Why ‘Protectionism’ will not make America Great Again

“Buy American, Hire American”, the famous one-liner from Trump’s inaugural speech that has been played over and over on (fake) news outlets worldwide. Yet a tools factory in the swing state of Wisconsin was where The Donald carried out his pledge and signed an executive order aimed at cracking down on skilled worker visa abuse and forcing US government agencies to buy more domestically produced products. The move attempts to put a surplus in the Balance of Payments back onto the list of macroeconomic objectives. Instead it adds to “The list of reasons why Trump doesn’t understand economics”.

The executive order comes in two parts, the first directs federal government agencies to crack down on fraud and abuse in the H-1B visa programme for skilled workers. The second part calls for the federal government to strengthen its various “Buy American” provisions that give preference to domestically produced products.

To first deal with the pitfalls of the executive order itself. The “Buy American” motif is constrained by America’s membership of the North American Free Trade Agreement and the government procurement agreement in the World Trade Organization, which has 19 signatories including the EU. Attempts to restrict procurement to domestic companies tend to backfire. They induce retaliation from trading partners, harming US businesses trying to sell abroad. They also raise input costs, in turn slowing the economy. With the “Hire American” project, the H-1B visa programme was designed to bring in high-skilled workers, particularly in the tech sector, who would be complementary to US workers. They would also help with start-ups and other fast-growing companies that would in turn increase local hiring. Often it has meant consultancy companies substituting lower-skilled employees with temporary workers and then offshoring production. The high demand for H-1Bs, with the annual 65,000 quota often rapidly filled, has led to their distribution by lottery rather than on merit. Reform to address that issue would be politically astute. Handing out the visas on the basis of offered salary would be a simple market-based solution, though it would mean more workers going to established tech companies and fewer going to start-ups. More complex but potentially more productive would be to give visas to companies that allowed workers to apply for permanent residency, showing they were interested in more than churning short-term employees.

Despite the flaws in this executive order, its Trump’s wider ‘protectionist’ economic agenda (or ‘Trumponomics’ as Michael Boskin would say) that is the major issue. Although the idea that protection will reduce trade deficits does make intuitive sense. It is wrong. This is because the economy does not consist of isolated markets: everything is related to everything else. Taxes on imports are also taxes on exports. If one imposes protection against imports, one pulls resources out of production for export. To put the point in other words, imports are just a way of supplying exports. Thus, protection reduces ratios of trade to gross domestic product (making economies more closed), not trade deficits.

So what is the solution to America’s trade deficit? The first is the acceptance of the idea that the openness to trade of a nation does not determine their Current Account. Recently Wilbur Ross, US Commerce Secretary, objected warnings of protectionism from Christine Lagarde, arguing that “we are the least protectionist of the major areas. We are far less protectionist than Europe. We are far less protectionist than Japan. We are far less protectionist than China… We also have trade deficits with all three of those places. So they talk free trade. But in fact what they practice is protectionism. And every time we do anything to defend ourselves, even against the puny obligations that they have, they call that protectionism. It’s rubbish.” It is in fact Mr Ross who is speaking rubbish.

The annual Index of Economic Freedom illustrates that the US is far from having the most liberal trade policies. Out of 177, USA is ranked 40th in “trade freedom” while nations like Norway and Germany are ranked 7th and 11th respectively. The index actually shows a weak correlation against protectionism, with countries that have more liberal trade policies tending to be more likely to have a surplus in the Current Account. Where there is a strong correlation, however, is between savings and the current account balance. The index illustrates a strong correlation between nations with high gross national savings (as a % of GDP) to having a surplus in the Current Account.

America is a relatively low-saving country that, largely as a result, has persistently run a current account deficit. Since the current account is equal to savings minus investment, it would be rational to believe that the solution to America’s current account deficit would be either to decrease investment (irrational and unlikely with “A Great Wall” among other spending plans) or to increase savings. If it wishes to do the latter, the obvious start would be not to slash taxes, as planned, but raise them, instead. This will of course anger Republican voters, a risk he is unwilling to take as he’s already eyeing up a win in 2020.

So ultimately the best option would be to simply do nothing. A surplus in the Balance of Payments is no longer a viable macroeconomic objective for Trump or America and proves why Trump’s vision of making America Great Again is not economically sound. I would recommend “A country is not a company” by Paul Krugman, just in case he hasn’t realised America isn’t the Trump Organisation.

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