Do trade deficits really matter?

The Thinker by Rodin

So we are having trade wars at the moment. Trump started all of them, first with a 30% tariff on solar panels manufactured in China but then on steel imports. It expanded into tariffs against Canada, Mexico, the European Union and more tariffs on China. Predictably these countries responded with counter-tariffs designed to give Trump’s biggest supporters a case of indigestion. And it’s working. Farming is typically a low margin business. With less demand, prices drop. With fewer crops being sold it is quickly making agriculture here unprofitable. Trump says that tariff wars are easy wins. That wasn’t the case in 1929 when they caused a global depression.

Trump acts like trade deficits really matter. Unquestionably they do matter to some businesses and people, i.e. those affected by them. After NAFTA was passed we lost a lot of our industrial base simply because countries like Mexico could manufacture stuff a lot cheaper than we could. To compete though in many ways we have upped our game. We are much more of a service economy now and we design leading edge stuff that is often manufactured elsewhere. Aside from Apple products, there is also stuff like my CPAP machine. This work is more specialized and the margins must be higher.

I don’t recall a time when the United States was not carrying a trade deficit. Perhaps we weren’t back in the 60s and 70s, but I was much younger then. And there are scattered months here and there when we do export more than we import. We have trade surpluses with some countries, like Canada. It’s a mystery then why Trump targeted that country. Mostly though it’s the other way around. While some sectors have suffered from all this free trade, I think overall it’s been a benefit.

One big benefit has been that trade has kept prices and thus inflation low. As long as these tariffs are in place, we are likely to see creeping inflation again. And Americans love imports. Low prices have helped us live beyond our means and our stagnant wages. It’s how companies like Walmart stay in business. Moreover, these imports increase competition and that too tends to lower prices. In many cases, the best quality products are available overseas. Take hybrid cars, for example. Yesterday I was in a neighbor’s Toyota Prius Prime and marveling at its engineering. This model may have been manufactured in the United States, but it’s an amazing value for the money. Since he too has solar panels on his house, most of the time he is driving using its electric motor. He’s getting very close to living carbon free, thanks to hybrids built and perfected overseas.

We have a choice of where we buy things. Most likely my next car will also be a foreign hybrid or fully electric car built or designed overseas. If I buy a Toyota Prius built in Japan and pay $30,000 for the privilege, while it causes a trade imbalance, it’s not like I didn’t get anything for my money. I get a great value in a car that gets 51mpg when it’s not running in fully electric mode. The effect of buying a foreign car is that some Americans (presumably) did not have a part in its design and manufacturing. Maybe that’s bad for the economy if we presume that whoever would have been building the car here in the states wasn’t doing work of similar or greater value. I’m not an economist but I’m not sure we can credibly make that claim.

In the case of hybrids and electric cars, American auto manufacturers are upping their game. In one case (Tesla) are providing a superior (albeit much more expensive) alternative. The Chevy Volt and Bolt are two other examples, although their cost is subsidized by generous federal tax credits. Tariffs on cars manufactured overseas do make our domestic versions more competitive, but only by raising foreign car prices. It doesn’t actually save buyers any money; in fact we pay a double penalty for tariffs: higher costs and potentially less competition.

There is certainly a convincing case to be made that China trades unfairly. To gain market share, it heavily subsidizes certain sectors like its solar and shipping sectors. It often doesn’t respect international copyright laws. In most cases though foreign products are cheaper because they can manufacture them for less. Often these industries are low profit. It’s unclear why we would want to compete in these low profit industries when doing so probably won’t give us a better lifestyle. Tariffs are at best a poor way for addressing these issues. They may work, but history is generally against you. Leveraging them in a large way like we are doing now is very dangerous, as the Great Depression attests.

In any event, the United States is not blameless. Even before these latest rounds of tariffs, we have been subsidizing many of our own industries through longstanding tariffs, including our sugar and peanut businesses. Free trade is one of these ideals that are rarely fully realized. When it is, someone is usually paying a price. Americans pay much more for sugar and peanuts than is necessary, and now we’re paying more for steel and solar panels too.

The evidence doesn’t seem to prove that trade deficits cause a country’s decline. In some ways they can demonstrate resilience. The strong U.S. dollar shows that we are a strong country in spite of these trade deficits. To me, trade deficits suggest that our knowledge economy is our real strength. Anything that we can do to continue to foster that, for example by allowing more technical people to acquire H1-B visas, should be a good use of government. On commodities like agriculture, we are highly efficient. In spite of the burgeoning world population, we can feed much of the world. Perhaps we should be strategically reducing the amount of farmland under cultivation to keep farming profitable.

I doubt that tariffs are the instrument we need. And I really am skeptical that trade deficits matter at all.

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