Politics & Policy

Understanding Trade Deficits

Cars at the port of Yokohama, Japan, in 2010. (Toru Hanai/Reuters)
Why trade deficits are not a sign of economic trouble, and trade surpluses are not necessarily a sign of economic health.

The problem with all this trade-deficit talk is that nobody seems to know what trade deficits are, what they mean, or what causes them.

A trade deficit is nothing like a budget deficit. Each year’s federal budget deficit adds to the total debt owed by the federal government. Trade deficits don’t do that, which is one reason why “trade deficit” is not a very useful term. A trade deficit is just a bookkeeping entry, not a debt that has to be paid. Countries don’t trade — people do. Americans are no more harmed by the trade deficit with Germany than you are by your trade deficit with Kroger.

Trade deficits are not caused by tariffs or other protectionist policies, and neither are trade surpluses. You wouldn’t know it to hear President Trump talk, but the United States and the European Union have on average almost the same tariff rate: 1.7 percent for the United States vs. 2.0 percent for the European Union, according to World Bank data. (Obviously, there is significant variation by item; Germany imposes a 10 percent tariff on imported automobiles, and the United States charges a 25 percent tariff on light trucks, a consequence of the so-called Chicken War.) In both cases, those average tariffs have been cut by nearly half since the early 1990s. China, which gives the Trump administration such agita, has cut its average tariff by nearly 90 percent since the 1990s, from a very high 32.2 percent to 3.5 percent — and its economy has thrived during that period.

Not only are trade deficits not driven mainly by trade policy, they are not really driven by consumer behavior, either. It’s true that many Americans prefer German cars and French wines — and cheap electronics and T-shirts made in China — but trade deficits mostly are the result of several other causes: macroeconomic factors such as tax policies and savings rates, the strength of a country’s currency, and, most important, its attractiveness to investors. Ironically, the corporate tax reform that President Trump is rightly proud of may contribute to higher trade deficits by making the United States a more attractive place to invest. Money invested in businesses and factories is not available for the purchase of consumer goods.

Trade deficits are not a sign of economic trouble, and trade surpluses are not necessarily a sign of economic health. The last time the U.S. ran a trade surplus with the world was 1975, when our economy was in a shambles. Britain ran a trade deficit from Waterloo to the Great War, a century marking the height of its power, and it grew vastly wealthy.

How? Consider our own trade deficit.

When the Germans run a $63 billion trade surplus with the United States, as they did last year, that means they have $63 billion on their hands. What can they do with that money? They can sit on it, as the Chinese and many other people around the world do, preferring to keep their savings in strong and steady dollars rather than in yuan, euros, or pesos. They can use it to buy dollar-denominated assets such as shares in Apple or Ford. Or they can invest it directly in the United States, as the Germans have with their automobile factories in the United States.

Far from being victimized by such trade, Americans are enriched by it. We get $118 billion in German-made goods in exchange for $54 billion in U.S.-made goods, which leaves $64 billion over to invest in American assets. Do you know who the largest U.S. automobile exporter is? It is BMW Manufacturing, which builds SUVs in Spartanburg, S.C., where it employs more than 9,000 people. Our trade deficit with Germany made that possible — that’s where the money to build the factory came from. Ask the autoworkers in South Carolina whether they think that’s a good tradeoff.

BMW, like Mercedes-Benz and General Motors, gets a lot more value out of each worker than it used to, through massive investments in robotics and other technology. American factories produce more than they ever have — our factory output has nearly doubled since 1990, and is much higher than it was in the so-called golden age of the 1950s and 1960s — but they need fewer people than they once did. As manufacturing payrolls have declined slightly, employment in other parts of the economy has grown substantially, and that — not trade deficits — is why manufacturing’s relative share of employment has declined.

We’ve seen that before: with farm jobs. Today, a small number of skilled workers operating sophisticated machinery on cotton and wheat farms can do the work that once required hundreds or thousands of hands. The United States is not worse off because fewer people work as farmhands: We are better off — radically. And we aren’t worse off because one autoworker can now do the work that once took 20 men.

U.S. farmers are the best in the world at what they do. The Chinese may talk a good nationalist game, but when Chinese bellies rumble, they are filled with Iowa-grown soybeans. One-third of U.S. soybeans are exported to China, and not because of some Machiavellian trade scheme carried out by Washington. And not because the Chinese are suckers, either. It’s a case of best product, best price.

We aren’t worse off because one autoworker can now do the work that once took 20 men.

It was good while it lasted.

President Trump now proposes to spend $12 billion to bail out U.S. farmers hurt by his batty trade war. That figure will grow if the trade war continues.

It took decades of hard work and innovation to make U.S. farmers the best in the world at what they do. It took the U.S. government about two weeks to make them into welfare cases.

Worse, the Trump administration is doing so for no good reason, because it doesn’t really understand trade deficits.

All our farmers really need is for the Trump administration to stop helping them.

NOW WATCH: ‘China Tariffs: We Can Do Better’

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