived low risk of default) attracts foreign investors. The foreign demand for dollars in order to buy these treasury securities increases (appreciates) the exchange rate of the dollar for other currencies. An appreciated dollar makes American exports more expensive to foreigners and foreign imports cheaper for Americans. The resulting increase in imports and reduction in exports increases the trade deficit, which then finances our fiscal deficit.

As Alan Blinder put it: “Nations that invest more than they save must borrow the difference from abroad. Happily, the U.S. can do that because foreign countries have confidence in American securities. When we import more than we export, foreigners get IOUs in return for goods and services Americans want. That sounds more like winning than losing: We get German cars, French wines, and Chinese solar panels, while the Germans, French and Chinese get paper assets. America’s tremendous ability to export IOUs has been called our “exorbitant privilege.” Yes, privilege.” “This-is-exactly-how-trade-wars-begin”

If you have made it this far, you will be better able to understand the errors of Secretary Ross’s statement above: “if we don’t do something, it [the trade deficit] will keep growing and keep destroying American jobs.” If the United States government wants to reduce our trade deficit, it should reduce, rather than further increase, our fiscal deficit.

As noted above, however, our trade deficits reflect many moving parts. In the above example, foreigners want to increase their holdings of U.S. dollars (and dollar assets) in part because the dollar is a widely used international reserve asset. Our trade deficit is the primary way in which we supply our dollars to the rest of the world (and its central banks). However, what if our trading partners were manipulating their exchange rates in order to produce trade surpluses for themselves?

In the past, China followed such a mercantilist policy of promoting its exports over imports as part of its economic development strategy. In that case our trade deficit would result in foreign investments in the US with the net dollars accumulated abroad even without U.S. fiscal deficits. If they are not soaked up financing government debt they will be invested in private securities or other assets (such as Trump Hotels). Just to keep it complicated, these foreign investments would either add financing to increased domestic investment (if they lowered U.S. interest rates) or would buy existing American assets freeing up funds of the sellers to help finance government deficits or new investment. As I said, there are many moving parts, which adjust depending on prices (interest rates) and the public’s buying and investing propensities.

Tariffs don’t violate the above national income identities. Rather they potentially change the allocation of resources toward or away from traded goods. The Better Way tax reform proposals of Congressman Kevin Brady in 2016 included a so-called border adjustment tax, which taxed all imports equally and exempted all exports from the domestic expenditure tax. The tax on imports would have been, in effect, a tariff on all imports. Interestingly Brady’s border adjustment tax would not have affected our trade balance nor distorted resource allocation. The dollar’s exchange rate would have adjusted to nullify the impact of the tariff/tax on the prices we would pay domestically on imports.

Contrast this with the tariffs proposed by President Trump on steel and aluminum imports. These tariffs were meant to prop up inefficient American steel and aluminum firms by increasing the cost of their imported competition. As such it would reallocate our workers and capital to activities that are less productive than they would otherwise be used for (i.e., to the increased production of steel and aluminum). Once all of the adjustments were made we would be poorer, though still fully employed. “Econ-101-trade-in-very-simple-terms.”

It turns out, however, that Trump’s tariff threats were probably a negotiating ploy (He has temporarily exempted Canada and Mexico from the tariffs and is making deals with other suppliers in exchange for suspending the tariff). China is already paying special tariffs on these products to counter Chinese government subsidies and only sells the U.S. 2% of its steel imports. Thus the tariff is largely irrelevant for China. The net short-term affect of Trump’s ploy may well result in almost no tariff revenue and no protection for U.S. steel and aluminum producers and some improvements in other trade deals with our trading partners (or at least what the President considers improvements). In short, Trump’s tariff threat could turn out to be helpful. However, given Trump’s generally negative and/or ill-informed views on trade, this may be an overly generous interpretation.

As The Economist magazine put it: “If this were the extent of Mr. Trump’s protectionism, it would simply be an act of senseless self-harm. In fact, it is a potential disaster—both for America and for the world economy.” “Trumps-tariffs-steel-and-aluminum-could undermine-rules-based-system” Why? Even if the tariffs are waved sufficiently to avoid the retaliatory trade war Europe and others are threatening, Trump’s use of the national security justification for his steel and aluminum tariffs can’t be taken seriously. “That excuse is self-evidently spurious. Most of America’s imports of steel come from Canada, the European Union, Mexico and South Korea, America’s allies.” The Economist My long time friend Jim Roumasset noted that “Wilber Ross did indeed make such a finding [of a national security threat], but then declared that the tariffs are “no big deal.” In other words, the tariffs won’t improve national security. Unfortunately, there is neither check nor balance against the ignorance of commerce secretaries.”

