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America’s massive trade deficit is destroying significant segments of American industry and eliminating badly needed jobs. This is happening because the United States is slow to recognize an unpleasant reality: The USA does not exist in a world of textbook free trade.

China, America’s largest trading partner has chosen mercantilism and is using the full powers of its government to advance its industries in ways that destroy  American rivals. The United States has turned a blind eye to this reality, but the United States is not powerless, not yet. There are ways to deal with trade deficits.

Tariffs

Tariffs have a long and checkered history reaching back through centuries. In the United States, no discussion of tariffs is complete without mentioning the Smoot-Hawley tariff of 1930. Tariffs can be enacted, repealed or modified by the United States without the consent of its trading partners. Whether that is compatible with World Trade Organization rules, which permits extraordinary actions in the face of severe and continuing trade imbalances, is unclear.

Enactment of tariffs can lead to yet other economic misfortunes.

Tariffs tend to diminish trade, and therefore its benefits. There is also the unpleasant possibility that tariffs could trigger a trade war in which countries react to their trading partner’s tariffs with tariffs of their own. This is the effect that followed the U.S.’s imposition of the Smoot-Hawley tariff. 

Economists fear such an outcome, and that is one reason that tariffs are so unpopular with economists.

Hesitant to chant the invocation and summon something as powerful and unpredictable as a tariff? There is an alternative. It is less well known, and is attributed to Warren Buffett, of the extraordinary returns.

…In a remarkable article that appeared in Fortune magazine in 2003, Warren Buffett described the use of what he called import certificates that could be used to balance trade [much like] a well-known economic concept called cap and trade used to set limits on pollution. With cap and trade, permits to pollute are either issued or auctioned to companies that emit pollutants. Companies must obtain enough permits to cover their emissions. If they can reduce their emissions they can sell their permits to others. Pollution cannot exceed the total of all the permit amounts issued. That is the cap.

When this same concept is applied to international trade it is called balancing trade with balanced certificates, or BT/BC… Unlike ordinary tariffs, the direct effect of BT/BC is not to lower or eliminate trade but to lower or eliminate the imbalance of trade… Imagine that the United States decides to balance trade with the set of countries with which it has persistently large trade imbalances. Such a group could be called China.

Mercantilism is not going to go away

The United States must find a way to deal with its consequences despite the fact that powerful sectors of American society benefit from the present situation and therefore oppose change. If the United States is willing to face up to the reality of mercantilism it will find ways to arrest its downward slide. The country must act before it is too late.

– Ralph Gomory is a Research Professor at NYU, President Emeritus of the Alfred P. Sloan Foundation and former IBM Senior Vice President of Science & Technology.

Quoted sections above via mpettis.com: “Will China Ever Unfetter the RMB?”

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