Canada/US trade war: Trump (like many people) suffers from a lack of economic understanding

MONTREAL, June 1, 2018 /CNW Telbec/ - The Trump administration decided to impose a 10% tariff on Canadian aluminum, and 25% on steel. This is a very bad decision. Unfortunately, like other decisions made by the US president when it comes to trade, this one is based on mistaken premises shared by a large number of decision-makers and commentators, deplores the President and CEO of the MEI, Michel Kelly-Gagnon.

These protectionist measures will make our exports less competitive on the American market, but in particular, American consumers will pay more for our products, which will make them poorer. The Canadian government's preferred solution, for Canada to "reply" by imposing its own tariffs on American products, is just as devoid of economic logic, even though it may be justifiable from a strictly political point of view. It will similarly make Canadian consumers poorer.

According to Mr. Kelly-Gagnon, this one-upmanship of bad decisions has a source, which economists have been fighting for centuries: the theory of mercantilism. "This way of seeing things, which amounts to economic obscurantism, was already thoroughly refuted by Adam Smith at the end of the 18^th century. Despite this, it is unfortunately still very much alive in the thinking of many people, and not at all limited to the Trump administration. Among others, there are many politicians and commentators who are complete dunces when it comes time to analyze matters of free trade and the so-called 'trade balance'," points out the MEI President.

From a mercantilist perspective, if we export more than we import, all is well. If, on the contrary, we import more than we export, we're in trouble. It necessarily follows that a country should do everything in its power to have a "more balanced" trade balance. However, the concept of the trade balance tells us precisely nothing about how a society enriches itself, and is actually only relevant in certain very specific circumstances.

"We all have 'trade deficits' with some people, like grocers, dentists, or music teachers. Should we be worried about this? Of course not! The same logic applies to trade between Montreal and Laval, or between Prince Edward Island and Saskatchewan. No one worries about surpluses or deficits between these different places," explains Mr. Kelly-Gagnon.

Moreover, the trade balance tells us about just one aspect of relations between countries. The analysis needs to be pushed further to arrive at a more complete picture of the situation. If we import more than we export, this means that foreigners are in a sense "buying" Canadian dollars with the goods that they sell us. These dollars represent assets for them, which they can then use to buy shares in Canadian companies or securities issued by Canadian governments. In doing so, they invest in Canada, and we thus "recover" this supposed "loss" due to a trade deficit.

"Unfortunately, this basic aspect of economic analysis is generally absent, which fosters the notion that a trade balance must necessarily be positive. This eventually leads to aberrant decisions like those announced yesterday," says Mr. Kelly-Gagnon. "In the future, in order to avoid other trade wars, it would be useful if this very simple lesson could be understood by everyone: Regardless of the direction of the flow of goods and services or capital, we are all richer thanks to these exchanges," he concludes.

* * *

The Montreal Economic Institute is an independent, non-partisan, not-for-profit research and educational organization. Through its studies and its conferences, the MEI stimulates debate on public policies in Quebec and across Canada by proposing wealth-creating reforms based on market mechanisms.

SOURCE Montreal Economic Institute