Ricardo Hausmann on What it Takes to Win a Trade War

countries are richer, more economically developed than others. And the metaphor was that certain products or industries are like trees in a forest, and the firms are like monkeys, and so businesses kind of jump from tree to tree, and so what you find is if a country gets good at one particular product, then the business the monkey will jump to the next tree, the next adjacent product, and

use that experience to build out their offerings. And so you tend to see, you know, the more complex economies, the bigger forests, the more monkeys swinging from trees are indicative of greater advancement and more wealth.

But when I think about, you know, the idea that Okay, now there's this trade barrier between the US and Canada, for example, and we have these complex webs of supply chains in which goods cross the border multiple times. Do we constrain our capacity to do complex things?

knowledge and tools and materials. So when you buy a cookbook, it says if you want to make an omelet, it says, you know, take eggs, take milk, take this, take that. It doesn't tell you how to make eggs. It doesn't tell you how to make milk. You just you just buy the eggs, and you don't you disregard all the technologies that go into making chickens and to making eggs, and to feeding the chickens, and you disregard all of that.

You just buy the eggs, right, and all the knowledge that was embedded in it, it's just in the egg. So embodied knowledge is one form of knowledge, and trade is one way to get it right. Codified knowledge is the knowledge that exists in recipes, formulas, algorithms, do files. You know, you just need to have the code and follow the instructions if you are and then the third form of knowledge is nohow in brains. And the problem with knowledge is that there's very little knowledge that fits

in a brain. So if you want to run a company, you need a lot of knowledge. You need knowledge about accounting, about finance, about human resource management, about procurement, about production, about branding, about marketing, you know about taxes, about contracts. So you need a lot of knowledge. And to bring that knowledge together, you need a team of people that you need to put together. And complexity comes from, you know,

the breadth of the team that you have to put together. Now, the more you can kind of modify stuff, then you don't need to put the brains together because it's all in the code. That's one of the things that we may talk about artificial intelligence. It makes things in some sense simpler because the knowledge is in the machine. It's

no longer you no longer need a brain to do it. Now, what these trade barriers are doing is that they are preventing you from, say, buying the eggs right so that now you need to know how to do the eggs yourself. So in some sense it's making things harder to do. As Larry Summers has pointed out, there are about sixty times more jobs using steel than job making steel. So you know, you protect steel, you're making it easier for all those guys that were going to make omelets by

making now the eggs harder to get. And that's going to come at a detriment. You're going to get maybe more jobs and steel making in the US, and you're going to make all the people who use steel have more trouble competing in the domestic market with their products and more trouble selling their products abroad because now they're

buying more expensive eggs, more expensive steel. In this metaphor, so in some sense, yes, what you're saying is that bread barriers are going to make the ability to put things together harder in the US. It's going to incentivize some of the things that are being protected, but it's going to create difficulties for everybody who you uses those things to make other things.

on steel and aluminum. They want more still and aluminum being made in the US. If you wanted more still and aluminum made in the US, what instruments could you have used? And its tariffs the right way? Okay, So first there is the argument that in order to make something, you have to know how to make it. You know, it's hard to make things you don't know how to make it, and typically when you start something you don't you're not particularly good at it, but maybe over time

you become better at it. There are some learning curves, and you want to get into those learning curves. And that's a compelling reason maybe to intervene in a relatively new industry where you know you haven't yet to figure things out, saying maybe like solar panels or batteries, or you know something that's relatively new that you still have

yet to figure out. You wouldn't do it for a mature industry like say like electric gas turbines, because you know they've optimized that to death and you know there's there's no significant breakthroughs for decades now, so still would not be the obvious thing that would come to mind. Right, it's a nineteenth century chnology, it's an industry that has that's quite mature, etc. But you might have a national security reasons to protect it or something, but definitely not

learning curves. By the way, those learning curves, if they are like inside the company, if it's something that the company is learning and the company owns, markets have been super happy to fund that. I mean, markets have funded Amazon for decades while the company was losing money because they're saying no, no, the company is figuring out how to sell stuff on the internet. Eventually, when they do figure it out, they will have access to a humongous

market and that's going to be super valuable. So markets supported negative cash flows in Amazon for a very long time. So you have to argue that these learning curves somehow spill over into the value chain, spill over into more complicated things to coordinate, and that's why you need some

kind of action. Sometimes the reason why industries get into trouble is that you have chicken and egg problems that you know the supplier is not there because you are not there and you're not there because the supplier is not there. So there's a good equilibrium in which both you and your suppliers are there, and there's a bad equilibrium in which neither of you is there. So how do you go from the val equilibrium where none is there to the good equilibrium where both are there. And

