The American President Donald Trump wants to make America great again. At the heart of his plan to make America great again lies the idea of encouraging American manufacturers, Trump wants to implement tariffs on imports into America from other countries. He has already implemented tariffs on steel and aluminium.

This method of trying to make America great again by forcing Americans to buy stuff made in America, goes against basic principles of economics.

One of the most quoted paragraphs in economics was written by Adam Smith in a book called The Wealth of Nations. Steve Pinker writes about this in Enlightenment Now—The Case for Reason, Science, Humanism and Progress: “Smith explained that economic activity was a form of mutually beneficial cooperation: each gets back something that is more valuable to him than what he gives up.”

As Smith put it: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest.”

Hence, exchange is at the heart of any market. Trump is basically trying to clamp down on this exchange, which ultimately makes things cheaper for Americans.

The reason why the United States lost its manufacturing prowess over the years, is simply because other countries produced similar or better goods at a cheaper price. Take the case of China. In 2017, the United States ran a trade deficit of $375 billion (or more than a billion dollars a day) with the country.

Why did the situation come to this? The answer lies in the fact that China produced stuff  that American consumers wanted to buy, at a much more competitive price than the American manufacturers did.

Of course, the American consumer benefited from this because he had to pay a lower price than if he had bought the same thing from an American manufacturer. As Smith had said, “through voluntary exchange, people benefit others by benefitting themselves”.
Americans benefited because of competitive pricing of Chinese goods and the Chinese benefited because they got dollars in return for what they sold. Of course, it needs to be said here that Americans paid paper dollars for tangible goods from China.

These dollars earned by China helped pull many millions  of Chinese out of poverty in a period of around four decades starting in 1978. At the same time, it helped America maintain a lower rate of inflation, though many American jobs were lost due to lack of competitiveness of American firms.

The Chinese companies earned dollars while selling stuff in the United States. But they couldn’t spend these dollars in China because the Chinese currency happens to be the renminbi (also known as the Yuan). They exchanged these dollars with the Chinese central bank, the People’s Bank of China, which gave them renminbi to spend. The Chinese central bank then invested a good portion of these dollars in financial securities issued by the American government and other American institutions.

This flood of dollars from China and other big exporters earning dollars, helped keep interest rates low in America.

Donald Trump is now looking to break this arrangement that has been in place for the past few decades. As economist Ludwig von Mises put it a few centuries after Adam Smith: “If the tailor goes to war against the baker, he must henceforth bake his own bread.”

By imposing tariffs, Trump will force American consumers to buy expensive American goods. And this will not create any jobs. Take the example of steel. Buying American steel will make things more expensive for American car manufacturers.

They will either pass on this increase in cost to the American consumer, who will then have to cut down on expenditure somewhere else. If they don’t do that and decide to maintain the cost, they will have to fire a few employees that they currently employ.
All in all, there are no short-cuts to make America great again. The only way is to be competitive. The sooner Trump understands this, things will be much better.

The column originally appeared in the Bangalore Mirror on March 22, 2018.


If Home Loans Are Growing, what is the Problem with Real Estate?


The government shared some data earlier this month in the Lok Sabha, which has led to this column. Take a look at Table 1. It gives us the total home loans given by public sector banks and housing finance companies over the last few years.

It was further pointed out as a part of an answer: “As per the data compiled by National Housing Bank, the growth in housing loans of public sector banks and housing finance companies during the six month period from 1st July, 2017 to 31stDecember, 2017, has been about 34% as against 12% during the corresponding previous half year.”

Table 1: Total amount of home loans given by public sector banks and housing finance companies.It would have been great if the government had shared the total amount of home loans given out between July 1, 2017 and December 31, 2017, instead of just sharing percentages.

Also, on a slightly different note, the National Housing Bank needs to share home loan lending data (both banks and housing finance companies) on a regular basis, which it currently doesn’t. While, the Reserve Bank of India shares the total amount of home loans given out by banks, no such data is regularly available for housing finance companies.

