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Expected US protectionist policies conflict with economic principles

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By Valentin A. Araneta

Valentin A. Araneta

Valentin A. Araneta

The Donald Trump administration has professed a trade policy that may be labeled as protectionist in contrast to free trade or global oriented.  This may be discerned from its attitude towards its trade with Mexico and China, its abandonment of the “Trans Pacific Partnership Agreement (TPP) and its negative attitude to the North American Free Trade Agreement (NAFTA).  The professed Trump economic policies seem to be based on the belief that as much as possible, products and services that can be produced in the United States should not be imported from other countries because this means more jobs in the United States.  This thinking runs against the grain of the principles of the “Economics of Comparative Advantage” and the “Economies of Scale.”

The Theory of the Economics of Comparative Advantage states that countries are better off specializing in products where their opportunity costs of production are lower and then exporting these to other countries and importing from other countries the products that these countries can produce at lower opportunity costs.It is under this principle that countries have industrialized and developed and traded with each other over the last two centuries.  China embraced this principle and transited from a centrally planned economy into a trade and market oriented economy during the Deng Xiao Peng leadership back in the 1980s.   In the next three decades, China enjoyed rapid double digit growth that was trade and investment led.

Economies of Scale means that as the volume of production increases, the cost of production per unit decreases because the fixed investment or overhead is spread out over a bigger scale hence, the term:  Economies of scale.  When scale is realized by spreading production over two or more countries through the specializations in the production of various components, we now have the “Global Supply Chain.”

Countries and Trading Blocks such as the European Union, NAFTA and ASEAN apply the principles of comparative advantage, economies of scale and the global supply chain in a dynamic manner.  In other words, investments in infrastructure and technology dynamically transform opportunity costs of countries and hence, products and services in which they have comparative advantage.  This phenomenon has been greatly enhanced by the emergence of the very large companies commonly referred to as the multinationals.  The dynamic growth of trade based on the principles of comparative advantage, economies of scale and the global supply chain is commonly referred to as “Globalization.”

Now the professed protectionist policy of the Trump administration threatens to disrupt the global supply chain because it believes that it can competitively produce more of these goods in its domestic market and therefore create more jobs for its population.  The key word is competitive because the principles of production according to opportunity costs and economies of scale are now challenged by threats of tariff and non-tariff barriers. Barriers to imports protect domestic producers by keeping out foreign products from competing in their domestic markets.  However, the consumers suffer because they are not able to have their choice of globally competitive products at the best value for their money.  More importantly, the US production structure is inexorably linked with the global supply chain where it probably contributes the greatest intellectual content and hence the greatest values.  This is in the area of information technology and its applications in connectivity, content, biotechnology, medicine and similar applications.  You see, the US imports and exports intermediate goods needed in the production of the final output.  In order to export its final products, the US needs to import a lot of intermediate goods and if protectionist policies require that these goods be produced in the US, it will most likely not be as cost-efficient as importing these from abroad, in other words, not competitive.   On the other hand, the US also imports finished products containing intermediate goods exported by the US Barriers against US the importation of these goods will also adversely affect the intermediate goods export of the US and therefore the jobs of Americans producing them.  Take for example the vehicles exported from Mexico into the US. According to one report, 40 percent of the value of those vehicles are from intermediate goods from the US. Therefore a protectionist policy against vehicle imports into the US from Mexico will also hurt the US companies producing and exporting those intermediate goods to Mexico. What is worse is if Mexico exports those vehicles also to Canada under NAFTA and other countries in the South American continent.  This means that the volume of US intermediate goods exports that will be affected will be proportionately bigger than vehicle imports that it prevents from coming into the US.

Agricultural products are another ironic case about the trade between the US and Mexico.  Mexico buys most of its corn imports from the United States as well as rice and dairy products.  This is because they are the most proximate to each other with a long common border and enhanced by NAFTA.  Under a US protectionist policy, it will now make sense for Mexico to source its agricultural products from South America and elsewhere because transport costs can now be offset by the increased costs caused by the imposed trade barriers and especially if NAFTA will be torn up by Donald Trump as he has threatened to do.  The irony of how a protectionist policy can actually hurt the US economically is no clearer than in the Business Process Outsourcing (BPO) Industry.  BPO is a highly labor intensive industry and just for comparison, the hourly wage rates in the US is about equal if not more than the daily wage rate in the Philippines i. e. eight times more expensive.  It has therefore made a lot of sense for industries and services in the advanced countries and the multinationals to take advantage of technological innovations to have the BPOsdone in the lower costing countries.  Obviously, if the Trump administration is going to impose the transfer of those BPO jobs back into the US, their BPO costs will grow substantially and adversely affect the users of BPO services which are the industries with the greatest intellectual contents and value added.

It is obvious that protectionism is not a “win – win situation” even for the US which has the biggest domestic market in the world.  While trading blocs can realign and China is being talked about now as the new fulcrum for world trade, it would be best for cooler heads to prevail and for the US to maintain its dynamism and creativeness at the frontiers of technology and applications.  As has been observed, many countries have attempted to replicate Silicon Valley and have not been successful.  This is because Silicon Valley is more than a location.  It is a state of mind of creativeness, diligence and dynamism fostered by a free and open democratic society.  This is what Americans and the whole world should wish for.

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The opinions expressed here are the views of the writer and do not necessarily reflect the views and opinions of FINEX.  You may email Mr. Araneta at vaaraneta@yahoo.com

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