In President Trump’s reckoning, international trade is a zero‐sum game with distinct winners and losers. Exports are Team America’s points. Imports are the foreign team’s points. The trade account is the scoreboard, and the deficit on that scoreboard proves that the home team is losing at trade. Accordingly, the president considers blocking imports and promoting exports to be integral to effective trade policymaking.
In 2018, Trump put that theory to the test. For a variety of reasons, including a desire to reduce the trade deficit, Trump imposed tariffs on $250 billion of imports from China.
According to the latest official Chinese data, the result was a record‐high bilateral U.S. trade deficit of $323 billion. Oops. What happened?
First, despite the existence of broadly applied tariffs, the value of U.S. imports from China still increased by 11.3 percent in 2018. Although one would expect tariffs to raise U.S. prices and induce consumers, businesses, and the public sector to purchase less from China, a confluence of factors were at work mitigating the impact.
For example, the strong U.S. economy, which was occasioned by meaningful wage growth in 2018, probably offset some of the price effects of the tariffs. With rising incomes, we can afford higher prices.
Meanwhile, for many U.S. producers whose supply chains run through China, the short‐term costs of finding new sources in other countries or repatriating production to the United States were probably too high in most cases to cause a large shift in 2018 consumption patterns. In other words, enduring the tariffs may cost less than the investments needed to avert them.
Another factor to consider is that a slowing economy in China, marked by declining domestic prices and a weakening Chinese currency, may be pushing Chinese export (pre‐tariff) prices down, blunting further the dissuasive effects of Trump’s tariffs. Of course, the sluggish Chinese economy also helps explain another major contributor to the rising trade deficit: stagnant U.S. exports.
While U.S. imports from China rose 11.3 percent, U.S. exports to China, which were subject to comparable, retaliatory Chinese tariffs, registered a mere 0.7 percent increase. When economies grow, demand for domestic and imported goods and services tends to rise. When economies contract, or when growth slows, demand for both tends to subside. Beyond the slowing Chinese economy, there are a variety of other explanations for stagnant U.S. export growth.
Among the major U.S. commercial targets of China’s retaliatory tariffs are industries in the agriculture and energy sectors. Products such as soya, rice, wheat, oil, and natural gas are commodities. They are widely available from sources other than the United States. Accordingly, the costs of rejiggering supply chains that may be deterring U.S. companies from shifting away from Chinese suppliers are a much less important consideration to Chinese companies, including state‐owned enterprises, who can substitute away from U.S. producers relatively painlessly.
Moreover, an enduring principle in economics known as the Lerner Symmetry Theorem holds that a tax on imports is a tax on exports. By inflating the costs of imports to reduce domestic demand, tariffs also increase the costs of U.S. exports by reducing the capacity of foreigners to afford them. If foreigners are going to purchase U.S. goods and services, they need to be able to sell their own goods and services to Americans.
It just so happens that tariffs have a negative effect on overall trade, imports and exports, but no predictable effect on the trade deficit. The trade deficit is not a function of trade policy, which is okay because neither is the U.S. trade deficit a problem to fix. It’s just a benign statistic.
Americans are able to purchase more goods and services from foreigners than we sell to them because foreigners buy more assets from Americans than we buy from foreigners. There is a positive inflow of dollars on the capital account. Foreigners don’t only buy goods and services from Americans. They buy U.S. assets (equities, property, factories, service centers, shopping malls, machines, other physical assets, corporate debt, and government debt) from Americans. Likewise, Americans don’t only buy goods and services from foreigners — we buy assets from foreigners as well.
If anything, the trade deficit, which is a luxury made possible by foreigners investing more in the United States than Americans investing abroad, signals that foreigners have faith in the U.S. economy as a safe and potentially lucrative destination for their savings. That is an enormous economic advantage that the United States enjoys and one that is threatened by Trump’s failure to appreciate it.