TRADE WARSTrump’s Obsession with Trade Deficits Has No Basis in Economics. And It’s a Bad Reason for Tariffs
President Donald Trump believes that if a country has a trade surplus with the U.S. it is somehow playing unfairly and needs to be dealt with. But anyone who understands the basics of international economics will recognize the fallacy in both of these beliefs. That the U.S. 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.
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 recognize the fallacy in both of these beliefs.
Trade takes place based on what economists call “comparative advantage” – 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, 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.
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, 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.
