As an economist trained in international trade, it is interesting to observe the difference between the economics of trade and the public perception of trade. The Venn diagram of these two perspectives shows very little overlap. And I think I know why: The costs of international trade are concentrated (it makes the news when RCA moves its production of TVs from Indiana to Mexico), but its benefits are diffuse (rarely do people, as they check out at their local store, acknowledge that they would pay more for a TV if it were manufactured in the U.S.). A further issue is that the outcomes of trade policy are a function of many voices at the bargaining table, and policy outcomes may not represent economic ideas.
First, from an economist’s perspective, it is important to note that international trade matters greatly to the U.S. and Wisconsin. Trade supports approximately 20% of jobs in Wisconsin. Imports of intermediate goods allow our firms to be cost competitive. Free trade agreements promote access to foreign markets, and foreign-owned companies invest in Wisconsin and employ 136,000 people. Ninety-five percent of the world’s population and 80% of its purchasing power reside outside of the U.S.; future economic growth depends on access to foreign markets.
The trade deficit is generally seen as a macroeconomic phenomenon. If we begin with the equation for Gross Domestic Product (GDP) and do a little rearranging, it can be shown that any trade deficit reflects the fact that we have less private sector saving than investment (which has been the case since the early 1980s) and/or increased federal budget deficits (from the early 1980s through about 1995, and again since 2000). Basically, the rest of the world is lending us money to maintain these deficits.
Over the centuries, economists have refined how they look at trade. We started with the Mercantilist School of thought (attributed to Thomas Mun) in which we “win” by running trade surpluses, and “lose” when we run trade deficits. Though this may sound familiar, it was debunked in 1800. That’s when we looked to the Classical School (Adam Smith), in which we traded based on having a lower absolute cost of producing a good. This was replaced by David Ricardo, who refined Smith’s thinking by considering not absolute costs, but rather lower relative costs (economists consider this in the context of opportunity cost).
When I teach these theories to students, I develop Ricardo’s model looking at trade first between Wisconsin and Minnesota. We see that by specializing and trading based on Ricardo’s theory, folks in both states can consume bundles of goods beyond what they can produce on their own: Trade lowers prices and increases not only how much we can consume, but also the variety of items we can consume. I believe we can all agree these are good outcomes, so when I change the economics from states to nations I ask why there is so much controversy. The economic logic is identical between the two examples. Economists are often criticized for not agreeing on many issues. Having said that, the idea of trade based on comparative advantage being a welfare-enhancing practice is one of the most universally agreed upon economic theories.
Our trade statistics are, as I like to put it, a noisy signal as to the true nature of bilateral trade relations. For example, when we import an iPhone from China, that adds $699 to our deficit. However, China has sourced many components from other nations. Only $8 of value added actually happened in China, so only $8 should be added to our trade deficit.
Another related hot topic is the one of “bringing back jobs.” The U.S. labor market is remarkably fluid. One hundred years ago, roughly 40% of the labor force worked in agriculture. Today, that number is less than 2%. Technological progress has offered far more “creative destruction” to jobs here than trade has. Yet we would never suggest discouraging innovation to preserve jobs. Moreover, in March the U.S. unemployment rate was 4.2%, below the target rate of unemployment. In Wisconsin, it was 3.2%. Based on these statistics, our labor market is strong.
When it comes to tariffs, we are essentially asking ourselves whether we prefer to pay more in taxes. Do consumers like to pay more at the checkout? Do firms like to pay more for the goods they buy in order to produce whatever final good they produce? I doubt either is the case.
Ultimately, economics is about weighing costs and benefits. As I see it, the costs of inhibiting trade are quite high while the benefits of doing so are very low. We tend to think that free trade in markets is a good thing domestically, and I’d argue it extends to the international community as well.
