In my oral radio commentary for Friday, April 18, I decided NOT to make any comments on the craziness of Trump’s on again off again tariff war with the rest of the world. When he introduced what he called “liberation day” he was promising massive tariff increases tied (completely illogically) to the trade deficits the US experienced with each country in the world. The stock market began to tank and perhaps more ominously, the bond market began to tank. (Usually when the economy fears a recession --- that’s the indicator when the stock market tanks --- people rush to BUY bonds as an alleged “safe haven” and the result is bond prices go up and interest rates go down.).
The fact that both the stock market and the bond market went down scared a lot of people in the business and policy community. Some of them probably warned Trump his tariffs were putting him and the entire Republican Party (let alone the world economy) in serious trouble. SO he “PAUSED” most of the tariffs, except the one on China. Later, he announced that he was exempting computers, smartphones, and electronics imported from China, only to have one of his cabinet secretaries muddy the waters a day later by suggesting that exemption was “temporary.” Then Trump actually completely walked back the promise of exemptions.
[Details here. ]
Thus, there are so many gyrations in Trump’s policy, and the uncertainties created by the rapid fire on-again off-again tariff announcements have been so serious, I believe it is probably not a good idea to attempt to analyze what is going on in real time.
[Here is one group of experts’ “take” on the early phases of Trump’s policy (from April 7)]
THEREFORE, for my radio commentary, I decided to try and present some background anlaysis to show that the idea that the US trade deficit was somehow caused by foreigners ripping us off --- and therefore, tariffs to stop them from selling as much to us as they did in the past were the way to solve the problem --- is total nonsense.
[By the way, a trade deficit is just the excess of spending by the US on foreign goods and services over the spending by foreigners (or a specific foreign country) on US goods and services. The trade deficit or surplus is part of the way total spending in the US economy is calculated. In an appendix for those who want further analysis, I present all elements of the aggregate demand that adds up to the annual Gross Domestic Product of the US and show the relationship between the budget deficit, the savings and investment decisions of the private sector and the trade deficit.]
And it is true that, Trump SEEMS to believe that when the United States runs a trade deficit with another country that means that country is RIPPING US OFF. (He’s so ignorant and also so uninterested in learning anything that I actually think it’s unclear WHAT he believes.). So, let’s try to unpack the alleged relationship between being “ripped off” and a trade deficit.
When someone rips you off, they are usually selling you something you don’t need or something that is not as good as you thought it was. The travelling snake oil salesman claims that what he’s selling will cure whatever ails you. By the time you’ve drunk it and discovered it did no good ---or maybe even made you sick --- he’s gone on to the next town selling to another bunch of suckers. That’s what being ripped off is. Or it’s the kind of thing Trump loved to do over and over again – refuse to pay people who have done work for him. Ripping off the services of contractors by never paying.
So how have foreigners been “ripping us off?” Well, it’s not quite like Trump stiffing his contractors or selling overpriced Trump steaks. Instead, he seems to be saying that by using certain interventions in international trade (tariffs, quotas, currency manipulation, etc.) these countries are artificially cutting back on their purchases of American products so that when they sell their products to us, we end up spending more of our dollars there than they spend here (first of course they have to buy our dollars with their currencies). In other words, by messing with the rules, they create or enlarge our trade deficit.
Now it is certainly possible to increase one country’s trade surplus with another by intervening in international trade. This is what the Reagan Administration did in the 1980s by brow-beating Japanese car exporters to “voluntarily” (yes, they used that word) reduce the number of cars they sold in the United States.
[Details here. ] But such efforts are just one of MANY causes of trade deficits.
Here's a list of possible causes of a trade deficit:
1. Imbalance of Savings and Investment:
A fundamental cause of a trade deficit is when a country's investment needs exceed its domestic savings, meaning it spends more than it earns. (For details see the appendix to this essay.)
2. Increased Government Spending:
When the government spend more, it can lead to a reduction in national savings, potentially increasing the trade deficit.
3. Economic Growth:
A strong economy can lead to increased consumer spending, including imports, which can widen the trade deficit. (In other words, often a surge in imports is a sign of the relative health of an economy – a faster rate of growth – than its trading partners.)
4. Exchange Rate Fluctuations:
This can get a little complicated. If, for some reason the value of your nation’s currency rises compared to one of your trading partners, that makes EVERYTHING you offer for sale internationally more expensive.
A weaker currency can make a country's exports cheaper and imports more expensive, potentially widening that country’s trade deficit. (The US sells an airplane for $60 million. If the currency of the country buying the plane declines (weakens) vis a vis the dollar [say from 1.5 to 2 per dollar] suddenly that $60 million costs them 33% more in their currency. So maybe they cancel the order! Result --- the US trade deficit increases or its trade surplus declines.)
[You can check out the dollar to Euro Exchange rate here.]
5. Comparative Advantage:
Some countries may have a comparative advantage in producing certain goods, leading to increased exports from those countries and imports for others. Lesotho has a giant trade surplus with the United States, not just from selling diamonds which they mine in abundance but also blue jeans which they produce very cheaply and efficiently.
6. Trade Policies:
While trade policies can impact trade flows, they primarily shift the trade deficit to another trading partner rather than creating or increasing the overall deficit. In other words, Chinese manipulation of its currency may affect the trade balance between it and, say, the United States but Chinese currency manipulation hardly affects the US trade balance with the rest of the world, if at all.
7. Foreign Investment:
A country can attract foreign investment, which can lead to a trade deficit as foreign investors purchase goods and services from outside the country. Say some European business builds a factory in an African country. The inputs into that factory have to be imported which increases the imports into that country perhaps leading to or increasing a trade deficit.
8. Reserve Currency Status:
THIS IS THE BIG ONE for the US.
