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A Deficit In Understanding Trade

cargo ship passing by the Golden Gate Bridge on a foggy day
photo by Mark Gunn

The term “trade deficit” has an image problem.

A deficit, after all, sounds like something that needs to be fixed. President Donald Trump certainly seems to see trade deficits that way, using them on the campaign trail to measure “winners” and “losers” in international economic exchanges. In an interview during the campaign, he said “So … we’re losing a tremendous amount of money, according to many stats, $800 billion a year on trade.” He’s made similar comments since his inauguration. Peter Navarro, an economist who serves as the director of the White House National Trade Council, has also consistently argued that large trade deficits – especially with China – hurt the United States.

But economists, academics and policymakers on both sides of the aisle have long agreed that a trade deficit by itself is not automatically bad. Talking about trade deficits as a problem to fix betrays an overly simplistic view of trade and the economy.

A trade deficit is not a debt a country has to repay. For every buyer there is a seller, which means that foreign buyers end up with a lot of U.S. dollars, or with U.S. real estate, stocks or debt. As an opinion column in The Wall Street Journal recently explained, a trade deficit can often be the sign of a prospering economy. (And, as many economists have recently observed, the reverse can also be true; the U.S. ran a trade surplus throughout most of the 1930s and the country’s deficit shrank during the Great Recession of 2008-09.)

It makes sense that Americans buy a lot of foreign goods when our currency is relatively strong and our population is confident enough to spend freely. Stan Veuger, a resident scholar at the American Enterprise Institute, theorized that tax reforms the president favors, such as reducing corporate taxation, could actually boost the overall trade deficit by putting more money in American consumers’ pockets and attracting more foreign investment to the United States.

The link between the trade deficit and gross domestic product is a favorite talking point for Navarro in particular, but he confuses correlation and causation. GDP measures domestic production, so the formula for its calculation excludes imports, since those goods and services were not actually produced in the country. Navarro is not wrong that as imports go up, GDP goes down. But that fact does not mean the country’s economic activity necessarily decreases at the same time. Assuming that the calculation is a zero-sum system is, at best, a controversial point of view.

It is impossible to assume that, say, if we did not import phones from China, we would create a proportionally greater amount of economic activity here to make up the difference. For one thing, that assumption ignores the globalization of the supply chain as it exists today. The iPhone counts as a Chinese import, but many of its parts and the intellectual property involved come from other countries, including the United States. Even if you look at a simple product – cheese, for instance – there are global factors such as foreign governments’ trade policies, the strength of foreign currencies and the demand for the product itself that exist beyond domestic policymakers’ control.

Even without these external factors, simply levying higher tariffs to reduce imports does not guarantee increased domestic economic activity. If imports overall suddenly became more expensive, consumers might simply reduce their spending. If country-specific tariffs went into effect, consumers might simply buy from another country instead, leaving import levels in the aggregate more or less unchanged. Other countries might also retaliate with tariffs of their own, which could damage the competitiveness of U.S. exports.

There are certainly individual workers and industries that suffer from foreign competition and stand to benefit from tariffs. Protectionism is also often politically useful, because it typically pits a smaller group of people who care a great deal about a tariff against a larger group of people who care less, even if the aggregate benefits of free trade outweigh the aggregate costs. As Jeffrey Dorfman observed in Forbes, “Trade creates both winners and losers, although we win in the aggregate,” a view many economists share. But the losers are the ones calling their representatives to complain.

The Wall Street Journal editorial writers noted that a group of economists identified the problem with the terms ‘surplus’ and ‘deficit’ back in 1978. They recommended that we avoid the terms as much as possible, since “these words are frequently taken to mean that the developments are ‘good’ or ‘bad’ respectively,” but “that interpretation is often incorrect.” Ultimately, factors underpinning a trade balance are complex and global, and many economists today agree that the trade deficit is not a terribly useful measure for policymakers.

There are certainly actions we can take to improve our position when it comes to global trade, and many of them are worth discussing. Reasonable people can disagree about the merits of globalization and the best policies to govern global trade. But the answer is not to just stop buying things from abroad. Fixating on the trade deficit, while rhetorically simple, is ultimately a mistake.

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