The large expansion of international trade made possible by removing trade barriers, including lowering tariffs, has enormously benefited us (the U.S. and the rest of the world). In 1980 60% of the world’s population earned less than $2.00 a day (inflation and purchasing power parity adjusted). Because of economic growth, significantly spurred by expanding world trade, this number as plummeted to 13% by 2012 (latest figure available). This incredible feat was made possible by the collective agreements of virtually all of the world’s countries to increasingly lower tariffs and other trade barriers and to agree on global rules for fair competition. These trade rules were developed under the General Agreement on Trade and Tariffs (GATT) created after WWII as one of the three Bretton Woods institutions (the International Monetary Fund, the World Bank, and the GATT), which became the World Trade Organization (WTO) in 1995.

With its large and diverse membership of 164 rich and poor countries, the GATT/WTO has not been able to conclude new global trade agreements since 1995. Thus attention shifted to regional, multilateral agreements such as the 11 country Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) successor to the Trans-Pacific Partnership (TPP) from which Trump very foolishly withdrew the U.S. last year. “The-shriveling-of-U.S.-influence”

When China was admitted to the WTO in 2001 we expected that it would continue to liberalize and privatize its economy in accordance with the requirements of the WTO’s rules. The expectation was that China’s membership in the WTO would draw it into the liberal international rule based trading system.

In 2002, the IMF sent me to China to discuss these requirements in the banking sector with the Peoples Bank of China. We had high expectations. Unfortunately, China’s liberalization has gone into reverse in recent years. While not a trade issue, China’s recent launch of its centralized rating of the good behavior of its citizens, drawing on its extensive surveillance capacities, and its just announced intension to bar people with low “social credit” scores from airplanes and trains is certainly not an example of the more bottom up civil liberties, human rights views and approaches of most other countries. “China-to-bar-people-with-bad-social-credit-from-planes-trains.”

China’s behavior has been a disappointment. From its accession into the WTO, China began flooding the world with its “cheap” exports while continuing to restrict its imports from the rest of the world. The normal market reaction and adjustment to the inflow of dollars to China from its resulting trade surplus would be an appreciation of the Chinese currency (renminbi), which would increase the cost of China’s exports to the rest of the world (and lower the cost of its foreign import). However, China intervened in foreign currency markets to prevent its currency from appreciating and as a result China accumulated huge foreign exchange reserves (peaking at 4 trillion U.S. dollars in 2014). Not only did China intervene to prevent the nominal appreciation of its currency, but it also sterilized the domestic increase in its money supply that would normally result from the currency intervention, thus preventing the domestic inflation that would also have increased the cost of its exports to the rest of the world.

China’s currency manipulation was not seriously challenged at that time. Economic conditions in China have more recently changed and since 2014 market forces have tended to depreciate the renminbi, which China resisted by drawing down its large FX reserves (all the way to 3 trillion USD by the end of 2016—they have risen modestly since then). China is no longer a currency manipulator as part of an export promotion (mercantilist) policy.

But China does continue to violate other WTO rules with many state subsidies to export industries and limits and conditions for imports and foreign investment (such as requiring U.S. companies to share their patents as a condition for investing in or operating in China). A government subsidy of exports distorts resource allocation and thus lowers overall output in the same way but in the opposite direction as do tariffs. Both reduce the benefits and gains from trade and are to be resisted. The WTO exists to help remove such barriers and distortions in mutually agreed, rule based ways. A tariff that balances a state subsidy helps restore the efficient allocation of resources upon which maximum economic growth depends. These are allowed by WTO rules when it is established that a country’s exports violate WTO rules. President Trump is considering such targeted tariffs (his steel and aluminum are certainly not an example of this type of tariff) and hopefully they will conform to WTO requirements. “Trump-eyes-tariffs-on-up-to-60-billion-chinese-goods-tech-telecoms-apparel-targeted”

Trump’s bypass of WTO rules for his steel and aluminum tariffs, undermine the WTO and the international standards that have contributed so much to lifting the standard of living around the world. Despite its many weaknesses and shortcomings our interests are better serviced by strengthening the WTO rather than weakening it. “Trumps-tariffs-aren’t-killing-the-world-trade-organ”

“Whatever the WTO’s problems, it would be a tragedy to undermine it. If America pursues a mercantilist trade policy in defiance of the global trading system, other countries are bound to follow. That might not lead to an immediate collapse of the WTO, but it would gradually erode one of the foundations of the globalised economy. Everyone would suffer.” The Economist

As an aside, our bilateral trade deficits (e.g., with China) and surpluses (e.g., with Canada) are totally irrelevant and any policy designed to achieve trade balance country by country would damage the extent and efficiency of our international trade and thus lower our standard of living. See my earlier discussion of this issue in: “The-balance-of-trade”

