Two years ago to the day, Donald Trump was preparing to enter his last month of campaigning for the U.S presidential elections, which he would go on to win in surprising and spectacular style. Trump has always held the conviction that one of his administration’s priorities was a reduction in the trade deficit. Along with the wall with Mexico, tax reform and abolishing Barack Obama’s health care law, it was among his favorite political slogans.
Rhetoric aside, the trade policies enacted by Trump’s administration during its first 20 months have not led to a reduction in the trade deficit. This might be seen as a positive. Indeed, to put it bluntly, as the famous Harvard economics professor Gregory Mankiw rightly explains on his blog, most people are confused by the expression “trade deficit.” It carries negative connotations for Trump and many others, but this should not be the case.
The American trade deficit is actually on the rise despite a number of policy initiatives. These include the revision of NAFTA (negotiations with Canada and Mexico have just concluded); the trade war with China (in the last few months, Washington and Beijing have jointly applied tariffs equaling $360 billion); the revision of the trade agreement with South Korea (which includes – among other things – the doubling of U.S. automobile exports and, in principle, a limit on Korean steel imports); and the scrapping of the Trans-Pacific Partnership and Transatlantic Trade and Investment Partnership and renewed interest in new trade deals with the EU and Japan.
In 2016, the last year of the Obama administration, the Department of Commerce’s latest figures showed that the trade balance (goods and services) registered a deficit of $502 billion. In 2017, Trump’s first year as president, there was a deficit of over $552 billion. The much-maligned trade deficit then rose again between January and July of 2018. If the average of those months also applies from August through December, the trade deficit could hit around $580 billion by the end of the year.
If, as Trump would prefer, only the trade deficit of goods — excluding services, where the United States enjoys a surplus — is taken into consideration, then the country’s trade balance is in the red to the tune of around $807 billion, an increase of more than $55 billion on 2016. If current trends continue into the second half of 2018, the trade deficit of goods could reach a historic high of more than $850 billion.
An analysis of the total trade balance (goods and services) as a percentage of U.S. gross domestic product reveals a small increase between 2016 and 2017. We will need to wait for this year’s figures but, based on current estimates, the trade deficit is on course to reach 2.5 percent of GDP. If you look instead at the entire current account, of which the trade balance is only a part, the International Monetary Fund estimates a rise of between 2.4 percent and 3 percent. In short, despite the small increase, there is nothing untoward to concern a president intent on defending the wellbeing of the American people and an economy with a nominal GDP of more than $21 trillion.
As many economists explain, the deficit in U.S. goods and services has very little to do with the trade policies that Washington has embarked on. The trade deficit of a nation is, in general, determined primarily by the flow of inward and outward investments. Those flows are caused by how much people in that specific country save and invest. To understand how the trade balance of a nation functions, you need to first grasp what the balance of payments is. Once these terms have been understood, you can get to the following equation: savings - investments = exports - imports. As a consequence, the macroeconomic variables of savings and investments are influenced only indirectly by the trade policies of a particular country.
Up to this point, Trump’s economic policy has largely been characterized by his expansionary fiscal strategy while in deficit. The U.S. budget deficit was 4.4 percent between August 2017 and August 2018, the highest level since May 2013. According to available figures, the Congress-approved $1.5 billion tax cut, made when the country is already in deficit, and the two-year federal spending deal will further increase the budget deficit over the next few years. Trump’s own administration states that the deficit is likely to exceed $1 trillion, or 5.1 percent of GDP, by 2020.
As well as increasing debt, this expansive strategy is fueling both GDP growth and imports. Thanks to positive economic conditions, American citizens are buying more goods from abroad. As well as this, when we refer to the trade balance, we also need to take into consideration monetary policy. A discussion of the trade balance is therefore much more complex than might be imagined.
To conclude, I will make two brief observations on Trump’s pointless economic obsession with the trade deficit. The first is the mistaken assumption that the trade deficit has a negative impact on employment and American wealth. In both cases, this is incorrect.
The most recent U.S. surplus was in 1976. Since then, and despite an ever-increasing trade deficit, American GDP per capita has grown by 1.8 percent (in line with a trend going back to the second half of the 19th century).
Unemployment is, however, only indirectly linked to the trade deficit through wider economic growth. For example, figures from the Congressional Research Service show that in 2009, in the middle of the global financial crisis, real GDP growth in the United States was negative (-3 percent), unemployment rose to around 10 percent and the trade deficit for goods shrank to around 40 percent, falling to $510 billion. In 2006, however, the unemployment rate in the United States fell to around 4 percent, while GDP on an annual basis increased to 2.7 percent and the trade deficit of goods hit a historical high of more than $830 billion. The last few years have seen unemployment in the United States continue to fall while economic growth has stabilized at over 2 percent, with the trade deficit of goods not once dropping below $750 billion.
My final observation is that Trump’s ultimate objective, as he has rightly repeated more than once, is to reduce trade tariffs, barriers and subsidies throughout the world. If this is the case, why is he not promoting a trade policy of unilateral openness rather than continuing to talk, mistakenly, of a problem (the trade deficit) that is nonexistent?
It is highly likely that such a move – just like a reduction in corporate taxes – would set off a positive process that leads to other countries following suit. As Paul Krugman reminds us in a piece written in 1997, the economic case for free trade is first and foremost a unilateral one. This means, as Frederic Bastiat says in “Economic Sophisms,” that countries should abolish tariffs and other trade barriers independently of what other countries decide to do. History has given us two examples of a unilateral opening to trade: mid-19th century England (following the abolition of the Corn Laws) and Hong Kong. In both cases, great success followed.