One of the frequent problems with government action is that it often falls victim to the Law of Unintended Consequences. This maxim holds that for many actions taken in a complex system there are often unanticipated and undesirable outcomes. In quite a few cases, the unintended consequence is to make the original problem worse. That seems to be the case with President Trump’s efforts to balance the trade deficit with China.
Ostensibly, the trade war began with tariffs intended to protect the American steel and aluminum industries for national security reasons. In reality, Trump has railed against the trade deficit since before his campaign began in 2015. In one tweet from 2018, Trump blamed the loss of factories and manufacturing jobs on the trade deficit.
There is both good news and bad news for President Trump on the trade deficit. The bad news is that despite his tariffs and trade war, the US trade deficit with China reached a record high last year. The Wall Street Journal reports, “China recorded $323.32 billion in surplus with the U.S. in 2018, representing a 17% jump from the figure in the previous year.” Citing data from China’s General Administration of Customs, the Journal said, “China’s exports to the U.S. rose 11.3 percent in 2018, while imports from the U.S. inched up 0.7 percent.”
The trade imbalance is at least partly due to the tax reform that revitalized the US economy. Another big part of the ballooning trade deficit is the trade war itself. Tariffs on both sides have slowed the Chinese economy and dampened the demand for American-made products. In particular, US agricultural producers have been hit by the trade war as China imports fewer American farm products and turns to other countries such as Brazil, but other American exporters have been hurt as well.
Essentially, the increase in the trade deficit is driven by the fact that many American consumers have more disposable income after tax reform while Chinese consumers are suffering through an economic slowdown that leaves them with less money to spend on imported goods.
The good news for President Trump is that the trade deficit isn’t as important as he thinks it is. In fact, according to the legendary economist Milton Friedman, President Trump has it exactly backward. When people talk about “favorable balance of trade,” Friedman famously noted, “It’s taken to mean that we export more than we import, but from the point of view of our well-being, that’s an unfavorable balance. That means we are sending out more goods and getting fewer in. Each of you in your private household would know better than that.”
As Friedman correctly pointed out, a trade deficit means that you’re getting a better deal than your trading partner. If you are getting more in the bargain than you’re paying, that is usually considered to be a good deal unless the topic is international trade.
The problem is that many people key in on the word “deficit.” In most other contexts, particularly with respect to the federal budget deficit, it means something bad. In international trade, however, getting rid of the trade deficit would mean that the US would pay more for the goods that it imports. In that case, eliminating the deficit would not be a good thing.
If you doubt that Trump is mistaken on the issue of trade deficits, consider the reductio ad absurdum, the war on the trade deficit taken to an absurd conclusion. The US could totally eliminate its trade deficit by simply eliminating international trade and investment. The result would devastate the US economy, however. American manufacturers would not be able to import raw materials or export finished products. Angry consumers would not be able to buy iPhones or other imported consumer goods, assuming they still had jobs. No one would be happy, but the trade deficit would be exactly zero.
So, what caused the loss of factories and manufacturing jobs that Trump blamed on the trade deficit? The answer is technology. As factories automate and become more efficient, fewer workers are needed and inefficient plants close. According to a study by the Center for Business and Economic Research at Ball State University, 85 percent of manufacturing job losses are actually due to technological changes and automation rather than international trade.
If President Trump continues to insist that trade deficits are bad and presses to reduce China’s trade surplus, it is apparent that his tariff war is not working. A better solution might be to enter into free trade agreements that help the economies of our trading partners grow. As the incomes of foreign workers rise, so will their appetites for American-made goods.
While it may be counterintuitive that helping what one Trump supporter recently described to me as our “trade adversaries” would ultimately help the US economy, it isn’t a new idea. The philosophy behind the benefits of free trade is the same as the one behind tax reform, namely that a rising tide lifts all boats.
Originally published on The Resurgent