Here’s The Problem With Trump’s Trade War: Trade Deficits Aren’t Necessarily Bad

WPA poster titled First Foreign Trade Zone - artist Jack Rivolta. Produced 1937 during New Deal trade initiative.

by Tony Wyman


Trade War Between Trump And Credible Economists

You could hit an imported Chinese golf ball into a room full of economists and have a pretty good chance of not hitting one who agrees with President Trump‘s trade kerfuffle with China.  Why?  Because, unlike the president, most economists think trade deficits aren’t a bad thing.  In fact, some even think they are good.

How can that be?  Doesn’t it make sense that we are losing against China if they are selling us more than we are selling them?  That’s what Mr. Trump has said in a tweet last week.

“We are not in a trade war with China – that war was lost many years ago by the foolish, or incompetent, people who represented the U.S. Now we have a Trade Deficit of $500 Billion a year, with Intellectual Property Theft of another $300 Billion. We cannot let this continue!”

If the president is right that we are “losing” $800 billion a year to China, why would economists not be up in arms over the number?

Trump campaigning during speech on world trade and where he pledged a trade war with China.
President Trump made what he called unfair trade relations between the United States and the nation’s largest trade partner, China, a major focus of his 2016 campaign.

Well, first, because the president is wrong about the size of our deficit with China

In fact, we haven’t “lost $500 billion a year” as he’s asserted. 

In 2017, the global U.S. trade deficit was $566 billion, up 12% since the year before and the highest it had been since 2008, the year the Great Recession started.

But our deficit with China was only $375.2 billion

And while this is a record high gap between the two economic superpowers, it falls well short of Mr. Trump’s assertion that the United States has a half-trillion dollar annual shortfall with China on the balance of trade.

Mr. Trump and his supporters can make a legitimate argument, however, that we are merely quibbling over the size of the offense when we point out the difference in the real number compared to the one the president uses in front of sympathetic audiences.  After all, it makes little difference if the gap is $500 billion or $375 billion if the point the president is making is the deficit is proof the Chinese are unfairly trading with the United States.

The reality, however, is economists don’t necessarily agree.  Yes, they are concerned about China’s strong-arm tactics when it comes to technology transfers, but they don’t place the same significance on the size of the trade imbalance as laymen do.  The reason why is a bit complicated, but it comes down to them not seeing the imbalance as money lost, as the president does.

Chinese workers in production factory assembling export goods that U.S. President Trump considers targets in his trade war rhetoric.
China exported $375.2 billion more to the United States than it imported in goods during 2017, a record deficit between the two nations.

The reason for this involves a number of components. 

They include the comparative value of each nation’s currencies and how much the people of those nations invest and save.

They also factor the strength of each trade partner’s economy in relation to the other. 

To grasp the mechanics of this, we have to understand what trade is and how it functions.

The balance of trade, as economists call it, is determined by how much a nation exports compared to how much it imports

On the surface, this is a simple idea.  Consider your weekly trip to the supermarket.  Your balance of trade with your grocer is equal to the amount you spend each week.  Some weeks are higher than others, so your balance of trade varies with your purchases.  If you are doing well financially, you are likely to spend more than you would if you had just taken a pay cut at work.  And since your grocer never buys anything from you, your trade deficit is 100% of whatever you spend.

Now, let’s look at the relationship between you and your grocer.  He is, in effect, an exporter of goods.  His economy is based solely on his ability to produce food and sell it to you at a profit.  He produces goods to meet your demand and is, therefore, at the mercy of your personal economy.

China, whose economy is largely driven by making and exporting goods, is much like your grocer.  For countries like China, their balance of trade moves in a positive direction when the countries they export to are in a period of economic expansion.  During the Great Recession that began in earnest in 2008, China’s export customers experienced a period of economic contraction, and China’s balance of trade contracted.

The flip side of this equation is a nation like the United States whose economic growth is based on demand, not production.  During time of economic expansion, the balance of trade between exporting countries selling goods and those importing them to meet expanding demand “worsens,” or, more correctly, expands. 

Let’s go back to the groceries.  If you are struggling to make ends meet, you may choose to buy Hunt’s ketchup fro $1.94 instead of Heinz ketchup for $2.87.  But, once you’ve received a bonus or gotten a promotion at work, the value of the savings gained by purchasing the lesser brand is erased by the consumer demand for the superior product.

