President Donald Trump certainly thinks it does. Since his campaign, he has tweeted frequently about his unhappiness with America’s trade deficit. Trump’s latest response is to impose tariffs on imported steel of 25% and 10% on aluminium. He once observed the problem was that there were a lot of Mercedes-Benz in New York and not many Chevrolets in European cities. But is that due to unfair trade barriers which can be addressed through imposing tariffs or to what consumers in America and Europe demand?
Economists since the days of Adam Smith and David Ricardo have pointed to the latter. Of course there are trade barriers and aspects of the international trading system that are not a level playing field. But, on balance, a country’s trade position is a reflection of its economic strengths and weaknesses. Trump’s planned 10% tariffs on all aluminium imports has led the very industry that it is supposed to help to ask the President to think again. The Aluminium Association that represents 114 aluminium producers has warned the tariff will likely do more harm than good. A tax will raise the cost of traded aluminium that will hurt their industry and their supply chain partners in Europe and elsewhere. Their suggestion is to focus on China as the source of over-capacity. More broadly, that can be said for a lot of trade barriers. If there are trade barriers that distort markets, then adding new tariffs or other barriers is likely to increase the distortions that can harm the industry that it intends to protect. Instead, something more targeted could potentially work better if the grievance can be established as falling within the rules of the World Trade Organisation, e.g., national security or anti-dumping. But, the more important factors that determine a country’s trade position are not tariffs; what a country produces leads to its trade position. This was understood in David Ricardo’s day when Britain repealed the Corn Laws in the mid-19th century which raised the cost of imported grain and was favoured as a protectionist measure by landowners. Ricardo is known as the father of international trade and his model pointed out that a country’s comparative advantage determined what it produced and thus traded. If a country was producing goods that were highly demanded by consumers everywhere, then it would sell that good abroad. So, to improve the trade balance, a country should focus on how to increase productivity and production of highly demanded goods and services. Because of specialisation, a country would produce less of other products and import those while focusing on what it was good at. Looking at America today, its long-standing trade deficit is due to a number of factors. Given that the U.S. economy is largely based on services, the lack of liberalisation of the global market for services in contrast to manufacturing has hindered its exports. America is still the largest exporter of services in the world and tends to run a surplus in this sector. For instance, the U.S. trade deficit rose to 2.9% of GDP due to an increase in its goods deficit and a decrease in its surplus in services exports. To remedy this would entail promoting the opening up of the services sector in markets around the world, which was a part of the abandoned US-EU free trade agreement (TTIP). Once investment flows are taken into account in the broadest measure of the external deficit, America still runs a current account deficit, but it is because foreign companies and investors invest in the U.S. Since the dollar is the global reserve currency, there is a lot of demand for US investments, debt and assets. So, there are “imports” of investment funds, due to the attractiveness of the U.S. economy. America’s deficit with the rest of the world thus reflects a range of economic considerations that explains why it has a long-standing current account deficit, of which tariffs are but a small part. Therefore, trade deficits only matter if they reflect an underlying weakness of an economy. For the U.S., that’s not likely to be the case. Comments are closed.
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