that's a problem that we know how to solve. In each one of these cases, caras may not be the right instrument. So for example, you know, if you wanted the supplier and you to be there, well, maybe the garment comes and says, you know, I'm going to give a supplier the guarantee that you're going to buy from them, and I'm going to give you a guarantee that the supplier is going to be there to sell you. So you install your plant, he installs this plant, and the

guarantee expires worthless. So the government can coordinate on the good equilibrium. Essentially no money and taxing nobody. A set of guarantees would do the trick. If you want the firm to learn, I mean, one thing is to have these temporary what they call infant protection and the term

in the literature is infant industry protection. So you take an industry at its infancy, and you give it some protection until it finds its way, and then you open up an alternative to that is you subsidize their capital investment, or you guarantee their demand maybe government procurement or something else, or you give it a special tax treatment, so you

have other ways to intervene. The moment you intervene with tariffs, you're essentially dumping the cost on the consumers of that industry, and the consumers of that industry are going to become less competitive, and their size will shrink, and they may become vulnerable to other attacks. So it's not the ideal instrument. There's an additional reason why it may not be the right thing to do. The US is and politically, part of all these policy is based on the fact that

the Midwest did very poorly. The russ Belt did very poorly. They lost a lot of manufacturing jobs, and you would like jobs to go back to the Midwest. Pittsburgh loss it's steal industry. Garandianna lots it's steal industry. Youngstown, Ohio, Cleveland, Detroit, et cetera. These cities lost jobs in some industries. Now you put the barriers you put tariffs at the national level. It doesn't mean that the industries are going to go to the Midwest. They may go to write to work

states in the South. They may go to the Southwest. So it's not not your solution to the places at your t I have to help those might be better dealt with using place based instruments.

Here's the former president of the London School of Economics, and he said, it is generally agreed that Adam Smith, when you suggested the division of labor leads to inventions because workmen engaged in specialized routine operations come to see better ways of accomplishing the same results miss the main point. The important thing, of course, is that with the division of labor, a group of complex processes is transformed into

a succession of simpler process. So therefore making something with eggs is simpler because someone else doing the simple job of making of growing eggs, I'm making the simple job of maybe making an omelet or something. Something becomes a

succession of simpler jobs. But the question I have is, does that mean that sort of like sheer market size as measured by even by things like population, et cetera, become important in these questions because if we're going to make complex things, doesn't that on some level require either through our population or our friends population, a decent number of people who can then do all of these individually simple tasks.

see a film? In the movies, sometimes they put at the end of a movie it says the end, but it's a misnomer because after they put the end, they start showing you the credits, and the credits go on for minutes and minutes. You know, there's there's the casting, there's the sound effects, there's the visual effects, there's editing, director of photography. So you need a whole massive team of people that are involved in that in that movie

making industry. Well, an industry that requires this deep pool of differentiated talent tends to locate only in very large cities, say like Los Angeles or New York. That's the only place where you would you could put together all that

necessary talent that is required. So industries that require a more diverse pool of talent tend to locate themselves in bigger cities, and the ones that are kind of simpler, lower complexity, they can afford to locate in a smaller city because in that smaller city they could probably find

the more limited diversity of skills that they need. Now, one of the things that is a feature of the American economy over the last twenty years is that the industries that tend to locate in large cities have done dramatically better than the industries that tend to locate in smaller cities. The industries that tend to locate in smaller cities, they tend to demand more land and not that diverse

labor force. So they're not willing to pay the high prices of land of big cities so they can buy more land and they don't rely so much on this diverse labor force. But the industries that require a deep, diverse pool of talent, they are willing to pay the higher price of land in larger cities because they don't use that much land. So what I would put it to you is that part of the drama of the US is the fact that there's been this shift in demand in favor of the things that happened to be

done in bigger cities. And by the way, let me make a very important point. We just saw the elections in Poland, and the elections in Poland meant that, you know, the president that won that election is a more called it, a more trump like figure, and in fact, his party pis he got elected more or less ten years or eleven years before Trump, so there was already kind of like a Trumpian motivation behind the election of that party. They were upset about Trey and globalization, and Europe and

so on. Now, the interesting thing about Poland is that Poland is at the exact opposite experience of the US. In terms of trade. Poland has seen rising market share across the board in all industries, in agriculture and manufacturing, in cars, in machinery, in textiles, they have made out

like Bandits. Trade has exploded positively in Poland. But the thing that has exploded in Poland has benefited these larger urban areas and has has heard the smaller, less metropolitan parts of the country, and that has generated a political backlafe.

