If Trump's Goal Was to Reduce the Trade Deficit, It's Not Working

In doggedly pursuing trade protection as the indicated route to reduce our trade deficit, the administration is blinding itself to one of macroeconomic theory’s few basic truths.

Any doubt that one might have entertained about the efficacy of President Trump’s policies to eliminate the US trade deficit should be confirmed by the Commerce Department’s latest trade numbers release. Those numbers show that far from moving in the direction of eliminating the trade deficit, under President Trump’s watch the trade deficit has increased from a monthly rate of US$40 billion to a monthly rate of US$60 billion. This has taken the trade deficit for 2018 to its highest level since 2008.

In its effort to reduce the country’s trade deficit, the administration has kept relying on increased import tariffs and renegotiating trade deals to do the job. It has done so despite the continued widening in the deficit.

Protectionism Ignores Economics

In doggedly pursuing trade protection as the indicated route to reduce our trade deficit, the administration is blinding itself to one of macroeconomic theory’s few basic truths. That theory teaches that purely as a matter of arithmetic a country’s trade balance is determined by the degree to which its savings level falls short of its investment level.

It follows from this truth that if a country wishes to reduce its trade imbalance there are two basic ways that it can achieve that result. It either must increase its savings rate or it must reduce the rate at which it invests.

Viewed through the Savings-Investment lens, it should have come as no surprise that the US trade deficit would keep rising despite the application of an America First trade policy. By engaging in a large unfunded tax cut and going along with public spending increases, the administration has put us on the path of substantially increased budget deficits.  By so doing, it has reduced public sector savings levels thereby raising the specter of the “twin deficit” problem of the 1980s when the country suffered from both a trade and a budget deficit.

Exercising better budget discipline at home might reduce our rate of public sector dissaving and help improve our savings-investment imbalance.

The administration’s protectionist trade policy is also having the effect of increasing our trade partners’ savings-investment surpluses. It is doing so by diminishing the economic outlook of those partners’ economies, which has the effect of reducing their investment levels.

If the administration were serious about wanting to reduce our trade deficit, it would concentrate its efforts on exercising a greater degree of budget discipline at home. That might reduce our rate of public sector dissaving and help improve our savings-investment imbalance. At the same time, it might pursue a less protectionist trade policy than it is now doing and use whatever leverage it had over a country like Germany to compel it to use the fiscal space that it now enjoys to stimulate its moribund economy and to reduce its trade surplus.

Maybe then we might hope that the world’s global imbalances might be addressed in the context of a healthy global economy and without the risk of triggering a world trade war. Sadly, there is little indication that the Trump administration is moving in that direction.

This article is republished with permission from the American Enterprise Institute. 

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