“Even though trade policies are unlikely to change the long-run trade balance, they are not unimportant. Americans will be better off if the United States can use trade negotiations to open foreign markets for its exports, not because more exports will increase the US trade surplus, but rather because US incomes will be higher if more US workers can be employed in the most efficient US firms that pay high wages, and if those firms can sell more exports at higher prices. Similarly, US living standards will be higher if the United States reduces its trade barriers at home because this will give consumers access to cheaper imports and make the economy more efficient. Ultimately, therefore, the goal of US trade policies should not be focused on trade balances but instead on eliminating trade barriers at home and abroad.” This is quoted from the excellent and more detailed discussion of many of these issues that can be found here: “Five reasons why the focus on trade deficits is misleading”

There is another, very important negative byproduct of Trump’s transactional, confrontational, zero sum approach to getting better trade agreements. Mutually beneficial trade relations strengthen political and security relations and cooperation. These have been important non-economic benefits, for example, of NAFTA. Trump’s confrontational approach undermines these benefits. Pew Research Center surveys in 37 countries found that: “In the closing years of the Obama presidency, a median of 64% had a positive view of the U.S. Today, just 49% are favorably inclined toward America. Again, some of the steepest declines in U.S. image are found among long-standing allies.” Senator Ben Sasse delivered an exceptional speech on this subject followed by an outstanding panel discussion of the NAFTA negotiations at the Heritage Foundation. I urge you to watch the following video of that event: “The-national-security-implications-of withdrawing from-NAFTA”

Econ 101—Trade in very simple terms

Trade allows people and firms to specialize in what they produce. This enables them to be more productive. This raises the income (standard of living) of both the seller and the buyer (who must also sell something in order to buy something)—i.e. both the exporter and importer. https://wcoats.blog/2017/09/15/a-basic-human-right/  https://wcoats.blog/2016/12/22/save-trade/

So what does Trump’s steel and aluminum tariff do?

The American economy is now fully employed (ok, maybe some of those who left the labor market in recent years, not all of whom are old, can be coaxed to return). Thus if high tariffs on steel and aluminum make previously non competitive and inefficient American steel and aluminum producers competitive again, where will the workers come from to do that work? They must be attracted away from what ever they are producing now—lets call it good A. So we will produce less of good A, which was competitive without taxpayer subsidies or regulatory favoritism, in order to produce more steel and aluminum, which was not competitive before given tariff protection. Add it up and our overall income goes down. The economy over all will be less efficient, less productive, and our overall incomes and standard of living will be reduced.

This reallocation of our resources from more productive to less productive products will make owners of steel and aluminum companies and property owners around closed foundries happy. Trump-may-prosper-from-tariffs-even-if-this-faded-port-town-doesnt/2018/03/02/. But what about those who buy steel and aluminum made more expensive by the tariffs? What about Boeing and other aircraft manufacturers who are the fourth largest American exporters, whose products will now be more expensive and less competitive with Airbus, etc.? When steel tariffs were imposed in the year 2002, 200,000 Americans in steel using industries lost their jobs. That is more than the total of around 150,000 workers in the steel industry! “If-the-US-steel-industry-employs-150000-people-then-how-can-imports-threaten-500,000-jobs?”

Subsidizing inefficient industries with tariffs hurts consumers, who will have to pay the higher prices of aluminum beer cans, etc., as well as exporters like Boeing. We will all (except steel and aluminum producers) pay the cost of this increased inefficiency. Commerce secretary Wilbur Ross thinks we should just get over these modest increases in the costs of our purchase of goods that include steel and aluminum for the greater good of American steel and aluminum producers and the 150,000 people who work for them. In case there are children listening I am withholding what I would like to say to Mr. Ross.

Only 2.2% of our steel and aluminum imports come from China while Canada (hardly a security threat to the U.S.) provides 16.1% of our imports of these products: https://www.washingtonpost.com/world/the_americas/canada-top-exporter-of-steel-and-aluminum-to-us-flabbergasted-by-trumps-tariff-proposals/2018/03/02/7c906c2a-1e22-11e8-98f5-ceecfa8741b6_story.html?undefined=&utm_term=.294884487749&wpisrc=nl_headlines&wpmm=1. The rest of the world will not roll over and play dead. The EU is already preparing counter measures to punish American exporters to Europe. “EU-vows-to-hit-back-against-trump-in-trade-war”

Following the end of WWII the world, lead by the U.S., has built up mechanisms for promoting fair trade (first the General Agreement on Trade and Tariffs—GATT—now called the World Trade Organization—WTO). Where countries violate these rules, and China frequently does, they should be addressed via the WTO. American interests, and the world’s interests more generally, are served by strengthening the WTO not weakening it. Trump’s unilateral tariffs do not serve our interests. Not only has he persistently undermined free markets with his misplaced attack on bilateral trade deficits https://wcoats.blog/2017/07/23/the-balance-of-trade/ but he has systematically undermined the WTO and the international rule of law. Please, Mr. President, stop this nonsense before it gets even worse.

