Trump and Trade

The Election

As yesterday’s election result was a bit of a surprise to me (and a lot of other people it seems) I wanted to dig in to the results a little to try and explain exactly what we’re seeing. As I looked at the ElectoralCollege map what stood out to me was how Trump managed to flip states like Ohio, Pennsylvania, Wisconsin and maybe Michigan from Democrat to Republican. With the exception of Ohio, George W. Bush didn’t win any of those states in 2000 or 2004 and they were all supposed to be a part of Hillary Clinton’sfirewall. So what changed and what does it have to do with trade?

Trade

As someone who has taken a lot of economics courses I’m a big proponent of trade. That said, I understand why people are often skeptical of its benefits. For better or worse, trade is almost always a net benefit to a country but the benefits are not shared evenly throughout the economy and it is usually really easy to see the places that were negatively impacted. To illustrate I’ve outlined a classic example below.

The Example

Imagine there are two countries with identical populations and resources. In Country A their economy would be capable of producing 200 million trucks (assuming that’s all they made) in a year or they could produce 400 million laptops. Country B however is poorer and less efficient so if all they made was trucks in the year they would produce 50 million and if all they made was laptops they would produce 200 million. Now you might think it makes no sense for the powerful Country A to trade with lowly Country B so let’s consider what would happen if they didn’t.

Assuming the countries didn’t trade at all and Country A wanted a mix of products so they took half the year and made trucks and half the year to make laptops. At the end of the year they would end up with:

• 100 million trucks
• 200 million laptops

Now, in an economy like this it should be clear that based on the time and effort to make these goods a truck should be worth roughly 2 laptops. Then in Country B assuming they did the exact same as Country A they would end up with:

• 25 million trucks
• 100 million laptops

Interestingly, in Country B they are relatively faster at making laptops compared to trucks than Country A so in this economy a truck ends up being worth 4 laptops.  Without trade this is where the story ends. The global economy produces a total of:

• 125 million trucks
• 300 million laptops

With that out of the way let’s look at what could happen if these countries started trading. To do that let’s pretend you are an enterprising trader in Country B and you visit Country A on a trade mission and you realize that in this crazy country people are willing to trade a truck for only 2 laptops! What a deal! In your country, trucks cost 4x what laptops do!

So how do you take advantage of this craziness? Well, you go back home, scrape up as much money as you can, use it to buy laptops and then head back to Country A with all these laptops. In this scenario let’s pretend your rich uncle lends you some cash and you manage to buy 2 million laptops. When you get to Country A you then trade those laptops for 1 million trucks and take the trucks back home. Once you’re home you can trade those 1 million trucks for 4 million laptops (you’ve doubled your investment already!) and then head right back to Country A to trade them for 2 million trucks. With 2 million trucks you can of course get 8 million laptops (4x what you started with) back home and you can easily pay your uncle back and retire or just keep going.

Of course, in both of these economies there isn’t just one trader, there are a bunch and so eventually these traders start requesting so many laptops from Country B and trucks from Country A that the mix of products made in these countries starts to change. Why produce any laptops in Country A when you get them cheap from Country B and why make trucks in Country B when we can easily trade for Country A’s trucks? In our theoretical example we could eventually get to the point where Country B only produces laptops resulting in the production of 200 million laptops. Now the world needs 300 million laptops (the old total) so Country A produces 100 million laptops which takes 3 months and allows the country to spend the rest of the year producing trucks. With the remaining 9 months of the year however Country A manages to produce 150 million trucks bringing the global totals to:

• 150 million trucks
• 300 million laptops

Now look back at the old totals. We’ve got the same number of laptops but global truck production is up 20% (150 million compared to 125 million before). Obviously the combined economic output of these two countries is higher now than it was without trade. That’s why economists frequently say “tradecreates wealth”. It’s also why the people who support trade agreements do it. Even in situations where one country is poorer than the other that poor country will have a ‘comparative advantage’ at producing something (in our case laptops) and therefore both countries will find a way to benefit from this relationship.

So Why Do Some People Hate Free Trade Agreements?