Chinese worker folds Trump campaign flag -displaying the contradiction of Trump's Trade War rhetoric.
Consumers in America have become accustomed to low-cost consumer goods, using the money saved to buy services, supporting the segment of the American economy that employs nearly 80% of workers.

So, now that we understand a bit about what a “trade deficit” really is, let’s address the president’s underlying belief that imbalances between nations indicate a transfer of economic power from one nation to the other. 

“You don’t have a country,” Mr. Trump said if we don’t have a robust manufacturing sector exporting products at equal value to what the nation imports.

 

There are, basically, two lines of thinking on this issue.  The first agrees with Mr. Trump that a country buying more than it sells is effectively weaker than the country doing the opposite.  It seems to make sense that increased spending on imports is a sign of weakness, especially when the importing country doesn’t produce a similar amount of exports that create jobs to replace those “shipped overseas” to foreign manufacturers.

The problem with this line of thinking is the numbers prove it to be false.  If a balance of trade deficit was responsible for the economic damage to the United States Mr. Trump claims that it is and that if the trade deficit he derides in speeches to his supporters benefits only China – it would make sense that the Gross Domestic Product growth of the United States would slow as we import an increasingly greater amount of imported goods.

The thing is, the numbers say this isn’t happening.  In fact, GDP is nearly three times what it was in 1996 when our trade deficit first crossed $100 billion.  Then, America’s GDP was $8.3 trillion and the trade deficit was $104 billion. 

In 2017, America’s GDP was a stunning $19.4 trillion compared to a trade deficit of $566 billion.  Our economy grew by $11.1 trillion, nearly the entire value of China’s economy in 2017 ($11.9 trillion).  In fact, the growth of the U.S. economy during that 21 year period is equal to the total economies of third, fourth and fifth wealthiest nations combined.

And while some jobs have certainly been lost to overseas manufacturing, American unemployment is currently at historic lows.  Even the manufacturing sector in the United States has seen job growth, with numbers rising steadily since 2010, the end of the Great Recession.  While they certainly aren’t at the highs seen in the 1970’s, manufacturing jobs are up by nearly 1 million since 2009.

The second way to think about trade imbalances says that an economy based on consumer demand, which saves at a negative rate (where individuals spend more than they save) and which produces more in services than it does in goods, will always run a trade deficit with less modern, less advanced economies that rely on the production of exportable goods to drive growth. 

As the American economy continues its evolution away from manufacturing and more towards technology, innovation, services and intangible products like entertainment, her trade imbalance will, inevitably, grow.

It is important to make this distinction, as well: people are the ones that trade, not governments.  People, basing their decisions on what is economically right for themselves, are the ones that choose to purchase goods from one place or another. 

When the government decides to involve itself in that decision-making process by imposing tariffs on goods imported from a foreign country, it creates an artificial cost that consumers end up paying, using funds they could have spent on domestic services.

Think of it this way, if you have to pay 25% more for groceries at the store, will you still have money to spend at the movies or a restaurant or on a round of golf with your friends.  The reality is tariffs come out of the wallets of consumers, not manufacturers.  And those lost funds punish domestic companies as much, if not more, than foreign manufacturers.

Even one of the economists who shares Mr. Trump’s concerns about trade imbalances, Joseph Gagnon, the author of a policy plan to reduce trade imbalances is reluctant to support tariffs. He said, If you look across countries, there’s no evidence that high tariffs reduce your trade deficit.”

He added that tariffs can have an impact “but I hate to recommend them when we’re not doing the most important thing, which is bring down our massive fiscal deficit.” 

Considering Mr. Trump just signed a budget into law that will increase the national debt by more than $1 trillion over ten years, Mr. Gagnon’s reluctance isn’t going away anytime soon.

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2 Thoughts to “Here’s The Problem With Trump’s Trade War: Trade Deficits Aren’t Necessarily Bad”

  1. Ellen Elmore

    This is the best explanation of trade deficits I have read. Thank you for your in depth analysis.

  2. Tony Wyman

    Thank you, Ellen. Glad it was helpful.

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