Why Trump's volatile trade strategy won't work

International trade is in a period of upheaval. With good, albeit misplaced intentions President Donald Trump has proposed aggressive protectionist trade policies. However, that instability will backfire because investors do not like uncertainty. Risk aversion is a fundamental aspect of investor behavior and it is not limited to stock market participants. Corporate leaders are also naturally risk averse.

Being a business leader means taking calculated risks. In periods of uncertainty, leaders wait for clarity. They pause because that is the safest action. But moving forward is what drives the economy and improves the lives of workers, consumers and trading partners.

Since the 1930s, trade liberalization has steadily advanced, creating opportunities for companies to sell and produce internationally at lower costs. Free trade has given consumers access to better products at cheaper prices and helped U.S. firms to expand their administrative role in the global economy. Unfortunately, in the process some lower-skilled workers were displaced. Overall though, free trade has been a force for economic development both domestically and internationally.

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President TrumpDonald John TrumpTrump conversation with foreign leader part of complaint that led to standoff between intel chief, Congress: report Pelosi: Lewandowski should have been held in contempt 'right then and there' Trump to withdraw FEMA chief nominee: report MORE wants to implement trade policy that would return us to the halcyon days of U.S. manufacturing dominance. That ideology is misguided and is already impacting corporate investment and consumer prices. If our wages were competitive with China or Mexico, his goal might make sense.  But the average manufacturing worker in China earns $10,000 while the average Mexican worker earns $5,000 annually. In comparison, U.S. manufacturing workers average $45,000 per year. Bringing back low-paying jobs will not develop our economy or help U.S. workers, who will not perform manual labor below minimum wage. Instead the costs of labor would rise dramatically, and prices would adjust accordingly.

Some labor inflation could be offset by logistics savings. For high labor content products, we would pay dramatically higher prices and could experience supply shortages as some companies are unable to fill open positions at competitive wages. While wage increases sound appealing, they would come at a cost to consumers. Some people might earn slightly more than today, but everyone’s real purchasing power would decrease as prices on everything from agricultural products to health care would rise.

However, that scenario is not likely. Instead of moving production from Mexico to the U.S., and significantly increasing labor cost to avoid tariffs, production will likely move to another low-cost country such as: Brazil ($7,000 average annual manufacturing wage), India ($1,250), Russia ($7,200), and Vietnam ($3,000). It would take a global tariff system to prevent this type of market response. A global tariff system would likely have far ranging impacts including global destabilization, simultaneous inflation and recession, and potential global stock market crashes.

Wall Street is already leery of potential impacts of the trade war. Investors know increasing costs for multinationals, either tariffs or labor costs, reduce corporate profits. As profits retreat, so do stock prices, and with them incentives for innovation and entrepreneurship. Falling stock prices likely mean more layoffs and price increases as firms try to maintain corporate profit margins, valuations and earnings.

What should the president do with trade and economic policy?

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Mr. Trump should lead the U.S. in making the most of our natural advantages. The United States has world-class capital markets and research universities. He should not stifle those institutions by restricting immigration, taxing endowments, and inflating stock markets by manipulating tax policy and interest rates. He should take advantage of our resources to lead an innovation revolution. Innovation brings higher wages for workers, opportunities for economic growth, higher employment, and offers spillover benefits to consumers in all sectors of the economy. 

If the president is worried about displaced workers, he should provide subsidized training opportunities and invest in them. Training would improve their earning potential. This would be good for displaced workers, firms looking for skilled workers and trading partners willing to manufacture our new products.

 More importantly, President Trump should be more predictable and stable in managing foreign trade.  He must signal that business leaders should not fear making investments, even abroad, when it makes sense. Decreasing the uncertainty, aligning policy with incentives and investing in the future will provide the best outcome for everyone in the United States, which is exactly what Mr. Trump is charged with doing.

Gregory Sabin, is a Senior Lecturer at the Questrom School of Business at Boston University where he teaches managerial accounting and corporate finance. He is affiliated faculty at Harvard University and a member of the American Accounting Association. Prior to academia, Dr. Sabin spent 12 years in industry, where he held senior management roles at companies including Ford Motor Company, Honeywell International and the Kellogg Company. His industry experience centered on international finance and operations; his research focuses on international business, foreign investment and international trade. Follow him on Twitter @GregSabin