Anyway, getting back to the point. Between July 2015 and June 2016, the home loan disbursement grew by around 25%. Between July 2016 and June 2017, it grew by around 13%.

Since then, growth rate has improved considerably, which tells us that the ill-effects of demonetisation which plagued the sector, are on their way out to some extent.

Now contrast this to data recently released by property consultant JLL. As of December 2017, a total of 4.4 lakh housing units remained unsold in seven major cities. Delhi along with the National Capital Region came on the top with 1.5 lakh unsold homes. Mumbai, Delhi-NCR, Chennai, Hyderabad, Pune, Bengaluru, Kolkata were the seven cities covered in this survey.

How does one contrast the JLL data with the increase in home loans being disbursed, is a question worth asking. There are several explanations. One is that homebuyers are no longer buying under-construction properties. Take the case of the JLL data, only 34,700 units are ready-to-move-in flats. Hence, people are not interested in buying properties which aren’t totally ready. Why?

The answer for this is very simple. Many builders in the last decade have taken money from prospective buyers and not delivered homes. And the prospective buyers have seen what has happened to the earlier set of buyers, and does not want to make the same mistake again. Nobody wants to get into a situation where the biggest investment of their life gets stuck and doesn’t go anywhere.

Given that many people bought real estate as an investment over the years, and kept those homes locked, my guess is, it is that inventory which is now being cleared, to some extent.

This loss of trust between the real estate companies and the prospective buyers, is the basic problem at the heart of India’s real estate crisis. And the data suggests, the lack of trust continues to prevail.

Further, the growth in home loans is basically coming in the affordable housing segment. As the Affordable Housing Report released by the Reserve Bank of India (RBI) in January 2018, points out: “Affordable housing is currently driving home loan growth in India… Housing loans up to Rs 10 lakh recorded robust growth in 2016-17, primarily driven by the public sector banks.. While the number of beneficiaries for loan amounts up to Rs 10 lakhs has increased sharply in 2016-17, the number of beneficiaries for higher value loans of above Rs 25 lakhs has, in fact, declined marginally during the year.”While the bulk of the lending still happens in the greater than Rs 25 lakh category, the growth actually is coming from the sub Rs 10 lakh segment, which is where the real market for homes in India is. Of course, much of this growth is being pushed by the government (which is why the government loves public sector banks) and is not happening in the top seven cities that JLL covers.

What this again tells us is that if home ownership in large cities has to pick up, the prices need to still fall from where they are. Also, buyers are not interested in buying under-construction property and that is something that the real estate companies need to realise and do something about. But that would mean a substantial change from their current way of operating. It hits at the heart of their current business model. And all change is a slow process.

This appeared on Equitymaster on March 22, 2018

Let’s Move Beyond Nirav Modi, Bad Loans Are Bleeding India

Nirav Modi, Nirav Modi, where have you been?” is a question that the bankers at the Punjab National Bank (PNB), must be asking themselves these days.

Media reports suggest that Nirav Modi is in New York, and has no plans of coming back to India. His operational fraud is expected to cost PNB Rs 12,646 crore. PNB is the second largest public sector bank in the country and as of December 31, 2017, had accumulated bad loans of Rs 57,519 crore. A bad loan is a loan which hasn’t been repaid for a period of 90 days or more.

The one good thing that has happened since Nirav Modi’s fraud came to light is the relentless focus of the mainstream media on the operations of India’s government owned public sector banks.

The total bad loans of the public sector banks as of December 31, 2017, stood at Rs 7,77,280 crore. This forms 86.4% of the total bad loans of scheduled commercial banks (i.e. public sector banks + private sector banks + foreign banks).  This basically means that the total bad loans of scheduled commercial banks as of December 31, 2017, would be around Rs 9,00,000 crore.

