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HOME NRI JOURNAL Takahide Kiuchi's View - Insight into World Economic Trends :
The Trap of Bilateral Trade Negotiations

NRI JOURNAL

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Takahide Kiuchi's View - Insight into World Economic Trends :
The Trap of Bilateral Trade Negotiations

Takahide Kiuchi, Executive Economist, Financial Technology Solution Division

May 14, 2019

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The Trump administration, which advocates the America First policy, is trying to resolve the U.S. trade deficit problem through bilateral negotiations. However, much of this is based on misconceptions.

Expansion of bilateral trade imbalance reflects progress in free trade

The Trump administration has been partially ignoring the international conventions of promoting trade liberalization and eliminating trade disputes under a multilateral framework. In order to rectify the bilateral trade imbalance, they are strengthening trade negotiations with the partner country. In addition, they have repeatedly introduced additional tariffs as a means of rectifying trade imbalances.
The Trump administration regards the U.S. trade deficit with a specific country, i.e., the trade imbalance between the two countries, as a matter of particular concern. Their attempt to resolve it through bilateral negotiations is based on the idea that such a correction of the trade imbalance will lead to the elimination of the U.S. trade deficit as a whole.
It is true that if the U.S. trade deficit as a whole expands, confidence in the U.S. dollar will reduce due to increased outflow. This will further destabilize the U.S. and global financial markets. However, it is a mistake to try to resolve this problem by correcting the bilateral trade imbalance.
This attitude is based on the concept of "partial equilibrium" rather than "general equilibrium," which is the idea that trade imbalance as a whole can be eliminated by correcting individual bilateral trade imbalances with other countries. However, this partially ignores the fact that imports and exports between the trading countries are interconnected with each other.
The International Monetary Fund (IMF) analysis (World Economic Outlook, April 2019) shows that while changes in the overall trade balance affect the bilateral trade balance, changes in the bilateral trade balance have little impact on the overall trade balance. This is because changes in the trade balance between two countries are offset by changes in the trade balance between two other countries.
There is a school of thought which says that trade imbalance between two countries reflects the benefits of promoting free trade. The advantage is that each country can increase global income by carrying out production in a focused field of expertise (such as an area where it can maximize profitability) and expanding the international division of labor. This is based on the concept of free trade theory. However, the Trump administration does not accept this idea.

Excessive fiscal expansion measures by the US is the main issue

The Trump administration also seems to believe that the U.S. trade deficit is a loss to the U.S. economy, deprives the U.S. of employment, and is caused by unfair trade practices and devaluation by trading partner countries. We are also forced to accept this idea!
The IMF analysis mentioned earlier shows that unlike the Trump administration's perception, trade imbalances are largely determined by macroeconomic factors such as excess demand. The IMF attributes the changes (1995 - 2015) in the U.S. and China’s respective trade balances with other major countries to three factors: (1) Macroeconomic factors, which include excess supply by trade surplus countries, or excess demand by trade deficit countries; (2) Tariffs and other trade cost factors, which include transportation costs and tariffs based on geographical conditions; and (3) Sector-specific factors, which include the difference between demand and supply (production) for each sector based on international division of labor.
According to this, most of the deterioration in the U.S. trade balance with China (about 98% on a net basis) can be explained by the macroeconomic factors described in (1). Given this point, the excess demand in the U.S. resulting from expansionary fiscal policies, such as large-scale tax cuts and infrastructure investments, is the main cause of the expansion of the U.S. trade deficit. Reviewing such policies, i.e., revising the U.S. macroeconomic policies is the most effective measure to reduce the U.S. trade deficit with China or the trade deficit as a whole.
However, in reality, the U.S. has been taking incorrect measures such as strongly condemning China’s micro-industrial policies (such as subsidies) and exchange rate policies to change trade costs, as well as trying to rectify the trade imbalance between the two countries through the introduction of additional tariffs.
If the U.S. continues to further expand bilateral negotiations and repeatedly introduce additional tariffs based on this misconception, it could greatly hinder the growth of the global economy. It is hoped that the Japanese government will persistently work on turning the attention of the Trump administration to correct measures for reducing the trade deficit.

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Nomura Research Institute, Ltd.
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E-mail: kouhou@nri.co.jp

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