A New Way to Win a Trade War

In early 2018, the gloves finally came off: The United States started to punish China for its unfair trade practices and threatened allies, like Europe and Canada, for their uneven trade policies. Since then, trade has been dominating the headlines, with threats and counterthreats from the opposing sides.

But the bluster is distracting the world from the fact that we’re in an outdated paradigm, and a major solution could be fairly simple.

For the current trade paradigm, when viewed from inside the complex, rigid, and bureaucratic international trade system that is the World Trade Organization (WTO) and the different domestic institutions tasked with managing trade, the Trump administration’s move to escalate the trade war is entirely understandable and justified.

According to the—severely flawed—rules of the game, China is exploiting the United States’ and Europe’s relatively free-trade policies to officially pursue its policy of complete domination of all industries. Europe and the rest of Asia are trying to gain an edge over the United States, although they are more interested in fair trade in principle than China.

For the United States, the tolerance of such trade practices resulted in persistent trade deficits with the rest of the world worth hundreds of billions of dollars, the loss of millions of manufacturing jobs, and trillions in international debt obligations. On the flip side, it also increased profit margins for multinational American corporations who produce abroad to sell in the United States, and it lowered prices of gadgets (some productive, many useless) for consumers.

So the Trump administration’s plan is to level the playing field by more or less getting even with tariffs on inbound goods, which are, on average, 10 percent in China, 4.8 percent in the European Union, and 3.5 percent in the United States. Those tariffs may be a simplified proxy of the complex trade barriers every country manages, but they do provide a good estimate of how much a country is really interested in free trade.

The solution is to radically liberalize trade, but not only internationally—the liberalization of domestic trade is more important.

Domestic trade? Mainstream economics and the mainstream media have indoctrinated us to believe that only nations trade. However, as with all aggregate economic statistics, this is nonsense. It is private companies and private individuals who trade, and it doesn’t really matter whether this is domestic or international.

If I order a couple of bars of Cailler Frigor Swiss chocolate on Amazon, I do the trading with the company that ships them to me from Europe through Amazon. I send them money, and they send me the product.

But the same is true if I buy a couple of domestically produced bars of Hershey’s—much cheaper but certainly not as good—from Amazon here in the United States.

Goods or services are exchanged for money, whether domestically or internationally. Every tax, tariff, or regulation that stands in the way of these transactions is hindering trade.

For domestic trade in the United States, the most important barriers to trade between individuals and companies are taxation on buying and selling goods and services (sales tax) and, more importantly, taxation on selling labor services (income tax).

Capital gains taxes and taxes on dividends stand in the way of the free flow of capital. The corrupt fractional reserve fiat money system under the management of the Federal Reserve further prevents capital from finding the right places to invest, leading to overcapacity in sectors like real estate and a complete lack of infrastructure investment, to cite just one problem.

Add to this other regulations that limit or prohibit commercial transactions, especially in the labor market, and you get the picture that domestic trade is severely crippled and operating far below its potential.

It is ironic that most of the people who are ostensibly pushing for the liberalization of international trade—in reality, they merely want regulations to favor them—are most against the liberalization of trade domestically.

If the potential of domestic trade were fully unleashed, the United States would not have to worry about 10 percent average tariff rates in China or exports to China at all, because domestically produced goods could easily compete with products coming from a semi-state planned, developing economy. Without the tax and regulatory costs, even solar panels produced in the United States would be cheaper and better than the state-subsidized products from China.

State planning is less efficient and effective than the operation of free markets; therefore, China cannot win the game in the long run, just as the Soviet Union could not win it, nor Japan, whose markets were very heavily managed by the state during its boom years. Of course, this does not mean China could not score some victories here and there by dumping some products on the U.S. market virtually for free and undermining an industry. Nothing is perfect. But the costs of China doing so would be even higher than they are today and would deplete the country’s resources in the long term.

As a result of liberalized domestic trade, people and companies in the United States would either produce domestically, because the added cost of taxation and regulation would be much lower, if not removed entirely, or trade with countries who are interested in real free trade. The ideal scenario would be that almost every product that now comes from China would be produced for the same price or less domestically, so no international trade tariffs would be necessary.

However, as job losses and the increase in debt have shown, U.S. domestic trade is not free enough to compete with hostile actors like China in the short term. This is the main risk of the free domestic trade strategy.

When unnecessary regulations, taxes, and tariffs are scrapped, there is bound to be some volatility as the economy adjusts to the freer environment. A hostile actor like China could use this adjustment period to move in and buy up companies and intellectual property.

Maybe this is why the Trump administration’s strategy of domestic liberalization and international interventionism could be just right for the time being, although both domestic and international barriers to commerce have to be removed eventually.

Many countries in the top 10 of the WEF competitive index who also rank highly in the enabling trade index, most notably Singapore (No. 1) and Hong Kong (No. 3), had their adjustment periods a few decades ago and are thriving with free domestic and international trade. They are international trading hubs and have relatively benign tax and regulatory regimes.

Both countries also have relatively balanced trade, with Singapore averaging a small surplus since the 1950s and Hong Kong a small deficit.

At the end of the economic cycle and in the long run, trade should always be balanced. By liberalizing domestic trade and unleashing the full productive capacity of the economy, the United States could achieve this goal and avoid trade wars.