The Grievance Doctrine

Donald Waiting for the Phone to Ring (with apologies to Godley and Creme)

The global guru of international trade, Richard Baldwin, recently published the book on Trump and his tariffs, The Great Trade Hack. Baldwin is essential reading to understand the upending of the global trading system by the US administration . If Richard were not here, then we would have to invent him.

What is Donald Trump’s objective in disrupting the global trading order? Ostensibly he seeks a healthy manufacturing sector through reindustrialization, in the flawed belief that a manufacturing restoration will in turn restore a large measure of well-paid employment to the rust belt states. And, in a troubled world, national security concerns have moved centre stage to economic policy making. The COVID-19 experience showed that the offshoring of production and the tightly coupled global supply chains freer trade created swapped resilience for efficiency. We have learned from the COVID-19 experience followed by the Russian invasion of Ukraine that national security demands more resilience even if it comes with less efficiency.

The preferred tool to achieve strategic reshoring is tariffs; but they are not up to the task. Tariffs – a microeconomic tool -- change the relative price of imports compared to domestic production, and will change the distribution of do trade flows, but they will not rid the US of a trade deficit.

Macro beats micro

The US is running large trade deficits because it is consuming more than it can produce, driven mostly by a federal budget deficit well north of 6% of GDP. The US should choose a macroeconomic tool if it wants to close the trade deficit – and that tool is a fiscal contraction through expenditure and tax changes. But fiscal adjustment without pressure is politically impossible, so the macroeconomic outcome will overwhelm the microeconomic objective. In the end, macro always wins.

Trump’s tariff offensive is reshaping the global trade environment. Much of the driving animus for Trump’s assault on both trade and macroeconomic orthodoxy is based on a belief that jobs have simply moved to low-cost low-wage countries, lured away by foreigners out to cheat America.

Baldwin challenges this belief by noting that all countries have experienced a reduction in the manufacturing share of employment, as productivity gains produce more with fewer workers and can be more readily achieved in physical goods production. Baldwin observes that after a big gain in manufacturing growth after 1990, even China subsequently lost millions of factory jobs between 2013 and 2018 as it applied labour-saving technology and robots.

The universal reduction in well paid jobs in regions dependent on manufacturing, across both the US and many other countries, has caused significant economic distress for families and communities everywhere. But the most distress was felt in the US. While many individuals lost economic power, they retained political power and this has been expressed most forcefully in the US. Why?

US economic and political beliefs, rooted in free market fundamentalism, meant that the transitional support available in other advanced countries to cushion the blow from globalization and automation was not available in the US. Weaving a tighter safety net equal to that in Canada and Europe to catch the falling is beyond the grasp of both American political beliefs and its political system. The powerful in the US believe that for every problem the market creates, the market will provide the solution.

Trump rose to power by giving voice to those in the middle and working classes who had been abandoned by the social and economic change of the past fifty years, offering them the potential for more than the instruction to “deal with it.” Trump’s diagnosis that trade created Midwest economic misery aligned with his conviction that the US has been cheated by trade. He spoke clearly to the need for action and identified the culprit: foreigners. Tariffs became the answer and the left behind rallied behind him. Donald Trump’s interest was their interest, which is the root of all successful ideologies.

Baldwin argues that Trump’s initiative is not so much trade policy as it is an emotional reaction to the economic bitterness shared between Trump and his supporters. Trade is a convenient scapegoat to avoid challenging existing economic and political beliefs necessary to weave a finer social safety net, one which would more directly meet the needs of the left behind.

Baldwin calls this anger at the world, and the perception that trade has undermined US economic power and prosperity, the "grievance doctrine.” The grievance doctrine perfectly reflects Trump’s approach to negotiation: disregard for rules and law, impatience with process, and a fondness for the exercise of “raw power.” The disruption is deliberate; it is punishment. And, trade “deals” (they used to be called agreements) are meant to disrupt the global trading system so American can apply its raw power.

Despite the emotional appeal of the grievance doctrine, tariffs are “policy placebos” providing a mirage of action that addresses wage stagnation and job insecurity. Baldwin makes a compelling case that the root cause of economic distress is the lack of transitional support for those negatively affected by “globotics” – a portmanteau of globalization and robotics. The support offered in every other advanced country, such as universal health care, education, and retraining, eases the downside pain of labour market adjustment. But the US is alone among the advanced economies in not providing comprehensive support.

To Donald trump and the left behind, tariffs are the wonder policy tool that reverses the looting of America and restores its economic power and dominance. But because trade is not a zero-sum game, this approach is disrupting the US economy as well as others. Tariffs as penalty blows-back on the domestic economy in unanticipated ways. Baldwin’s analysis reveals that the tariffs primarily benefit a small segment of the workforce while adversely affecting the majority, particularly those in the service sector, who receive no protection from tariffs on goods; rather, they pay for them. But even the goods sector will be negatively affected.