Trade wars are never good, and no one wins in the end. Instead we should be enforcing and improving the rules of trade via the WTO, which has helped left millions of people out of poverty and raised the standard of living of the average person.

 

Trump’s Foreign Policy and Mexico

“From this day forward, it’s going to be only America First. America first!” Video of Trump’s inaugural address. Or was it “Trump First?”

If President Trump’s plea for others, such as Mexico, to treat the U.S. fairly were merely an embarrassing gesture, we might overlook it having grown used to Trump’s need for approval. But this is the status and fate of my country at stake. In a hysterical satire made by Dutch television, they ask whether if America is First, they might be second: Dutch youtube satire

There is little disagreement that American foreign policy should serve America’s interests. Even the neocons see the promotion of democracy as ultimately good for America, if we can survive the wars they want us to fight to impose it on the rest of the world. We have and should continue to see our interests in long-run terms—enlightened self interest. As he has shortsightedly done with trade, “Trump outlined a world in which foreign relations are collapsed into a zero-sum game. They gain, we lose.” Charles Krauthammer on Trump’s foreign policy revolution /2017/01/26/.

The real issue is which policies actually serve our interests. These policies should keep us safe and prosperous.

Military: Obviously we need a military capability sufficient to protect our shores from attack, but we need to avoid devoting more of our resources to our military than necessary for that purpose (with a reasonable margin for error) because every dollar spent on the military is a dollar taken away from building our economic strength, which is equally important for our defense and well being.

Diplomacy: We also need to invest in building good relations with other countries, especially our immediate neighbors, in part to minimize the prospect of ever needing to use our military. Thus we must devote the resources, including training, needed by our State Department to build our effective soft power. In an article in Time magazine January 26, 2017, Mikhail Gorbachev, the last president of the Soviet Union said:   “No problem is more urgent today than the militarization of politics and the new arms race. Stopping and reversing this ruinous race must be our top priority.” Gorbachev on Putin – Trump

Treaties: But here is the part least appreciated by the American public and least understood by Trump (I don’t know about the rest of his team yet and eagerly await his appointment to the Undersecretary of State position). Just as the rule of law has been critical to development and vitality of our economy and the protection of our liberties at home, it remains as important when we cross the border. This extends far beyond the critically important agreements on trade, the international monetary system, and the rules of war, to the more mundane aspects of every day life as well.

According to The Washington Post: “Trump proposes internal high-level committees to examine multilateral treaties, with a view toward leaving them….

“John B. Bellinger III, who served as legal counsel to both the National Security Council and the State Department in the George W. Bush administration, said the treaty examination was based on a ‘false premise . . . that the United States has become party to numerous multi­lateral treaties that are not in the United States’ interest.’

“’There are “many hundreds of multi­lateral treaties that help Americans every day in concrete ways,’ he said. Without them, ‘Americans could not have our letters delivered in foreign countries; could not fly over foreign countries or drive on foreign roads using our state driver’s licenses; could not have access to a foreign consular official if we are arrested abroad; could not have our children returned if abducted by a parent; and could not prevent foreign ships from polluting our waters.’” Trump-lays-groundwork-to-change-US-role-in-the-world/2017/01/26/

The Bretton Woods institutions created after World War II (the International Monetary Fund, World Bank, and World Trade Organization) established the institutional arrangements for cooperation in developing the rules of international trade and finance. American leadership in creating the international institutions through which we interact with others abroad, i.e., through which the rule of law is established and enforced internationally, has ensured that the international order has remained true to the liberal values on which America was founded. We would be wise to keep China as strong and active a member of these institutions and the rules they oversee as possible. US global leadership and the AIIB. It would be tragically misguided to undermine these institutions and our leadership of them. But this is the direction President Trump seems to be headed.

Mexico: Close to home, Mexico provides a tragic example of Trump’s failing approach to foreign policy. Our relationship with Mexico is one of our most important in the world. We share a 2,000 mile border with Mexico and it is our second largest export market earning $235 billion in 2016 while importing $296 billion worth of goods and services. The difference of $61 billion, the so-called trade deficit, reflects net Mexican investments in the U.S. Though Mexicans have been leaving the U.S. on net for the last few years, illegal immigration across our shared border has been a big campaign issue for Trump, and the Mexican border is the gateway for many non-Mexican Central American illegal immigrants. The flow of drugs across that border is also an issue.

