As President Trump prepares to roll out new tariffs this week, it is worth asking what tariffs do — more specifically, whether they will do what Trump wants: decrease the trade deficit. Useful in this exercise is the latest from Joseph Gagnon, a senior fellow at the Peterson Institute of International Economics. Writing for The Hill, he sets out some misconceptions about trade deficits.
For one, the problem isn’t that other countries don’t want to buy U.S. exports. In fact, he argues, “America is the world’s No. 2 exporter, with exports of goods and services worth $2.3 trillion in 2017, only slightly below China’s exports of $2.4 trillion.” Those exports come in the form of cultural products and grain and other inputs that most people don’t think about.
And those exports could be a harder sell if Trump institutes sweeping tariffs. “When America buys less foreign steel, foreigners have fewer dollars to buy our exports,” Gagnon explains. “The resulting dollar scarcity pushes up the dollar exchange rate, making other imports cheaper and U.S. exports more expensive.” Even when a tariff targets one particular country, it might decrease the deficit with that country, but it will tend to raise deficits with other nations. The net effect, then, is nil.
That doesn’t mean that the United States should just forget about its trade-balance problem. Although a trade deficit can be a “helpful safety valve for an economy that is overheating” — it checks inflation and interest rates when growth is high and unemployment is low — for the United States, the trade deficit mostly finances the fiscal deficit. With the United States’ debt to the rest of the world growing faster than its economy, the trade imbalance has become unsustainable, Gagnon argues, and should be addressed.
Rather than implement ineffective and possibly illegal tariffs or pursue policies aimed at weakening the dollar to boost exports, however, Gagnon suggests that “the best course of action for sustainable U.S. and global economic expansion with relatively balanced trade is for America to reverse its imprudent fiscal binge while standing ready to counteract any renewed burst of dollar strength with appropriate currency policies such as foreign exchange intervention or taxation of foreign capital.”
While I definitely understand Gagnon’s concern about the deteriorating U.S. fiscal position, there’s another way of looking at America’s fiscal binge: We are, to at least some extent, supporting demand not just at home but globally, which in turn is helping keep the economies of the surplus countries aloft. My sense is that this has been true for much of the post-crisis era. Rather than focus solely on what the U.S. can do unilaterally, I wonder if we should call upon our allies to do more.
Taking a page from Matt Klein of the Financial Times, I’m thus more concerned about the euro area’s aggregate fiscal position than I am with that of the U.S., at least for now. My sense is that underspending in Europe is stymieing the recovery in its weakest economies while contributing to unsustainable global imbalances. The same can be said of some of our allies in East Asia, a point that’s been raised by Brad Setser of the Council on Foreign Relations. Yes, we ought to have a lower deficit, and deficit spending should be more oriented towards investment than consumption. But if our allies were doing their part, we’d all be much better off.