Since hitting new all-time highs two weeks ago, the S&P 500 has fallen about 2.2% as trade negotiations with China hit a snag. Last week, the US announced new tariffs on Chinese imports. This morning, China announced new tariffs on some US goods. Many fear a widening trade war.
Don't get us wrong. We want free trade, and we understand the dangers of trade wars and tariffs (which are just taxes on consumers). At the same time, we think trade deficits themselves are not a reason for trade wars. We all run personal trade deficits with the local grocery store and benefit from that. Even if the entire world went to zero tariffs, the US would almost certainly still run trade deficits, even with China.
But today, the trade deficit with China is partly due to the fact that China has higher tariffs on imports than the US does – working to eliminate these lopsided tariffs is worthwhile.
In 1980, China was an impoverished nation. Then it began adopting tools of capitalism – property rights, markets, free prices and wages. Chinese businesses started to import the West's technology, and growth accelerated.
Initially, China didn't have to worry about intellectual property. When you replace oxen with a tractor, all you have to do is buy the tractor, not reinvent the internal combustion engine. But China has now picked, and benefited from, the lowest hanging fruit. So, China decided to steal the R&D of firms located abroad. Some estimates of this collective theft run into the hundreds of billions of dollars.
That's why normal free market and free trade principles don't neatly apply to China.
Remember President Reagan's old story supporting free trade? "We're in the same boat with our trading partners," Reagan said. "If one partner shoots a hole in the boat, does it make sense for the other one to shoot another hole in the boat?" The obvious answer is that it doesn't, and so our own protectionism would hurt us.