Close cooperation with Mexico in dealing with these issues has been a critical aspect of managing them. The North American Free Trade Agreement (NAFTA) has been an enormous benefit. Former Mexican President Carlos Salinas told G.H.W. Bush that “goods bought by American consumers will be produced by Mexican workers, it is only a question of where those Mexican workers live!” He also indicated that in addition to jobs that keep Mexicans in Mexico, NAFTA also helped bring the rule of law to Mexico. Jerry Jordon

Illegal immigration reflects and responds to the incentives faced by potential immigrants. These include the quality of life, including jobs, in their home country, the demand for workers in the U.S., and the option of legal immigration. The problem of illegal immigration to the U.S. would be helped by a better legal immigration law, such as proposed by George W Bush in 2007 or later as contained in the Senate law drafted by the Gang of Eight in 2013. Better enforcement of work permit requirements with American employers could help a great deal.

President Trump’s approach has been grossly adversarial rather than cooperative. He has threatened to tear up (or at least renegotiate) NAFTA and build a wall on the U.S. –Mexican border that he would force Mexico to pay for. His approach is disastrously wrong. “President Trump’s Homeland Security secretary, John F. Kelly, has been clear about his views on a border wall with Mexico: It won’t work.” Homeland Security John Kelly on border wall – NYT. Mexican billionaire Carlos Slim stated that: “The best wall is investment, which generates employment in Mexico…. Mexico is the best partner the U.S. has.” Mexico digs in and Trump lashes back as border wall standoff deepens /2017/01/27/

The Mayor of Berlin Michael Mueller urged US President Donald Trump “not to go down the road of isolation.” He warned that such division causes “slavery and pain” and would “destroy the lives of millions.” BBC 1/27/2017. This doesn’t seem fully applicable to the Mexican wall, but still the Berliners know a lot about walls. John Oliver provides a hilarious but informative commentary on The Wall on Last Week Tonight. John Oliver video on The Wall

President Trump’s continued insistence on building the wall and his insulting claim that Mexico will pay for it has damaged the cooperative relationship that we badly need to maintain with Mexico. Trump’s tweet that Mexico should pay for the wall or Mexican President Enrique Peña Nieto should cancel his planned visit to Washington and stay home is an insult beneath the dignity of an American President as well as stupid. That President Trump is surely ignorant of these and other seriously damaging knock on effects of his mishandling of our relations with Mexico is no excuse for his insane behavior. Trump’s ruinous stance on Mexico-deportation-border-wall-tariff-trade.

“For 70 years, we sustained an international system of open commerce and democratic alliances that has enabled America and the West to grow and thrive. Global leadership is what made America great. We abandon it at our peril.” [Krauthammer]

The Liberal International Order

A monopolist enjoys a bigger profit than would a competitive supplier of the same items by restricting the supply in order to charge a higher price. This assumes that he can increase the price by more than the reduction in his sales, but I will skip these economic details in order to get to my point.

Monopoly is good for the producer and bad for the consumer. Monopoly is generally impossible without help from government to restrict competition. The United States has flourished economically, in part, because we have chosen the competitive model—the level playing field of commerce—as the social and economic model we aim for domestically and promote internationally. Many other nations have also embraced this model and our leadership in promoting it. We extend and promote the rule of law on which a level playing field is built through the Bretton Woods Institutions created after World War II (the IMF, World Bank and World Trade Organization) and other international bodies and agreements. Our leadership in promoting these values is now in jeopardy for a variety of reasons that include our aggressive use (and misuse) of our military power and our unilateralism.

Chas Freedman is the most articulate champion I know of, of the wise use of American diplomacy to promote the above and other values that have characterized our country’s governance. Chas was Nixon’s interpreter during the President’s first trip to China in 1972. His three decades as a U.S. diplomat included Ambassadorship to Saudi Arabia during Operations Desert Shield and Desert Storm and a term as Assistant Secretary of Defense for International Security Affairs. The following challenge to the United States is taken from his latest book American’s Continuing Misadventures in the Middle East and was contained in his August 29, 2012 address to the American Foreign Service Association’s Adair Memorial Lecture at the American University School of International Service, Washington D. C. He enumerates the conditions for our continued (or restored) leadership of the liberal international order that has served us and the world so well. Chas concentrates more wisdom into fewer words than anyone I know:

“Americans believe that societies that respect the rule of law and rely upon democratic debate to make decisions are more prosperous, successful, and stable than those that do not. Recent efforts to impose our freedoms on others by force have reminded us that they can be spread only by our setting an example that others see as worthy of emulation. Freedom cannot be sustained if we ourselves violate its principles. This means that we must respect the right of others to make their own choices as long as these do not harm us. It also presupposes a contest of ideas. Our ideas will not prosper unless we maintain solidarity with others who value and also practice them.