open economy. It's smaller, right, much smaller than the country it's in right, and it's more open because it trades with not only the rest of the world, but the rest of the country, and the labor force can either come from the rest of the country or leave to the rest of the country. Right, So what tends to characterize a city. And you know, for a country, its export base is super important. For a city, its export base is even more important because a city is less

self sufficient than a country. A city needs to consume a lot of things that it doesn't make. Most cities don't make cars, don't make antibiotics, most cities don't make X ray machines, they don't make, you know, eggs. So all of these things have to be brought in and to pay for these things that they want to consume in the city, they need to earn money from outside the city. They need to export in order to be

able to import. So the set of export activities in a city determines very much the life of the city. If those export activities in the city get into trouble, then it's not just that those jobs in those exports, in thus trees getting, you know, are lost, but those workers used to you know, go to the barber, go to a grocer go to the dentist. So all those jobs in all of these local services also get lost, and you get this multiplier local effect and people start

leaving the city. The moment people start leaving the city, their housing prices go down. There's less money to pay for education, so the quality of education, the theories, and you get all of these negative local effects in the city. Okay, that's associated with the export industry of your city getting into trouble. So what I'm saying is that the shift

in demand has it hurt cities. The kinds of industries that tend to locate in smaller cities, the kind of industries that need less of a deep pool of talent and more land. And the current industry is a good example. The whole still you skill is a dirty, complicated, large thing. So it may hire a lot of workers, but it doesn't want to have too many people around them. They need a lot of land, so they're not going to

go to Los Angeles. They're going to go to a place where they can acquire a lot of land to put their big plant. And it's the fact that the export sector of cities in the Midwest, say, got into trouble.

The fact that the export activities in some parts of Poland got into trouble, that they got into this negative spiral as people you know, left because they have better opportunities, and maybe other parts of the country, in larger cities, they leave behind a deteriorating economic and social situation.

own supply. Are there not arguments, you know for certain things that you would want to have the capacity to build those components at home in order to enable you to build more complex items.

Many things that could destroy your food production. So you're going to face much less risk if you have a diversified source of materials. And that's one reason why you would want to have a good trading relationships with many countries because that way, you know, if you get in trouble, you can buy from somewhere else. So no, I in general, this idea that the price of wheat worldwide goes up, that's the reason for you to have your own wheat production.

That doesn't follow at all. Your wheat production might be it might subject you to even more risks than a diversified source of wheat from across the world. It's a different thing if you're talking militarily, right.

et cetera. But you know, in creating an encouragement for and by the way, convincing TSMC or the Taiwan Semiconductor Manufacturing Company, which is the best a foundry in the world, to come and see if they can figure out how to make it in Arizona. And by the way, it's very interesting and it shows you the importance of knowledge and know how that sometimes it's very very difficult for the same firm that supposedly the firm knows how to

do something, say Boying knows how to make airplanes in Seattle. Well, guess what, making airplanes in South Carolina. Making Boying airplanes in South Carolina proved to be much harder than making airplanes in Seattle, and transporting the knowledge was a big headache, and right now TSMC is facing serious challenges and transporting the knowledge to Arizona. So if you put the accent on moving the knowledge, things look a little bit different than just a discussion about tariffs.

globally diverse supply chain. It's becoming in many areas a

China only supply chain. That China's lead in this, that its network effects, that it's internal whatever is becoming so concentrated in one country for such a big range of goods that at least from a non China perspective, it feels like from a risk management standpoint, et cetera, that there probably is a very good imperative to put forth effort towards not necessarily having an American production capacity, but a non China production capacity.

into poor states like Vietnam or Indonesia. So what you have is that the more advanced manufacturing or the more advanced parts of the value chain like R and D design, et cetera, are retained in headquarters, and you move the more labor intensive, the less skill intensive, the less complex parts, the more standardized parts. You moved to a locations that pay lower wages, and everybody is better off because for

those locations, it's a step up for you. It's a way to save on labor costs that you cannot afford in your country because you want to pay your workers very very well, and you can afford to do that because you have plenty of jobs for them, and the more complex part of the value chain you don't need to hire them, and the less complex part part of the beligian So there is a world in which this

is a process. China is getting richer. A lot of the things that are being done in China, by the way, initially they were done in the coast, and so now the coast has become too expensive, they're moving to elsewhere in the country and to elsewhere in the region. And you know, now there's more production in Vietnam, there's more production even in Cambodia. There's more production in poor other countries simply because the Chinese worker is now too expensive.

