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Trade in the CEA's Annual Report

Trade war? What could go wron... If You Hurt Us, We're Going to...

by Pierre Lemieux

It is usual for the CEA, whose members are political appointees, to prudently defend the administration's policies. It was obviously more difficult for credible economists to do it in the present case.

snail's pace.jpgAmong the many topics it covers, the annual Economic Report of the President transmitted to Congress on February 21 repeats the current administration's protectionist claims. The president's message asserts that the administration "believes in the benefits of free trade," but that this means "fairness and reciprocity" and no tolerance for "unfair trade practices." The report assumes that "the interests of the American people" or of "our Nation" require us to "boost our exports" and justifies protectionist measures against imports.

More serious and interesting is the analysis contained in the Annual Report of the Council of Economic Advisers (hereafter identified as "the CEA's report" or simply "the report") which is, as usual, attached to the Economic Report of the President. Chapter 5 of the CEA's report deals with trade. It is certainly less bad than the protectionist statements from the administration, and than the president's message itself. Some might say "better" instead of "less bad." This must have something to do with the fact that serious and reputable economists are members of the CEA, and that its staff of economists also knows something about economic analysis. The chapter tries hard to reconcile the economics of trade with the administration's position. Not surprisingly, it does not succeed.

The first section of Chapter 5, titled "The Economics of Trade," admits that a consensus exists among economists on "the central importance of comparative advantage" and the mutual benefits of international trade. But this is preceded by an introduction that is obviously a political compromise with those who wanted to pull the CEA towards the administration. Ignore the banality of a statement such as "the economy, both in the United States and around the world, has changed since the days of David Ricardo and Adam Smith." Consider the following statement:

Nothing about the principle of comparative advantage would lend itself to a defense of a status quo that imposes higher barriers to exports on America's producers than on foreign producers.
The principle of comparative advantage suggests that (in most cases) all countries will most benefit from the operation of comparative advantage in the absence of any political barrier to trade. But it certainly does not suggest that domestic protectionist measures should be used to retaliate against foreign protectionist measures. Most economists would agree with Joan Robinson's remark that protectionist retaliation looks as sensible as it would be "to dump rocks into our harbors because other nations have rocky coasts."

After the intriguing (and false if it is not purely descriptive of a protectionist argument) statement that "[o]ne way to assess the distribution of gains between trading partners is to examine the balance of trade," the CEA's report seems to admit that the U.S. trade deficit is due to the international role of the dollar and to an "excessive level of public or private consumption." This amounts to recognizing that the federal deficit is partly (I would say, in large part) responsible for the trade deficit. Foreign purchases of Treasury bonds push the dollar up and thereby boost imports and restrain exports. This is a good point, but it might have been less discrete.

It is usual for the CEA, whose members are political appointees, to prudently defend the administration's policies. It was obviously more difficult for credible economists to do it in the present case. The compromises appear all the more obvious.

The CEA defends trade mainly for promoting exports, which is a common but bad reason. To be fair, the report does occasionally mention the real reason, that is, the benefits to consumers. Yet, it remains mainly focused on obtaining from foreign governments "concessions" that will help American exporters. The CEA thus defends labor and environmental standards in free trade agreements so that American "firms and workers compete on more comparable terms with foreign producers." The economic truth is that these anti-competitive standards partly deny to American consumers the benefits of comparative advantage.

More generally, the ideal of a "level playing field," often invoked in the CEA's report, not only makes the current administration ideologically similar to the previous one, but it also negates the reason for the existence of comparative advantage and the benefits of trade--that is, the fact that relative costs differ between countries. This is quite clear and uncontroversial in the case of labor: the poor country's relatively inexpensive labor allows them to surmount their low productivity and still be able to compete by offering better prices to American consumers. If everybody had the same relative costs, nobody would trade with anybody.

To see why imports, not exports, are what is most important in trade, consider the following. Exports amounts to using the resources of Americans to produce stuff for foreigners. Why not produce for Americans instead? For example, the (small) contribution of agricultural exports to American GDP (which the Report emphasizes) corresponds to value added that is shipped outside the country. This is good, of course, but only because it allows Americans (through the resulting higher value of the dollar) to import goods and services.

The CEA's economists know all this, of course. I would argue that the political compromises they accept unduly sacrifice economic analysis to political partisanship.

Here is another example. The report recognizes that "trade across international borders will virtually always generate net gains for all nations involved," and that American leadership in the pursuit of (I would qualify the pursuit as moderate) free trade has generated gains that "have, as a whole, served to boost income in the U.S. as well as around the world." But the report then underplays these observations by focusing on the costs of adjustment that trade has generated for a small minority of American workers. Worse, it lauds the current administration for using "all available tools to address imbalances," meaning protectionist actions against foreign competitors, as if "imbalances," whatever that is, were not a normal consequence of economic freedom in a dynamic economy.

Compared with its many fundamental concessions to protectionism, the CEA's suggestion of more direct government assistance to workers displaced by international trade looks like a minor drift.

Is it better if a government agency openly defends protectionism or if it tries to defend free trade with weak or invalid arguments? The latter is largely what the CEA's report does, by emphasizing mostly the benefits to producers and the socialist mantra of a "level playing field." The danger with this approach is that it weakens the intellectual case for free trade in public opinion. If the goal is to help producers and if equality--the "equal playing field"--is better than liberty, can we blame people for concluding that protectionism is good?

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CATEGORIES: International Trade


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