President Donald J. Trump has long believed that other countries have been taking advantage of the United States, treating it unfairly in trade. The consequence, in his view, has been large trade deficits, massive job losses in manufacturing, and the destruction of the middle class. He sees pacts such as the North American Free Trade Agreement as badly negotiated and disastrous, and he has pledged that his administration will begin to undo the damage.
As a result, Trump has unleashed a dizzying array of policies. He pulled the US out of the Trans-Pacific Partnership (TPP) and has been renegotiating NAFTA, under his threat of terminating the agreement. He has imposed stiff tariffs—under the guise of national security—on imports of steel and aluminum, raising costs to domestic steel-using manufacturers and drawing foreign reprisals against US exports. He also slapped duties on imports from China in retaliation for unfair trade practices that include intellectual-property theft and so-called forced-technology-transfer policies that pressure companies to share their technology in order to do business in China.
Yet for all the Sturm und Drang of his trade policy, the president is likely to end up being terribly disappointed by the results of his efforts. He wants to reduce the trade deficit, create new manufacturing jobs, enhance national economic security, and force China to change its policies. He is unlikely to achieve any of these objectives. In the end, his policies will likely be an exercise in frustration. Unfortunately, there could be a lot of collateral damage done along the way.
Reducing the trade deficit
President Trump wants to reduce the US trade deficit, wherein we import more from other countries than we export to them. As a businessman, he views the deficit as a bad thing because, after all, if a company’s expenses are greater than its revenues, it is losing money and will fold. If other countries sell more to us than we sell to them, the logic goes, we are losers and they are winners.
Economists reject this premise. A country’s trade deficit is not like a business’s bottom line: although a business must earn a profit to flourish, a country does not need to earn more in exports than it spends on imports. A country is not a company, and a country with a trade deficit is not losing money, nor is a trade deficit an indication that the US has an open market and other markets are closed.
Understanding the causes of a trade deficit is important in designing policies that could reduce it—if that is the objective.
The trade balance is the difference between a country’s exports and imports of goods and services. But in looking at a country’s overall international position, trade in assets also has to be accounted for. And it turns out that, as a matter of an accounting identity, the trade balance and the asset balance sum to zero. (The trade balance is sometimes called the current account and the asset balance is the capital or financial account.)
If we import $100 more than we export, the US isn’t “losing money”; that $100 will come back to the US to buy some asset here. The flip side of a trade deficit is the fact that the US is a net recipient of capital from the rest of the world—through purchases of government debt or a company’s stock, or new direct investments (such as building a factory). These asset transactions are driven partly by the higher rate of return in the US, and partly by the fact that dollar-denominated assets are viewed as safe.
These trade and asset balances are driven by macroeconomic factors, not tariff levels or market openness. In particular, if a country has a high savings rate relative to investment, that country will have a trade surplus because it will send some of its excess savings to other countries. That is why countries such as China, Japan, and Germany—all with high savings rates—have trade surpluses. And the US has deficits because it is a low-savings, high-consumption country that draws in capital from the rest of the world.
Trump’s economic policies are likely to increase the trade deficit, not reduce it, because they will reduce national savings. The large tax cut and rise in government spending will temporarily boost consumption and economic growth, but also increase the trade deficit by increasing domestic demand. In addition, with the fiscal deficit due to grow in coming years, government dissaving will also tend to lead to a higher trade deficit.