A global trade war may produce a recession in the U.S., Stanford economist says

When the United States imposes tariffs on Chinese goods, the consequences can reach far into the U.S. economy, according to a Stanford scholar.

“If the trade war between the U.S. and China and the U.S. and Europe intensifies, it can lead to a recession,” said economist Russ Roberts, the John and Jean De Nault Research Fellow at Stanford’s Hoover Institution.

Beginning in January 2018, the United States imposed tariffs on such items as solar panel components and washing machines, and in June 2018 added a 25 percent tariff on imports of steel and a 10 percent tariff on aluminum on several nations. In turn, those nations have levied retaliatory tariffs.

Roberts, who founded the award-winning weekly podcast EconTalk in 2006 and authored The Choice: A Fable of Free Trade and Protectionism, recently addressed the issue:

 

What is the argument for tariffs?

President Trump has argued that China and other nations have exploited the U.S., saying that we need tariffs to punish them and to get them to negotiate trade deals that will be more favorable than deals that have been agreed to in the past. Trump has also argued that the size of the trade deficits the U.S. has with China proves that China is trading unfairly – after all, the dollar value of goods the U.S. imports from China greatly exceeds the dollar value of American goods that China imports. So, we need to have a better deal and tariffs will punish China and push them to the negotiating table.

 

What is the argument against tariffs?

There are many problems with Trump’s argument. First, trade deficits tell us nothing about the fairness of trade between two nations. Just as the U.S. runs a massive trade deficit with the rest of the world, it also runs a massive capital surplus – the U.S. is a much more attractive place to invest. The Chinese, in particular, buy U.S. Treasurys. Those purchases keep down interest rates in the U.S. and allow Americans to buy lots of Chinese goods. By focusing on the imports of goods and services and ignoring the imports of assets, it looks like something nefarious must be happening. But it is normal for trade flows to be uneven. For example, California does not import the same dollar amount of goods from Nevada as Nevada does from California, but that inequality tells us nothing about the fairness of trade between the two states.

Trump is correct that China follows different rules than the U.S. does in the trade arena – the treatment of intellectual property is probably the most important example. But it is not obvious that putting tariffs on Chinese goods will encourage China to change its policies. The only effect so far is that it has caused China to put tariffs on U.S. goods.

When America puts tariffs on Chinese goods, it helps U.S. producers at the expense of U.S. consumers.

 

What is the likely result of a trade war with China, the European Union and other countries?

If the trade war between the U.S. and China and the U.S. and Europe intensifies, it can lead to a recession. It will cause consumers in the U.S. to cut back on purchases of the now more expensive domestically produced goods. The U.S. producers of those goods will expand their workforces and purchases of raw materials, but other U.S. producers will find less demand for their products from foreign buyers as well as U.S. consumers who are now poorer due to the imposition of tariffs. Those producers will lay off workers and buy fewer raw materials. The adjustment to this new pattern of demand will not be instantaneous and will be painful and costly to the workers thrown out of work.

 

What benefits does a freer trade market offer consumers, workers and companies?

Free trade is misunderstood – its costs are obvious while many of its benefits are hidden or easily misunderstood. Since 2000, the U.S. has increased its trade with China dramatically. The result has been the loss of millions of manufacturing jobs. Automation has also caused the loss of manufacturing jobs as better technology allows factories to produce more with fewer workers. Both of these changes have been hard on manufacturing workers while benefiting American consumers. There are about 5 million fewer manufacturing jobs today than there were in 2000.

Yet, the total number of jobs is much higher by about 14 million. How is that possible? By importing goods from China, prices of those goods fell. That freed up workers and resources to buy more of something else, creating employment in those industries. That process of creative destruction happens with improved productivity via technology as well. By finding ways to produce more output with fewer workers, prices fall and consumers can buy more of something else. Both trade and innovation create economic change that expands the standard of living of most Americans today through lower prices and the opportunity to use resources for new products and services.

Not every worker is better off. Not every worker, especially those with specialized skills, is able to find work somewhere else in the economy. But most Americans benefit from the lower prices, and over time the gains go to the next generation that comes along and inherits a wealthier world.

In 1900, 40 percent of Americans worked in agriculture. Over the last century, we’ve found ways to grow an immensely larger amount of food with a much smaller workforce. For farmers and their families in the first half of the 20th century, that was a tough transition. But the children and grandchildren of those farmers inherited a world with much more opportunity outside the farm because we needed fewer resources to feed the nation. The same process is happening with trade. Because China can make clothes and toys, for example, much more cheaply than Americans, we can have a lot more of other goods and services than if we kept out Chinese competition via tariffs.

And those other goods and services employ millions of Americans – we just don’t usually notice that those jobs are created by the opportunity to buy inexpensively from China.