Debating trade deficits
Guns and Butter, that old economic school exercise delving into the choice of a nation's production, is well known. But when it comes to trade, and trade deficits, the analogy might be framed with "disposables for farmland."
Milton Friedman was adamant about the benefits of trade without tariffs or barriers. He espoused that trade imbalances are a poor measure of who benefits from trade. Professor Friedman said, "Getting more by sending out less ... is good." Adam Smith's invisible hand, the free flow of capital unencumbered by government restrictions or controls, will result in the benefit of all parties and the proper allocation of resources.
But the question might arise: "Then why is a country such as China so happy with this arrangement of trade imbalances?" They, in Friedman's example, are the ones getting less and giving more. Trump's secretary of commerce poses this.
[Wilbur] Ross maintained that trade deficits – the disparity between imports and exports – matter. "If trade deficits are good, why is China so pleased that they run a huge trade surplus?" he asked. "It's perfectly obvious that if China hadn't been such a huge net-exporter it never would have grown at the rate that it did."
Friedman would hold that the one with the trade surplus resultantly is left with the currency of the deficit nation. This would then require that country to reinvest or purchase items within that deficit nation or exchange out of the currency. The exchange out of the currency would put pressure on that currency and theoretically reduce its value. The trade creditor nation's goods would thus become more expensive, and the trade deficit nation would buy less with its depressed currency. A balance would be approached.
If the creditor nation were to reinvest in the trade deficit nation with that nation's currency, the return of money and capital would boost economic activity in that nation. Jobs would be created. The benefits of floating exchange rates or reinvestment thus promote balances.
However, there could be a transfer of ownership in the reinvestment scenario. Economic theorists might envision that foreign nation would build factories and create jobs. But what if they bought hotels, existing landmark buildings in great cities, or farmland? What jobs then?
In that case, the eventual net exchange could be electronic gizmos for Iowa farmland, cheap clothing for coastal shipping facilities – disposable, expendable, and ephemeral products for the tangible core of a nation. Then what of the balances?
Trade imbalances and their effects, while honing efficiencies, may eradicate critical domestic industries. Friedman and others unfold their theories into a perfect world, free from the threat of global conflict. The loss of certain industries due to competitive trade could prove fatal for a nation. When necessity demanded, Edsel Ford turned a car assembly line into a B24 factory, eventually producing one plane per hour. Who now could domestically produce the computer chips, car parts, rocket engines, steel, and other products upon whose foreign production we have come to rely if there were indeed a national defense necessity?
Friedman said, "Even Adam Smith made national defense an exception. But I think, while in principle it is an exception, in practice it is an excuse." True enough. It is an excuse for the protectionists until that crystallized emergency moment when it becomes critical. This is an intellectual inconvenience for the theoretician.
Friedman held, "Protectionism protects the consumer against one thing, low prices." However, when the net effect is trading soon to be obsolete electronic devices for the bones of a country, the winner in the exchange seems obvious. Protectionism may, when applied to essential industry, protect the defense of a nation. The great questions are "What is an essential industry?" and "Who decides?" Answering these questions and quantifying national threats are difficult tasks. Not making the effort is terminal.