A recent posting at the American Compass describes a trade problem that is not really a problem and then prescribes three bold solutions that are not really solutions

By Daniel Griswold of Cato and Spencer Pratt.

"A recent posting at the American Compass describes a trade problem that is not really a problem and then prescribes three bold solutions that are not really solutions. If implemented, their proposals would in fact create real problems for an American economy struggling to tame inflation and dodge a recession.

Like many skeptics of trade, American Compass focuses on the trade deficit as a sign of failure of U.S. trade policy. Here’s how it summarizes the problem: “America imports massively more than it exports, leaving us deeply indebted to our trading partners. Rather than exchange American goods for foreign goods, we import on credit, sending back IOUs and ownership of our economy, which future generations will pay for. In the process, we allow the erosion of American industry and innovation, the decline of manufacturing employment, and the collapse of communities.”

To combat the deficit, the American Compass proposes three sweeping new tax and licensing systems on international commerce: 1) a Global Tariff on all U.S. imports starting at 10 percent; 2) a licensing system of Import Certificates that would ration the value of U.S. imports to equal the value of U.S. exports; and 3) a Market Access Charge of 50 basis points or more on all foreign purchases of U.S. assets, i.e. inward foreign investment.

Before I count the ways that each of these prescriptions would damage the economy and the well‐​being of Americans, let’s examine what’s wrong with the diagnosis.

The Non‐​problem of the Trade Deficit

The U.S. trade deficit is not a problem to be solved, but a basic feature of a U.S. economy that excels at attracting foreign investment from around the world. That investment, which even American Compass folks occasionally celebrate, keeps domestic interest rates lower than they would be otherwise and fuels job creation, innovation, and the construction or modernization of plant and equipment at U.S. factories.

American Compass complains that years of trade deficits have only succeeded in piling up “more than $13 trillion of trade debt.” That figure is a misleading way of describing America’s “net international investment position”—the difference between the value of assets abroad owned by Americans and the value of U.S.-based assets owned by foreigners. At the end of 2020, the difference was indeed more than $13 trillion, with foreign‐​owned assets in the United States totaling $46.7 trillion and U.S.-owned assets abroad $32.0 trillion. But that difference is not “debt” in any normal sense. Most of the assets that foreigners own in the United States are in the form of foreign direct investment (FDI) in U.S. companies and portfolio investment in equities. When people outside the United States invest $1 billion in Apple Inc. stock or an automobile factory in Tennessee, this is not debt our children need to repay, but an infusion of new capital into the American economy.

The critics push back that almost all inward FDI comes in the form of mergers and acquisitions rather than “greenfield” investment in new plants. But as my Cato colleague Scott Lincicome has argued, this misses the important fact that those mergers and acquisitions allow U.S. sellers to reinvest those funds in other enterprise, injecting additional capital into the U.S. economy. Those transactions also encourage further investment in domestic firms that may then draw foreign partners in the future. Foreign acquisitions also typically lead to improved production methods, better marketing and customer service, and greater investment in research and development. The net inflow of FDI enhances the productivity of the nearly 8 million Americans who work for foreign‐​owned affiliates in the United States, boosting their wages and benefits.

Whatever its composition, the $13 trillion in “trade debt” is economically sustainable. Americans routinely earn about $200 billion more each year on their investments abroad than what foreigners earn on their investments in the United States. And $13 trillion may seem like a big number, but according to the Federal Reserve Board’s quarterly “Financial Accounts of the United States,” the net worth of American households, non‐​profits, and businesses (corporate and non‐​corporate) at the end of 2020 was a whopping $170 trillion. Far from selling off our assets to fund consumption, the net worth of Americans has been growing impressively since the Great Recession of 2008-09. The inflow of foreign capital has made America a wealthier place.

The American Compass critique is even flimsier when it claims that trade deficits have been bad for American industry. It’s true that manufacturing employment has been on a downward trend, but that has been true for decades. The decline is driven more by rising productivity in manufacturing rather than by rising imports—and it’s been happening (often even more steeply) in countries such as Japan and Germany with persistent trade surpluses. Meanwhile, total manufacturing value‐​added in the United States, adjusted for inflation, has increased 36 percent since 2000—reaching a record $2.5 trillion in 2021. The struggles of certain communities tied to heavy industry, such as Youngstown, Ohio, date back to the 1970s, before trade deficits became an issue.

To address this non‐​problem of the trade deficit, American Compass calls on the federal government to dramatically extend its powers to tax and regulate America’s international commerce. Leaving aside the obvious conflicts these policies would have with U.S. international trade agreement commitments, each suffers from serious economic flaws:

Non‐​solution #1: The Global Tariff

The first club American Compass would wield is a “Global Tariff.” The tariff would start at 10 percent on all imports, rising by another 5 percentage points each year if the trade deficit persists. If the U.S. runs a trade surplus, the global tariff would fall by 5 percentage points in the following year.

This crude sledgehammer would do nothing to “cure” the trade deficit. As the American Compass authors acknowledge, such a tariff would not alter the net inflow for foreign investment, which by necessity mirrors the trade balance. Despite the tariff, foreign investment would continue to flow into the United States, filling the gap between the level of domestic savings and investment. That’s why the U.S. goods deficit remained high under the Trump administration, around $800 billion a year, despite its escalating tariff war with China and other major trading partners.

