Is a Trade Deficit Bad for the United States
Brandon:
President Trump has recently announced large tariffs on steel and aluminum. He has also announced tariffs on China for their trade practices.
The President has explained that the purpose of these tariffs is to correct the balance of trade, specifically with China.
The economic press has produced a lot of reaction to this news.
Here are the questions I put to him.
Neil:
In this post I will tackle your first two questions. I will tackle the potential impact of a long term trade war in a subsequent post.
The overall balance of trade is a poorly understood concept. As Paul Krugman points out the meaning of a trade deficit or trade surplus can only be understood in the context of international financial markets: "Except at times of mass unemployment, trade deficits aren’t a subtraction from the economies that run them, nor are trade surpluses an addition to the economies on the other side of the imbalance. Over all, the U.S. trade deficit is just the flip side of the fact that America attracts more inward investment from foreigners than the amount Americans invest abroad. Trade policy has nothing to do with it.” PK mercifully does not go into the intricacies of international trade, finance and currency models and I won’t go there either since I have forgotten most of the details, which aren’t really relevant here. It is enough to simply understand that the overall trade balance is not an addition to or a subtraction from our economy.
If the overall trade balance does not have a simple additive relationship to the economy as a whole, a bilateral trade balance (eg US and China) are about as close to meaningless piece of data as you can get. First of all you can have a bilateral deficit with one country and an offsetting surplus with another (for example, we run a surplus with Canada). Unfortunately Donald Trump and his advisors see a bilateral deficit in the same context as a 17th century mercantilist, trade as a zero sum game. A deficit with anyone means you are losing. As Veronique de Rugy eloquently points out Adam Smith demolished this argument nearly 250 years ago.
Even if a bilateral deficit was a legitimate economic concept, in a world of complex multinational supply chains and growing trade in services the data used to calculate a bilateral balance is incomplete and flawed. First trade in services, for example dollars spent by Chinese tourists or students in the US is not counted as an "export". Moreover, bilateral trade flow data do not take into account the origin of each component of an imported or exported product. This problem can create a distorted picture of total imports, especially for a country like China, the 'great assembler." The iPhone is a good example. Components of the phone come from multiple countries, yet the entire value of an iPhone coming into the US counts as an import from China. In overall trade balance data most of this comes out in the wash, but bilateral trade flow data can be wildly distorted. Interestingly, many of the goods that we export to China are commodities, like soybeans, which are entirely a product of the U.S.A. As a result of these data issues I am convinced that the bilateral trade balance between China and the US showing a $375 bil. deficit is overstated. However, more importantly the concept of a bilateral trade balance is, as both liberal economists (Krugman) and conservative economists (de Rugy) point out, junk economics.
On to your second question, do tariffs work to "correct a trade deficit?" The short answer is no. Once again both Krugman and de Rugy agree, trade policy has nothing to do with the trade deficit. Other nations export to use because they want to reinvest dollars in the United States. Some of this investment goes into the private sector, but of course much of it is invested in government bonds, financing our growing national debt. As de Rugy points out: "We could reduce our trade deficit by reducing our government’s dependence on borrowing, but that requires a discipline that no one seems to have."
President Trump has recently announced large tariffs on steel and aluminum. He has also announced tariffs on China for their trade practices.
- Trump announces steel and aluminum tariffs, but with 'flexible' exceptions
- Trump announces tariffs on $60bn in Chinese imports
The President has explained that the purpose of these tariffs is to correct the balance of trade, specifically with China.
The economic press has produced a lot of reaction to this news.
- Why Donald Trump's China tariffs are likely to be a bad thing for him
- Trump's trade tariffs: Long on rhetoric, short on impact?
- Trump’s Tariff Plan Leaves Blue-Collar Winners and Losers
Here are the questions I put to him.
- Is it bad for the United States to run a trade deficit?
- Do tariffs work to correct trade deficits?
Neil:
In this post I will tackle your first two questions. I will tackle the potential impact of a long term trade war in a subsequent post.
The overall balance of trade is a poorly understood concept. As Paul Krugman points out the meaning of a trade deficit or trade surplus can only be understood in the context of international financial markets: "Except at times of mass unemployment, trade deficits aren’t a subtraction from the economies that run them, nor are trade surpluses an addition to the economies on the other side of the imbalance. Over all, the U.S. trade deficit is just the flip side of the fact that America attracts more inward investment from foreigners than the amount Americans invest abroad. Trade policy has nothing to do with it.” PK mercifully does not go into the intricacies of international trade, finance and currency models and I won’t go there either since I have forgotten most of the details, which aren’t really relevant here. It is enough to simply understand that the overall trade balance is not an addition to or a subtraction from our economy.
If the overall trade balance does not have a simple additive relationship to the economy as a whole, a bilateral trade balance (eg US and China) are about as close to meaningless piece of data as you can get. First of all you can have a bilateral deficit with one country and an offsetting surplus with another (for example, we run a surplus with Canada). Unfortunately Donald Trump and his advisors see a bilateral deficit in the same context as a 17th century mercantilist, trade as a zero sum game. A deficit with anyone means you are losing. As Veronique de Rugy eloquently points out Adam Smith demolished this argument nearly 250 years ago.
Even if a bilateral deficit was a legitimate economic concept, in a world of complex multinational supply chains and growing trade in services the data used to calculate a bilateral balance is incomplete and flawed. First trade in services, for example dollars spent by Chinese tourists or students in the US is not counted as an "export". Moreover, bilateral trade flow data do not take into account the origin of each component of an imported or exported product. This problem can create a distorted picture of total imports, especially for a country like China, the 'great assembler." The iPhone is a good example. Components of the phone come from multiple countries, yet the entire value of an iPhone coming into the US counts as an import from China. In overall trade balance data most of this comes out in the wash, but bilateral trade flow data can be wildly distorted. Interestingly, many of the goods that we export to China are commodities, like soybeans, which are entirely a product of the U.S.A. As a result of these data issues I am convinced that the bilateral trade balance between China and the US showing a $375 bil. deficit is overstated. However, more importantly the concept of a bilateral trade balance is, as both liberal economists (Krugman) and conservative economists (de Rugy) point out, junk economics.
On to your second question, do tariffs work to "correct a trade deficit?" The short answer is no. Once again both Krugman and de Rugy agree, trade policy has nothing to do with the trade deficit. Other nations export to use because they want to reinvest dollars in the United States. Some of this investment goes into the private sector, but of course much of it is invested in government bonds, financing our growing national debt. As de Rugy points out: "We could reduce our trade deficit by reducing our government’s dependence on borrowing, but that requires a discipline that no one seems to have."
It is interesting to note that President Trump is weighing joining the Trans Pacific Partnership after all:
ReplyDeletehttps://www.washingtonpost.com/business/economy/trump-weighs-rejoining-trans-pacific-partnership/2018/04/12/37d59500-3e71-11e8-8d53-eba0ed2371cc_story.html?utm_term=.f8f0ca25e9a5
Does anyone attempt to calculate the trade balance with China with services factored in?
ReplyDeleteThe answer is yes. The Census Bureau publishes these data. I seldom see them cited.
Deletehttps://www.census.gov/foreign-trade/Press-Release/current_press_release/index.html
Here is a short article from the St Louis Fed highlighting our surplus in service trade.
https://www.stlouisfed.org/on-the-economy/2017/june/us-trade-deficit-driven-goods-services