Balance of Trade

In 2018, the US trade deficit in goods grew to $891 billion, the highest on record, meaning that the value of US imports exceeded exports by more than it ever has. Moreover, imbalance with China soared. Although a trade deficit isn’t necessarily (or even usually) a bad thing in and of itself, the fact that it rose despite trade policy (tariffs) purportedly aimed at reducing it sheds light on the fundamental problems with such policies – they fly in the face of basic economics and they don’t work!! Just to pile on, they are also counterproductive.

Since last summer, the US has imposed tariffs on a laundry list of products, with leveling the playing field and reducing the trade deficit as the stated rationale. Not surprisingly, other nations have responded with tariffs on US goods. As the two biggest economies on the planet, escalating trade tensions between the US and China have been particularly problematic. Even so, deficits continue to increase to historic levels.

With the US economy performing well and incomes rising (due in part but not solely to tax cuts), households have more disposable income. Much of this additional money is spent on consumer goods. A large proportion of these items that Americans choose to buy are made in other nations (including China), representing tens of billions of dollars in imports. All tariffs accomplish is forcing us to pay more for the things we want. Similarly, the government dramatically increased deficit spending (including for foreign goods) and some of our major customers in the world saw economic slowdowns. All of these things increase trade deficits.

The benefits of free trade go back to the simple idea of comparative advantage. Essentially, comparative advantage indicates that production should flow to the regions with relative advantages, such as lower costs or proximity to needed inputs. Any artificial constraints on global trade cause resources to be used with less than optimal efficiency, decreasing overall wellbeing. This principle was first articulated more than two centuries ago and the basic math is incontrovertible.

While the US has advantages in some products and services, primarily those involving high levels of innovation, there are many where we clearly do not. For instance, unless we as a society want wage rates comparable to those in China (which we obviously don’t), many labor-intensive Chinese products will cost less and represent good values to American consumers. To the extent trade deficits go down in the future, it will likely be due to our rapidly expanding exports of energy and ongoing innovations enhancing our competitiveness in other sectors. It definitely won’t be because of any trade wars or other needless impediments. It’s nothing more than supply and demand.