A global tariff on U.S. imports would reduce overall trade but not the trade deficit. To the extent it discourages imports, it will cut the flow of dollars into the foreign exchange market, driving up the dollar’s value and discouraging exports, while likely spurring retaliatory tariffs as well. Both imports and exports would fall in roughly equal measure, leaving the trade deficit fundamentally unchanged. Without a change in the trade deficit, the global tariff would continue to rise unchecked until it would virtually cut the United States off from international trade.

The global tariff would drive up the cost of living for American workers and families and the cost of business for American producers. U.S. businesses would be forced to pay more for imported components, commodities, and capital machinery, making them less competitive in global markets. For American households, the tariff would fall disproportionately on lower‐​income households, which spend a higher share of their incomes on more tradable goods such as food, clothing, footwear, and housewares. It would further reduce the real wages of American workers, who are already struggling under the highest inflation rate in 40 years.

Proponents of the global tariff wistfully claim that the higher prices would be offset by the redistribution of tariff revenue. They claim, for example, that the tariff revenue could be used to offset sales taxes, but of course it’s the federal government that collects the tariff revenue while it is states that impose sales taxes. Do they assume the debt‐​ridden U.S. treasury will send billions to California, New York and other states so they can reduce their sales taxes? That is not likely. In practice, their tariff would act as a regressive tax that would widen income inequality.

Non‐​solution #2: The Import Certificate

Under this second club, Congress would create a licensing system that would allow U.S. companies to import only when they can present a government certificate authorizing the transaction. Companies could earn certificates by exporting, and then sell them for the going price on an open market—similar to “cap and trade” markets for pollution control. A company that exports $100 million in, say, wheat or semiconductors could then sell the certificate it earned to another company that wants to import $100 million in bananas or shoes. The system, if rigorously enforced, would in theory reduce the value of imports to match the value of exports. Hocus Pocus, Alakazam, no more trade deficit!

In practice, import certificates could be an even worse restriction on international trade than the global tariff. It would create a kind of “licensing raj” that was a sad feature of pre‐​reform India, longtime economic basket‐​case Argentina, and other developing countries forced to ration foreign exchange reserves. It would expand the power of the administrative state, encourage smuggling, complicate supply chains and potentially create shortages on retail shelves as well as factory assembly lines. Like the global tariff, it would raise costs for U.S. households and producers but without producing any tariff revenue that could—in theory, at least—be used to compensate households or invest in public infrastructure.

Like a tariff, import certificates would also fail to address the underlying causes of the trade deficit. The national level of savings and investment that drive cross‐​border investment flows would not be fundamentally altered. If the government attempted to enforce such a licensing scheme, the value of U.S. imports would almost certainly drop, but so too would the outflow of dollars from the United States into global currency markets. This in turn would drive up the value of the dollar, making U.S. exports and U.S. assets more expensive and less attractive to foreign buyers. Imports and exports would both fall in a death spiral, depriving the U.S. economy of the gains from both international trade and investment.

Non‐​solution #3: A Market Access Charge on Inward Investment

The third club proposed by American Compass would empower the Federal Reserve Board to impose a “Market Access Charge” on the purchase of domestic assets by foreign entities. Under their plan, the Fed would start by charging 50 basis points (0.5 percent) on the value of any foreign purchase of a U.S. asset. As with the global tariff, the Fed would be directed to vary the charge depending on the size of the deficit, “increasing it while the trade balance remains in deficit and decreasing it once trade is balanced.” Banks would collect the charge from cross‐​border financial transactions and deposit the revenue in an “American International Competitiveness Account” at the U.S. Treasury “to be used for improving global competitiveness”—whatever that means.

A tax on inward capital flows is arguably the most serious of the three “solutions.” It at least has the virtue of aiming at the underlying cause of the trade deficit—the persistent net inflow of foreign capital to the United States. A bill has been introduced in the U.S. Senate that closely resembles the American Compass proposal. But like the two clubs aimed at imports, it’s hard to imagine how making U.S. assets less attractive to foreign investors will make Americans more wealthy and prosperous. Russia’s war in Ukraine has made its assets less attractive, downright toxic, to foreign investors. This may have even contributed to an “improvement” in Russia’s trade balance, but the flight of foreign capital has caused real damage to its domestic economy and living standards.

If the access charge were to work as advertised, it would deprive the U.S. economy of investment capital. Domestic savings would need to rise, or the level of domestic investment to fall, for there to be any real change in the trade balance. With U.S. household savings low, and the federal government still borrowing a trillion dollars or more per year, less inward foreign investment would likely translate into a lower level of domestic investment (with federal borrowing crowding out private investment). Less foreign demand for Treasury bills would put downward pressure on bond prices, leading to higher interest rates, driving up borrowing costs for the federal government, businesses, and homebuyers.

In reality, the inward investment tax may have less impact than its advocates predict. The United States remains the most popular “safe haven” for global savings. The U.S. economy, and in particular Treasury bills, offer global investors safety and liquidity in times of economic or geopolitical uncertainty. In effect, the United States acts as “banker to the world,” paying a lower interest rate on global inward investment while earning higher returns by re‐​investing those funds at home and abroad. An access charge on U.S. assets is unlikely to fundamentally alter the global appeal of U.S. assets, leaving the trade deficit intact while expanding the taxing power of the federal government.

For all the reasons above, a persistent trade deficit at current levels would be far preferable for the U.S. economy and the welfare of Americans than any of the three radical interventions proposed by the American Compass and its fellow travelers."