How Not to Solve the Problem of Trade Deficits

The U.S. has run persistent trade deficits since the early 1990s and the annual trade deficit has increased to $566 billion in 2017.  This has raised concerns that our trading partners are taking advantage of us.  Since March, President Trump has roared about our trade deficit with China, equal to $375 billion in 2017, as well as China’s unfair trading practices including appropriation of our intellectual property.  After several rounds of fruitless talks, the Trump administration announced additional 25% tariffs, effective July 6, on a list of goods imported from China that are estimated to be worth $50 billion. China has responded in kind by imposing tariffs on a range of U.S. products.  America’s relationships with other major trading partners – including the European Union, Canada and Mexico – are also strained due to the new U.S. tariffs on steel (25%) and aluminum (10%), as well as the Trump administration’s threats to withdraw from the WTO and other trade agreements.
Tariffs are taxes on imported goods. As is true for any tax, the distribution of the burden of a tariff between the buyers and sellers depends on the relative “elasticity” of the demand and supply to price changes, where the less elastic party bears a larger portion of the burden.  Suppliers tend to have higher elasticity than demanders, which implies that American consumers and firms will ultimately foot the bill for most of the tariffs imposed on imported goods.

The world would not be as prosperous as it is today without the existing trade agreements that have brought down tariff and non-tariff trade barriers. This is true for the U.S. as well.  Enormous effort and goodwill were spent to achieve the existing trade agreements, which were considered mutually beneficial at the time.  If some provisions are now considered “unfair” it is better to deal with those within the existing framework than start over from the beginning.  For example, under the WTO, the U.S. has a 2.5% tariff on imported cars, whereas the EU and China have much higher tariffs on car imports, at 10% and 25%, respectively.  These tariff rates indeed seem unfair, and can and should be made more equal within the existing framework.

Free trade and low or zero tariffs are policy goals we should strive to achieve.  Equally important is protection of intellectual property rights - vital to U.S. interests.  Threats of tariffs, and threats of withdrawing from trade agreements, could be smart bargaining techniques in negotiations of a more fair, reciprocal and free trade regime.  But the ultimate policy goals need to be kept in mind, and these include low tariffs and freer trade.

What if some foreign governments subsidize their exports and our domestic firms cannot compete?  Can this situation be dealt with within the existing trading regime and without imposing tariffs? For some goods, especially non-strategic consumer goods, we might happily welcome low-priced imports.  When a country decides to subsidize its exports so that they can sell their products at lower prices, buyers in the receiving country - consumers and firms – gain by paying the lower prices.  The situation is less clear when there are economic or national-security spillovers. Threats of tariffs can be used strategically to discipline trading partners who are deemed to be in violation of the terms of existing agreements. Appeals to trade organizations may work, but trade organizations often have limited enforcement powers. When it comes to international trade agreements, the final arbiters are the trading partners themselves.

What can be said about those trade deficits?  By themselves, a country’s trade deficits are not necessarily good or bad; they can be partially mitigated by adjustments in the exchange rate.  Trade deficits of a country exert downward pressure on the value of domestic currency relative to foreign currencies, which causes more exports and less imports and reduces the trade deficit. Persistent trade deficits may be indicative of a country saving too little compared to the demand for investment.  A nation’s saving includes both private saving and government saving.  If a government is serious about reducing trade deficits, it can reduce its budget deficit and thereby increase government saving.  In a recent blog post, we document how the actions of the current U.S. administration and Congress have increased our already-large budget deficit, and this has exacerbated our trade imbalance. 

Current threats of tariffs or of our withdrawal from trade agreements may eventually be seen as a smart negotiating strategy to level the playing field on trade.  Only time will tell.  Just days before the Trump administration’s additional tariffs on a select list of Chinese products took effect on July 6, China announced new policies to reduce tariff and non-tariff barriers to the Chinese market, which include cutting tariffs on imported cars from 25% to 15%. The Trump administration’s tariffs, and threats to withdraw from treaties, could work because our trading partners have more to lose from reduced trade than we do. However, this is a dangerous strategy, and our trading partners could adopt a tit-for-tat strategy that leads to a world with higher tariffs and reduced trade.  Our long term goal should be the opposite, lower tariffs and increased trade, with all the benefits that trade brings. 

Dennis W. Jansen is the Director of the Private Enterprise Research Center and professor of economics at Texas A&M University.

Liqun Liu is a Research Scientist at the Private Enterprise Research Center.

Andrew J. Rettenmaier is the Executive Associate Director of the Private Enterprise Research Center.

Posted: July 09, 2018 by Dennis W. Jansen, Liqun Liu, Andrew J. Rettenmaier