President Trump continues to shock his country and the world with outside the box decisions that run counter to economic logic.
And while I truly believe that someone must shake up the Bretton Woods Order, I do not think dynamite to be the appropriate tool to reach such goal.
Indeed, the international institutional framework was built for a world economy where manufacturing reigned supreme. But as services took over and technology permeated every human activity, manufacturing has retreated.
The reduction of manufacturing within the world GDP can be ascertained by its participation in the U.S. economy. Manufacturing as a percentage of GDP declined from 27% in 1950 to 23% in 1970 to 14% in 2000 to 11% in 2009.
Services have filled this gap and increasingly technology has made its entry through services. This essentially means that both incentive as well as restrictive measures to manage the word economy must be adjusted to the new realities.
Protectionist measures that seal competitors out of a country could be a very antiquated and damaging tool.
Given the degree of internationalization of the supply chain there are many ways to circumvent tariffs.
But while the new short cuts are created or unveiled, prices will go up to consumers who will be hit by the measure.
The measure thus ends hurting those who it intends to protect.
Meanwhile those benefiting from the protectionist measure enjoy a newfound spring of rent extraction that freezes innovation and seals in cost increases.
From the political viewpoint, tariff hikes could trigger trade wars which are devastating to the initiator.
To fully understand how this boomerang effect can bring down the soundest economy in the world, one only needs to study the impact of the Smoot-Hawley Act of 1930 which raised U.S. tariffs to the highest level since 1828, sparking a devastating trade war that destroyed 66% of world trade from 1929 to 1934.
Today the results would probably be equally devastating.
In 1929 international trade only represented 5% of U.S. GDP. But by 2014 international trade represented 30% of U.S. GDP. Canada would be even worse off as international trade represents 60% of that country’s GDP.
I thus think that President Trump probably has taken the decision to raise tariffs on steel and aluminum to gain strength and negotiate other significant matters for the U.S. national interest. But the gamble could be dangerous, as a trade induced deflation could materialize in a reelection year.
Published by LAHT.com on March 4th, 2018