The discussion about the economy lately has revolved around what the new administration might do in several key areas, including trade. In his inauguration speech, President Trump made it very clear that he intends to carry out the promises he campaigned on, and his recent decision to withdraw the U.S. from the Trans-Pacific Partnership (TPP) shows that he’s serious. Next up, NAFTA.
Before we consider the Trump administration’s plans, however, it is worth going back to fundamentals.
Why do we have these deals in the first place?
Free trade, remember, has been the economic consensus for decades. The leading role of the U.S. in the global economy has been considered a strength; the trade deficits and other costs have been accepted as a reasonable price to pay for the benefits. President Trump has taken a much more critical view of those (very real) costs.
At a certain point in any cycle, benefits start to be taken for granted, and we tend to focus more on the costs. We have seen this in every economic area—most recently, with the Fed’s transition on interest rates. In this sense, the discussion on trade is, if anything, overdue. At the same time, though, any decisions based on eliminating costs should also factor in the benefits that might be surrendered in doing so.
The pros: Over the past century, the U.S. has been the world’s largest and most open economy; its position at the center of the global economy has been unassailable. The dollar became the reserve currency, U.S. capital markets became the hub of world finance, and the value of U.S. assets increased. By competing against the best in the world, U.S. companies became the best in the world. With access to workshops across the globe, U.S. consumers got better goods, cheaper, than they ever had before. The U.S. economy, as we now know it, would be significantly different (and likely worse off) had that not been the case.
The cons: Of course, as we have seen in recent decades, free trade isn't without legitimate costs, including lost jobs and lower wages. These are real issues, which have gone unaddressed. President Trump’s policies are an attempt to recover those costs.
The question investors and citizens need to ask is this: what new problems will arise as we attempt to fix the old ones?
Economic superpower status could be up for grabs
Let’s look at the effects of President Trump’s actions so far. With his decision to pull out of the TPP, the U.S. has just surrendered its place at the center of the Asian economic system. We had brokered a deal that essentially left us in control of the big picture, at the cost of opening U.S. markets a bit further. Now that the deal is off, who will take control of the Asian economic system? I suspect it will be the Chinese. Countries in that area have no choice but to deal with China and, in the absence of the U.S., no ability to compete on a geopolitical level.
Depending on how it goes with NAFTA, we could turn Mexico from an ally into an enemy. As it stands, Mexico has a very real interest in maintaining good relations with the U.S., which means working to crack down on the drug trade, illegal immigration, and terrorism. If the U.S. declares war on NAFTA, many of those incentives could disappear. In fact, Mexico is already considering potential responses. Do we really want that?
On a longer-term basis, the U.S. could lose its position as the world’s economic superpower, replaced by China or Europe or another area. By sitting on the sidelines, we encourage other countries’ growth and integration while missing out on the potential benefits, as well as the chance to control the situation.
You can argue the merits of any individual action, and I’m not saying that the Trump administration’s plans will have no positive effects. But it’s clear that, although there may be benefits, they are likely to be short term and largely economic, whereas the costs will be longer term and largely geopolitical. That may be a trade-off worth making, as long as we’ve fully considered both the benefits and the costs.