International trade contributes to the growth of GDP and employment if it is favorable—that is, if exports are greater than imports as was the case for the United States during 1895 – 1971. However, since 1971 the U.S. international trade balance has been negative. In May 2017 the U.S. trade balance was -$46.5 billion, meaning that amount was subtracted from U.S. GDP in May of 2017. The unfavorable trade balance, as identified by President Trump, has been caused largely by China and Mexico. The favorable trade balance of China since the 80’s has boosted its own GDP significantly. According to International Monetary Fund, now China’s GDP is number one in the world, exceeding that of the United States.
The theory of international trade was the brainchild of the British classical economist Adan Smith who in 1776 demonstrated that international trade was mutually beneficial to the trading nations. He said that nations should specialize in goods and services that had absolute advantage. Moreover, another English economist, David Ricardo, (1817) advanced that theory and pointed out that nations can benefit from trade by specializing in exporting goods and services in which they have comparative advantage. John Stuart Mill (1848) and John M. Keynes (1936) further embellished the idea of trade. The basic assumption behind the theory of trade was that the governments would not interfere by providing subsidies or manipulating foreign exchange rates that would make international trade disadvantageous, as China has done to the United States. To rectify this imbalance, international trade would have to adhere to flexible not fixed exchange rates. Then international trade would proceed by productivity and cost advantage not rigged foreign exchange and subsidized prices. In addition, China and India must be further included in the international trade and finance community.
China and other countries would be wise not to go back to the period from 1914 to 1945 when destructive competition, shrinking international trade, trade wars, and economic depression ensued. What is needed, which we hope President Trump is pursuing, is fair and open trade, use of flexible exchange rates, and balance among trade partners.
Economic nationalism is a horrible thing of the past. The U.S. producers are highly productive and they can bring the balance of trade from negative to positive in no time when trade is fair.