Those who claim that current trade policies are harming the US have, to our knowledge, proposed no clear mechanism. We propose one here.
We show that, while balanced free trade may be beneficial to all, or at least not harmful, when trade is not balanced, the net exporting country grows at the expense of the importing country. That is, the net importing country’s economy undergoes deflation, and erodes. The demand of the importing country’s economy is driven down, and its industry is increasingly idled. Since this affects labor, even many of those consumers enjoying the immediate benefits of lower prices, may pay a greater price, in lower wages and higher unemployment. Consumers are involved, whether they want to be or not.
We should also expect erosion of the tax base. There is, in the economy as a whole, more pain than gain. We model the mechanism.
The basic idea is that the price level in the importing country goes down, decreasing the revenue available to its industries. However, that country’s demand is ultimately equal to the revenue of its industries. That is the key relationship. The country's demand declines with the decline of the revenue of its industries. With continued imports, the price level continues to go down, as does revenue and demand, along the Aggregate Supply curve. With the continued erosion of revenue, industries are increasingly idled, and unemployment increases. The importing country is forced into a deflationary spiral.
In the exporting country, on the other hand, the price level goes up, and including the revenue from its exports, so does the revenue of its industries, and ultimately the country’s demand. Its industries, with increased revenue, grow, as does the country’s demand, along the Aggregate Supply curve. With continued exports and continuing increases of revenue, industries continue to grow. So does demand, and employment.
The unbalance of trade has been an issue for some time. When one is not doing well, one looks around for someone to blame. One also looks for causes. When one finds both, one must act- wisely.
Note that when trade is balanced, there is, here, no effect. Only when there is an imbalance in trade, where one country is a net exporter, and the other country a net importer, does the importer’s economy erode, and the exporter’s economy grow. There is a certain symmetry: The exporter benefits at the importer’s expense, despite the apparent benefits to the importing country, and the apparent costs to the exporting country.