Hence, Nirav Modi’s fraud of Rs 12,646 crore is just a drop in this ocean of bad loans. But his fraud has put a face to the sad state of affairs that prevails at public sector banks and has thus elicited interest from the mainstream media and the common public.

Before Nirav Modi came long, the bad loans of public sector banks was just an issue which with the business press was concerned about. Now even the TV channels in different languages are having discussions around the issue.

Nevertheless, the fundamental issue at the heart of the bad loans of India’s public sector banks continues to remain unaddressed. Who is responsible for this mess and what should be done about it?

The government released some interesting data earlier this month in an answer to a question raised in the Lok Sabha. As per data from the Reserve Bank of India (RBI), the total bad loans from the “industry-large” category of loans, as of December 31, 2017, stood at Rs 5,27,876 crore. This was for scheduled commercial banks as a whole. The RBI defines a large borrower as a borrower with whom the bank has an exposure of Rs 5 crore or more.

Such borrowers are essentially responsible for a bulk of the bad loans of the banks in India. They are responsible for around 59% of the bad loans (Rs 5,27,876 crore expressed as a percentage of Rs 9,00,000 crore) of scheduled commercial banks. Bank loans to large industrial borrowers formed 59% of the bad loans, even though the total lending by banks to such borrowers formed only around 30 per cent of the total loans given by banks.

Public sector banks accounted for Rs 4,64,253 crore or 88% of bad loans in this.
In fact, the much criticised public sector banks do a pretty decent job of lending to the retail sector. Take a look at Table 1, which basically compares proportion of retail loans which turn bad with proportion of loans to corporates which turn bad, for a few public sector banks.
Table 1:

Name of the bank Retail bad loans
( in %)
Corporate bad loans
(in %)
State Bank of India 1.3 21.9
Bank of India 2.6 27.6
Syndicate Bank 4 16
Bank of Baroda 3.4 16
IDBI Bank 1.4 39.4
Central Bank of India 4.6 23.5
Bank of Maharashtra 4.4 15.3
Andhra Bank 1.8 29.1
Source: Investor/Analyst presentations of banks.    

Table 1 clearly shows that corporate bad loans are much higher than retail bad loans. The question is why? The answer perhaps lies in what economists call regulatory capture. As Noble Prize winning French economist Jean Tirole writes in his book Economics for the Common Good: “The state often fails. There are many reasons for these failures. Regulatory capture is one of them. We are well aware of the friendships and mutual support that create complicity between a public body and those who are supposed to be regulating it.”

How does one interpret this in the Indian case? While it would be totally unfair to suggest that the RBI, which regulates banks in India, is pally with corporates, but it would be totally fair to say that Indian politicians are very pally with Indian corporates. This is where the problem for public sector banks in India lies.

While giving out retail loans, the managers running public sector banks, can make right lending decisions, the same cannot be said when they carry out corporate lending, given the political pressure that prevails on many occasions.

In this scenario, it is worth asking whether all the 21 public sector banks in India should actually carry out corporate lending and put public deposits at risk, over and over again? This is a discussion that we should now be having as a nation and the mainstream media is where this discussion should be happening.

The column originally appeared on The Quint on March 22, 2018

India’s Demographic Dividend is Collapsing

indian flag

Sometimes we get accused of being a stuck like a broken record. But then how else does one follow an issue of utmost importance to a nation, without saying the same things over and over again.

A few days back, The Economic Times reported that the Indian Railways had received a record 1.5 crore applications for 90,000 vacancies. This is the highest number of applications that the Railways has ever received. These are vacancies in Group C and Group D categories, with salaries ranging from Rs 18,000 to Rs 60,000.

Of the 90,000 jobs, around 63,000 jobs are in the Group D category, which includes the job of a gangman. Around 26,500 jobs are in the Group C category, which includes jobs of loco pilots and assistant loco pilots.

The last day of the application is March 31, 2018.  “The number could cross even two crore as there’s still a lot of time to file application,” a senior railway ministry official not willing to be identified told The Economic Times.

