Trade confusion

My last post sparked a critical post from Tim Worstall and extensive comments both on his post and mine. Tim's criticism was over my use of the term comparative advantage, and I shall not address that in this post. But the discussion on both posts was fascinating. Nearly all of it missed the point.

Basically, people confused international trade with national trade policy. They are not remotely related. National trade policy that aims to achieve a sustained trade surplus does not increase trade. Indeed it may actually reduce it.

Firstly, let me address the (partly justified) criticism that I had incorrectly described international trade as zero-sum. Clearly, from the point of view of individual agents trading with each other, this is not true. One business's exports are not bought at the price of another's: people that fail to compete in one market will look for other markets where they can be more successful, so overall, competition tends to increase global trade.

But from a macroeconomic point of view, international trade is zero sum. If one country has a trade surplus, other countries must have trade deficits to the same value. The absolute volume and value of trade across the globe may indeed increase as businesses compete with each other for domestic and export markets, but that makes no difference to the nature of trade between countries. Whatever the scale of global trade, national trade surpluses and deficits always sum to zero. An increase in trade surplus by one country always means an increase in trade deficit somewhere else.*

So a national trade policy that aims to create a trade surplus is no more capable of increasing the volume or value of trade than a policy that aims to create a trade deficit. Mercantilist policy that depresses domestic demand in order to push businesses towards exporting does not increase trade. All it does is move it out of the country. Total economic activity across the globe includes domestic as well as international trade. If a trade surplus is achieved by depressing domestic demand, therefore, it has simply driven trading activity out of the country. It has not increased trade.

Similarly, mercantilist policy that imposes tariffs on imports or depresses the value of the currency in order to discourage imports and encourage exports does not increase trade. It discourages the economic activity of exporters in other countries. Clearly, if one country is discouraging imports by means of tariffs or currency interventions, exporters in other countries will look for other markets for their goods. But if the majority of countries impose tariffs and/or depress currency values in order to discourage imports, export markets are seriously diminished. Resource-rich countries with a wide diversity of production would probably survive this, but smaller countries and those with resource limitations would suffer. And worldwide, there would be a considerable decline in economic activity. There would, in short, be global depression.

Because tariffs and exchange controls reduce trade, they are frowned upon by international organisations and are the subject of numerous summit meetings and international agreements. The world is now a much less protectionist place than it was in the past, and we are in general much richer for it. Admittedly, those riches are not equally distributed: but that is not a reason to return to the protectionism of old.

However, the subtler form of mercantilism - where domestic demand is deliberately repressed in order to push businesses towards exporting - also reduces trade. This is because when domestic demand is repressed, for example by forcing down wages, imports fall as they become unaffordable. It is the equivalent of imposing tariffs on imports. If only one or two countries operate in this way, exporters turn to other markets as they would if faced with trade tariffs, although it is possible - if the countries concerned are large - that global GDP could be lower than it would have been if these countries were less repressive. But when the majority of countries repress domestic demand in order to promote exports, the inevitable result is a reduction in global economic activity.

Whatever means is used to discourage imports - tariffs, currency interventions or repression of domestic demand - the effect is to discourage economic activity. As long as the rest of the world is willing to absorb trade surpluses by running trade deficits, there may be no net fall in global trade. But for the world as a whole to achieve its output potential, countries must be as willing to import as they are to export. Therefore the desire of some countries to run persistent trade surpluses is damaging to the global economy.

Of course, some countries have trade surpluses simply because their products and services sell better than those from other countries. But to return to where we started - this is where the behaviour of individual agents becomes important. Businesses that can't compete in one market look for others where they can be more successful. In the absence of artificial constraints on trade, therefore, we would expect that national trade surpluses should be temporary: they represent market inefficiencies that should be competed away (in a financial market, they would be arbitrage opportunities). If they persist, therefore, it is because in some subtle way balanced trade is being discouraged. Therefore, countries that run persistent trade surpluses - even if they don't intend to - require structural reforms.

A persistent trade surplus is NOT an indicator of economic strength: on the contrary, countries that are very export dependent are very vulnerable to exogenous shocks. And it does NOT improve global trade. Not ever.

* UPDATE. Jonathan Finegold has pointed out (see comments in his post) that since the deficit position confers as many economic benefits as the surplus position, international trade is not zero-sum even from the macroeconomic position. I would accept this if it were not for the moral values assigned to "deficit" and "surplus" that I identified in my previous post. When the prevailing belief of policymakers is that policy should be designed with the objective of achieving trade surplus, the game is zero-sum, since achieving this objective is only possible if others fail to achieve it.