Making US manufacturing uncompetitive one tariff at a time

As Larry Summers argues, for every one job in steel production, there are sixty other jobs in industries that use steel as an input. The 25% tariffs on steel – durable on national security grounds – puts US users of steel in fabrication at a disadvantage to put some of those sixty jobs at risk. Steel produced outside the US can now be redirected to non-US manufacturers. For example, a Canadian steel producer redirects exported steel to domestic Canadian finished goods production. As the Canadian fabricator now has cheaper steel than its US competitor, and because the finished goods tariff is lower than the steel tariff, the Canadian import is now relatively cheaper than the US domestic competitor.

China exports both intermediate and finished goods to the US and has a much bigger footprint than Canada, making China Trump’s key adversary. Trump’s naïve understanding of trade, and his vengeance-driven actions, fail to recognize that the exploitation of China’s cheap labour was a bargain between China and US industrialists.

The ICT revolution opened the door to accelerated offshoring and facilitated safe and manageable access to low wage economies. China provided extremely cheap labour but wanted something in return: US know-how, technology, and capital. US corporations eagerly agreed so they could boost profitability.

The deal with China was the following: it boosted US corporate profitability, the downside of which was lost jobs in manufacturing. China compensated the US by providing low-cost imported goods by suppressing its own wages so long as it had excess labour, and by keeping its exchange rate low. Lower US$ priced goods boosted US domestic disposable income so creating more demand for services to employ those displaced by the China “deal.” But China moved up the value chain and anticipating that it would run out of excess labour it became more productive and sophisticated. Its goods are still competitive, and it can now go toe-to-toe with the US.

The rising GDP share of services is not a unique US experience; all advanced economies have experienced a reduction in manufacturing from about 65% in 1990 to about 30% today while the manufacturing share – until recently -- grew in EM counties and China. If tariffs raise the US$ relative price of goods, US disposable incomes are compressed and the entire process goes in reverse; as goods prices rise, jobs will be lost in the service sector where most people in advanced countries work.

One can conclude that if Trump is looking for a villain for the hollowing-out of US manufacturing, and the unquestionable distress caused in the industrial heartlands, he needs to look closer to home and consider providing a social safety net with a finer weave. But this is beyond US politics to deliver.

As the grievance doctrine prevails, and the US fails to provide the comprehensive social support provided elsewhere, there can be no trade deals only US dominance. The volatility is the point. Trump shows loyalty to no one; his signature is not binding. He dismisses allies and disregards friends. His is rage not reason, and there is always something or someone to rage against. There is no point in succumbing to US power in a zero-sum game. So Donald sits waiting for the phone to ring.

No way out

The Great Trade Hack warns that the disruption to the international trade system and architecture could spell significant trouble, the depths of which depends on how the rest of the world responds. Remember the demands of the grievance doctrine can never be satisfied, and no “deal” has any chance of being honoured. The point of NAFTA latterly USMCA and other trade agreements, was to reduce the risk from time inconsistent policies, the see-saw of policy depending on who wins after each electoral cycle. Investors need confidence in policy stability to risk large capital projects. With trust broken, Humpty Dumpty cannot be put together again – with or without Donald Trump.

The key economic issue is the relative lack of social support for the US population to manage economic disruption. Failure to tackle this issue means the political pressure for action will not dissipate. Many in the US are consigned to an endless loop of dashed expectations and policy failure. Tariffs cannot meet the moment to fix labour market precarity. And the service sector is next as AI moves to the ascendancy.

The social nexus of stable family life for the two decades following the second world war –affordable access to healthcare, decent housing, and education -- will remain beyond the reach of many. The pressure for policy to act will be constant, yet US policy and political beliefs cannot accommodate the income transfers necessary to manage the economic distress of change. Trade, and the cunning and cheating foreigners it facilitates, will always be the scapegoat.

With US policy increasingly made by presidential decree, the probability is rising that the US will transition from a market economy to a command economy based on import substitution. This will sap US dynamism, erode competitiveness, and lead the US to turn ever inward. By abandoning the responsibility that goes with global leadership, the US will lose its global privilege. The US bond market and the US$ are increasingly pricing-in this outcome; only the equity market chooses to ignore it.

What should the rest of us do?

The rest of the world must put analysis ahead of anger, put reason before rage, and preserve the benefits of globalization without America. Rules that bound the WTO can migrate to other institutions, or what Baldwin defines as managed multilateral drift. While trade recedes as a force for efficiency and rising prosperity, trade survives and the rest of us avoid being dragged down by US trade folly. After all Baldwin observes, the western trade alliance prospered while the Soviet Union, China and India were largely absent from the post-war trading relationship.

The US had already retreated from full participation in global trade before Trump acted on the grievance doctrine, by undermining the WTO Appellate Body. In response, other countries and regions have stepped-up to preserve elements of the rules-based trading system. Witness Japan’s lead to keep the trans pacific partnership alive after the US abandoned it, and the EU sponsored Multi-Party Interim Appeal Arbitration Agreement in response to the US-felled WTO Appellate Body.

The rest of the world has a choice: engage in a race to the bottom through tit-for-tat retaliation or find a negotiated way to trade with each other. Even after Trump leaves the scene, trust in and respect for the US has been severely damaged and the world will move on as best it can.

The rest of the world will have to trade without the US, following WTO rules governed by the alternative dispute resolution forums that have already emerged. If the world choses the latter, then living standards need not decline even if they will grow more slowly.