Trade policy should boost GDP, not reward specific industries

The threat of new tariffs on auto imports hit share prices of some foreign carmakers last Thursday, but broader equity markets shrugged off the possibility of a renewed trade war. Indeed, there were only modest changes in stock prices of U.S. carmakers that presumably would benefit most from auto tariffs.

Market participants appear to have quickly realized that the notion of auto imports as a threat to U.S. national security is a stretch. The Commerce Department will take several months to work through an investigation, but this threat appears to be more of a bargaining tactic than a policy tool.

Yet, even if auto tariffs do not materialize, there is evidence that the trade actions already taken over the past year are affecting the U.S. economy — and not for the better.

{mosads}In its most recent meeting, The Federal Reserve’s interest-rate-setting committee, the Federal Open Market Committee (FOMC), amid a host of positive observations of an improving U.S. economy, noted that businesses in many parts of the country were reporting rising costs of “steel, aluminum, lumber, and petroleum-based commodities.”

It is possible in principle for rising costs of important inputs used across manufacturing and construction to represent good news. After all, a booming U.S. economy would be expected to drive up prices of steel and lumber.

In this case, car makers and homebuilders might be paying more for raw materials, but doing so to fill orders that were the embodiment of rising demand and higher incomes.

The U.S. economy indeed looks to have shifted into a higher gear, with credible estimates of second-quarter GDP growth ranging upward of 3 percent. The Atlanta Fed’s “GDP Now” tracker even suggests 4.1-percent Q2 growth, potentially defying early-2018 skepticism of a presidential vow to reach the 4-percent mark.

But rather than being the artifact of good news, the Fed’s observation more likely represents the undesirable consequences of tariffs on lumber and steel.

These actions mean increased costs for firms, translating into some combination of lower profits and higher prices for cars and homes — and thus fewer of these items purchased and constructed than would have been the case without the tariffs. This is unfortunate.

The U.S. economy is doing well even with the drag from these trade actions, but the tariffs reduce the purchasing power of American families’ incomes and mean less spending, ultimately reducing overall business investment and job creation.

To be sure, firms sheltered by trade barriers might benefit, but the overall economy is worse as a result. There are many more workers whose jobs involve the use of steel and lumber than its production.

The Fed’s observation on rising steel prices suggests that the tariffs are biting despite the exemptions that had been expected to mute their impact. The lumber tariffs are especially pernicious in their negative effect on lower-income families, since higher costs for homes put upward pressure on apartment rents.

The irony is that the administration is in the midst of some important positive steps in its trade agenda, with the prospect of arriving at outcomes that will strengthen the U.S. economy and that should receive bipartisan support.

Pursuing Chinese practices regarding technology transfer through a World Trade Organization complaint and Chinese violations of U.S. intellectual property rights under Section 301 are foremost among the administration’s potentially beneficial trade actions.

Success on these dimensions would mean higher U.S. incomes as China pays for the fruits of American innovation. An important argument for our negotiators to make is that improved protection for intellectual property is fundamentally in China’s own interest, as that nation has steadily become a center for research and innovation rather than merely assembly.

It will not be long before Chinese entrepreneurs seek their government’s assistance as their own intellectual property is misused by firms in other emerging-market countries. If Chinese officials remain too slow to realize this shared interest, American trade actions are appropriate to drive forward to a mutually beneficial outcome.

Improvement of the North American Free Trade Agreement (NAFTA) with Canada and Mexico makes sense as well, including updates of the rules of origin for items such as autos that remain a key stumbling block in the negotiations.

After all, the Mexican economy is far more advanced, and the auto sectors of the three countries are far more integrated than when the agreement went into effect in 1994.

The idea of a five-year sunset to NAFTA would mean unnecessary uncertainty that detracts from the benefits of the agreement, but the idea of an ongoing review is fine so long as businesses can be assured of the stability of the fundamental aspects of the agreement.

The legal timetable on the U.S. side means that congressional action on a revised agreement more likely would take place in 2019 rather than in the lame-duck congressional session this year. This is fine. Reaching an improved NAFTA that means more trade within North America should not be rushed.

Even if the House flips in January, newly-empowered Democrats should support a trade agreement that fosters mutual economic growth rather than giving in to the potential desire to deny President Trump an accomplishment.

Indeed, an outcome in which a Democratic-controlled House of Representatives votes in favor of a Republican-negotiated NAFTA revision would make the trade agreement more politically stable.

The key to the U.S. trade agenda thus is to stay focused on policies that support GDP growth. Ultimately what matters more than the magnitude of any bilateral trade balance is the strength of the overall economy.

If the United States enjoys sustained growth at a 3-percent pace or better, then U.S. manufacturing firms will prosper and workers will benefit from job creation and rising wages, even while imports go up. That would be the best sort of shared prosperity, and one in which trade policy can make a positive contribution.

Phillip Swagel is a professor at the University of Maryland’s School of Public Policy and a senior fellow at the Milken Institute. He was assistant secretary for economic policy at the Treasury Department from December 2006 to January 2009.