  1. so what are the reforms

    I suggest education

    When workers realize that they producing goods in return for credits to buy in trade deficit countries
    they will buy from them

  2. Is international trade a kind of iterated prisoners' dilemma, where it's always in the self-interest of any individual nation to be mercantilist (due to accumulating cash reserves and reduced unemployment) but where the gain for the mercantilist nation is less than the loss to its victims?

  3. Continuing your thoughts (I think), Germany is a good example of the importance of currency. Germany didn't run persistent trade surpluses until they were on the Euro. Until then consumers in other nations wanted efficiently produced German goods, for which they would pay in Deutsche Marks. That demand for the German currency made it stronger than other currencies, making their goods relatively more expensive in foreign nations and limiting exports, while making imports relatively cheap in Germany. It is hard for a floating currency to have an aggregate trade imbalance for long.

    When the Euro was adopted the currencies within most of Europe were no longer floating with each other. German goods were no longer expensive. To pay for the goods, Germany in essence lent money to its importing neighbors and this money was invested in real estate since that is a sector in which German exports cannot compete. Real estate bubbles are a common outlet for the foreign investment that comes from trade surplus nations.

    On the other hand the People's Bank of China creates trillions of Yuan to buy US dollars from Chinese exporters, and then uses those dollars to buy US Treasuries and Agency MBS. This currency manipulation essentially exports jobs, consumption, and inflation from the US to China. People thought Greenspan was a maestro for low interest rates and low inflation when they should have thanked the PBOC.

    A nation with persistent large trade surpluses probably doesn't have a floating currency. Free trade without open currencies isn't fair trade. Because most people don't understand the role of currency, they mistakenly turn it into a moral story, as you have pointed out. The irony is that US capitalists support the People's Bank of China.

    Americans have been taught to fear how they will repay the Treasury debt owned to foreign nations. What isn't appreciated is that 75% of Treasuries held in foreign nations are owned by foreign governments and their agents, which should raise the question of how these governments got the dollars in the first place.

    More importantly, how will the foreign governments ever use the US dollars? Let's say that tomorrow the US paid off $1 trillion in Treasuries to the PBOC. What would the PBOC do with $1 trillion (ignoring currency and balance sheet implications)? A central bank doesn't buy goods from the US, nor will they disperse it to their citizens to spend. They could buy commodities or hard assets, but more than likely the PBOC will endlessly recycle their dollars into US bonds. So the second irony is that the largest owners of Treasuries are communist central bankers that can't figure out how to spend US dollars.

    1. Ah. I shall be writing about this shortly, Kent. Believe me. China has a use for US Treasuries, and for dollars. As does the entire world.

  4. Keynes' great failure is he never examined industrialization critically as to whether it was a going concern or not, he simply assumed it was and began his majesterial rationalizations from that starting point. Assume the can opener: Keynes' entire career was spent trying to square a circle, to straddle the chasm that yawned at his feet -- to somehow prove that industrialization could be made to 'work' -- and he failed, ultimately. He had to, entropy always wins, there are no free lunches anywhere, only illusions; industrialization does not produce, it reduces; it is theft from the community which produces and is ultimately the killer of the community.

    "The world is now a much less protectionist place than it was in the past, and we are in general much richer for it. Admittedly, those riches are not equally distributed: but that is not a reason to return to the protectionism of old."

    And so, real capital is destroyed, the residue or ash left over after capital is burned is called 'money', we believe in our hearts that we are better off but instead we are utterly and entirely bankrupted by our grasping and burning process. All that remains is to sweep up the debris ... pack up our home planet and cart it off to the dump ... and bury the dead if we can.

    No! No! No we need no more trade we need no more 'wealth' we have had enough! More wealth is no different from more machine guns or more methamphetamines, more insanity, more violence; our unending war against our life support system ... more cars and 'luxury', insatiable demand for resource capital ... so that we consume ourselves in the all-devouring fire, that our children and our grandchildren ... and their children and grandchildren hate us with every molecule of their being and damn us with every breath cursing us for giving them life ... stealing away the means to live it ... all this so that we might have a ... current account surplus. Good grief!

    God in the Bible would give us damnation, he would turn us into pillars of salt for our pride. But we killed god and made it into an amusement park ride, we get to live the consequences of our stupidity, instead.

    1. "we believe in our hearts that we are better off"

      Well, I am. And so is my wife.

    2. I think you make a good point unless true values are placed on all parts of the trade equation then the ability of any Nation/company or persons drags down potential further trade


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