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Expert Analyses

The US has been conducting a trade war for a long time

Bogdan Szafrański – an economist and Americanist, a member of the Polish Development Fund supervisory board, and Polonia Institute.

Donald Trump’s fair trade is not protectionism

Donald Trump’s pursuit of fair trade is ridiculed and derided by his opponents. He is accused of protectionism and isolationism and the pursuit of a trade war with every country, including close allies. The tariffs imposed on imports of steel and aluminum are also assessed accordingly. In fact, one of the main reasons for the divergence of views is a different understanding of the functioning of the VAT tax system, which was not adopted in the US, and its role is filled to a very limited extent by a sales tax at the state level.

According to the US President Donald Trump and his economic advisers, there is no longer free trade, which is currently effectively disrupted by several multilateral trade agreements, arbitrary policy of international organizations regulating trade and trade policy of many countries exploiting such a structure to achieve their goals, usually at the expense of interests of the American economy.

On the war path

These are the views preached by the co-founders of the pre-election economic plan of Donald Trump – a business professor at the University of California in Irvine (UCI) Peter Navarro and an outstanding private investor and entrepreneur Wilbur Ross. Today, they are the most important people in the White House, responsible for American trade and reindustrialization of the economy. They believe, that those suggesting that Trump’s trade policy, will ignite a trade war, ignore the fact that the United States is already involved in a trade war. A war in which America has already lost tens of thousands of factories, millions of jobs, and billions in tax revenues. Donald Trump will put the government in defense of American interests.

The primary objective of the US president’s economic policy is to achieve and consolidate the rate of economic growth at the level of 3-4 percent annually (many economists, especially supporters of the Democratic Party have assumed that the new “normal” level economic growth in the 21st century is in the lower gear and amounts to only 1-2 percent annually). The higher level of economic growth will translate into an enrichment of the majority of the population of the country and it will create millions of places of well-paid jobs (this ambitious goal applies rather to the possible two terms of the presidency, but a record low unemployment rate has already been achieved).

To accomplish these ambitious goals, Trump’s economic plan includes many systemic elements known from the time of the presidency of Ronald Reagan (the so-called supply-side economics popularly known as Reaganomics), such as widespread reduction of tax rates and government spending, deregulation and a sound, stable dollar. However, this plan is additionally enhanced by an ingenious energy and trade policy, infrastructure revitalization, and as a derivative of deregulation and energy policy, a much looser policy of environmental protection (including the US leaving the multilateral Paris climate treaty).

High taxes, unfriendly business regulations, unfavorable trade agreements prompted US corporations to transfer industrial production abroad, to countries with lower costs (so-called offshoring). While in 1977 in the US, the industry employed 22 percent of its manpower, in 2015 it was only 8 percent. The most technologically advanced competitors (by the way robotics leaders) like Japan still employ 17 percent in industry and Germany 20 percent of their respective manpower. They produce cars, electronics, biomedical equipment, chemicals, pharmaceuticals, rolling stock, 3D printers and robotics. According to Trump and his advisers, the United States will become more competitive in each of these sectors if there are tax cuts, regulatory burdens are simplified, unfair trading practices of foreign partners are abolished, such as undervalued currencies and the availability of unjustified and even illegal export subsidies are successively reduced.

Distorted trade exchange by VAT

An important area of Trump’s economic reforms is the reduction of the trade deficit in the trade of goods, which in 2015 amounted to approx. 800 billion USD. This huge amount mainly consisted of deficits in trade with China and Germany as well as with neighboring countries, i.e. Mexico and Canada (members of NAFTA – the North American Free Trade Area). President Trump and his advisers have a well-grounded view that VAT is one of the main causes of imbalances in trade of goods. In their view, this is a key issue of unequal treatment of the US income tax system by the World Trade Organization (WTO) – while the United States operates primarily in the income tax system, all of America’s main trading partners rely heavily on the value added tax system (VAT, sometimes called goods and services tax).

The VAT concept was invented 100 years ago in Germany (in 1918 by Wilhelm von Siemens). It was first implemented to a limited extent in France in 1954, and soon became the basic element of economic harmonization in the European Union. Today, VAT is used in 166 countries (out of 193) in the world, with the exception of the US and a few countries in the Caribbean and the Pacific. VAT rates are usually from 15 to 25 percent. For example, the VAT rate is 25 percent in Denmark, 19 percent in Germany, 18 percent in Russia, 17 percent in China and 16 percent in Mexico (in Poland it is 23 percent).

According to the WTO rules, any foreign (i.e. located outside the US) company producing in this country and exporting goods to America (or elsewhere) receives a rebate on VAT, which has been locally paid in the country of the importer. Thus, this tax refund converts VAT into a hidden export subsidy.

