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– December 14, 2016

Weighing the costs and benefits of free trade
During the presidential campaign, candidate Donald Trump’s chief economic issue was trade. While politicians from both parties recently have focused on the broad benefits to society afforded by freer trade, Trump’s focus was instead on reforming U.S. trade policy for those who feel they’ve lost jobs as the result of previous trade deals. American exporters and consumers, who have benefited from global markets and low prices enabled by free trade, are now considering the possible impacts of a range of policy options available to the new president.

First, it is possible that President-elect Trump could aggressively negotiate changes to deals within the current framework and institutions of international trade. In pursuing this course, he could offer some relief to his anti-trade constituency while only marginally affecting the trade system’s broader benefits. Politically, such a path would also allow Trump to tout individual successes in keeping American jobs while not running afoul of big business or consumers. Many trade experts view this course as potentially beneficial to the country as a whole (see The New York Times, “What Will Trump Trade Policy Actually Look Like? Three Possibilities,” 11/22/16 (www.nytimes.com/2016/11/22/upshot/what-will-trump-trade-policy-actually-look-like-three-possibilities.html).

President-elect Trump has more extreme options that, while keeping many of his core supporters happy, would have tangible negative impacts on businesses and consumers. Presidents have the authority to impose tariffs on imports from individual nations. Specific tariffs levied against China or Mexico might cause some manufacturing jobs to stay in the U.S. (at least in the short term) but could result in higher prices for consumer goods. Moreover, such moves would be likely to precipitate a trade war, in which nations would impose tariffs on U.S. goods, and U.S. exporters would see global markets dry up. This, along with the uncertainty of future policy moves, could adversely affect the stock market and the wider economy. Such negative impacts would only increase if Trump removed the U.S. entirely from trade deals such as NAFTA, the North American Free Trade Agreement; and the WTO, the World Trade Organization.

In considering potential outcomes of the new president’s trade policies, it is useful to review how and why free trade can benefit the country while harming a smaller group of its citizens.

Free trade has clear benefits to American consumers. They can purchase imported goods and services, and international competition leads to lower prices and better products. Trade has a more complex impact on American workers and local labor markets, and it is in this spirit that President-elect Trump’s comments have been taken.

While the benefits of trade flow to all American consumers, the costs are borne disproportionately by some places and sectors. In one widely cited 2013 study in The American Economic Review (www.ingentaconnect.com/content/aea/aer/2013/00000103/00000006/art00004), economists found that a quarter of the manufacturing employment decline 1990–2007 could be explained by Chinese import competition. The markets most exposed to this competition also saw higher unemployment, lower labor-force participation, and lower wages. It can therefore be tempting to think that limiting competition from imports may help stimulate growth in these areas.

However, the story is not that simple. Manufacturing employment in the U.S. dropped from about 18 million in 1990 to 14 million in 2007, before the dip due to the Great Recession, and is further down to a little over 12 million today. Limiting trade will not bring most of those jobs back. Automation and other factors play a much bigger role. While jobs in manufacturing have declined, real manufacturing output rose throughout the 1990s and 2000s and is now roughly at pre-Great Recession levels.

There are other reasons that limiting imports would be a mixed blessing for U.S. manufacturing. One simple reason is that some large manufacturing industries rely on exporting their products, a channel that would likely be cut off or made more difficult under any policy that restricts trade. A primary example is Boeing, which currently sells about $10 billion worth of aircraft in China each year. Overall, nearly 20 percent of U.S. manufacturing output is sold abroad (see www.esa.doc.gov/reports/what-made-america).

Another important point is the frequent absence of a clear line between domestic and foreign manufacturing. In many cases, U.S. factories produce final goods using some foreign materials and parts. A more restrictive trade policy could endanger those products and jobs as well. A 2015 report by the Department of Commerce found that 21 percent of the value added of domestic gross output was from foreign sources. 

For example, the U.S. steel and aluminum industries face serious competition from Chinese metalworking, and President-elect Trump has often used steel as an example of an American industry he is going to fight for. However, protection for these industries makes it harder for large American manufacturers that use steel or aluminum to be competitive. Daniel Pearson of the Cato Institute wrote in April (www.cato.org/publications/free-trade-bulletin/global-steel-overcapacity-trade-remedy-cure-worse-disease), “Such trade remedy measures do great harm to manufacturing companies by making steel in the United States higher in price than in most of the rest of the world. This tends to make downstream manufacturers less competitive, thus encouraging imports of steel-containing products from other countries.” 

According to the Commerce Department’s Economics and Statistics Administration, total manufacturing of cars and parts, machinery, fabricated metal products, and other transportation equipment (mostly aircraft) is about as large or larger than the U.S. primary metals industry. In each of these sectors over 85 percent of gross output is produced from domestic sources. These industries, which make around $2 trillion in products annually, would all be harmed by higher U.S. metal prices. They would either face greater pressure from cheaper imports, or they might also require protection, leading to higher prices for U.S. consumers. 

For every problem that trade restrictions may solve, others are created. 

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