Around 167 individuals are competing for one job. If the number of applicants goes up to 2 crore, then 222 individuals will compete for one job in the Indian Railways.

This is India’s demographic dividend, competing for a government job, when barely any are going around. Nearly two million people cross the age of 14 every month in India. Potentially, all of them can join the labour force to look for a job. But all of them don’t. Some people continue to study. A bulk of the women do not look for a job. After adjusting for this, and folks leaving the workforce through retirement, nearly a million Indians join the workforce every month i.e. 1.2 crore a year, which is around half the population of Australia and two and a half times, the population of New Zealand.
A recent estimate made by the Centre for Monitoring Indian Economy suggests that in 2017, two million jobs were created for 11.5 million Indians who joined the labour force during the year.

Of course, the Indian Railways example cited earlier is just one example which shows the lack of jobs for the Indian youth entering the workforce every year. A random Google search will tell you that this is not an isolated example. A late January 2018 newsreport in The Times of India points out that, engineers, law graduates and MBAs were among the 2.81 lakh people who applied for 738 peon posts in Madhya Pradesh.

Another newsreport which appeared in The Indian Express in early January 2018 pointed out that at least “129 engineers, 23 lawyers, a chartered accountant and 393 postgraduates in arts were among 12,453 people interviewed for 18 Class IV posts — in this case, for jobs as peons — in the Rajasthan Assembly secretariat.”

Imagine, if 12,453 individuals were interviewed for 18 posts of peon, how many people would have applied in the first place?

Another newsreport in The Telegraph points out that 1,000 people turned up for three data entry posts that the Odisha University of Agriculture and Technology (OUAT) had advertised for. As the newsreport points out: “While the required qualification for the post was graduation with mandatory knowledge of computer, candidates with BTech, MCA and law degrees turned up for the job interview.”

These are not isolated news stories. Such stories have appeared in the media regularly over the last few years. They are the best example of the fact that there aren’t enough jobs going around for India’s youth, the country’s demographic dividend.

As the Fifth Report on Employment and Unemployment points out: “The Unemployment Rate for the persons aged 18-29 years and holding a degree in graduation and above was found to be maximum with 18.4 per cent based on the Usual Principal Status Approach at the All India level.” Also, the Usual Principal Status Approach considers anyone working for a period of 183 days or more during the course of the year, as employed. Hence, a person could be unemployed for 182 days, and still considered to be employed.

In fact, in a recent answer to a question raised in the Lok Sabha, the government basically pointed out that the more educated an individual is in rural India, the more difficult it is to find a job, in India. Take a look at Table 1.

Table 1:

Educational classification Unemployed
Not literate 2.3%
Primary 3.3%
Middle/Secondary/ Higher Secondary 3.7%
Graduate & above 23.8%

As the 12th Five Year Plan (2012-2017) document pointed out: “One hundred and eighty-three million additional income seekers are expected to join the workforce over the next 15 years.” This essentially means that a little over 12 million individuals will keep joining the workforce every year, in the years to come. This works out to around one million a month. And at this rate, the Indian workforce is expected to be larger than that of China by 2030.

And this is India’s demographic dividend. As these individuals enter the workforce, find work, earn money and spend it, the Indian economy is expected to do well. This will put India on the path to faster economic growth, which will eventually pull millions of Indians out of poverty.

The demographic dividend is a period of a few decades in the lifecycle of nation where the working population expands at a faster pace than the overall population. As the working population gets into the workforce, finds a job, starts earning and spends money, all this creates rapid economic growth, which pulls millions of people out of poverty. At least that is how it is supposed to work in theory. In India’s case it isn’t.

How have things been with other countries been in the past? Have countries which were expected to benefit from the demographic dividend benefitted from it?

