Will Economic illiteracy cause a trade war?

Date:25Apr2017

This is what Jeff Sachs boldly asks in a recent Project Syndicate column, a key point being that trade (or more broadly current account) deficits are about a country’s saving-investment gap, not about stopping imports or incentivizing exports, which don’t work because of myriad of reasons. A similar point is made here by Martin Feldstein, who says that the issue boils down to the saving behavior of the Americans. Noah Smith late last year has addressed this protectionism or trade fallacy in reaction to statements from Trump advisor and econ professor Peter Navarro (so did WSJ).*

But this is the easier bit of the protectionist debates… There are other more complicated issues that come under the protectionism heading, but are still being hotly debated among economist, like the role of China in lost U.S. manufacturing jobs or the pros and cons of BAT (Border Adjustment Tax) or whether we should be doggedly pro-free trade (related to the China issue), whether protectionism kind of makes sense in a world of secular stagnation and finally whether it is already too late to compensate the losers, as it is often advocated by those who favor free trade but appreciate the deep and adverse “distributional” implications, especially for the advanced country middle classes. (Remember the “elephant curve”?)

If you want to see pretty much this stuff all in one place, check this Foreign Affairs article by D. A. Irwin of Dartmouth College who writes – very convincingly and beautifully in my humble view — about “The False Promise of Protectionism”. (And Tom Keene seems to agree…)

You are reading all this mainly because they make very useful readings for the students of Global Economy 101…

*Ok, lets refresh ourselves up a bit on the national income identities without being too careful with the precise definitions. Start with Y=C+I+X-M where Y=Gross National Income; C is consumption (public and private); I is investment (public and private), X is exports of goods, services, income and transfers and M is imports of those things – the gap between the last two makes up the current account balance, by definition. It then follows, moving C and I to the left (and recalling that Saving (S) = Y-C), we end up with two identities: Saving – Investment = Current Account Balance and Income – Spending (C+I) = Current Account Balance.

The upshot of these equations is that if you want to fix your deficit, you have to figure a way of living within your means…  If that sounds too “Turkish” to you, then you definitely get the point…