Trump’s obsession with trade deficits has no basis in economics. And it’s a bad reason for tariffs
- Written by Nigel Driffield, Professor of International Business, Warwick Business School, University of Warwick
Those of us who study trade and investment for a living are, I suspect, becoming exasperated with both the White House stance on tariffs and the way that this is reported in much of the media. US president Donald Trump believes that if a country has a trade surplus with the US it is somehow playing unfairly and needs to be dealt with. But anyone who understands the basics of international economics will recognise the fallacy in both of these beliefs.
Trade takes place based on what economists call “comparative advantage”[1] – countries import those goods that are otherwise relatively expensive for them to produce. And they export what they produce cheaply relative to other countries.
So the UK[2], for example, has a trade surplus in services but a deficit in goods that are made in low-cost locations. This is similar to the position of the US[3].
To understand what the US is seeking to achieve, the first questions must be: what are tariffs designed to do? And when are they typically applied? These issues lead to another point. If Trump is so convinced that his tariffs will produce a win-win, why haven’t they succeeded before?
Trade policy in the form of tariffs is designed to make imports more expensive and encourage buyers to switch to domestic producers. This may be an attempt to protect or support local industry, or as part of a bargaining strategy to access others’ markets.
But this assumes two things. First, that the demand for such imports is relatively price sensitive (that is, buyers will be put off by price rises). And second, that there are domestic producers able to fill this gap at an appropriate price.
But tariffs can also cause what is known as “trade substitution” – where the country imports the goods from alternative sources instead.
To illustrate how this can work in practice, the US has long applied tariffs on European whisky[4], ranging from 10% to 25% in recent years.
The US already produces various drinks that are considered to be similar to whisky. So the reason for importing is likely for variety, or possibly the allure of consuming a premium product like a Scottish single malt. As such, price increases may not encourage substitution away from imports – or it may trigger substitution to other imports with lower tariffs.
An alternative example of the case for tariffs is the steel industry. Many countries believe that they should have a steel industry for strategic reasons, but also because steel is an input into so many aspects of the economy.
There have also been concerns globally in the industry [5] about the pricing of Chinese steel, and whether it should attract tariffs to balance what is seen as unfair competition. Chinese steel receives subsidies[6] from the Chinese government, after all.
While this may be a valid concern, it also forces governments to make choices about what they see as “strategic industries”. A good example of this is the desire to protect steel jobs[7] in richer countries, in contrast to the willingness to import cheap clothes from Asia in order to keep inflation down.
This is typically why, if tariffs are used at all, they tend to be targeted[8] to certain industries.
So will the US tariffs plan work? Unfortunately for Trump, the answer is probably not. This type of trade policy has been tried, but has seldom been shown to be effective.
The second point is whether the president of a large global power should be concerned about its trade balance with another country. Unless he believes that the country is engaging in large-scale subsidy in order to dump goods on foreign markets, the answer is almost certainly no.
Casual inspection of trade statistics[9] for the US and Canada suggests that the most common exports from Canada to the US include crude petroleum, petroleum gas, refined petroleum and motor vehicle parts and accessories.
Tariffs on the first three will simply push prices up for US consumers. The last one demonstrates, often to the frustration of policymakers who seek to intervene on trade, that there is little that governments can do to influence modern supply chains, unless they seek to break them all together.
‘We don’t need anything Canada has.’Firms will locate activities based on combinations of efficiency and where their customers are. So seeking to change these patterns through tariffs will simply increase the cost of imported inputs and make production in the US less competitive.
In simple terms, complaining that you have a trade deficit with one country is like complaining that you have a trade deficit with your corner shop. They sell you things, you give them money, but they never buy from you. They provide goods that you want for money that you earn elsewhere.
You could shop elsewhere (and have a deficit with the new shop), you can give up your job and even grow your own food. But were you to impose a “tariff” on your corner shop, it would simply put up the prices that you have to pay.
That the US has a trade deficit is not a sign that the rest of the world is “ripping it off”. It is a reflection of an affluent society with relatively high wages buying products from countries that can produce them more cheaply. Trump’s tariffs will hurt Americans first – basic international economics is clear on that too.
References
- ^ “comparative advantage” (www.youtube.com)
- ^ the UK (www.ons.gov.uk)
- ^ position of the US (www.bea.gov)
- ^ European whisky (www.distilledspirits.org)
- ^ concerns globally in the industry (www.gtreview.com)
- ^ subsidies (news.sky.com)
- ^ protect steel jobs (theconversation.com)
- ^ targeted (theconversation.com)
- ^ trade statistics (www.cer-rec.gc.ca)
