Explain trade to the secretary of commerce
As students across the country begin their final exams, we are reminded of the sad reality that much of what we learn in school or in other areas of life will eventually be forgotten. Usually, this is more of a nuisance than a problem. Failure to remember the intricacies of Shakespearean literature is unlikely to bother most accountants, nor is a marketer likely to lose sleep over the lost ability to define the theorem of Pythagoras. It is a more serious problem, however, when the Commerce Secretary forgets some basic lessons of international trade.
Appearing at an Atlantic Council event earlier this week, Commerce Secretary Wilbur Ross argued that the Korea-United States Free Trade Agreement (KORUS) should address the United States’ trade deficit United with South Korea. Despite the fact that economists generally agree that the trade deficit is not a good indicator of a country’s economic performance – or, as our colleague Dan Ikenson argues, is not a problem to be solved – the secretary Ross thinks otherwise. In the context of President Trump’s recent visit to Asia, he said the following:
President Trump… stressed the need to rebalance the KORUS free trade agreement to reduce the substantial trade deficit we have with Korea. This deficit has almost tripled to $ 27.7 billion since KORUS took effect. The imbalance between auto imports and exports is one of the main reasons for the increasing deficit. Our auto imports from Korea are almost nine times our auto exports to them. And as remarkable as it may sound, we export to Korea for more dollars in corn and beef combined than we do in cars – it seems odd for an industrialized economy.
The solution he proposed to this “problem” was for South Korea to agree to buy more liquefied natural gas, petroleum, foodstuffs, machinery and industrial equipment from the United States rather than from the United States. other countries.
There are two basic things Secretary Ross is wrong in this reasoning. First, he misunderstands the only true and non-trivial principle of social science, which is Ricardo’s theory of comparative advantage. Second, by focusing only on goods – and cars in particular – it ignores the diversity of the U.S. economy and some of its greatest strengths, such as the service sector. We address the two in turn.
David Ricardo clearly explained the theory of comparative advantage in On the principles of political economy and taxation 200 years ago. He stated:
If Portugal had no commercial ties with other countries, instead of using a large part of its capital and industry in the production of wines, with which it buys for its own use the fabric and material of In other countries, it would be obliged to devote a part of this capital to the manufacture of these goods, which it would thus probably obtain of lower quality than quantity.
The quantity of wine which she will give in exchange for the stuff of England is not determined by the respective quantities of labor devoted to the production of each, as it would be if the two goods were made in England, or the two in Portugal.
England may be so circumstantial that the production of the cloth may require the labor of 100 men for a year; and if she tried to make wine, it might require the work of 120 men for the same time. England would therefore have an interest in importing wine and buying it through the export of fabrics.
Producing wine in Portugal, might require only the labor of 80 men for a year, and producing the cloth in the same country, might require the labor of 90 men for the same time. It would therefore be advantageous for her to export wine in exchange for fabric. This exchange could even take place, although the goods imported by Portugal could be produced there with less labor than in England. Although she could make the cloth with the labor of 90 men, she would import it from a country where it would take the labor of 100 men to produce it, since it would be rather advantageous to employ her capital in the production of wine, for which she would obtain more material from England than she could produce by diverting part of her capital from growing vines to making cloth (paras. 7.13-7.16).
This example highlights an important element of comparative advantage. First, even if a country is the best at everything (in other words, has an absolute advantage), it is even better served by focusing on what it produces best and importing the remaining items. Why? Because absolute advantage does not necessarily equate to comparative advantage, as the latter is based on the opportunity cost of making one thing over another. For example, if you are planning a birthday party with a friend and you are better at both baking cakes and writing beautiful invitations, but only a little better at invitations, it makes more sense that you prepare the cake and have your friend send it. prompts them for you to do both. Not only is this more efficient, but it also saves you the time you would have spent writing those invitations to focus on making an even better cake. Essentially, comparative advantage allows for a greater investment in what you’re good at and, in turn, makes you better at it over time.
This logic easily applies to bilateral trade relations between the United States and South Korea. Benefiting from vast tracts of land perfectly suited to both grazing cattle and growing corn, the United States enjoys a considerable comparative advantage in these products and is the world’s largest producer of both. Deprived of such geographic advantages, but possessing a highly skilled workforce and some of the largest manufacturing companies in the world, South Koreans instead specialize in the production of cars. By focusing on what each country does best and then engaging in trade, the citizens of both countries are better off. Rather than building cars, Iowa’s corn farmers raise crops, harvest them, and then send them to foreign lands where in return they receive cars and other needed goods. Forcing South Korean auto workers to grow their own corn or forcing Iowa farmers to build their own cars would be like living in a less prosperous world.
Secretary Ross also forgets that a country as large and economically developed as the United States is able to enjoy comparative advantages in multiple sectors and industries. As well as being a heavyweight in agriculture, the United States is – perhaps contrary to popular accounts – a manufacturing powerhouse with near-record production. Although the United States does send large quantities of beef, corn and other agricultural products to South Korea – worth $ 6.2 billion in 2016 – these are eclipsed by its manufacturing exports. . Indeed, only one category of manufacturing exports, machinery, saw its exports ($ 6.1 billion) almost equal agricultural products in their entirety. In addition, the United States exported an additional $ 5.3 billion in electrical machinery, $ 5.2 billion in aircraft, and $ 2.9 billion in optical and medical instruments, in addition to vehicle sales. of $ 2.2 billion.
Beyond its massive agricultural and manufacturing sectors, the United States – like most advanced economies – is also increasingly oriented towards the production of services where it has considerable expertise. The Commerce Secretary did not mention that the United States exported $ 21.6 billion in services to South Korea in 2016 and ended up with a trade surplus in this sector of $ 10.7 billion.
Unlike the merchandise trade deficit, Secretary Ross has not indicated that he thinks this particular trade surplus is a problem or that he intends to pressure Americans to buy southern services. – additional Koreans to achieve balance. He shouldn’t either. Rather, the citizens of the United States and South Korea should be left to their own devices to buy the products and services they want and trade as they see fit with minimal interference. Instead of bemoaning a merchandise trade deficit which is more of a statistical oddity than an indicator of economic vitality, or wondering why the United States doesn’t export more than one particular good, Ross had better spend his time remove remaining barriers to trade between the United States. United States and South Korea and let the miracle of comparative advantage work its magic.