Tuesday, April 13, 2010

Protectionist Arguments - The Trade Deficit Fetish

This post is a bit of a late repsonse to a Tim Worstall post on protectionist arguments that supposedly don't add up, this one:
Second, the total balance of trade deficit went from (0.9 billion to 0.2 billion). In other words, the United States was losing less money because of Smoot-Hawley. It was in aggregate better off.
Tim's suggestion is an argument that he's used before, it's imports we want, exports are just the thing we do so that we can afford to buy imports. The real question here is why protectionists make a fetish of the balance of
trade figures railing against the idea of maintaining a negative balance of trade. What follows is my reasoning for why the government should actively seek to address balance of trade problems.

The concern in this case is not that it's a problem in itself, it's more that it's storing up problems for later. While it's possible to have an unequal balance of trade, the balance of payments always has to equal. The result of this is that in a situation where a nation has a trade deficit the shortfall is made up for by other payments.

These payments come from various sources, foreign investments, sale of assets, borrowing and such. The problem with a lot of these payments is that they mean an influx of money now in exchange for a commitment to future outgoing payments. The obvious problem with such a situation is that it is not sustainable in the long term, eventually exports will need to rise in order to meet the need for imports as well as these aquired financial commitments.

There's an obvious response to this which is that a market economy will adjust to this situation and exports will increase. The problem is that when faced with the need to make a sudden adjustment and increase the level of exports the economy will not be able to make these adjustments quickly enough. This is likely to have very nasty consequences both economically and politically.

The path from this line of reasoning to the proposal of protectionist policies then goes like this. Firstly, we accept that the nasty consequences of continuously running a trade deficit are something we would like to avoid. From here we question whether the market economy is capable of sorting it out on it's own account or whether the state needs to intervene, the argument here would be that trade deficit problems are not something individual entrepreneurs concern themselves with and have little power to influence anyway. Once we've made the leap to it being the state's problem we need to take a look at what policies would be most effective at keeping things in check, it's here where protectionism makes an appearance because such policies are incredibly effective at solving trade deficit problems.

Update: Expanded on the last paragraph, since I though the first effort was a bit lacking.


Tim Worstall said...

"it's here where protectionism makes an appearance because such policies are incredibly effective at solving trade deficit problems."

Well, if you want to define "effective" as "making everyone poorer" then OK. But it's not a definition I would use.

Andreas Paterson said...

Hi Tim, and thanks for your reply. I'm not entirely certain about the making people poorer argument myself, I will however happily accept that such policies would lead to a redistribution away from some individuals and towards those interests favoured by the particular policy. I'm not entirely sure this would make us poorer as a whole though.

The question though is, if we accept that running a signifigant trade deficit for a long time could lead to a crisis (and I'll admit that opinion is pretty split on this) whether the side effect (and any negative consequences therein) is a price worth paying to avoid a crisis that could make us all signifigantly poorer.

Personally, I do subscribe to the idea that running a constant trade deficits is storing up trouble and do think that the state should look to address them. I think there are far subtler ways of doing it that adopting full on protectionist solutions.