As Ruchir Sharma writes in his new book The Rise and Fall of Nations—Ten Rules of Change in the Post-Crisis World: “The trick is to avoid falling for the fallacy of the “demographic dividend,” the idea that population growth pays off automatically in rapid economic growth. It pays off only if political leaders create the economic conditions necessary to attract investment and generate jobs.” This has clearly not happened in India, with the investment to GDP ratio constantly falling over the last decade.

Sharma then talks about the Arab world which despite being poised to, did not benefit from a demographic dividend. As Sharma writes: “The Arab world provides a cautionary tale. There between 1985 and 2005 the working age population grew by an average annual rate of more than 3 percent, or nearly twice as face as the rest of the world. But no economic dividend resulted. In the early 2010s many Arab countries suffered from cripplingly high youth unemployment rates; more than 40 percent in Iraq and more than 30 percent in Saudi Arabia, Egypt, and Tunisia, where the violence and chaos of the Arab Spring began.”

So, what is the way out for India? The answer as we have said over and over again in our previous columns, is the export of low-end manufacturing goods. This is something that India has missed out on. As Sharma said in a recent conference: “If you look at the success stories across the world, their key to success was all the same thing which is they all exported their way to prosperity. They exported their way to prosperity by producing low end manufacturing goods. It is low end manufacturing goods where you end up getting a huge amount of employment growth as well.”

Given that India has missed the manufacturing bus, jobs are hard to come by. As Nobel Prize winning economist said in a recent conference: “India’s lack in the manufacturing sector could work against it, as it doesn’t have the jobs essential to sustain the projected growth in demography. You have to find jobs for people.”

All this leaves us with the question, what does the future have for India? Pakodas we guess.

This column originally appeared in Equitymaster on March 19, 2018.

There’s a Basic Disconnect in Trump’s Plan to Make America Great Again

donald trumpThis is the third and the final column in the series, where I explain that Donald Trump’s idea of making America great again, by imposing tariffs, is not going to work.

Dear Reader, before you start reading this column, it perhaps makes sense to read the two columns published before this, in order to get a complete perspective on the topic. (You can read the columns here and here).

In today’s column we will take a look at how Trump’s entire idea of driving up exports while driving down imports, is contradictory to say the least. Let’s start by looking at Figure 1, which basically plots the trade deficit of the United States over the years.

Figure 1: US trade deficit (in $ million) 

Trade deficit is a situation where the imports of a country are more than its exports. We can see that the United States has run a trade deficit with the rest of the world over the last four decades. The trade deficit peaked between 2004 and 2008, fell for a few years after that, and started going up again.

The American trade deficit came down in the years 2009 and 2010, and these were years when the American economy and the global economy, were both not doing well. Now let’s take a look at Figure 2, which basically plots the exports and imports of the United States over the last four decades.

Figure 2: 

Figure 2 makes for a very interesting reading. The exports and the imports curves of the United States, move more or less in the same way. This basically means that when imports go up, exports also go up and vice versa. Why is that the case? The reason for this is very straightforward. The United States is the largest market in the world. When it imports stuff, it pays dollars to other countries, which are exporting stuff to the United States. These countries can then use these dollars to pay for American exports.

Hence, if Trump keeps going ahead with imposing more tariffs on imports into the US, as he has suggested for a while, he will deny other countries an opportunity to earn “enough” dollars through which they can pay for their imports from the US, which are basically the exports for the US. The larger point being that it is not possible to increase American exports and decrease American imports at the same time. This is the simplistic plan that Trump has to make America great again and there is a basic disconnect at the heart of it. Also, any such plan will have a negative international impact.

Now let’s take a look at Figure 3, which basically plots the American trade deficit with one country, and that is China.

Figure 3: 

Figure 3 clearly shows that the American trade deficit with China has gone up dramatically over the years. The Chinese imports help keep inflation low in the United States. They also help keep interest rates low, as the dollars earned by the Chinese, have over the years found their way back into the United States and are invested in American treasury securities and other debt securities. This foreign demand for American financial securities has helped keep interest rates low in the US. Over and above this, there is another major point that arises here. Take a look Figure 4. It plots the overall trade deficit of the United States, along with the trade deficit that the country runs with China.

