American Economics, Part 1 – The U.S.-China Trade War

| May 30, 2020 | 0 Comments

This is the first article in a three-part series exploring certain practices of the American government related to economics. In this installment, I will take a brief look at what happened during the U.S.-China trade war that ended a few months ago. I also will include some of what economists have to say about certain trade practices and the ripple effects they have on the economy.

The U.S.-China Trade War

From January 2018 until February 2020, the United States was engaged in a trade war with China. This was obviously not a war fought with guns, tanks and strategic bombers, but rather with words, threats, and tariffs. The war started out small and has now come to an end, but it was a big deal at one point. What happened in the conflict? Did someone win? What were the goals of those who began the war and have those goals been realized?

Since the 1980’s, Donald Trump has been an advocate of government policies that reduce the U.S. trade deficit with the world and protect the domestic manufacturing of America. When he was campaigning for the presidency, one of his stated goals if elected president was to impose tariffs on imported goods in order to reduce competition for American industry. China was the main target, due to the fact that almost 50% of America’s trade deficit in recent years has been with China. Trump made good his promises when, on January 22, 2018, his administration announced tariffs on solar panels and washing machines being imported from China. This was not a big deal, as solar panels and washing machines make up only a tiny fraction of what the U.S. buys from China. However, it was just the precursor of what was to come.

In March 2018, the American government proposed tariffs on $50-60 billion worth of Chinese goods, and China soon responded by placing tariffs on almost 130 different goods that it imports from America. The U.S. countered by saying it was considering tariffs on an additional $100 billion worth of Chinese goods, and so the war was on. For approximately a year and a half, the U.S. and China threatened tariffs, applied tariffs, repealed tariffs, and beseeched the World Trade Organization to please make the other country behave as it should. Finally, in October 2019, real progress began being made toward a resolution, and on February 14, 2020 the “Economic and Trade Agreement between the United States of America and the People’s Republic of China” took effect.

Did there have to be a war?

Why did the trade war even happen? Was it necessary? President Trump and his advisors said yes. For years, China has supposedly engaged in unfair trade practices. China has “stolen” vast amounts of intellectual property from United States industry, trade secrets that allow China to build its industry without going through the extensive (and expensive) research and development process that U.S. businesses did. China also intentionally keeps its currency valued low against the U.S. dollar, lowering the prices of the goods that it exports and making them very attractive to American importers. Because of its efficient manufacturing (thanks to all the trade secrets obtained from the United States) and low production costs (thanks in part to the low value of the Chinese dollar), China exported much more to the United States than it bought from the United States. President Trump viewed this trade deficit as a sign of weakness on the part of the United States.

The Trump administration was of the opinion that the United States government was responsible for protecting the wellbeing of American manufacturing, and felt that American manufacturing could not thrive if they were constantly being undersold by Chinese companies. Also, China should pay for the trade practices learned from U.S. industry that had allowed it to become the second-largest economy in the world. The quickest way to accomplish this dual goal – punishing China and correcting the trade deficit – seemed to be tariffs, so tariffs it was.

What are tariffs?

Let’s define some terms here. What are imports, exports, and tariffs, and what is a trade deficit? Imports are goods that are produced abroad and consumed domestically. From the U.S. perspective, imports are goods that are produced in any other country and purchased and consumed in America. Exports are goods that are produced domestically and consumed abroad—that is, goods produced in America and purchased and consumed by the people of another country. A tariff is a tax placed on imports, typically for the purpose of reducing the amount of imports coming into a country. The importers of any good that has a tariff on it must pay a certain percentage of the value of the good to the government imposing the tariff. A trade deficit is the situation that arises when a country imports more than it exports. The United States had a trade deficit with China because the U.S. bought more goods from China than China bought from the United States.

The effects of tariffs

When the U.S. and China placed tariffs on each others’ goods, they effectively increased the prices of said goods. China’s goods may have been cheap compared to American goods before the tariffs, but now the importers of the goods had to pay a hefty tax in order to get them into the United States. This raised the prices of Chinese goods, an increase that was either absorbed by the importer or passed on to the American consumer. If the importer was forced to absorb the tax, his incentive to import from China was greatly reduced and he may have stopped doing it altogether. If the price increase was passed on to the consumer, the Chinese goods suddenly became more expensive, giving the consumer less incentive to choose the Chinese goods over goods that were made in America. The result of either option was decreased purchases of Chinese goods by American consumers.

The exact same thing happened from China’s perspective as China placed tariffs on American goods. This meant that while the trade war was ongoing, neither certain American producers nor certain Chinese producers could sell everything they were capable of producing, suppressing production and leading to the layoff of workers. This reduction in production meant that the economies of both China and America were smaller in 2018 and 2019 than they otherwise would have been. However, there were other sectors of the economy of the two countries that flourished while the trade war was ongoing, due to reduced competition from the equivalent industry of the other country.

The outcome of the trade war was China’s agreement to buy billions of dollars more of American products than it previously had. Existing tariffs were reduced and threatened tariffs were suspended. The “Phase One” trade deal signed by China has done little so far to increase the amount of goods it imports from America as the coronavirus hinders purchasing, but American exports to China should be picking up soon as normal shipping and Chinese purchasing is restored. China has agreed to support American manufacturers and farmers by buying more from them instead of producing the goods in China or buying them from elsewhere.

Why trade?