Hopefully, the example above convinced you that trade is good even between countries with very different levels of wealth. If that’s the case you are probably wondering why Donald Trump would talk about ripping up NAFTA (the North American Free Trade Agreement), why he would suggest that China and Mexico were stealing America’s manufacturing jobs and why this message resonated so strongly in places like Pennsylvania, Ohio, Wisconsin and Michigan that he will be America’s 45^th President. To understand this you need only consider how the truck makers in Country B would feel in our example.

While it’s obvious that both countries are producing more after trading and are therefore wealthier I doubt that’s much consolation to all the people who used to work in Country B’s truck factories. The honest truth is that all of those jobs are gone after trade started with Country A. Just like many of the laptop makers in Country A are out of business because Country B is now producing 67% of the world’s laptops instead of the 33% they used to. My guess is that if you are still making laptops in Country A you’re:

1. Happy to have a job because many of your friends and neighbours don’t anymore. 
2. Haven’t had a raise since trade with Country B started. 
3. Voting for anyone who promises to bring those jobs back.

Sound familiar? Now in a perfect world all the workers who used to build laptops in Country A or trucks in Country B would just start working in the other factories. In reality however the skills required for those industries can be very different and the jobs can be located in different geographic regions so switching industries might require people to move away from their friends and families. Over a long period of time it would eventually start to happen but it definitely wouldn’t be overnight and it would probably never be totally complete. Furthermore, even if you did eventually find work in the other industry you might still resent the transition and that “stupid trade deal” that caused it.

Just to take this one step further imagine you were still working in Country A’s laptop industry despite the massive contraction (50% of the industry is gone), you haven’t gotten a raise since it happened (15 years ago) and now people from Country B are moving to your country (illegally!) in relatively large numbers and some of them are managing to get jobs at your factory (and yet your brother hasn’t worked in a decade)! Then someone running for President promises to bring jobs back to the laptop industry, deport those people from Country B who got in illegally and “make Country A great again”. That in a nutshell is what I believe happened on Tuesday.

Tying it Together

While most of this piece focused on two theoretical countries and two theoretical industries I surely hope anyone reading this far put together the similarities between Country A and the US and Country B and Mexico/China. Furthermore, in the real world the US actually lost a lot of manufacturing jobs in places like Ohio, Pennsylvania and Michigan (remember them) but on the whole the US economy has grown and has benefited from trade with Mexico and China. The problem for those people in the Rust Belt is that they were like the laptop industry in our example. While the countries overall have benefited these people haven’t and they probably feel left behind by the people in places like California and New York that have benefited from trade.

While we’re on the topic of benefiting, I think I should make clear which industries in the US have benefited from these trade agreements. Unlike our example it definitely wasn’t truck manufacturing! In fact the US’ comparative advantage over countries like Mexico and China tends to be in industries that require a lot of highly educated people. The US of course has some of the world’s best universities and because of that the US’ comparative advantage tends to be in things like management, design, finance, etc. When I think about this I tend to think about companies like Apple. They employ a ton of university educated people who work on product development, software design, marketing and all the necessary back office functions like accounting and HR. All of these people benefited from Apple’s ability to produce their goods cheaply in Asia while performing all the intellectual work in the US and making very big profits. Those profits of course resulted in the hiring of more of these people and the competition for people with those skills has driven wages for these positions dramatically higher over time (just look at house prices in Silicon Valley). Unsurprisingly Donald Trump’s core message did not resonate with these people…

Last Thoughts

While I can certainly see why people who have been negatively impacted by trade voted the way they did on Tuesday I am definitely not anti-trade myself. The truth is that trade is beneficial on the whole despite the fact that it will always cause pain in certain areas. What I think everyone should take away from this however is that some of the gains from trade need to be redirected to those areas that will see a negative impact. What that looks like is probably beyond the scope of this article but if nothing is done to help those groups they will rightly blame trade for their struggles and if that group gets big enough they will do everything they can to reverse the trade (and the benefits that came with it) and make it harder to create more trade in the future.

One last point…while Donald Trump’s message resonated with the negatively impacted group I’m almost certain that he can/will do nothing to actually fix it. Undoing the trade the US has with the rest of the world would simply be too hard and cause too much pain in other areas for it to be feasible. Most of the US’ manufacturing jobs are gone and they aren’t coming back.  He will do a few things like tighten immigration standards and increase deportation of illegal immigrants but it won’t make the enormous difference that I’m sure his supporters were hoping for.