Figure 4: 

Figure 4 tells us very clearly that over the years, the trade deficit with China has formed a greater proportion of the overall trade deficit run by the United States. In 2017, the trade deficit with China formed nearly 66% of the overall trade deficit.

Much has been said about the fact that Trump is basically not thinking about the long-term, but is trying to beat down American trading partners into giving American companies better terms. The trouble is that the bulk of the American trade deficit is with China and unless Trump takes on China, the gains of his so called policy are going to be very low.

Of course, it is not easy to bully China, given that other than helping maintain a low inflation and low interest rates in the US, the Chinese also own more than a trillion dollars of American government treasury securities and if push comes to the shove, it can use these treasury securities, as a bargaining tool.

Also, the current Chinese regime is turning more and more authoritarian and is unlikely to take to any bullying by the US, lightly. The only way America can become great again on the industrial front is, if it is able to compete with the products being produced internationally, both on the price as well as the quality front.

The column originally appeared on Equitymaster on March 16, 2018.

Trump’s Trade Wars Will Hurt Dollar’s Exorbitant Privilege

Dear Reader, we would suggest that before you start reading this column, you read the column published yesterday. In yesterday’s column we saw how the tariffs unleashed by the US President Donald Trump will hurt America, instead of making it great again. Reading this column, before you read today’s column, will give you a complete perspective on the issue. This is the second in a series of three columns on the issue. The third column will appear on Thursday.

The American dollar is at the heart of the global financial system as it has evolved. The reasons for this are historical.

By 1944, it was clear that the Allied forces are going to win the Second World War. In July 1944, they gathered at the Mount Washington Hotel, Bretton Woods, New Hampshire in the US, to design a new financial system for the world. Europe had been totally destroyed during the course of the war and even countries like Britain and France were in a bad shape despite being on the winning side. European countries were in no position to negotiate. And so, the American dollar was placed at the heart of the financial system that evolved at Bretton Woods.

The US was ready to convert dollars into gold at the rate of $35 for one ounce (31.1 grams) of gold. This came to be known as the Bretton Woods Agreement. It made the
American dollar the premier international currency of choice, as it was the only currency that could be converted into gold.

This ensured that over a period of time countries moved to carrying out their international trade primarily in American dollars. It also ensured that countries held their foreign exchange reserves in dollars because dollar was the only currency which could be converted into gold.

This structure that emerged gave the American dollar an exorbitant privilege. While the rest of the world had to earn these dollars by exporting stuff, the United States could simply print them and buy all the stuff that it needed. This has been one of the primary reasons why United States, over the decades, has turned into a big buyer of things. All the American buying drives global demand.

Given that the dollar became the international trading and reserve currency, the oil cartel OPEC (Organization of the Petroleum Exporting Countries), also sold the oil that it produced, in dollars. This was one more reason for the world to buy and sell stuff in dollars. Every country did not produce the total oil it consumed, and in order to import enough oil to fulfil its consumption needs, it needed dollars. The only way to earn these dollars was to price its exports in dollars.

In fact, the Saudi Arabia led OPEC continuing to price oil in dollars, is one of the major reasons why dollar continues to be the major reserve as well as trading currency of the world. Even the Americans recognise this fact.

As Nassim Nicholas Taleb writes in his new book Skin in the Game—Hidden Asymmetries in Daily Life: “It is clear since the attack on the World Trade Center (in which most of the attackers were Saudi citizens) that someone in that nonpartying kingdom had a hand—somehow—in the matter. But no bureaucrat, fearful of oil disruptions, made the right decision—instead, the absurd invasion of Iraq was endorsed because it appeared to be simpler.”

So, dollar due to various reasons is the international currency in which people and countries want to deal with. As George Gilder writes in The Scandal of Money—Why Wall Street Recovers But the Economy Never Does: Today it [i.e. the dollar] handles more than 60 percent of world trade, denominates more than half the market capitalization of world stocks, and partakes in 87 percent of global currency trades.”