“That is why a first priority of American diplomacy must now be to re-forge the unity of the Atlantic community behind the concept of the rule of law. This cannot be done unless we confront and correct our own lapses from the great traditions of our republic. To re-empower our diplomacy by inspiring others to look to our leadership, we much restore our respect for our Bill of Rights as well as our deference to the dignity of the individual both at home and abroad. Let me be specific.

“We must revive the Fourth Amendment’s ban of search and seizures of persons, houses, papers, and other personal effects without probable cause. No more ‘extraordinary rendition.’ No more universal electronic eavesdropping, warrantless seizure of paper and electronic records at the border, and intrusive inspection of anything and everything in the possession of passengers using public transportation.

“We must reinstate the Fifth Amendment’s protections against deprivation ‘of life, liberty, or property, without due process of law.’ No more suspension of habeas corpus or executive branch assertions of a right to detain or even kill people, including American citizens, without charge or trail.

“We must return to respect for the Sixth Amendment’s guarantee of the right of anyone accused of a crime to be informed of the charges and confronted with the witnesses against him and to be represented by a lawyer. No more ‘secret evidence.’

“We must reinstate the Eighth Amendment’s prohibition of ‘cruel and unusual punishments,’ including torture, and we must reaffirm our adherence to the several Geneva Conventions. We Americans can have no credibility as advocates for human rights if we do not practice what we preach.

“In short, the path to renewed effectiveness in American diplomacy lies not just in wise and dexterous statecraft and the professionalization of those who implement it abroad. It rests on the rebuilding of credibility through the rediscovery of the values that made our country great.”

My Political Platform for the Nation – 2017

For me, the ideal American government would deliver its important but limited functions efficiently and effectively and would raise the money to pay for these activities with efficient, minimally distorting (neutral), and fair taxes following a principle of maximum subsidiarity (decisions made and services performed at the most local levels possible). The government should do fewer things than it does now but should do them better and should fully pay for them with taxes and fees (cyclically balanced budgets).

My unrestrained, radical platform will be presented here at a high level of general principles. Details need to be refined by a political process involving public discussion and are likely to evolve somewhat over time. Links to earlier articles provide additional details. In the very broadest terms Americans should be self reliant and free to work and play as hard as they choose with the government supporting their choices by providing security, the legal foundation and framework of private property and contracts, and an efficient safety net when individual undertakings are not feasible or fail.

The limited functions of the Federal government are enumerated in Article 1 section 8 of the U.S. Constitution. Broadly these are to:

  1. Develop and maintain our relations with other countries and international bodies and to maintain an Army, Navy and Air Force for the purposes of defending and promoting the security of the United States;
  2. Establish and enforce the rights to property and contracts and to adjudicate related disputes;
  3. Provide for public safety;
  4. Provide an efficient and effective social safety net (welfare);
  5. “Regulate commerce with foreign Nations, and among the several States;”
  6. “Coin money, regulate the value thereof, and of foreign coin, and fix the Standard of Weights and Measures;”
  7. Arrange for the provision of roads and essential infrastructure; and
  8. Tax, borrow, and levy fees and tariffs to pay for these activities.

Our Social Contract

Sovereignty resides with each individual, who have collectively ceded limited powers to government for the general welfare. Each of us is free, within legal limits on doing harm to others, to lead our own lives and build or work at whatever we choose. Thus the government’s laws apply equally to each of us without regard to our race, religion, sex, or sexual orientation. From this environment of freedom and innovation, America has built the most successful economy in the world.

When building companies or developing products, many will fail and try again. The government provides the legal framework (bankruptcy) for resolving such failures. The implicit agreement between citizens and their government is that government will provide a floor—a safety net—whenever a person’s efforts fail or when, e.g., for health reasons, a person is unable to provide for him or herself. The level of the safety net should reflect the level of the country’s income and social consensus and should be designed to achieve its objective as efficiently as possible with careful consideration of the incentives it creates.

Income redistribution: taxation and a guaranteed minimum income

All income (personal and corporate) taxes should be replaced with a comprehensive, flat, consumption tax (Value Added Tax—VAT) and limited progressivity introduced by paying every legal man, woman and child resident a guaranteed minimum income. US federal tax policy, Cayman Financial Review July 2009 Each recipient of these monthly guaranteed income payments would be required to set aside a minimum amount for health insurance (chosen by each person or family in the competitive market place) and a minimum amount for retirement (invested in qualifying retirement funds in the competitive market place). Saving social security

As the guaranteed minimum income should be at a level sufficient to minimally support life’s basic needs, supplements such as unemployment or disability insurance would not be needed or provided. However, disabilities acquired from military or public safety service should receive additional income support.