You may be wondering why China and the United States even need to trade. When the two countries imposed tariffs on each others’ goods, why didn’t the consumers in the United States and China simply start buying the products grown and manufactured in their respective countries? Surely they could make out just fine this way. Surely both China and the U.S. are capable of producing everything that their respective citizens could possibly need. The answer is technically “yes,” but here we need to talk about something called comparative advantage.

Comparative advantage refers the ability of one producer to produce a good at a lower cost than another producer. China and the United States could both potentially produce anything that their people need, but each country is better at producing certain things than the other country. China excels in manufactured goods, largely because labor is so cheap in China. The United States could manufacture the goods it needs, but the cost of producing the goods would be higher, leading to higher prices for the consumer. The United States excels at producing computer software, due to the enormous amount of research and development that has been done in computer science in the States, as well as all the talented computer scientists that have immigrated to the States from places like China and India. As a result, the United States exports much more computer software than it imports. China could conceivably produce its own computer software, but it would have to divert workers from its manufacturing industry, train them to be computer programmers, and increase the amount of computer software it produces before it could meet domestic demand. The United States has very fertile farmland and exports many agricultural products to China. China could maybe grow all the food it needs, but it would need to heavily invest in ways to make its agricultural sector more productive first. There is more to comparative advantage than this, and economists have all kinds of graphs and analogies for explaining comparative advantage which I will not go into, but just remember this: Each country has goods that it can produce at a lower cost than another country.

So if China and the U.S. can make something at a lower cost than the other country, each country is better off if there is an uninterrupted flow of trade between the two. (This is true if cheap goods are the only concern. It may not be true if certain other issues are important.) If there are goods that China can produce cheaper than the United States can, it makes sense for China to make those goods and trade them for the United States’ cheap computer software. That way both countries reap the benefits of the other’s skills. If tariffs are implemented to protect the industries of each country, it keeps the consumers of each country from reaping the benefits of the other’s manufacturing skills.

Over years of free trade, each country has expanded the industries in which it has the comparative advantage and contracted the industries in which is out-produced. This means the U.S. produces more computer software and farm goods than it can use or eat. It sells the excess to China. China produces more manufactured goods than Chinese consumers want. It sells the excess to the United States. When the tariffs were put in place and the amount of goods flowing back and forth decreased, each country now had excesses of some goods and shortages of others. The United States was now producing too much of certain products, because they couldn’t flow so freely to China. The sectors that made those products had to scale back and some workers were laid off. American farmers were hurt by low crop prices. At the same time, goods coming from China were reduced in volume or raised in price, either way resulting in higher prices for American consumers. The same thing happened in China. The trade war actually depressed the economies of both countries.

There is an important economic “truth” here that almost all economists agree on. Free trade between any two countries maximizes the benefits that these countries can receive from each other’s superior production capabilities. Phrased another way, free trade brings the most economic good to the largest number of people.

So why tariffs?

If the most people enjoy the most good when free trade is happening, why would tariffs even be considered? The primary reason is that the benefits of free trade are unevenly distributed.

If Chinese manufacturers can make a good (let’s use plastic spoons as an example) cheaper than the American plastic spoon manufacturers, American consumers will benefit from buying cheaper Chinese spoons. They can use the money saved to buy something else. However, the American spoon manufacturers suffer loss because now no one is buying their spoons. The plastic spoon manufacturers then lobby the government to implement tariffs to raise the price of Chinese spoons to a level where the American spoon manufacturers can compete, market their spoons, and make a profit. However, the American consumers of plastic spoons have to deal with the higher prices that result. The best solution, if only overall economic good is being considered, would be for the American plastic spoon manufacturers to give up, admit that China is a better plastic spoon manufacturer, and go find jobs in production sectors where the United States has a comparative advantage.

Tariffs continue to be implemented because American plastic spoon manufacturers have lobby groups trying to convince Congress that they need to be protected. The government sometimes gives in to their pleas because a democratic government is supposed to listen to the pleas of the people (or maybe in order to gain their political support). After all, if each American adult spends $2 more per year on plastic spoons because of a tariff, they will hardly notice it. The American plastic spoon manufacturers benefit at the cost of their countrymen. However, the “suffering” of the countrymen when there are tariffs is not nearly as acute as the “suffering” of the manufacturers when there are no tariffs. This is why, year after year, administration after administration, the American government has taken steps to protect American industry from foreign competition, even though it is at the cost to the public of greater economic benefit not being gained.

Now, you might ask, won’t the income from the tariffs counteract the losses of the American spoon consumers? The answer is no. Economists have consistently demonstrated that the losses of American consumers because of a tariff are higher than the combined monetary gains of the tariffs and the increased incomes of American manufacturers.

Mission accomplished?

One of the Trump administration’s reasons for starting the trade war was to protect the livelihoods of certain American manufacturers. This goal was at least somewhat realized. However, it resulted in a reduced average standard of living for both American and Chinese consumers. A second reason was to make China pay for the benefit it had received from certain U.S. research and development. Did China pay? Well, they did “suffer” during the war, but Americans probably “suffered” just as much.

And what happened to the trade deficit that was another reason for starting the war? The United States’ trade deficit with China fell over the course of the trade war, but the trade deficit with countries other than China grew as American importers turned to other foreign producers to satisfy the needs and wants of American consumers. The trade deficit is not China’s problem and is not something that can be solved with a bunch of tariffs. In my opinion, it is the result of an American problem that will be discussed in Part 3 of of this series on American Economics.

~Leonard Hege

Definitions of economic terms in this article obtained from:
Principles of Macroeconomics, Seventh Edition, by N. Gregory Mankiw


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