Trump advisor's 'China' documentary reveals possible direction of U.S. economic policy

Peter Navarro, a professor of economics at the Paul Merage School of Business at the University of California, Irvine, is the only academic economist on Donald Trump’s economic advisory team. Unusual for an economist, Navarro has written and directed a documentary film called Death by China. In the hope of obtaining some insight about the types of economic policies of a Trump presidency, which obviously would also affect Canada and Canadians, I recently watched this 80-minute film.

Narrated by Martin Sheen, Death by China tells an alarmist tale about how China, since its admission to the World Trade Organization (WTO) in 2001, has conspired with multinational corporations and the American political elite to steal U.S. jobs and hollow out America’s manufacturing base. According to Navarro, China’s success is due to the combination of “unfair” trade policies it has pursued. In particular, Navarro argues that “currency manipulation” (i.e. undervaluing the Chinese RMB relative to the U.S. dollar), weak or non-existent worker and environmental protection regulations, the practice of selling low-quality goods, and the theft of U.S. intellectual property, have given China a substantial cost advantage in manufacturing. The result, argues Navarro, is a large U.S. trade deficit and the loss of U.S. manufacturing jobs. Navarro’s policy solution to this dilemma is “trade reform” that eliminates the U.S. trade deficit and brings manufacturing employment back to America.

While there’s good evidence that trade with China has had negative impacts on local U.S. labour markets that house industries that compete directly with Chinese imports, the economics behind much of Navarro’s story is weak at best. Consider, for instance, his claim about currency manipulation.

It’s true that the People’s Bank of China has historically pegged the nominal value of the RMB relative to the U.S. dollar (actually a basket of currencies, of which the U.S. dollar is a major component). However, Navarro makes the mistake of thinking that the nominal exchange rate affects trade flows when in fact what matters is the real exchange rate (i.e. the nominal exchange rate adjusted for differences in domestic price levels), which mostly reflects comparative advantages due to differences in endowments and technologies across countries. As Dartmouth University economist Matthew Slaughter notes, there’s no evidence that long-term trade flows are influenced by nominal exchange rates. Accordingly, currency manipulation—which can only affect the nominal exchange rate—cannot be blamed for the U.S. trade deficit with respect to China.

Consider also Navarro’s argument about the unfair cost advantage derived from the fact that Chinese goods are of inferior quality. It may indeed be the case that some Chinese goods are of lower quality than U.S. goods with which they compete. However, to the extent that consumers care about quality, and it’s relatively easy for consumers to determine quality after purchase, market forces work to ensure that producers of low-quality goods are punished, either because consumers switch to other producers, or because consumers are willing to pay less for Chinese goods (buying high quality is not always the best strategy, especially for low-income consumers). The fact that U.S. consumers willingly continue to purchase Chinese products in great volume some 15 years after China’s admission to the WTO suggests that Navarro’s argument has little merit.

Moreover, Navarro mostly ignores the main benefit of trade with China, which is the enormous boon it has been for U.S. consumers. As a consequence of trade with China, a fantastic range of products has become cheaper than ever. Indeed, economists Pablo Fajgelbaum (University of California, Los Angeles) and Anil Khandelwat (Columbia University) estimate that lower-income households benefit most from trade because their expenditures are disproportionately concentrated on traded goods. Unfortunately, because the benefits of trade are diffuse while the costs (in terms of job losses) are highly concentrated, the benefits are more often than not ignored. As an economist, Navarro should know better than to focus only on what is seen at the expense of what is not.

Finally, Navarro’s policy prescription of “trade reform” that boosts U.S. exports and reduces imports so that net exports (i.e. the difference in the value of exports and imports) increase is naïve. First, Navarro is vague about what policies would allow him to achieve this goal. The film mentions import substitution and a consumer boycott of Chinese goods as possible paths but neither is likely to succeed; boycotts, because they are voluntary, usually founder as a result of a collective action problem, while import substitution is a mostly discredited approach to economic development. Second, as Harvard economist Greg Mankiw has noted in a brief critique of a recently-released Trump economic policy document co-authored by Navarro, only the most simplistic of policymakers would believe that they could raise net exports without offsetting impacts on investment and consumption.  

That one of Trump’s key economic advisors should be so misinformed about basic economic principles should be a major concern not only for Americans, but for Canadians. Approximately 20 per cent of Canada’s GDP comes from exports to the U.S. Canadians should therefore be wary of any presidential candidate whose key advisor holds such zero-sum views about international trade.