Health care

Each person will be responsible for paying for at least part of routine medical care (the copay required by the insurance they have chosen) and will thus care about its cost. The cheapest insurance policies will be limited to major medical expenses (catastrophic health insurance). As everyone will be required to contribute monthly to a health savings account from their guaranteed minimum income, most people will chose to use such funds to buy health insurance, which would not be tied to employment or an employer.

Doctors and hospitals will be required to make medical service costs transparent. On that basis, patients, in consultation with their doctors, will decide the level of care and treatments to receive. These measures will introduce normal market competition into the provision of medical care that is currently absent, which will improve its quality and lower its cost.

Education

Equal access to quality education is a critical element in maximizing opportunity for all and the wealth of our society and each person in it. The public school system has often failed in this objective. While the wealthy can afford to put their children in private schools when the neighborhood school is of poor quality, lower income families generally cannot. Every K-12 aged child will receive a tuition voucher that covers the cost of state provided education. The amount will generally vary from state to state (or school district to school district). The voucher can be used to attend the local neighborhood public school with no additional cost, or any private school the family chooses, which might incur additional costs. Schools eligible to receive such vouchers must meet minimum education standards set by the state and must disclose the performance of their students on state administered achievement tests. This information must be available to the public. The learning progress of each child is more important than the average level of achievement of each school’s students as some schools might well specialize in slow or problem learners and performance data should reflect this distinction. The neighborhood school has the advantage of being easier to get to every day and will normally be chosen by families if it provides a good education. The argument for universal tuition vouchers goes beyond providing a level playing field to all. It also introduces the competition for students that is the basis for good quality, low cost goods and services in every other area of our economy.

Access to higher education raises different issues. Those with the aptitude and desire for a college or postgraduate degree can significantly increase their lifetime incomes as a result. It would hardly be fair to tax the general public to subsidize the higher education of those who will become wealthier as a result. However, the tuition loans that may be needed by those from lower income families to make this investment would be hard to get without insurance against default. Many states also provide community (or Jr.) colleges at public expense that provide training in various trade skills as well as four year college preparatory courses. These seem to have often been successful in leveling the playing field. The optimal structuring of higher education subsidies (e.g. between insurance guarantees and tuition subsidies) needs further examination.

Monetary and Financial Policies

Government policies that affect business should be as rule based and transparent as possible. Monetary policy stands out as a particularly important area in which clearer rules are needed. A currency with stable real value (purchasing power) is an important part of the foundation of efficient free markets. At the very minimum the Federal Reserve’s mandate should be tightened as provided in the very pragmatic Federal Reserve Accountability and Transparency Act of 2014. This act would require the Fed to chose an operational rule, from which it could depart only with an explanation to Congress of its reasons. A deeper review of options is proposed by the Centennial Monetary Commission Act of 2015. I have proposed a more radical reform in the spirit of the gold standard but with tighter rules and an anchor of a large number of goods rather than just gold. The supply of this currency, which ideally would become the global currency, would be regulated by the market using currency board rules and “indirect redeemability.” A hard anchor for the dollar.

The banking and financial sector are currently smothered with detailed regulations the compliance cost of which are driving smaller banks out of business. Under the Dodd Frank law adopted after the financial crisis of 2008, the largest five American banks have grown even larger (in absolute terms and as a share of the banking sector) than they were in 2008. Regulators, despite (or because of) their detailed banking regulations have failed to make banks safer and have slowed the competitive process of producing better and cheaper services. Bank owners and market preferences should regulate risk taking by banks.

Bank regulation by the government should focus on broad principles with strong owner accountability. Bank capital requirements should be raised and the no bail out rules strengthened. Bank owners and investors should absorb any bank losses. The payment services of banks should be isolated from the rest of its lending and investing business by adopting the Chicago Plan of one hundred percent reserve requirements against current account deposits, and virtually all other regulations (other than accounting and reporting standards) should be dropped. Larger banks will develop their own risk weighted capital requirements for their internal use, but the government’s capital requirements should state the minimum required leverage ratio (ratio of core capital to total assets) and set it at a high level. Changing direction on bank regulation, Cayman Financial Review April 2015. A bill now in congress moves in this direction: The Financial Choice Act

