Teaching international trade policy at Colby has never been more fun for me than it has been this semester. It seems as if every month brings with it a new trade-related dispute of one sort or another, from U.S. claims of steel dumping to a simmering trade war with Europe over bananas.

Most likely, policy makers around the world have become increasingly active in their conduct of trade policy recently simply because they recognize the pedagogical value of real-world examples in economics courses. Students and teachers of economics should be thankful! However, several important questions naturally arise when confronted with this largesse. What, exactly, are these trade disputes really about? What lies behind this resurgence in confrontations over trade policy? Nearly all economists agree that trade protection almost always reduces overall welfare; that is, that tariffs or quotas on imports will hurt more than they will help. Then why have policy makers been moving so strongly toward protectionism? And finally, how much do we really need to worry, either about the underlying causes or about the disputes themselves?

First things first. Let’s take a closer look at a few recent examples of increasing tensions between nations over international trade issues.

A Tariff for Every Occasion

The conflict that wins the award for conjuring up the most amusing images is certainly “The Banana War,” between the United States and European Union (EU). The EU has restricted the import of bananas from Latin America, in order to favor bananas from several Caribbean and African nations that used to be former colonies of Great Britain and France. Protesting, several Latin American countries and the U.S. (whose firms own most Latin American bananas) filed a complaint with the World Trade Organization (WTO) —the international body designed to resolve trade disputes between member nations — and recently the Clinton administration announced that it would impose 100% import tariffs on a range of European goods, from bath oils to coffee makers.

To repay this kind gesture, some European policy makers have threatened to retaliate against the U.S. by raising tariffs on various American products. The effects of the tariffs announced by the U.S. government will thus be to significantly harm the associated industries in Europe, dramatically raise the price of those goods for American consumers, and potentially spark a tit-for-tat trade war with Europe. As entertaining as a banana war sounds, most observers would probably agree that such an outcome is less than ideal.

With these threatening noises still echoing across the Atlantic, last month the U.S. announced yet another set of tariffs, this time on imports of steel. The steel industry in the United States has faced rapidly growing competition from cheap imports over the past two years; in fact, imports surged

by over one-third in 1998 alone. The industry claims that the reason for this rise is that several foreign countries, notably Russia, Brazil, Japan, China, and South Korea, have been dumping or selling steel in the U.S. below cost. Last month the U.S. government agreed with the steel industry and announced that it would impose import duties on steel from those countries. Again, the results will be higher prices for all consumers of steel (namely people buying new cars or household appliances), the costs of which will almost certainly more than offset the few thousand jobs —out of a total of more than 100 million jobs in the U.S. — that the tariffs are intended to save.

Another recent trade-related news item has been the Clinton administration’s negotiations with China over their accession to the WTO. Ever since the late 1980’s China has consistently expressed its wish to be a member of the organization, which contains over a hundred of the world’s nations. Yet public sentiment, and the sentiment of a substantial number of U.S. legislators, seems opposed to allowing China into this group of countries. The reasons are numerous, from complaints about systematic human rights abuses in China to concerns over the massive trade surplus that China has with the United States — as of this spring, even larger than Japan’s.

In these cases and many others, protectionist voices in the U.S. seem to be gaining sway. The costs of such protectionism will be higher prices for consumers and businesses in the U.S., and a greater likelihood of sparking a trade war, with retaliation and counter-retaliation for tariff increases. The last time the world witnessed such a trade war was in 1930, and it is widely credited with helping to cause, or at least exacerbate, the Great Depression.

Why Protectionism? Why Now?

The curious need only open up the latest issue of a news magazine like The Economist to uncover even more tales of newly explosive potential trade conflicts: passenger aircraft, shrimp imports, and hormone-treated beef are but a few. Truly, the voices of protectionists in the U.S. seem to be getting louder by the week. But I think that one consideration suggested above can provide some insight into the causes of this trend. Perhaps a leading culprit behind this trend is the rapidly widening U.S. current account deficit.

The current account deficit, which is the difference between the United States’ exports and imports of all goods, services and investment income, has increased from an already large $167 billion in 1997 to a record $233 billion in the past 12 months. The main reason for this, of course, is that the U.S. economy has been booming, with the income and wealth of Americans growing rapidly. This in turn enables U.S. residents to buy more imports, whether they are Taiwanese computers, vacations in Mexico, or German beer. Simultaneously, much of the rest of the world has been faced with rather difficult (in some places downright awful) economic conditions, in part due to the financial crisis in East Asia last year. These tough economic times have had two effects. First, foreign producers have reduced prices in a desperate attempt to increase sales and stay afloat. Second, the world has had to cut back on its consumption of U.S. products, and so U.S. exports have been stagnant or even falling. The result of this combination is a dramatically increasing trade deficit.

