Up to now the trade balance of the United States has been determined as a residual item, in other words it is not a target that policy makers and citizens look at but is the result of other variables like GNP growth, inflation, productivity, the value of the dollar, opportunities, preferences, etc. in the US and abroad.

If the Trump administration decides to target a reduction in the trade deficit (as seemed implicit in the campaign) that is a MAJOR change in how the economy operates and I wonder what consequences it would have. Is it even possible? Of course it is possible and many countries (such as Japan in the 60-70s, germany, china) have operated with such policies), but it is a big change in thinking for the US. My economics professors decades ago derided such policies with the epithet 'mercantilist' and refused to even discuss them ("it's not Pareto optimal, so forget it"). But at least some countries (esp. developing countries) have had some success with it as long as the ROW did not follow their example. We now understand such policies have some *benefits* as well as costs.

What form would the trade policy of the Trump administration take?

The most attractive would be an export promotion strategy, like the Asian Tiger countries. I have a friend who believes that the US should set up Special Economic Zones like the Shenzhen area in China, where special rules are applied to favor the establishment of new enterprises that are oriented to export. Low taxes, light regulation, waiver of union rules and so on would be targeted to a small geographic area (near an international transportation hub) with a view to boosting its productivity and export ability. It is a very Asian top-down approach and  have some doubts whether this could be done in the context of Western decentralized, democratic and rule of law traditions. But there is an even bigger problem: where would the exports go to, when there are no longer any large developed countries available as export destinations.

The other strategy would be an import compression or 'onshoring production' strategy. This can be accomplished via Tariffs such as Trump has proposed but would have the side effect of raising the cost of products to US consumers. In addition because one country's imports are another country's exports it would result in a decrease in international trade. Since the mid-2000s international trade has been stagnant (after a period of high growth) so it would not be surprising that after Trump, Brexit, etc, it would turn down. What would be the investment implications of a fall in international trade and investment? Historical periods of decreased international trade are not exactly bullish for the economy.

As you can see, although I do believe the Trump administration will be the greatest and best, I have trouble seeing how the policies can be applied without causing major changes and some kind of negative disruptions in the world economy. I would like to hear from you any ideas how we can analyze the situation in a clear and practical way. What asset prices will be affected and how.

Anonymous replies:

My sense is that the Trump trade policy would work through tax incentives (like the tax incentives now offered by states to businesses who locate or stay there) rather than through tariffs.

West coast dude suggests:

Future increases in prices of consumer products as a result of switching to domestic production are already being reflected in the price of bonds, which are falling in response to higher expected inflation.


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