Business activities and regulation

The government should only provide services that that private sector can’t. It should provide the legal and regulatory framework for the private economy rather than compete with it. Though the approaches to providing “public goods” such as police, courts, prisons, firemen, parks, highways, airports, etc. have varied over time, they are almost always paid for by the government (i.e. collectively by tax payers) and should be provided efficiently at the level expected by the public. Publicly funded and privately produced goods and services are often sources of hard or soft corruption. Rather than over charging for services or paying bribes to win contracts (hard corruption), soft corruption exploits influence on government to obtain contract terms or regulations favorable to particular firms (“rent seeking”). The government’s purchases of goods and services from the private sector should be governed by transparent rules that promote competition among suppliers. This is easier said than done. Open the Books

While the government is involved in and trying to do far too many things, it doesn’t do many of them very well. Of those services the government needs to provide, states generally perform better than the federal government though performance varies across states. In Maryland, where I live, I was able to register my Limited Liability Company on line in about 30 minutes start to finish. Registering my car and updating my driver’s license is quick and easy. However, it took me months to obtain a statement of my residency from the U.S. Treasury and a personal trip to the State Department to have it certified to provide to the National Bank of Kazakhstan before they could pay me for my services. Getting a passport or green card is more complicated and takes longer than they should. The government should do much less and do it much better.

Those in the government who believe they can judge better than competitive private markets how best to allocate resources (what to invest in and produce) are generally wrong. Moreover, they establish an opportunity and thus incentive for corruption.

The government’s regulation of private businesses in the interest of public safety, environmental protection, and market competition should be limited and subject to very serious cost/benefit tests. Cost/benefit analysis unavoidably reflects subjective judgments but their role should be limited to the extent possible by full transparency of the basis of any assessment. Competitive capitalism vs. the other kinds.

Foreign policy and national security

The purpose of our foreign policy is to serve American security interests and the international rule of law under which American’s can explore the world and American businesses can compete globally on a level playing field. Our security requires a strong military, but it also requires the skillful use of diplomacy. Our military must be structured for defense, not offensive wars of our choosing. Our 2003 war in Iraq and subsequent developments in the Middle East have cost many lives (some American) and treasure, undermined our moral authority, and seriously damaged our security. Our foreign policy should be one of “restraint.”

Our relations with other countries should be based on shared interests consistent with our respect for individual dignity and the rule of law. We should support and, where appropriate, lead international bodies dedicated to developing, promoting, and overseeing compliance with the rule of law internationally. Our international leadership should rest, in addition to our economic and military strength, on our commitment to broadly shared values and standards of behavior. Just as we give up limited amounts of our individual sovereignty to our own government when it serves our individual and collective interests, so should we give up limited amounts of our national sovereignty to international bodies when it serves our national and international interests.

Our economic strength depends in part on providing for a sufficiently strong military in the most economical way possible. Money spent on tanks can be spent on building other businesses and producing goods that we enjoy. The very nature of the relationship between our military and the industries that supply it, what President Eisenhower called “the military industrial complex,” makes achieving this objective very difficult. As argued above, clear rules and transparency are important tools. Our unsupportable empire

Trade

Next to the right to personal property, nothing is as central to our liberty and well being as the right to trade. It is the basis of virtually all of our enormous increase in productivity and thus our standard of living. The government impedes our right to trade with a wide range of often unnecessary or excessive regulations. Restricting our freedom to trade across national borders is also a mistake that reduces our standard of living from its potential.

Trade has destroyed some jobs while creating others. “Since 1900, the portion of the U.S. workforce in agriculture has declined from 41 percent to less than 2 percent. Output per remaining farmer and per acre has soared since millions of agricultural workers made the modernization trek from farms to more productive employment in city factories…. Manufacturing’s postwar share of the labor force peaked at about 30 percent” in 1953 and has since declined to less than 9 percent while manufacturing output continued to climb. “Of the 5.6 million manufacturing jobs lost between 2000 and 2010, trade accounted for 13 percent of job losses and productivity improvements accounted for more than 85 percent.” George Will, Washington Post.

As with domestic, competitive trade, those out-performed in competitive markets suffer, at least temporarily. The safety net for “losers” in the competitive process discussed above is an important feature in our willingness to unleash the benefits of free trade. We must insure that they are adequate. We should support the World Trade Organization (WTO) as well as regional and bilateral agreements that reduce the barriers to trade and promote freer trade. Save trade. Globalization and nationalism-good and/or bad?. Trade and globalization

Conclusion

Our government should assume that each of us is capable of and has the right to make our own decisions and lead our own lives as we see fit. Its role is to protect those rights, in part by protecting us from others, foreign and domestic, who would violate them. We are, however, part of and best flourish within broader communities. Our government should develop legal frameworks to facilitate our interactions and relationships within and across societies both business and personal. Our successful flourishing will also depend greatly on a shared culture of mutual respect and comity.