Ep60 “A Trade Deficit? More Like a Capital Surplus” with John Cochrane

Summary of All Else Equal Podcast: Trade Deficits and Tariffs

Key Concepts:

• Trade Deficit vs. Capital Surplus: The inverse relationship between the two.
• Mercantilism: The belief that exporting more than importing is beneficial.
• Fallacy of Composition: The error of assuming that what is good for an individual is necessarily good for the whole.
• Savings and Investment: The fundamental drivers of trade deficits.
• Unilateral Free Trade: The idea that a country benefits from free trade regardless of other countries' policies.
• Supply Chains: The interconnected network of businesses involved in the production and distribution of goods.
• Stagflation: A combination of slow economic growth and high inflation.

Trade Deficits and Capital Surpluses

• A trade deficit occurs when a country imports more goods and services than it exports.
• John Cochran argues that policymakers are fixated on the trade deficit due to mercantilist beliefs and fallacies of composition.
• Jonathan Burke jokes about renaming the trade deficit to the "capital surplus" to highlight the inverse relationship.
• A trade deficit is always matched by a capital account surplus. When a country has a trade deficit, it is essentially borrowing from other countries.
• If China sends goods to the US, they receive dollars, which they then use to invest in US securities. This investment is the capital account surplus.
• Countries like China and Japan with aging populations may optimally invest abroad to save for future consumption needs.
• The overall trade deficit is determined by the difference between savings and investment within a country.
• Distortions in savings and investment policies, such as China's lack of a welfare state and the US government's borrowing for consumption, can affect trade deficits.

The Impact of Tariffs

• Tariffs are taxes on imported goods.
• The Trump administration imposed tariffs to reduce trade deficits and protect domestic industries.
• John Cochran believes that tariffs are an answer wildly in search of a question.
• Tariffs on avocados from Mexico will not stop China from invading Taiwan.
• Tariffs are unlikely to solve the underlying issues facing disenfranchised communities.
• The economic damage of a tax rate is proportional to the square of the tax rate. A 100% tariff is much more damaging than a 10% tariff.
• Tariffs can disrupt supply chains, leading to higher prices and job losses.
• The uncertainty created by tariffs can discourage investment.
• Tariffs can lead to stagflation, bankruptcies, and a recession.
• Tariffs can damage relationships with other countries, making it difficult to cooperate on other issues.
• Janet Yellen called tariffs the greatest unforced error in economic policymaking.
• Tariffs can disproportionately affect the cost of goods, leading to inflation.
• Many imports from China are industrial inputs and manufactured goods. Taxing these goods can hurt US businesses.
• Under current tariffs, businesses do not get credit for what they have exported. If a part is in a car and it goes back across the border five times, you tariff it five times.

Historical Perspective and Alternative Solutions

• Historically, countries that are open to trade have been more prosperous.
• Countries that have erected tariff and protection barriers have experienced stagnation and lack of innovation.
• Examples of countries that have suffered from protectionist policies include India, Europe, and the US.
• The China shock was very small.
• There is an underemployment problem in the US, but it is not from lack of jobs.
• The people who've been sitting around for ten years and cashing a government check are not able to take 12-hour day jobs assembling iPhones or even the high-tech manufacturing they're doing.
• The US should focus on addressing the social problems and lack of skills that prevent people from participating in the labor force.

Geopolitical Considerations

• Tariffs may be used as a negotiating tactic to lower tariffs globally.
• However, it is not clear that this is the Trump administration's goal.
• The administration may be aiming for zero trade deficits with every country.
• Tariffs can damage relationships with allies, making it difficult to cooperate on other issues.
• Tariffs may be driving the world into China's hands.
• The US bailed out of the Trans Pacific Partnership, now they're on their own.

Conclusion

• The podcast concludes with a discussion of the potential negative consequences of tariffs, including economic damage, political fallout, and damage to international relations.
• John Cochran expresses concern that tariffs will lead to a recession and undermine the Trump administration's other policy goals.
• The speakers emphasize the importance of understanding the relationship between trade deficits, capital surpluses, and economic well-being.
• The podcast highlights the complexities of trade policy and the need for careful consideration of the potential consequences of tariffs.