I’m no fan of the Trump tariff tantrum, but weak criticism of it does no one a service. And while I agree with Paul Krugman on a lot of things, he has a long history of being misguided on trade policy. Alas, his op-ed in today’s New York Times continues the legacy of the Bad Krugman, not the good one.
Before getting to the theoretical meat, let’s take a moment to observe the holes in his argument that should have been identified and vetted before publication.
1. He cites a graphic from the Peterson Institute for International Economics that claims that Trump’s tariffs on Chinese goods have risen to 21.5% this month from 3.1% under Obama (under the Most Favored Nation provision). Applied to $500 billion in imports from China, that comes to almost $100 billion more in tariff collections, right? Not so fast. He reproduces a FRED chart that shows tariff revenue rising by only about $35 billion during the same period. He hedges a bit (“the revenue numbers don’t yet include the full range of Trump tariffs”) and then tries to squirm his way out of the evidence that US consumers aren’t really paying $100 billion more for these goods. We’ll get to the squirm in a moment, but note that some portion of the tariff will be paid by Chinese producers in the form of lower prices to maintain market share, and the evidence suggests that this portion is much too great to simply handwave away.
2. The squirm is Krugman’s assertion that the missing tariff revenue can be partly explained by trade diversion, where some goods formerly supplied by China will now come to us from producers in other countries like Vietnam. Here there are two problems. First, trade diversion does not explain the missing tariff revenue, since we are still looking at $500 billion of Chinese exports to the US. Second, it is wrong to assume, as Krugman apparently does, that the shift from Chinese to Vietnamese suppliers can be interpreted as a hidden tax on US purchasers—“instead of importing from China, we buy stuff from higher-cost sources like Vietnam”—since there a multiple reasons why Vietnam might be a less desired source than China at the same price, such as quality, delivery reliability or Chinese domestic content rules. Yes, there might be some diminution in the satisfaction we get from substituting non-Chinese goods, but this is not a tax in the macroeconomic sense.
3. Finally, to the extent tariffs function like a tax on domestic consumers—and of course they do insofar as we pay them—they can be offset through fiscal expansion. Krugman is right to snicker at the Trump tax cut, whose benefits mostly accrued to corporations, which in turn mostly used them to finance stock buybacks. So far, so good. But in principle we could institute other, more beneficial types of fiscal expansion; in fact, that’s a central pillar of the Green New Deal. So the bottom line is that, while there is a modest fiscal drag from unproductive tariffs on Chinese goods, what makes this a macroeconomic problem is that there isn’t a corresponding fiscal lift from environmental and infrastructure spending.
Now on to the theoretical problem, which psychologically if not analytically drives everything else. Krugman is a high priest of the doctrine that trade balances are caused by capital account balances, which in turn are caused by macroeconomic “fundamentals”. You can read all about it in the textbook he coauthored with Maurice Obstfeld; it will set you back only $300. (Not mainly PK’s fault, of course.) It shows up in his op-ed when he says, “Trade balances are mainly about macroeconomics, not tariff policy. In particular, the persistent weakness of the Japanese and European economies, probably mainly the result of shrinking prime-age work forces, keeps the yen and the euro low and makes the U.S. less competitive.”
The theory that trade balances are determined by macroeconomic aggregates (via impacts on exchange rates) is as close to being objectively wrong as any in economics. First, the trade balance, or more accurately, the current account balance, is not one thing which can cause or be caused by another thing called the capital account, which expresses differences in national savings and investment. They are one identical thing, the country’s international position. We are talking identities here, three little parallel lines (≡), not two (=). It is essentially what economists call a general equilibrium problem, where what is to be determined is not this component or that but all of them simultaneously, much the way the demand for natural gas can’t be said to “cause” the demand for coal, or vice versa, but both are reflections of underlying factors. Elsewhere I’ve laid out the evidence that, based on what we know about transmission mechanisms, there is no general dominance of “macro” factors over “micro” ones.
If you want to know why some countries like the US have trade (and current account) deficits year after year, while others, like Germany, China and the Scandinavian countries, have chronic surpluses, the places to turn are international political economy and the varieties of capitalism literature in sociology and political science. That would give us an entirely different agenda for repositioning the US within the global division of labor and finance, not Trumpian but not Krugmanian either.