Many voters, commentators, and policy makers in the U.S. have noticed this, and come to the conclusion that the deficit must be a symptom of unfair trade practices by other countries. Their prescription is therefore to retaliate by imposing tariffs. They hope that this will reduce imports into the U.S., and thus reduce the trade deficit. And if only the U.S.’s trade deficit were not so great, the U.S. economy would be better off, they believe.

For example, steel industry supporters explicitly cite the growing trade imbalance in steel as evidence that foreign steel producers are unfairly dumping steel in the U.S. Not by coincidence, the countries accused of dumping steel are also those with which the U.S. trade balance has deteriorated most over the past year.

Likewise, discussions about China almost always include concerns over the vast trade deficit that the U.S. runs with China. On the other hand, countries that have had falling trade surpluses with the U.S. have inspired little recent protectionist activity. These are symptoms that the resurgence of trade protectionism in the U.S. may largely be due to American insecurity about widening trade imbalances.

The Other Side of the Current Account Deficit

But is the current account deficit such a bad thing? As mentioned above, the deficit is fundamentally a function of the fact that Americans feel wealthy, and thus wish to buy lots of goods from all around the world. In essence, the U.S. is currently able to purchase more goods than it produces, because goods from the rest of the world can make up the difference.

But suppose for a moment that the U.S. did not run a current account deficit, so that the country must import only as much as it exports. Unfortunately, this would drive up prices in the U.S. For example, if there were fewer cases of German beer for sale in the U.S., then people would bid up the price of that scarce beer, causing it to rise. Likewise, with fewer imports of all sorts in the U.S., prices of nearly all goods would rise. Would that be a good thing? Most people would agree that higher prices (which, incidentally, typically hurt poor people even more than the average) would not be.

In addition, consider what would happen to long-term business investment in the U.S. Currently, firms are able to buy lots of goods that will help to make them more productive over the coming years, from airplanes and computers to new pizza ovens. But if the U.S. reduced spending in the aggregate, so that the country bought only as much as it sold, then businesses would be forced to buy fewer such investment goods. This would cause firms to be less productive in the future, since they would have to continue working with deteriorating and outdated equipment. Future production by the U.S. economy would surely suffer.

In fact, as the current account deficit has grown, so has spending by businesses on investment goods. Such business spending has risen by 20% in just the last two years, and is probably even a major cause of the current account deficit. Such strong growth in business investment is a sign that U.S. firms will continue to increase productivity and output over the coming years, bringing steadily rising wealth.

What is to be done?

So the large and growing trade imbalance that the U.S. is experiencing with the rest of the world is not necessarily a cause for concern. Yet it is certainly true that whenever a country engages in trade, there will be winners and losers. A compassionate society may choose to help those who suffer from international competition, a decision with which I would personally agree. But that issue should not be confused with concern about the U.S. current account deficit more generally, which may be a very good thing for the U.S.

Nevertheless, the fact remains that the two issues have become conflated for many policy makers, rightly or wrongly. This remains the one true danger of the U.S. current account deficit, in my opinion. If current account deficits lead to rising levels of trade protectionism, then they are in fact something that we need to worry about. I’m not presuming to make a judgement in any specific trade dispute. Each case should be evaluated based on its own merits or flaws. But it does seem that the increase in protectionism is largely motivated by the growing U.S. trade deficit. I believe that the connection between the two is logically invalid, but for whatever reason it does seem to exist politically, and thus must be addressed.

Given my interpretation of trade protectionism in the United States, the solution is a difficult one. The perceived problem of the U.S. trade deficit must be revealed as the red herring that it is. Individuals must recognize that the country benefits more from international trade than it loses, even (and perhaps especially) when the country can import more than it exports. Until this is widely recognized, I fear that the unfortunate Banana Wars will merely be a prelude to greater battles yet to come.

Kashif Mansori is an Assistant Professor of Economics at Colby where he teaches Open-Economy Macroeconomics, and Principles of Economics.

The Economist	The Great Deficit Scares : The Federal Budget, Trade, and Social Security
The Financial Times	Against the Tide : An Intellectual History of Free Trade