No matter how many times President Trump reverses, or “pauses,” tariffs against other nations, a global trade war seems imminent. This trade war would be reminiscent of the one following the Smoot-Hawley tariffs of 1930, which worsened the global economic downturn following the 1929 crash of stock markets around the world.
The world has seen enough economic crises over the past decades: the Latin American debt crisis of 1982, the Mexican Tequila Crisis of 1994, the Asian financial crisis of 1997, the global financial crisis of 2008 and the Covid-19 pandemic of 2021. A trade crisis could be at least as devastating as any of these. The recovery from Covid-19 came relatively quickly, thanks to the rapid development of vaccines, but unraveling a global trade war would surely take much longer.
We do not need this. We have had enough crises over the past 40 years. And the ostensible goals causing the United States to start this trade war—bringing back manufacturing jobs and running trade surpluses with every nation on earth—are unrealistic to the point of absurdity.
It doesn’t have to be this way. There are less drastic ways to address trade deficits. When policymakers, particularly in South America, spoke of tariffs as a policy instrument for correcting trade deficits, the late Rudiger Dornbusch of M.I.T. used to chime in at academic conferences, “For this reason, God created exchange rates.” In other words, a mild depreciation of the exchange rate—making export goods less expensive on world markets and imported goods more expensive for domestic consumers—could alleviate chronic trade deficits and promote both foreign and domestic investment in more competitive American exports.
The advantage of a currency depreciation is that it is not directed against any one country or small group of countries but rather is more universal in its impact—both in terms of affected countries and types of commodities. In international trade terms, exchange rate depreciation is a much less distortionary or biased policy instrument than the use of bilateral tariffs.
Exchange rate depreciation is only one instrument for correcting the trade balance. Keep in mind that imbalances in the global trading system reflect differences in how much the citizens of different nations keep in savings and invest. Countries that save more than they invest absorb fewer of the world’s resources than they produce, resulting in positive trade balances. In contrast, countries that save too little relative to investment consume more of the world’s resources than they produce, leading to chronic trade deficits.
The U.S. savings rate—both public and private—is 18.6 percent of the gross domestic product. Japan has a rate of 22 percent, Germany has 29 percent, China has over 40 percent, and Singapore has around 47 percent. So the root cause of the chronic U.S. trade imbalance is macroeconomic: We save too little relative to our major trading partners.
One policy response would be to implement a federal consumption tax, or a general sales tax, as Japan and many European countries have done. In the United States, the only federal sales tax is a gasoline tax used to fund interstate highways.
The problem with a broader consumption tax is that it is politically sensitive. Such a tax would disproportionately affect the elderly and lower-income groups, who consume a higher proportion of their income. However, such a system can be made more progressive by taxing basic food and clothing items, particularly for children, at lower rates and taxing luxury items at higher rates. Specific services such as health care and public transportation can be exempt from such taxes. The advantage of such a consumption-based system is that it would engender a culture of saving, with greater taxation on what we take out of society and less taxation on what we contribute to society through labor.
A better Social Security system
Another policy to promote savings and a more widespread culture of saving is to reform Social Security, using the model of a national pension scheme like Singapore’s Central Provident Fund. Singaporeans are required to contribute 20 percent of their monthly salary into this fund, which is managed as a sovereign wealth fund and invested globally. They may draw from the fund for housing, education or retirement income. Not surprisingly, Singapore has a very high savings rate and chronic trade surpluses.
Naturally, transitioning from the current pay-as-you-go Social Security system would require significant political negotiation, basically a grand bargain between the two major political parties. The reason is that one generation—those currently working—would effectively have to pay a double tax, both to support the current generation of retirees as well as to save for their own retirement. The ideal time for such a transition would have been the 1990s, when the economy was booming and federal debt was declining. But this change would bring long-term major benefits whenever the United States chooses to undertake it. We should remember that our current Social Security system was designed in the aftermath of the 1929 stock market crash. Let us hope that it does not take another major crisis, brought on by a trade war, for a much-needed reform of our Social Security system.
Certainly, the United States has glaring trade imbalances that must be addressed. But to achieve this goal, there must be a corresponding correction in global savings imbalances across major trading partners. This is politically difficult, and it will take time, but it can be done. A mild depreciation of our exchange rate, coupled with a consumption tax and Social Security reform to promote greater saving, would go a long way toward leveling the playing field in global trade without the repercussions of a trade war.
We should also be under no illusion that our industrial and manufacturing base will return to the idyllic 1950s. The massive changes from that time are largely due to technological advances. For example, the U.S. textile industry shrank once emerging markets gained the ability to refine their own home-grown cotton into finished products. They no longer needed to export raw cotton or unrefined cloth to the United States for final processing. Similarly, the steel industry in Pennsylvania declined with the advent of steel recycling technology, which allowed for more efficient and environmentally friendly production closer to the end users.
Technological changes will continue. But continued global trade, rather than isolation through tariff walls, provides linkages and discipline for both management and workers to learn from the best practices of competitors.
[Read next: “What Catholic social teaching says about Trump’s tariffs”]