At the same time, VAT is levied on all goods that are imported and consumed there, so a product exported from the USA to the country with VAT is subject to VAT. In this way, VAT becomes a hidden tariff for the US exporters over corporate income tax that they have to pay in the US. These principles of the VAT system in foreign trade were used to create VAT carousels, i.e. tax fraud so-called missing middleman fraud, very popular in the European Union causing approx. 60 billion EUR tax loss a year.

Under the WTO system, American corporations lose three times: foreign exports to the US market recieve a VAT exemption (a hidden subsidy), US exports to foreign markets have to pay VAT (this is a hidden duty), and US exporters do not receive a tax relief from income tax paid in the USA.

On the Internet, it is easy to find calculations confirming these assumptions, i.e. subsidizing export to the US by the VAT rebate and high duties in the form of input VAT on imports from the USA. However, there are also alternative calculations indicating that in the case of an identical structure and level of costs in products in the US and the country with VAT, the VAT and sales tax system (state tax is usually calculated at the level of 6-8% from consumption) is arithmetically equivalent. However, this is an idealistic situation, impossible to occur, i.e. that the price and cost levels are identical. What’s more, the analysis of the impact of taxes on the economy is not just simple arithmetic calculations (an example of the Laffer curve), but also a complex economic analysis of statistical data on nonlinear related and dynamically dependent variables.

Harmful transfer of production

According to Trump and his advisers, the practical effect of unequal WTO treatment of the US income tax system is a 15-25 percent unfair tax advantage on the international transaction market in favor of major US trading partners. That’s why American corporations moved their factories abroad and then exported their products back to the USA. US subsidiaries located abroad received benefits from VAT on exports back to the USA. Such export to America from (offshored) production plants increases the US trade deficit, and (offshored) capital investment also reduces GDP growth in the USA.

The fact that WTO rules are harmful to the USA is difficult to undermine. This is demonstrated by the chronic deficit in trade with major partners. Trade deficits would be short-lived phenomena, leveled by the depreciation of the dollar and as a consequence an increase in cheaper US exports and a fall in more expensive imports to the USA. Nothing such phenomenon occurs,inter alia as a result of manipulation of exchange rates, e.g. via China and Germany (as part of the euro). China artificially maintains the undervalued exchange rate of the yuan, and Germany uses the euro average rate, which is undervalued in the competitive strength of the German economy, but which is overvalued for weaker economies, such as Italy, and even more so for Greece.

Tariffs as a whip for receipt

Donald Trump understands that the only way to correct this unfair tax treatment is to lever the US’s position as the largest economy, consumer, and importer in the world to apply pressure on the WTO to change this unequal treatment. Without the United States as a member of the WTO, this organization will not make much sense.

The Trump administration has begun using the first available means to defend US workers and production facilities. These are tariffs for imported steel (25 percent) and aluminum (15 percent). The imposition of duties on the import of goods from China worth 50 billion dollars raised the stakes. After the reaction of China, the next tariffs are planned for goods worth a further 200 billion USD.

Tariffs are and will be used not as a final and permanent goal, but rather as a negotiation tool to encourage business partners to stop using unfair practices and cheating. If, however, such practices do not end, Trump will impose appropriate defense tariffs on these and other commodities in order to equalize the opportunities in mutual trade.

In conclusion, it is worth noting one underrated feature of Trump’s policy. While in international and internal policies he is able to quickly adapt to changing conditions and opportunities, that is, he is extremely flexible in his actions – some commentator’s view this as being unpredictable- in the case of his economic policies and beliefs it is otherwise. He is extremely consistent and stable, he does not change his opinion, at most he slightly adapts to the resistance of the matter, such as in the case of dilution of his tax reform. In order to pass it he agreed to some concessions. He withdrew from TPP (Trans Pacific Partnership), as he announced in the election campaign, he froze TTIP (Transatlantic Trade and Investment Partnership) negotiations with the European Union. He is renegotiating NAFTA (North American Free Trade Agreement), so that it may be replaced with separate agreements with Canada and Mexico. In the “trade war” Trump seems more determined to achieve his goal, and his trump cards are really strong, so far underappreciated by the leaders of the main trading partners in the G7, like Emmanuel Macron, Justin Trudeau or Angela Merkel.

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1 comment

Blog ekspertów PFR | USA od dawna prowadzą wojnę handlową August 24, 2018 at 7:13 am

[…] pierwotnie ukazał się na łamach Polonia Institute, a także na łamach dziennika Rzeczpospolita 27 czerwca 2018 […]

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