Given this, over the years, countries have accumulated huge dollar reserves. A significant chunk of these reserves have been earned by exporting stuff to the United States.  The United States is the biggest economy in the world. It accounts for nearly one-fourth of the world’s GDP. By virtue of this, it is also the world’s biggest market, where China, Japan and countries from South- East Asia sell their goods and earn dollars in the process.

It is also the world’s biggest consumer of oil and consumes nearly a fourth of the global oil production. This meant that oil-rich states such as Saudi Arabia could sell oil to it and thus earn dollars in the process.

The dollars earned by other countries haven’t stayed in the vaults of their central banks. They have been invested in American treasury securities and other debt securities. Treasury securities are basically financial securities issued by the American government to finance its fiscal deficit, which is the difference between what a government earns and what it spends. Take a look at Figure 1. It basically plots the foreign investment in American treasuries over the last 40 years.

Figure 1:

Source: Board of Governors of the Federal Reserve System (US)


The foreigners currently own more than $6 trillion of American government treasury securities. This along with the easy money policy initiated by the Federal Reserve of the United States, in the aftermath of the financial crisis that broke out in September 2008, has ensured that the interest that the US government pays on these securities has been around 2% per year, over the last five years.

The interest paid on the US treasury securities sets the benchmark for other loans in the American financial system (or for that matter any other financial system) because lending to the government is deemed to be the safest form of lending. Over and above this, the foreigners have invested close to $3.3 trillion in other American debt securities.

This inflow of dollars into the United States has kept interest rates low. These low interest rates have kept the American consumption story going to some extent. As the American stand-up comedian George Calrin once said: “Consumption is the new national pastime. People spending money they don’t have on things they don’t need, money they don’t have so they can max out their credit cards… And they didn’t like it when they got it home anyway.”

Donald Trump’s tariff policy will attack at the heart of this model. Countries earn dollars by exporting stuff to the United States and other parts of the world. These dollars then find their way back to the United States where they are invested in treasury and other debt securities, and help maintain low interest rates.

If Trump and America shut out the American market to other countries, the countries exporting stuff to the US (Japan, China, South Korea, Taiwan, and a whole host of other countries), will not earn as many dollars as they currently are. And if they don’t earn enough dollars, the likelihood of them continuing to invest in American debt securities, is very low. This will mean that the interest rates in the United States will start to rise. This is something that the country which is currently going through an early stage of economic recovery, cannot really afford.

Further, the other countries might also start to try and price their exports in currencies other than the dollar, as well. China has been working towards this for quite a while. Trump’s decision to introduce tariffs might just be the final push that the country needs.
If countries start pricing their exports in non-dollar currencies, Trump’s plan to impose tariff will hurt the exorbitant privilege that the dollar has enjoyed over the years.

In fact, in the third and final column in this series, which will appear on Thursday, we will see why Trump’s plan of trying to increase American exports while shrinking its imports, is essentially contradictory in nature.

The column originally appeared on Equitymaster on March 13, 2018.

Trump’s Trade Wars Aren’t Going to Make America Great Again

donald trump
Donald Trump’s campaign slogan while fighting the American presidential elections, was to ‘Make America Great Again’. On March 1, 2018, a little over a year after taking over as the 45th president of the United States, Trump announced a 25% tariff on steel and a 10% tariff on aluminium.

The question is, how does this fit into Trump’s plan to make America great again? Trump plans to drive up exports and drive down imports. By driving down imports through tariffs, the American consumer will be forced to buy stuff produced within the country. This will encourage domestic industry and in turn create jobs. By driving up exports, again domestic industry will be encouraged and this will create jobs. QED.

Now only if it was as simple as that. The trouble is that most politicians while making economic decisions look at only the first order effects of their decisions. In the current case this basically means that the steel tariff of 25%, will also allow the American domestic steel industry to compete.

