By Fabio Rafael Fiallo
Any introductory course to international economics will educate students on the so-called theory of the second best. The theory can be formulated as follows: If several distortions to perfect competition are at work, the elimination of some (but not all) of those distortions does not necessarily lead to improving conditions. Thus, if a set of tariffs, export restrictions, or import quotas is in place, removing some, but not all, of those hurdles may actually have an adverse impact on trade, and for that matter on the economy as a whole. It follows that under certain circumstances it may be more efficient to create further distortions -- that is, to introduce new restrictions -- rather than removing only a portion of the prevailing ones.
Conclusion: in the absence of perfect (fair) competition -- which the theory in question labels the “first best” situation -- the “second-best” option may be to impose additional distortions or constraints.
The second-best narrative provides the rationale for a wide range of economic measures intended to react to market imperfections. It has been used to justify not only the imposition of tariffs and other barriers to trade, but also the formation of customs unions and the introduction of welfare benefits.
In the U.S. economic-policy landscape, Democratic lawmakers and like-minded economic and political analysts have become known for their inclination to advocate trade, financial, and monetary policies that are grounded in second-best considerations. Trade-restricting laws adopted by Democratic-controlled Congressesinclude the Trade Expansion Act (1962), the Trade Act (1974) and the International Emergency Economic Powers Act (1977).
In the same vein, writing in 2014 on how to overcome the tepid economic recovery of the Obama years, progressive economic pundit Larry Summers called for pro-inflation policies aimed at reducing real interest rates and boosting demand. This course of action was characterized in The Economist as a second-best solution. (The first-best option would have been, according to their narrative, to promote deficit-financed public investment, which governments of advanced economies were deemed to be unwilling to carry out).
Cue Donald Trump and his self-assumed empathy for tariffs and financial arm-twisting; and then, all of a sudden, Democrats and progressives cry foul at the very kind of restrictions that they themselves had steadfastly advocated and managed to impose in the past.
Democrats’ sudden anti-tariff conversion led the Wall Street Journal's James Freeman to assert (not without a touch of irony) that “one benefit [of Trump’s tariffs] is that they are finally teaching Democrats about tax incidence”.
The commonly invoked argument against Trump’s utilization of economic weaponry asserts that the U.S. president is wreaking havoc on the rules-based, market-friendly global order that the United States and its allies took so much pain to build in the aftermath of World War II -- and from which, the argument runs, the United States and other capitalist economies as well as emerging economies have benefitted so much.
This criticism of Trump’s economic warfare overlooks how long it has been since the global economic system has worked properly at all.Some major players have been showing scant regard for the obligations that the system imposes. Government subsidies to unprofitable state-owned enterprises, currency tinkering, and technological theft form part of the panoply of questionable practices that have been undermining the foundations of the rules-based global order.
In other words, long before Trump’s presidency, the multilateral system was no longer providing a first-best environment for the conduct of international economic relations. What Trump has done is to react to that state of affairs through the use of economic statecraft.
True, Trump has utilized the vast economic weaponry at the disposal of the United States not only to react to malpractices in the trade and technological domains but also to achieve geopolitical objectives.But this is no novelty: The use of economic instruments for political or geopolitical purposes forms part of a longstanding American tradition, as explained by Robert D. Blackwill and Jennifer M. Harris in their book Geoeconomics and Statecraft: War by Other Means. The authors of that book explicitly regret how often in the recent past the United States has disregarded that tradition and preferred to use “the gun instead of the purse in its foreign policy.”
It can be said that under Trump, the economy has become the continuation of war by other means. Or, as French foreign-policy analyst Renaud Girard asserts in an article in Le Figaro, “Trump’s baseline paradigm is not war, but business”.
This, too, can be seen as a second-best situation. The first-best situation would have been the absence of both war and trade and technological malpractices -- a utopian state of affairs that is very far from our reality.
As a matter of fact, Trump is not alone in brandishing economic weapons so as to influence the behavior of other countries. Leaders of the European Union, too, have utilized similar strong-armed tactics, for instance to try to force tiny Switzerland to fold on a variety of political and economic issues.
Let’s not get carried away: Tariffs and financial sanctions do involve an economic cost, and Trump’s economic warfare is not an exception to that. Yet there are situations during which it may be appropriate, on second-best grounds, to thump the table and respond with real measures to countries that long stopped complying with the rules that govern international economic relations.
Fabio Rafael Fiallo is an economist, writer and retired official of the United Nations Conference on Trade and Development (Unctad). His book "Ternes Eclats" or "Dimmed Lights – In the corridors of Geneva International" (Paris: L'Harmattan, 2009) presents a critique of multilateral organizations. The views expressed in this column are the author’s alone and do not represent those of the institution at which he worked.
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