By Maurice OBSTFELD
Donald Trump wrongly believes that America’s trade deficit is an urgent economic problem. Worse, his preferred corrective – wide-ranging import tariffs – would damage the US and world economies, all while diverting attention from the US deficit that actually does matter.
The external trade balance is the amount a country earns from its exports minus the amount it spends on its imports. In 2023, the US trade deficit equaled 2.9% of GDP, or about $799 billion of spending on imports not covered by export earnings.
For comparison, the trade deficit averaged 2.82% of GDP during President Barack Obama’s second term and 2.78% over the subsequent three years of Trump’s administration (despite the trade wars he claims to have won). It then swelled during the pandemic (2020-22) before returning close to pre-pandemic levels.
A common intuition is that a tariff, which is a tax on imports, will reduce the trade deficit by inducing people to import less. But this ignores the fact that across-the-board tariffs (like what Trump has proposed) will affect much else in the economy, with repercussions on imports and exports alike.
To account for these effects, a better way to think about the trade balance is as the difference between everything we produce and sell throughout the world, which is our GDP, and everything we purchase. If our total purchases exceed our total sales, our purchases abroad must exceed what we are selling abroad – and that difference must equal our trade deficit. Viewed this way, tariffs will shrink the deficit only if they either raise total production or induce households, businesses, and the government to cut consumption and investment.
Without more investment, which would increase the deficit, total production would increase only if currently unemployed or discouraged workers come off the sidelines. In fact, tariff advocates – like Republican vice-presidential nominee J.D. Vance – believe that tariffs will make this happen.
They reason that more and better jobs will be available if America produces for itself more of the goods it now imports from abroad. Yet in an economy that is already near full employment (according to conventional measures), this is a big leap of faith, reminiscent of the unfulfilled promises of supply-side economics.
Moreover, tariffs will raise costs and make the economy less efficient. A tariff forces households to pay more and increases the costs of intermediate inputs for businesses. It also reduces the need for domestic businesses to compete, which harms innovation and consumers. Tariffs are therefore likely to weaken consumption, investment, and output itself. They will reduce productivity rather than igniting the productivity boom advocates are promising.
A common rationale for tariffs is that they are negotiating tools to extract trade concessions from others. But large countries are as likely to retaliate as to submit, especially if the United States is seen to be violating global trade agreements.
Aside from the resulting economic damage, favorable effects on the US trade balance are not guaranteed. The record of the first Trump administration makes that clear.
If tariffs are unlikely to increase production, is there value in compressing consumption and investment simply to reduce the trade deficit? Conservative commentators point out that when Americans pay for imports not with exports but with bonds and equities, they commit to providing a perpetual stream of interest and dividend payments to foreigners. America, they conclude, is failing to provide for the future, much like a profligate household that borrows to spend beyond its means.
But this argument has three major shortcomings. First, if US households save too little (which is possible) or businesses invest too much, more focused and less disruptive policy tools than tariffs can correct these problems.
Second, some of the trade deficit is financed by inward foreign direct investment, which is generally considered a good thing – as when Hyundai builds an electric-vehicle plant in Georgia. A better analogy than an improvident household may be a growing business that raises outside funding for productive investments.
Finally, while data on international investment returns are imperfect, the US remains a net winner from its international financial transactions. Even though the country has, on net, borrowed abroad through its trade deficits, it holds vast foreign assets alongside its liabilities to foreigners, much like a hedge fund.
True, unlike a hedge fund, America’s liabilities exceed its assets. But, for now, US international borrowing costs are low enough that America earns more on its huge stock of foreign assets than it pays out on its even bigger foreign debts.
In national balance-of-payments statistics, the net gain to the US from its international investment position totaled $15.12 billion in the first quarter of 2024. While the US certainly cannot run trade deficits forever, the current costs of those deficits hardly justify drastic action – and certainly not ineffective and damaging tariffs.
The more pressing problem for America, which neither political party is addressing, is the US government’s budget deficit and the rapid accumulation of debt that future generations must repay. The 2020 Republican Party platform mentioned it only because the entire document was carried over from 2016.
The GOP has since gone silent on the issue, while decrying trade deficits and endorsing tariffs. The 2020 Democratic platform was similarly in denial; and while the 2024 platform is still under construction, we should not expect much.
Still, the bottom line is that the government’s deficit is a main driver of the trade deficit. Policies to place the federal debt on a sustainable footing would directly improve the trade balance by reducing government spending and taxing the spending power of the private sector.
But the main benefit would not be a lower trade deficit; it would be a reduced burden on future generations, including a lower risk of a government funding crisis down the road. Conversely, if America’s public debt continues on its current trajectory, pushing up government borrowing costs, a growing foreign debt will indeed become much more costly and problematic.
For now, however, the deficit that matters is the one that neither political party wants to talk about.
Maurice Obstfeld, a former chief economist of the International Monetary Fund, is Senior Fellow at the Peterson Institute for International Economics and Professor of Economics Emeritus at the University of California, Berkeley.
Copyright: Project Syndicate, 2024.
www.project-syndicate.org