As of now the American steel industry cannot compete simply because it cannot produce steel at a price at which steel can be imported into the United States. The tariff of 25% will make imported steel costlier and in the process allow American steel companies to compete. And this will create jobs. At least that is what Trump and his advisers who have helped him to arrive at this decision, hope for.

This is the first order effect of Trump’s decision which looks just at the impact of the tariff  on the American steel producers. As Henry Hazlitt writes in Economics in One Lesson: “Those who favour it [i.e. tariffs] think only of the interests of the producers immediately benefitted by the particular duties involved. They forget the interests of the consumers who are immediately injured by being forced to pay these duties.”

Hazlitt is talking about the first order effect of Trump’s decision which benefits American steel companies and the second order effect of Trump’s decision which hurts American companies consuming steel.

Steel (either imported or produced in America) is bought by other American companies. It is used as a major component while making buildings, tools, ships, automobiles, machines, appliances, and weapons. Other than weapons, the United States cannot do without the other things listed in the last sentence.

On second thought, given the American obsession with guns, neither can the country do without weapons.

Steel is also used as a major input into building physical infrastructure.

While the tariff on steel will make American steel producers viable, it will make steel more expensive for American steel consumers, as they will have to pay more for steel. This increase in cost will be passed on to the end consumers. So, everything from cars to appliances to homes will cost more. The end consumer only has so much money going around. Hence, he or she may not buy the stuff he has been planning to, due to higher prices. If he does so, his expenses will have to increase or he will have to balance his overall expenses, by cutting down on his other expenditure.

As Hazlitt writes: “The added amount which consumers pay for a tariff protected article leaves them just that much less with which to buy all other articles. There is no net gain to industry as a whole.” This is a very basic point which politicians encouraging any sort of protectionism don’t seem to get.

The tariffs will impact the overall sales of other American businesses, which might in turn fire people to maintain their profitability. It’s just that it is not possible to exactly quantify these job losses and loss of business.

As Hazlitt writes: “It would be impossible for even the cleverest statistician to know precisely what the incidence of the loss of other jobs had been—precisely how many men and women had been laid off from each particular industry, precisely how much business each particular industry had lost—because consumer had to pay more [for steel in this case].”

The news agency Reuters has a story on how 780 workers of the Novolipetsk Steel will lose their jobs. The company imports two million tonnes of steel slabs per year from its Russian parent company. It then rolls these slabs into sheets for various American companies, ranging from Home Depot to Harley Davidson to Caterpillar.

The customers of this steel company now need to be ready to accept a 25% increase in the price of steel. If they do, the company survives. If they don’t, then the company will have to start firing workers. This is the second order effect of a tariff, which is not very clear up front.

If these companies accept a 25% increase it will only be in a situation where they can’t source the steel they need from a cheaper source. Further, it will lead to a rise in the price of their end product, depending on what proportion steel forms of their total inputs.

Also, it is worth remembering here, that if America can impose tariffs on its imports, other countries can do the same on their imports, hurting American exports. In fact, this is precisely how things played out in the aftermath of the First World War, when America tried to protect its domestic industry through tariffs. In return, other countries imposed tariffs on their imports and this led to the start of the global trade war, hurting American exports.

Hence, driving down imports, while trying to drive up exports, is sort of contradictory. There are many other aspects to this, which we shall see in tomorrow’s column.

The Economist estimates that steel and aluminium accounted for around 2% of the total American imports of $2.4 trillion, last year. This formed around 0.2% of the American GDP. Given this, currently the level of protectionism unleashed by the American president is very small. But the level of rhetoric that Donald Trump has unleashed around the issue, it doesn’t seem that he is going to stop just at this. This also becomes clear from the fact that on March 6, 2018, Gary Cohn, the chief economic adviser of Trump, quit.

We will return to this discussion in tomorrow’s column.

The column originally appeared on Equitymaster on March 12, 2018.