A country whose currency is used as a reserve currency (like the US dollar) can experience a strong demand for its currency, which can lead to increased imports. Since foreigners want to hold dollars for reserves and for international purchases, they buy lots of dollars on international exchange markets. The rise in the value of the dollar leads to US exports being more expensive (see 4 above). (However, this is a small price to pay for the advantage of being the main reserve currency for the rest of the world.)
9. Low Domestic Savings:
If a country has low domestic savings, it may need to borrow from foreign lenders or permit foreign investment to finance its spending, potentially leading to a trade deficit.
[this one gets complicated --- for an explanation see the APPENDIX.]
IMPORTANT CONCLUSION --- A TRADE deficit is NOT evidence that foreigners are “ripping us off” ---
NOW – a high trade deficit can cause a reduction in GDP growth --- similarly a high trade surplus can lead to an increase in GDP growth. These two facts provided the reasoning behind the Smoot-Hawley tariff of 1930. Unfortunately, the problem then was, the passage of the law called forth retaliation. Thus, Smoot-Hawley and the subsequent breakdown of international trade due to world-wide adoption of trade barriers produced no big advantages for any one country over the rest of the world.
Given the mercurial nature of Trump and his absolutely unhinged decision-making, we have no idea what will be the long-run (six months? -- a year?) impact of the gyrations in policy we have experienced in the last few weeks. Nevertheless, it is important that the main point of this essay be understood.
1. To say that the trade deficit is an unmitigated disaster for the United States is nonsense.
2. To say that the trade deficit is caused by foreigners ripping us off is nonsense.
3. And to argue that high tariffs ACROSS THE BOARD is THE way to reduce trade deficits is ALSO nonsense.
NONE OF THIS, of course, means that the policies adopted by both Democratic and Republican Administrations beginning with the signing of NAFTA back in 1994 have been “good” for the economy. In fact, they have not. NONE OF THIS of course means that some strategic use of tariffs such as attempted by the Biden Administration during his four years is a bad idea. However, as the economist Paul Krugman argued in a recent Substack, industrial policy to directly support good paying jobs is much better than tariffs.
[For an interesting discussion on just this issue, see the following interview with Sean Fain the head of the United Auto Workers available here and then for the other side, see Paul Krugman’s Substack.]
APPENDIX:
For those readers who wish to get “into the weeds” to see how a low domestic savings rate and/or a high budget deficit can cause a trade deficit, check out this Appendix.
One of the first algebraic formulations students learn in Principles of Economics is the following.
GDP = C + I + G + X – M
Translating this into English --- Gross Domestic Product can be expressed as the sum of Consumption, Private Investment, Government Purchases of Goods and Services and the excess of Exports over Imports.
BUT CONSUMPTION DEPENDS ON DISPOSABLE INCOME WHICH is GDP minus Taxes plus Transfer Payments.
[Transfer payments are government expenditures like Unemployment Compensation or Social Security pensions. They add to the Disposable Income of people who get those payments (and almost all retirees get social security payments) but they only indirectly increase GDP by increasing consumption. That is why only Government purchases of goods and services (workers in the Social Security Administration, Jeeps for the military, etc.) raise the GDP.]
[Getting Principles of Economics students to understand the difference between G (actual government purchases) and Tr (money paid to individuals NOT in exchange for a current good or service – people earn the right to a social security pension while they were working --- they receive the pension after they finish working) is an important goal of any first semester instructor.]
[ Meanwhile, taxes reduce the Disposable Income of individuals – which indirectly lowers the GDP by reducing consumption spending.]
DI = GDP – Taxes(T) + Transfer Payments (Tr) or
DI = C + I + G + X - M – T + Tr
But Disposable Income also can be expressed as the sum of Consumption plus National Savings (personal savings my individuals plus savings internal to corporations which show up in the National Accounts as Undistributed Corporate Profits.)
DI = C + NS
SET BOTH SIDES EQUAL TO EACH OTHER
C + I + G + X – M – T + Tr = C + NS
GET RID OF C from both sides and collect terms
(G – T + Tr) + (I - NS) = (M – X)
In English, the first item in parenthesis is the budget deficit. The next item is the excess of private investment over national savings and the last item is the trade deficit. This shows that while the level of X might be affected by protectionist activities overseas, and it is possible to use government policy to reduce M and therefore increase the part of Consumption spent on imports and also possibly increase investment in the future, once the government runs a deficit and once private investment decisions and personal and corporate savings decisions are made, the trade deficit is determined. A country has to change one of the fundamentals – either the government deficit or the amount of national savings in order to significantly reduce the trade deficit.
What follows is a way of finding the various components of GDP ---
Find GDP at BEA table 1.1.5. [BEA is the Bureau of Economic Analysis of the Department of Commerce.]
The formula is GDP (we use Y as a shortcut) = C + I + G + X - M
The numbers for 2023 are --- $27,720.7 = $18,822.8 + $4,984.8 + $4,701.5 – $797.3 (in billions)
[note because that last number is negative that means the US had a trade deficit! Also, these numbers might not add up due to rounding in the data table.]
In percentages -- C/Y = 67.9%, I/Y = 18.0%, G/Y = 17.0 %, (X-M)/Y = -2.9%
NOTICE that though it is possible to raise GDP by raising X – M, there isn’t much room to maneuver. The trade deficit has a relatively small effect on overall GDP.
The numbers for 2024 were ---$29,184.9 = $19.825.3 + $5,272.9 + $4,989.7 – $903.1 (in billions)
In percentages -- C/Y = 67.9%, I/Y = 18.1%, G/Y = 17.1 %, (X-M)/Y = -3.1%
Michael Meeropol is professor emeritus of Economics at Western New England University. He is the author with Howard and Paul Sherman of the recently published second edition of Principles of Macroeconomics: Activist vs. Austerity Policies.
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