So there's a world in which this is just part of just a repetition of what happened in Japan. But let me make an important point. When a production is happening elsewhere, it might be happening in a country. A good question is where does the knowledge that they're using come from? Because what is happening in the world today is that the rich countries are becoming more and more

concentrated in producing knowledge. In order to monetize that knowledge, they need to put brick and mortar things that they prefer to put them in other parts of the world. So Japan, for example, has come up with a lot of innovations and a lot of R and D and a lot of patents. But the way they monetize their patents is not by hiring Japanese workers. That you know, Japanese labor forces is declining and so on, and they

are at full employment. Anyway, they monetize their knowledge by deploying that knowledge elsewhere with foreign direct investments and so on. And that means that a lot of the of accounting of how this process happens is not well captured by our standard accounting techniques. For example, if Japan does R and D and that improves the productivity of their foreign investment,

it doesn't show up as higher Japanese productivity. It is increasing productivity, but not just not in Japan, in the place is where Japan has its plans, and the same

is happening in the US. If you think of the Magnificent Seven, the magnificence and for example Google, when Google sort of like this places all the small newspapers of the world because all advertising revenue is moving to it's moving online, and Google is capturing a good chunk of that that doesn't count as a US export because it's some subsidiary that Google put in I don't know, in South Africa or wherever that is collecting that revenue, and that revenue you could count it as a US export,

but it's not being counted as a US export.

much are you paying for those sixteen trillion dollars. Let's say four percent? No, so four percent would be six hundred and forty billion dollars in interest payments right on the deck you borrowed. Now, if you look at the US balance of payments primary income, essentially, the US doesn't look like a country that has an external debt. They are essentially paying zero. They borrowed sixteen trillion dollars, which is say, sixty percent of GDP, and they're essentially not

paying anything for it. So you would say, well, if I can borrow sixty percent of GDP for free, I would do that. Well, in some sense, that's what do you has done. The way I would like to describe it is that US didn't just borrow sixteen trillion dollars. It borrowed more like thirty two trillion dollars. It used sixteen trillion dollars to cover that official deficit and use the other sixteen trillion dollars to mix it with your

knowledge and invest abroad. And that investment abroad, say Google in South Africa, mixed with US knowledge as this huge rate of return. So when you borrow thirty two trillion dollars, sixteen trillion dollars you borrowed at four percent, but the other sixteen trillion dollars you invested at a much higher rate of return because it was mobilizing your knowledge. And so thirty two trillion, say, you pay four percent over thirty two trillion dollars you borrowed, but you make eight

percent on the sixteen trillion dollars you invest abroad. Well, it just turns out that eight percent over sixteen trillion dollars is the same as four percent over thirty two trillion dollars. You're not really running a deficit. You are monetizing your knowledge, but current accounting standards don't capture that.

undervalue foreign direct investment. But I would have thought that, like foreign direct investment, valuations inherently reflect market expectations. And to Joe's point, I'm channeling Joe's love of the efficient market's HYPOTHESI here, but they should be captured in market cap and things like that. Why do we assume that the statistical agencies, the accounting systems systematically mispriced these assets. Are they not included anywhere.

at the market value. By the way, it's very hard to calculate that market value because these are subsidiaries of companies that listed the S and P five hundred and say, if the price earningserration in the US is twenty six or something like that last time I checked, it means that they are thinking that all that's money that the Magnificent seven are making a broad they multiply by twenty six or an even higher number. Right, But that was

not the accounting was made at book value. So in most of these companies there's a huge difference between book value and market value.

But I'm curious. One of the things that people bemoan about the current environment in the United States and probably elsewhere is that cities are no longer a good place for upward mobility. That you can't be poor or middle class that move to a city and find a job and move up the career ladder in the same way you could when cities were more centers of hard industrial activity. And I'm curious when you talk about the types of companies that locate in big cities versus the type of

companies that locate in smaller cities, et cetera. Are the type of companies that locate in big cities not as conducive inherently towards upward mobility because there's just so much talent required just to get in the door anywhere at these firms.

That if cities had a more elastic supply of housing, a more elastic supply of urban space, this dynamic would help generate more opportunities in those cities and would help maybe raise the price of labor in the cities where people are leaving, because now they've become scarcer and people

would be willing to pay more for them. So that's why you're seeing so much growth in cities like Boiseaira or or Salt Lake City, or cities in Texas, Visa these cities in California and having incredibly inelastic supply of housing. So I would put there that, you know, on a more inclusive policy involves urban development that allows for that inclusion to happen.

like what is captured in the activity. I'm really intrigued by this idea.

lot about this actually in the context of software. But there is some you know. The fact is is that like Microsoft is gigantic and so even, and there's you know, these companies that are trillions in trillions of dollars and have huge footholds all around the world, and whether they're accruing value to America in a way that doesn't show up strictly in trade statistics strikes me as an important load to continue to mind.

doesn't include intangibles, but you know, maybe it should. But if it should, then how do you avoid the problem of over inflating because you think that this brand value is really good and it's difficult to actually measure.