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Tariffs, Trade Deficits & Under-Employment

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Yesterday I did a twitter thread on the President’s use of tariffs and then dove a bit further into trade balances and under-employment.

I am not in favor of tariffs as an economic policy. But I am in favor of the manner in which President Trump is currently using them.

I wrote this thread fully expecting to receive a significant amount of backlash.

To my surprise, the response was large and overwhelmingly positive. Almost exclusively so.

Yesterday, President Trump sent out this tweet on tariffs:

The President’s tweet generated a fair amount of response including this article from David Harsanyi at the Federalist, who makes what I view as the classical argument against tariffs.

As I noted, I’m not in favor of tariffs as an economic policy. I believe in free trade.

But free trade is something we have not had for a very long time. If ever.

Multi-lateral trade agreements like NAFTA, by their very definition, are not free trade. They are multi-party trade agreements.

A pure free trade agreement is politically hard to come by in the real world. Issues of corporate tax rates, governmental regulations, etc. intrude their way into practical application.

If we must enter into trade agreements, let’s do so directly, on a bi-lateral negotiated basis.

The important thing to note about President Trump’s policy is that tariffs are not the actual goal. They are simply a means to an end.

The ultimate goal of his plan is no tariffs at all.

President Trump is looking at short-term, tactical use of targeted tariffs – but not for the sake of having tariffs. He is looking to use them as a bargaining chip leading to a more balanced playing field and increased domestic production.

From President Trump’s February 13, 2018 opening comments:

I look at it two ways: I want to keep prices down, but I also want to make sure that we have a steel industry and aluminum industry.

You may have a higher price or maybe a little bit higher, but you’re going to have jobs.

In the other case, you may have a lower price, but you’re not going have jobs; it’s going to be made in China and other places.

But, to me, jobs are very important.

Here’s the giveaway:

Ultimately, what’s going to happen – either we’ll collect the same that they’re collecting, or they’ll end up not charging a tax and we won’t have a tax.

And that becomes free trade.

The other day, I wrote of a great interview with President Trump. It’s worth your time:

President Trump – A Great CNBC Interview

Some comments:

We are being taken advantage of and I don’t like it. And I haven’t liked it for many years.

China, $507 billion a year in deficits.

With the EU $151 billion.

With Mexico, $120 billion.

I could go through every country. I could talk about Japan – they’re very good allies, but no wonder they’re good.

Here is where President Trump shows his understanding:

PRESIDENT TRUMP: I would have a higher stock market right now, it’s already up almost 40%, as you know, since the election. It could be 80% if I didn’t want to do this.

But ultimately, what I’m doing is making it so it’s right.

KERNEN: In the context of the stock market…does that go into your thinking in terms of if we’re ever going to address some of these…

PRESIDENT TRUMP: This is the time.

President Trump understands that tariffs aren’t good as a standing trade policy.

But in our unique case – an economic destination market – they can be effective as a short-term club.

I will note one minor disagreement. President Trump tends to speak of trade deficits and surpluses as profit/loss columns, which is technically incorrect.

This basic economic formula may help.

GDP = Private Consumption Spending + Investments + Government Spending + (Exports – Imports)

An examination of the formula should make clear that GDP increases when Exports rise and/or Imports fall.

Said another way, reducing our trade deficit increases GDP. As we shall see shortly, it also decreases foreign investment.

The Balance of Trade – or Trade Balance – is simply the value of Exports minus the value of Imports.

A Trade Surplus means the Value of Exports exceeds the Value of Imports.

A Trade Deficit means the Value of Imports exceeds the Value of Exports.

Let’s use a simplistic example (intentionally leaving aside currency rates).

Country A exports chips and imports beer. Country B exports beer and imports chips. Countries A & B trade only with each other.

The price of chips is $2 and the price of beer is $3.

Country A exports 4 bags of chips and imports 3 bottles of beer. Country B exports 3 bottles of beer and imports 4 bags of chips.

The trade balance for Country A = Price of Chips * Bags of Chips – Price of Beer * Bottles of Beer:

TB = ($2 * 4) – ($3 * 3)

TB = $8 – $9

Trade Balance = -$1

Country A is running a Trade Deficit of $1. Conversely, Country B is running a Trade Surplus of $1 (Price of Beer * Bottles of Beer – Price of Chips * Bags of Chips).

Notably, the sum of Country A’s Trade Surplus and Country B’s Trade Deficit = $0.

Assume Country A is the United States and Country B is China.

China will be lending $1 to the United States in the scenario above.

The U.S. receives $9 worth of beer – plus $8 dollars worth of yuan for the chips sold to China.

China receives $8 worth of chips – plus $9 for the beer sold to the U.S.

The U.S. can trade its $8 in yuan for $8 of the $9 dollars China is holding from their transaction.

The remaining $1 in China’s possession is now a debt of the United States. China has a $1 promise of future goods or services from the United States.

Assume this trade pattern is repeated – again and again. Soon China has accumulated a large number of dollars – $1 for each transaction.

China will be forced to put these accumulated dollars to work by buying U.S. Treasury Bonds and/or U.S. stocks.

China could also choose to buy factories – or other hard assets – in the United States but China already has a surplus of workers.

Therefore, China has an inherent motivation to purchase bonds and/or stock as opposed to physical assets.

