Here’s a note to my good friend, the radio host Ross Kaminsky.
Ross:
Thanks for your email in response to my criticism of Jordan McGillis for his failing to recognize that increased foreign direct investment into the U.S. tends to cause U.S. trade deficits to swell rather than shrink. You ask: “Wouldn’t it be true that if Americans were allowed to buy Chinese cars, buying them from a factory here rather than a factory there would lower the trade deficit going forward, at least to the extent that Chinese car factories in the U.S. don’t import all of the parts they use to make the vehicles?”
Your question is excellent.
It’s true that if in the future the existence of Chinese car factories in the U.S. causes Americans to buy fewer imported automobiles, that fact, standing alone, would shrink U.S. trade deficits. But that fact doesn’t, and cannot, stand alone. The Chinese factories here would draw workers, land, and other resources in America away from the production of other outputs – outputs that Americans produce at a comparative advantage. Americans might buy fewer imported automobiles, but because our production of other outputs would fall (as it must if we’re to produce more cars), our imports of things other than cars would likely increase. Moreover, because this protectionist-induced increase in Chinese auto production on U.S. soil draws Americans away from producing things at which Americans have a comparative advantage, our ability to export would fall.
Now as we become poorer, we’d also buy fewer imports – with this effect possibly swamping the decrease in exports. But surely such an outcome – Americans buying fewer imports only because our real incomes have fallen in response to tariffs – is not the one Trump envisions or wishes to peddle to the American public.
There’s an alternative, but complementary, way to trace out the result. Protective tariffs, by reducing Americans’ demand for foreign currencies, cause the value of foreign currencies to fall against the dollar – which is the same thing as an increase in the value of the dollar against foreign currencies. With the dollar now buying more foreign currency, foreign-made goods become less expensive in America while American-made goods become more expensive abroad. The result is to encourage American importation and discourage American exportation.
A caveat: If U.S. protectionism is so widespread and steep, the damage done to America’s economy could be so great that the value of the dollar permanently falls. This unfortunate outcome would happen if foreigners’ interest in buying American goods and, especially, in investing in America, decreases so substantially in response to the protectionism-induced worsening of the American economy that foreigners’ demand for dollars tanks.
IIn the end, while there is every good reason to cheer market-induced foreign investment in America – and the resulting higher U.S. trade deficits – there is every good reason to jeer at protectionism-induced foreign investment, regardless of the ultimate effect on the balance of trade.
Sincerely,
Don
