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By Dr. Jim Leontiades
Cyprus International Institute of Management
Donald Trump’s views on trade have sent alarm signals throughout the western world. During his recent meeting with Germany’s Angela Merkel, he made clear his belief that the US has been treated “very very unfairly” in previous trade negotiations. Moreover, he has signalled his determination to change this. Angela Merkel and other national leaders have expressed alarm at this radical change in the American position.
What has happened to bring about such change? Much of the present international system of trade is influenced by trade theory which remains one of the most respected areas of economics. Many nations have subscribed to its major principle: a lowering of trade barriers which improve trade can benefit all parties. The US has historically been one of the main supporters of such negotiations, e.g. the Kennedy trade negotiations which lowered trade barriers around the world. Why the reversal?
Let’s be clear, there is no such thing as “free trade”. All countries and trade groups (such as the EU) have some trade barriers. Periodically, they meet to review and adjust these – hopefully downward. Although economists tell us that removing protectionist barriers can benefit all countries, they do not say how such benefits will be distributed. The result of trade negotiations may benefit some countries more than others.
The US has had a persistent and consistent trade deficit for some 40 years. Germany is on the opposite side of the spectrum with major long term trade surpluses for the past 25 years. In 2016 its exports to the USA came to $114 bln, imports were at $49 bln. Such trade imbalances impact a country’s industries and the lives of those employed there. Manufacturing employment in the US has dropped to 8% of the labour force. For Germany the analogous figure is 20%.
Furthermore, trade theory does not tell us how the benefits of trade will be distributed within a country. Will such benefits fall mainly to lawyers, bankers, hedge fund managers, etc? Studies of the Economic Policy Institute show that between 2007 and 2015, the top 1% of the American population has gained disproportionally, enjoying substantial income gains during this period. But the incomes of the lower 95% of the population were actually lower than those in 2007. Other studies show that incomes of the working class sector of the US population are now lower than in the 1980s. Many of those most affected reside in the so called American “rust belt”, those manufacturing areas which have been unable to compete against imports. These are the people who overwhelmingly voted for Trump and whom he has promised to help.
What has happened?
During his recent meeting with Angela Merkel, Trump referred to the exchange rate as contributing to the trade imbalance between Germany and the US. Merkel pointed out, correctly, that as a member of the Euro, Germany’s exchange rate was the same as for other members of that currency. Germany has no individual influence over the Euro’s exchange rate. It nevertheless enjoys the trade benefit that this brings. Is this what the “Donald” refers to when he refers to fairness? Possibly. But fairness in trade issues is something very difficult to determine. Nor is it often the most relevant factor is such disputes. If a country feels disadvantaged it is likely to try to do something about it
What will Trump do?
An American border tax is one option. Like the European VAT, this places a tax on imports but not on exports. If successful, this would help Trump kill three birds with one stone. Firstly, it would have a major impact on reducing imports. It would also enable Trump to reduce the present US tax on corporate profits, now at the relatively high level of 35% (for Cyprus and Ireland it is 12.5%) to something closer to 15-20%. The reduced tax would spur investment by increasing profitability. It could also motivate American international companies that have been trying to avoid the present high corporate tax by not repatriating many billions in profits held abroad. A number of European governments have expressed unease at the prospect for such a tax. The term “trade war” has been mentioned more than once.
The successful passage of a border tax through Congress is by no means assured. Some members of Congress are concerned that it could alienate consumers by raising the price of imports. There are also companies that would be hurt as the tax on imports would disrupt supply chains which bring vital parts from foreign based operations. Despite such objections and given the president’s campaign promises, we may expect a real effort on his part for either a border tax or some other form of restriction on imports. Furthermore, in light of the recent defeat Trump suffered in his unsuccessful attempt to change the Obamacare health programme, we may also expect better preparation this time for its passage through Congress. It seems that the US and Europe led by Germany are set on a collision course.
A historic divide
The split between Trump and Merkel extends beyond trade. Trump has repeatedly stated NATO members should stick by their agreement to maintain defence expenditure at 2% of GDP. Only four European members have done so (Greece, Poland, Estonia and the UK). Germany’s Foreign Minister has indicated that Germany would increase defence expenditures but he is also reported as saying that he knows of no German politician who considers the 2% target as neither reachable or desirable.
Coming at a time when the UK is negotiating its exit from the EU, these issues threaten to initiate a historic divide that goes well beyond trade. International agreements supporting convertible exchange rates, defence, as well as trade which have been in place since World War II are threatened and with them the unity of the West.
