The economic effect of a potential trade war is a timely issue given the anti-trade stance embraced by both presidential candidates.
The most recent examples of trade wars are mostly limited to the Smoot-Hawley Tariff Act of 1930. Nearly everyone who has studied this period concludes that it played a leading role in deepening and lengthening the Great Depression.
Still, there are a number of Americans who think global trade a problem. Thinking about the facts of the issue might help them to change their minds. I offer two important sets of facts, and a conclusion.
First, despite the large share of commerce that crosses international borders, Americans now spend a larger share of their incomes on local goods and services than at any time in history. This is important, because the economic impact of trade for a city is the same if the trading partner is across the state or across the ocean.
In the mid-60s less than half of income was spent on goods and services produced in the same county or city. Today it is closer to 70 percent of household spending. Thus, all the breathless, pseudo-intellectual chatter about growing globalization is mostly the mindless description of a mirage.
Second, there is an asymmetry of trade that actually favors the United States. The fundamental insight of trade, be it within a household or in global markets, is that one trades on their comparative advantage. So, by doing what you are relatively good at, and trading with someone else doing what a they are relatively good at, both parties are better off.
The American comparative advantage is in high value goods and services. United States is a highly advanced economy, with robust capital markets, quality public infrastructure and a workforce that enjoys maybe $125,000 per person in public investment before they graduate from high school.
We typically make highly sophisticated products, and import less advanced products. Cheap clothing, Happy Meal toys, inexpensive auto parts, or 50-year-old technologies like HVAC units are typically made overseas and sold to us. So what would happen if all this trade stops?
Well, nearly everything would become more expensive due to the loss of the cost benefits of comparative advantage. However, there are businesses in many countries who can }provide the high quality goods we manufacture such as Germany, Canada, Great Britain and France. So, a trade war affecting only the U.S. is a huge windfall to businesses in other advanced economies. There will be great demand for their goods and services in markets where Americans formerly dominated.
But how about the cheap products? Well, there is not a ready and waiting American workforce and investors waiting to compete on the production of cheap goods or American consumers ready to pay more for them. So what will be the net effect of ending trade?
Well, the most likely result is that American exporters will be pummeled, losing business in places where they now compete effectively. Meanwhile, American consumers will face higher prices and fewer consumption choices.
So, in short, for Americans a trade war will really look a lot like a deep and lengthy recession. If we’re lucky.
<em>Michael J. Hicks is the director of the Center for Business and Economic Research and an associate professor of economics in the Miller College of Business at Ball State University. Send comments to [email protected]</em>