De Rugy: How Trump Misunderstands Trade
By Veronique de Rugy
President Trump recently tweeted, referring to the United States trade deficit with China, “When you’re already $500 billion down, you can’t lose!”
In 1776, Adam Smith observed that nothing “can be more absurd than this whole doctrine of the balance of trade.” Sadly, almost 250 years later, the president — along with his economic adviser Peter Navarro and Commerce Secretary Wilbur Ross — has elevated this economic fallacy into a pretext for protectionism.
Fueling this bipartisan hysteria is the widespread failure to understand that United States trade deficits generally add capital to our economy — more factories, more R & D or more machines.
Further confusing the American people, the power held by those advisers means that we hear them on television daily repeating, contrary to almost every reputable economist, their mistaken belief that our $800 billion trade deficit — including a $375 billion goods deficit with China — reduces our gross domestic product and is evidence of foreign-government chicanery.
The notion that trade deficits are always bad for the economy is based on several fundamental mistakes. The first mistake is the assumption that trade is a zero-sum game, suggesting that the country selling products abroad is a winner while the one who buys is a loser. That’s simply wrong.
Think about your own experience. Without ever worrying about it, we run up trade deficits on a daily basis with many merchants. When you shop at the grocery store, enjoy a drink at your favorite bar or get your hair cut, you run up a personal trade deficit with your grocer, bar and hair stylist. Do they ever buy anything from you in return? When you get paid by your employer, he runs up his trade deficit with you. Do you buy as much from your employer as he buys from you?
These examples illustrate how trade deficits with other economic entities are almost always nothing to fret about. They’re unavoidable consequences of the specialization and trade on which our modern prosperity depends. To be sure, on rare occasions trade deficits are symptoms of underlying dysfunctions, but they are never themselves a cause of these dysfunctions.
Even if we were to ignore the counsel of nearly every economist and blindly accept the notion that a United States trade deficit with the rest of the planet is undesirable, it would still be completely untrue that a deficit with any single country is undesirable. In this world of nearly 200 countries, bilateral trade deficits are as unavoidable and as economically meaningless as your trade deficit with your grocer. If America’s overall trade deficit were balanced, we’d still have deficits with some countries and surpluses with others.
More generally, we mustn’t forget that the American dollars we spend on imports eventually return to America, either by foreigners purchasing American exports or making investments. Protectionists like Mr. Trump always complain about the United States’ trade deficit for goods but mention neither the surplus of foreign investment capital that we get nor our trade surplus in services.
Here’s how it works: The American dollars we use to buy imports are of little use to foreigners outside our borders. They are, however, of great use to foreigners who want to invest within the United States. And that’s what happens with the dollars that aren’t spent on American exports.
Foreign investment is key to our economic growth here at home. In other words, we Americans win when we get to buy the stuff we want from abroad and when those dollars are pumped back into our economy.
This benefit remains intact despite Beijing’s many violations of our trade rules — such as its subsidization of Chinese steel makers. It’s true that those subsidies artificially lower the price of steel imported by America and might hurt some American steel mills and workers. But this effect is the same as it would be if Chinese steel makers had a genuine efficiency advantage over our producers. Despite the administration’s constant refrain about the devastating impact of foreign export subsidies on the steel industry, experts know that a vastly greater number of steel jobs were lost to innovation, not trade.
Even in the subsidization scenario, we pay for Chinese steel with dollars, and the Chinese then use some of those dollars to buy our exports and use the rest to invest in our country. In both cases, it creates jobs here. The same relationship holds when the Chinese manipulate their currency to stimulate their exports.
Some worry that the Chinese won’t spend their dollars in the United States, but this concern is misplaced. If there were no foreigners who wanted to spend or invest dollars in America, the Chinese would not have exported steel to the United States to begin with. At the end of the day, dollars have value only because they can ultimately be used to buy American-made outputs or be invested in American assets.
If the Chinese spend their dollars in Japan, the Japanese will turn around and spend their dollars in America, by investing in such things as a brand-new Toyota plant that will employ United States workers. Dollars will always find their way home.
Another way these dollars make their way back home is through foreign investors who buy Uncle Sam’s debt. As of January 2018, for instance, China has returned $1.17 trillion this way. Overall, about $6.3 trillion of our $15 trillion in public debt is held by foreigners.
President Trump argues that yet another reason to eliminate the trade deficit is because it fuels our debt. Nonsense. The only reason we have so much debt is because our government spends more than it collects in taxes. That’s not the fault of foreigners.
We could reduce our trade deficit by reducing our government’s dependence on borrowing, but that requires a discipline that no one seems to have. Until that changes, foreigners help us shoulder the burden of our irresponsible debt. In fact, we should hope that they don’t ever change their minds about buying our debt, because the resulting higher interest rates would lead to even bigger budget deficits and even higher taxes on everyone.
President Trump should be careful what he wishes for. His attempt to reduce the trade deficit with tariffs will lead not only to fewer imports but also to fewer exports, as economists have long understood. Recessions, reduced foreign investment in the United States and a weak dollar are the most effective ways to reduce the trade deficit. I doubt any of us would enjoy these remedies, which result in slower economic growth, less innovation and lower living standards. Maybe that’s why few seem to notice or actually care that the trade deficit has been growing under this president — to its highest level in nearly a decade.