How Trump’s Misunderstanding of Foreign Trade May Help His Bargaining Position
In the next weeks and months, the United States and China will enter into a serious dialogue on trade. At stake is the Chinese economy, the protection of U.S. intellectual property, and the welfare of consumers on both sides of the Pacific. The latest indication is that President Trump and Chinese leader Xi Jinping will do the important deal-cutting themselves. Very reasonably, this might worry Americans—Trump has given every indication he fails to grasp even the most basic principles of international economics, apparently still viewing trade as a zero-sum game and trade surpluses like company profits. Yet ironically, his ignorance may work to both his and the U.S’s advantage in negotiations with China. I will try to explain why.
Essentially all economists agree that whether or not one of our trade partners erects trade barriers against our country, that our country is better off without erecting trade barriers as part of its own policy. Let’s call the scenario in which both countries engage in free trade scenario A, where the trading partner has barriers (but we don’t) as scenario B, where we have trade barriers (but the trading partner doesn’t) as scenario C, and where both countries have trade barriers as scenario D.
Scenario A is the best for everyone. It allows each country to specialize in its area of comparative advantage and then reap the full gains from trade. But what if the trade partner refuses to remove trade barriers? The belief in economics is that scenario B is better than D. This is because, as students learn in introductory international economics classes, any gain to domestic producers from moving from B to D is outweighed by a bigger loss to domestic consumers. But the problem over the last couple of decades in negotiating with the Chinese that they know that we know that scenario B is better for us than D. This has rendered all of our threats of tariff retaliation non-credible to the Chinese, and resulted in the decades long stalemate of an undervalued Chinese currency, cheap Chinese imports for American consumers, but continued theft of U.S. intellectual property, and a $375 billion annual trade deficit financed by Chinese purchases of U.S. treasury bills.
But here is the difference with Trump: he truly believes scenario D is better than scenario B. In the language of game theory, it is that unlike the economics profession that thinks free trade is the dominant strategy, Trump believes that enacting tariffs is the dominant strategy. This could be purely because he doesn’t understand the welfare effects of tariffs. Or he could be less ignorant than economists think, and prefer scenario D to scenario B because those who benefit from the new American tariffs are more important to him politically (manufacturing workers in rust-belt states) than those who suffer (pretty much everyone else). But it really doesn’t matter. The Chinese leadership now knows that someone is in charge in our country who is either crazy enough, ignorant enough, at least or politically motivated enough to believe scenario D is truly better than scenario B, and unlike past U.S. administrations, this makes Trumps threat to keep his tariffs in place for a long time completely credible.
At first this was probably puzzling to the Chinese, that a President would stick hard to a policy in the long-run that would damage the welfare of his own country, not only to consumers, but to farmers hit with retaliatory tariffs, to the auto industry paying higher prices for steel, aluminum and other critical materials. But reality of Trump-think appears to have finally sunk in for the Chinese. Someone who believes building a wall on the Mexican border embodies the grand solution to America’s problems is likely to be someone who thinks raising huge tariffs on imports is good for America too. It is like escalating a bar fight with someone who is so inebriated he doesn’t believe he is getting hurt—not a comforting thought. This is an important development, because for Trump’s ignorance to work in America’s favor, the Chinese have to believe Trump really thinks U.S. tariffs are a good thing for the U.S., otherwise they will think that he will eventually capitulate like other U.S. leaders. But Trump shows no sign of capitulating. He believes with his whole heart that his tariffs are a good thing for America despite that amping up the trade war would cost hundreds of dollars to most U.S. households and tons of jobs.
So it’s hard to say exactly how this will play out, but it wouldn’t be surprising if we do see some major Chinese capitulation on intellectual property or the value of the yuan. The next few weeks will be interesting. And I’m not saying it’s good to be ignorant about economics, but there seem to some strange cases where it can be an advantage.
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