Keynes Prescription for the U.S.: Balanced Trade

by: Howard Richman

There has been a significant movement within the economic profession within the past few months. Economists who a few years ago were in love with unilateral free trade now realize that China is hurting the American economy.

But these decent clear-thinking economists still don't think we should do anything, because doing anything would be protectionism. They are all stuck in the free-trade vs. protectionism dichotomy. Haven't any of them heard of BALANCED TRADE?

Robert J. Samuelson is the latest. In his commentary in the Washington Post on Monday (Obama's Tire Tariff: Bad Policy, Right Message), he held that China's trade policy is harming America, but we shouldn't do anything about it, because to do so would encourage protectionism.

Ironically these economists are ignoring the founder of macroeconomics, the study of the economy as a whole. John Maynard Keyes advocated balanced trade, not free trade, yet macroeconomics textbooks conspicuously ignore that aspect of his thinking.

After graduation from college, Keynes held the classical opinion about free trade that is still propounded in macroecoonomics textbooks today, that free trade is always the best policy. In his magnum opus, The General Theory of Employment Interest and Money, he wrote:

So lately as 1923, as a faithful pupil of the classical school [of economics] who did not at that time doubt what he had been taught..., I wrote: "If there is one thing that Protection can not do, it is to cure Unemployment . . . . There are some arguments for Protection, based upon its securing possible but improbable advantages, to which there is no simple answer. But the claim to cure Unemployment involves the Protectionist fallacy in its grossest and crudest form."

As for earlier mercantilist theory, no intelligible account was available; and we were brought up to believe that it was little better than nonsense. So absolutely and overwhelming and complete has been the domination of the classical school. (pp. 334-335)

But once he took a close look at the real world, he changed his mind. In his magnum opus, he goes on to make the case that mercantilism can indeed help the country practicing it, although it may hurt the overall world economy.

Mercantilism results in the mercantilist country getting more fixed investment, while its trade-deficit victims get less. Keynes' discussion doesn't figure on the modern version of mercantilism in which the mercantilists loan the money earned from trade to the trade deficit country. But his analysis is still accurate, even though the loans from the mercantilist country do postpone the financial crisis in the trade deficit country.

Volume 25 of his collected writings is full of his plans for the institution that would regulate the world economy after World War II. Both the IMF and the WTO were founded based upon Keynes' advice. But the institution that Keynes would have created would have enshrined balanced trade as its primary mechanism, not free trade. Trade surplus countries would be required to take down their trade barriers. Trade deficit countries would be allowed to use export subsidies, import restrictions, and tariff barriers to bring trade into balance.

His institution would have avoided the worldwide economic disaster that began in October 2008, caused by imbalanced trade. Under balanced trade, all countries benefit. Balanced trade can grow forever. Unfortunately, imbalanced trade eventually bankrupts the trade deficit countries, ruining the markets for the trade surplus countries.

In his magnum opus, Keynes predicted what would happen to a trade deficit country if it allowed its trade deficits to persist. He wrote:

(NYSE:A) favorable balance, provided it is not too large, will prove extremely stimulating; whilst an unfavorable balance may soon produce a state of persistent depression. (p. 338)

America has experienced persistent trade deficits for over two decades. These trade deficits were chiefly caused by the actions of countries practicing mercantilism, especially Japan and China.

Since October 2008, the United States has been experiencing the financial crisis that results from too much borrowing from abroad. All of this was predicted by Keynes over 60 years ago. It's time that the economics profession took a look at his solution: balanced trade.

Disclosure: No positions