U..S. Trade Policy Is Just Plain Schizo

Fortune issue: April 12, 1999


U.S. Trade Policy Is Just Plain Schizo

First Principles

By N. Gregory Mankiw

The U. S. government works so well, I was taught as a child, because of our well-tuned system of checks and balances. You can see the beauty of this system in all its glory right now. As the Treasury Department is trying to concoct ways to help the world's ailing economies, the Commerce Department is screwing up . . . excuse us, balancing that effort by making these problems worse.

Responding to pressure from the U.S. steel industry, over the past couple of months Commerce has announced several measures to reduce the import of cheap steel from abroad. Specifically targeted are Japan, Brazil, and Russia--i.e., win, place, and show in the global economic-dysfunction derby. According to the New York Times, Commerce Secretary William Daley explained the policy with this noble sentiment: "We are trying to respond to the steel industry's concerns without bringing Russia to its knees." It's just too bad that steel imports from Russia have dropped more than 90% since November.

In principle, the U.S. government is committed to promoting free trade around the world--a policy supported by an overwhelming (and rare) consensus of economists. Yet politicians, not economists, make trade policy, and so the principle of free trade often loses out to the practice of protectionism.

One example is the Clinton Administration's March 3 decision, in response to disputes over the world banana trade, to place 100% tariffs on European goods ranging from cheese to cashmere--a hit list that itself was the product of the most unseemly kind of lobbying. These tariffs are the economic equivalent of mutually assured destruction: Bill Clinton is trying to get Europeans to remove a tiny trade barrier by threatening massive retaliation. Sometimes such brinkmanship works, but when it doesn't, we all go over the brink together. And the Europeans, remember, are supposed to be our friends and allies.

Bad as the banana wars are, however, the recent decisions regarding the steel industry are even worse. They flout the most basic lessons of economics, and they hurt economies we are otherwise trying to help.

The theory is that Brazil, Japan, and Russia are "dumping" steel on U.S. markets. Dumping means to sell below the cost of production. If these countries were more efficient at producing steel than we were and therefore had lower costs, it would be fine to import their steel. But when they sell steel below cost, the argument goes, this trade is unfair to U.S. producers that compete against these cut-price imports. Buying foreign steel in this case, it is alleged, is not in America's best interest because of the damage it would do to our own industry. Congress is seriously considering a bill that would limit steel imports to a quarter of domestic consumption--exactly the kind of import quota that sent the U.S. up a tree over bananas.

One problem with dumping arguments is that they rely on arbitrary measures of historical production costs, which changing circumstances have rendered irrelevant. Companies in these ailing economies are trying to sell their products abroad largely because their domestic markets have dried up. It makes perfect sense that the products would come with attractive prices. Think of a department store running a clearance sale on Christmas ornaments in January. The ornaments may be priced below the cost of manufacture, but the relevant cost once they are made is what the store could otherwise get for the merchandise. There is nothing sinister at work when this price, known as the opportunity cost, runs below the historical cost.

Another problem with the dumping theory is that it assumes that foreign costs matter. They don't. The free-trade argument is that U.S. steel consumers gain from the opportunity to buy steel imports at attractive prices, and these gains exceed the losses suffered by U.S. steel producers. What matters is the price, and a low price is a bargain we should take advantage of, whatever the reason for it.

The irony in the steel debate is that U.S. policymakers in other parts of the government are eager to send money to many of these countries, often via the IMF. The U.S. has an interest, they argue with some justification, in promoting world prosperity. Yet taken as a whole, U.S. policy conveys a strange message: We Americans should happily send our dollars to ailing economies, but we should object if they send us steel in return. This defies all logic.

Policymakers would do everyone a favor if they heeded the old slogan of economic development: "trade, not aid." Direct payments to foreign governments, dispensed with or without IMF advice, sometimes do more harm than good. By contrast, an open trading system is one of the surest ways to promote growth around the world. Sadly, current American policy is getting things exactly backward.


N. GREGORY MANKIW is an economics professor at Harvard and the author of Principles of Economics.