The rest of the world, says US President Donald Trump, is buying far too little from the US compared to what the US is buying from it and this boils down to boosting employment abroad at the expense of US jobs. He has therefore decided to impose harsh duties on US imports. The measure, in his view, will encourage American producers to increase domestic production and hence employment. Note, however, that Trump’s perception of the US unemployment scenario runs counter to the assessment of the Federal Reserve Bank, which has recently raised the key interest rate on the ground that “job gains are boosting income and confidence” in the economy.
What does conventional economics have to offer on the issue? Begin with the simplest possible case. Suppose we import laptops for $m each and export motorcycles for $x each. A 20 percent duty on laptops will raise their price to $1.2 m per piece in our domestic economy, which will incentivise domestic producers to produce more. As far as foreign laptops go, we will continue to import them at $m each, but sell them in the market for $1.2m, with the government collecting $0.2m per laptop to be spent on its own projects. In other words, consumers will be paying $1.2 m per laptop, whether imported or home produced. They will not be happy about the engineered price rise.
A higher laptop price will induce consumers to purchase fewer laptops. Our total demand for laptops will fall, even as our total domestic production of laptops rises! Consequently, our import of laptops will shrink and employment in the domestic laptop industry will rise, just the way Trump wishes it to for the US economy.
Notice though that we buy the imported laptops with the help of our export earnings from motorcycles. If the international prices $m and $x have not been affected by the import duty, then importing fewer laptops at $m each will involve lesser total expenditure than in the past. Our import expenditure in turn is the foreigners’ income and it is this income that they will normally use to buy our motorcycles. The number of motorcycles we end up selling therefore will go down simultaneously.
Consequently, motorcycle production at home falls, along with employment in that industry. Employment wise then, we have a rise in the laptop industry and a fall in the motorcycle industry. The net result, Trumponomics notwithstanding, is unpredictable.
The story doesn’t end here. If the laptop importing economy is large (like America), its imports will be significant too. A fall in American imports could severely dent the world demand for laptops. If so, then the international price of laptops might actually fall, relative to the price of motorcycles. This means that to purchase each motorcycle from US, foreigners will need to give up more laptops, which amounts to a rise in the price of motorcycles. There is additional reason now for the demand for US motorcycles to fall. The impact on net employment could be negative as well as severe.
In our argument, we have been assuming the value of imports to be exactly equal to that of exports. In reality, US runs a trade deficit ($568.4 billion in 2017, according to the Bureau of Economic Analysis). Tariffs could well reduce this deficit but, as argued, a simultaneous fall in employment cannot be ruled out. If other countries (such as China, India and so on) retaliate, as they are likely to, their own economies too could run into problems.
Trumponomics may well slow down the world economy as a whole, just when it is showing signs of recovery.
Dipankar Dasgupta is former Professor of Economics, Indian Statistical Institute, Delhi and Kolkata