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Squeezing a Balloon

September 26, 2019 Leave a comment

Via the Financial Times I have read the Asian Development Bank Asian Development Outlook 2019 Update. The outlook has an interesting section on the impact of the US-China trade war on the region. Let me simply quote the relevant paragraph: “Recent trade data also provide evidence of trade redirection. In the first 6 months of 2019, US imports from the PRC fell by 12% from the same period in 2018. At the same time, US imports from the rest of developing Asia rose by about 10%, with notably large increases of 33% for Vietnam; 20% for Taipei,China; and 13% for Bangladesh” (page 14). I also copied and pasted the figure in the following page:

This was to be expected. Of course trade diversion is not automatic, nor costless. Supply chains need to be reorganized, bottlenecks may appear. But it is obvious that as long as US demand for the goods produced abroad remains strong, if the price of these increases in China, the demand will look elsewhere. Now, the US has been recording substantial negative net lending (the sign of an excess of domestic demand over supply) since at least the early 1990s:

The source of this excess demand has not always been the same. Sometimes corporations, rarely households (most notably in the run-up to the crisis), and most of the times the government.

In particular, in recent years households have experienced excess savings, initially joined by corporations which then gradually went to equilibrium. The government is keeping demand high, and as a consequence the trade deficit alive.

The tariffs on China, in this context, are just like squeezing a balloon. As long as US domestic demand remains strong, compressing Chinese imports simply pops imports from Vietnam, or Bangladesh, or who knows what other country next. As long as American excess demand will persist, somebody elsewhere will provide the supply for it. Reducing bilateral trade deficit with China is not a solution to persistent excess domestic demand.

Of course, the US could impose barriers to imports from all countries. This would solve the problem and reduce the trade deficit. Higher import prices and competition between households, firms and the government, would reduce purchasing power and, together with excess domestic demand, the welfare of American voters. Mr. Trump should try this before November 3rd, 2020.