This is what is meant by “foreign investment is the inverse of trade deficits…the bigger your deficit, the more foreign investment you get”.

In the short-run there is nothing inherently bad about this practice.

China and the U.S. each get the goods they want – chips for China and beer for the U.S. – presumably at prices cheaper than the items could be manufactured at home.

There are several important inherent assumptions.

First, the country accumulating the debt is only better off if it’s using the proceeds for productive growth purposes.

Second, that we operate in a free and open market.

Third, displaced workers can transition to new, similar-paying jobs over time.

We have not had free markets for decades – if ever.

And we have been running a trade deficit since 1976.

A sustained practice of running trade deficits leads to underinvestment in those industries from which goods are being purchased abroad.

Expertise is lost, jobs are outsourced and entire industries can become effectively outsourced to other nations.

There are also some underlying problems.

Economists’ measures of benefit from trade are, by definition, net measures. They calculate the increase in benefit to the nation as a whole – not to individuals.

But what happens when the benefits accrue to the few – while the many bear a disproportionate cost.

What happens when good-paying manufacturing jobs are “traded” for low-paying service sector jobs.

And are we adequately capturing that cost in our economic assessments.

It’s easy to point to low levels of unemployment as a counter to trade deficits.

If a perennial trade deficit is “bad”, why are our current levels of unemployment so low.

Unemployment provides a directional indicator of our economy’s health but it masks some measurement flaws.

We also need to focus on Under-Employment.

This occurred when workers were forcefully transitioned from higher paying manufacturing jobs into service-sector jobs that offered little in the way of advancement or higher income opportunity.

Here is some hard data to illustrate the under-employment problem.

In May 2018, the unemployment rate was 3.8 percent.

The number of unemployed persons was 6.1 million.

The number of long-term unemployed (those jobless for 27 weeks or more) was 1.2 million in May 2018 and accounted for 19.4 percent of the unemployed.

The labor force participation rate was 62.7 percent.

The number of involuntary part-time workers was 4.9 million in May 2018.

Involuntary part-time workers are those who want full-time employment and are working part time because their hours had been cut back or because they were unable to find a full-time job.

An additional 1.5 million persons were marginally attached to the labor force.

These individuals wanted and were available for work, and had looked for a job in the prior 12 months.

They were not counted as unemployed because they had not searched for work in the last 4 weeks.

So, while our unemployment rate is at 3.8 percent the available pool is double that figure:

  • 6.1 million unemployed Americans.
  • 4.9 million involuntary part-time working Americans.
  • 1.5 million Americans who have temporarily given up looking for work.

12.5 million Americans looking for full-time employment.

And there’s another pool of workers that can supplement the 12.5 million number.

President Trump sometimes references 100 million Americans not in the workforce. This is factually correct – the actual number for January 2018 was 95.6 million.

About half of the 95.6 million – 46.7 million – are retired.

Another 13.8 million are on some form of disability. The disability system is endemic with fraud & misuse – the number of truly disabled is inflated.

Another 6.4 million are Social Security beneficiaries who are neither aged nor disabled (i.e. early retirees, young survivors).

15 million are in school or in job-training.

The remaining pool of ~13.7 million Americans are care-givers of some nature.

There are currently 12.5 million Americans looking for full-time employment.

If we add folks who are “retired but willing to work” along with excesses from our disability ranks and those lured by higher wages, one can see that we have significantly more flexibility within our employment levels than the stated rate of 3.8% would suggest.

Here’s another way to look at the employment scenario:

The percentage of Americans expected to pay no Federal Income tax in 2018 is 45%.

This doesn’t mean 45% of Americans pay no taxes. Most people still pay Social Security and Medicare payroll taxes along with state and local sales taxes.

And of course, there will always be a significant percentage who pay no federal taxes due to retirement, etc.

But it doesn’t equate to anywhere near 45%.

The 45% rate, when combined with low reported unemployment levels, is indicative of the problem.

A large portion of Americans are chronically under-employed, working in low-paying service sector jobs, trying to make ends meet.

Manufacturing jobs provided a large segment of our population with a viable means to support themselves.

Some of these folks couldn’t afford a higher education or lacked the opportunities to gain skills required for the white-collar world.

Manufacturing jobs offered these folks a chance to pursue the American Dream.

Now, many are relegated to McDonald’s or Starbucks for career paths.

Our unemployment numbers are good. But there are a lot of folks who under-employed and willing to work for higher paying jobs.

I’m not arguing for government intervention or protectionism.

I’m arguing for the removal of unfair trade agreements.

I’m arguing for the death of NAFTA.

I’m arguing for the removal of layers of unnecessary regulations.

I’m arguing for an even playing field.

The United States is the sum of its individual citizens. A net economic number fails to adequately tell the underlying story.

President Trump understands this dynamic. And he’s doing something about it.

We have the most productive workers on earth. It’s time we unleashed them once again.

Yesterday, Charles Payne noted the following:

I would add this.

Markets are forward looking. They price in all available information.

I’m pretty sure the markets expect President Trump’s tariff’s will be short-lived.

And ultimately job-additive.

To those in disagreement, Mr. Payne puts forth a simple question:

Shortly after the completion of my thread President Trump sent out a tweet.

It caught my attention:

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