By Paul Krugman
Opinion Columnist
As
I write this, China’s announcement of a new round of tit-for-tat
tariffs has stoked fears of trade war and sent stock futures plunging.
If this morning’s futures hold, the S&P 500 will be about 10.5
percent off its January peak, around 6 percent off its level when Gary
Cohn, the last of the Trump “globalists,” was pushed out.
My question is, why such a large fall?
One
good answer is, that’s a stupid question. The three rules you need to
bear in mind when discussing the stock market are (1) the stock market
is not the economy (2) the stock market is not the economy (3) the stock
market is not the economy. And stocks move for all sorts of reasons, or
no visible reason at all. As Paul Samuelson famously quipped, the
market has forecast nine of the last five recessions.
Another
answer is that the trade war is a signal: Trump, Navarro et al are
showing that they really are as unhinged and irresponsible as they seem,
and markets are taking notice. Imagine how these people would handle a
financial crisis.
Still, I think it’s
worth noting that even if we are headed for a full-scale trade war,
conventional estimates of the costs of such a war don’t come anywhere
near to 10 percent of GDP, or even 6 percent. In fact, it’s one of the
dirty little secrets of international economics that standard estimates
of the cost of protectionism, while not trivial, aren’t usually
earthshaking either.
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Yet
there is a reason why stock prices might overshoot the overall economic
costs of a trade war. For a trade war that “deglobalized” the U.S.
economy would require a big reallocation of resources, including
capital. Yet you go to trade war with the capital you have, not the
capital you’re eventually going to want – and stocks are claims on the
capital we have now, not the capital we’ll need if America goes all in
on Trumponomics.
Or to put it another way, a trade war would produce a lot of stranded assets.
First,
about the costs of trade war. This is the wonkish part, so feel free to
skim and don’t worry if it seems incomprehensible, as long as you’re
willing to accept the bottom line for the sake of argument.
The costs of protectionism, according to conventional economic theory, are not
that tariffs caused the Great Depression, or anything like that. They
come, instead, from moving your economy away from things you’re
relatively good at to things you aren’t. American workers could sew
clothes together, instead of importing apparel from Bangladesh; in fact,
we’d surely produce more pajamas per person-hour than the Bangladeshis
do. But our productivity advantage is much bigger in other things, so
there’s an efficiency gain – for both economies – in having us
concentrate on the things we do best.
And
a trade war, by imposing artificial costs such as tariffs on
international trade, undoes that productive specialization, making
everyone less efficient.
We can, with
some heroic assumptions, put numbers to the kind of costs involved.
Strictly speaking, we should do this using “general equilibrium” –
modeling the economy as a whole. But another dirty little secret of
international economics – much littler than the previous one – is that
you get pretty close with “partial equilibrium” – just treating the
market for imports as if it were the market for a single product that’s a
small part of the economy.
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In
the figure, the downward-sloping line is the demand for imports as a
function of their price, measured relative to the price of domestic
goods. Under free trade, we import anything that costs less to produce
abroad than at home. If we impose a tariff, we end up not importing
stuff unless the price of the import is sufficiently low that it’s
cheaper even including the tariff. The marginal good we import, then, is
actually much cheaper than a domestic product, and the marginal good we
don’t import costs the economy a lot – specifically, the tariff that we would have paid if we did import it.
Image
If
you imagine raising the tariff step by step, then, at each step we are
imposing costs on the economy equal to the extra cost of the domestic
product that replaces an import. The total costs of the tariff are
represented by the area of the triangle: the reduction in imports caused
by the tariff, multiplied by (roughly) half the tariff rate.
(Somebody is going to ask, what about exports? They’re implicitly included in this estimate. Trust me.)
So,
what would a trade war do? Suppose the US were to impose a 30 percent
tariff across the board, with other countries retaliating in kind so
that there’s no improvement in the U.S. terms of trade (more technical
stuff I don’t want to get into.) How much would this reduce trade? It
depends on the elasticity of import demand; a reasonable number
seems to be around 4. This would mean a fall in imports from 15 percent
of GDP to around 5 percent – a 10-point reduction. And that in turn
means a reduction in US real income of around 1.5 percent.
Obviously
this is just an illustrative calculation; I’ve tried to use
reasonable-ish numbers, but you don’t want to make too much of it. What
it does suggest, however, is that even a trade war that drastically
rolled back globalization wouldn’t impose costs on the economy
comparable to the kinds of movement we’ve seen in stock prices.
But the costs to the economy as a whole might not be a good indicator of the costs to existing corporate assets.
Since
about 1990 corporate America has bet heavily on hyperglobalization – on
the continuance of an open-market regime that has encouraged complex
value chains that sprawl across borders. The notebook on which I’m
writing this was designed in California, but probably assembled in
China, with many of the components coming from South Korea and Japan.
Apple could produce it entirely in North America, and probably would in
the face of 30 percent tariffs. But the factories it would take to do
that don’t (yet) exist.
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Meanwhile,
the factories that do exist were built to serve globalized production –
and many of them would be marginalized, maybe even made worthless, by
tariffs that broke up those global value chains. That is, they would
become stranded assets. Call it the anti-China shock.
Of
course, it wouldn’t just be factories left stranded by a trade war. A
lot of people would be stranded too. The point of the famous “China shock”
paper by Autor et al wasn’t that rapid trade growth made America as a
whole poorer, it was that rapid changes in the location of production
displaced a significant number of workers, creating personal hardship
and hurting their communities. The irony is that an anti-China shock
would do exactly the same thing. And I, at least, care more about the
impact on workers than the impact on capital.
Still,
my original question was why stocks are dropping so much more than the
likely costs of trade war to the economy. And one answer, I’d suggest,
is disruption – which business leaders love to celebrate in their
rhetoric, but hate when it happens to them.
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