We have repeatedly heard from President Trump that the United States' main trading partners are taking advantage of the country. Trump administration advisers have argued that trade deals result in trade deficits that have weakened the US economy. Trade adviser Peter Navarro has gone even further than that. To them, a trade deficit is about victimization: a signal of weakness and policy failure of a country, evidence that you let trading partners abuse you.
We agree that there is some long-held abuse in current United States trade patterns. For example, state-owned enterprises should not be allowed to compete on an unfair playing field against private firms, wherever they are located. And foreign investment opportunities should be reciprocal. But the trade deficit is not a good indicator of where to find problems like this, so relying on broad tariffs to reduce the overall deficit will not fix trade.
Many of today's trading relationships actually make America more globally competitive. In fact, much of that trade deficit comes from internal factors, among them US fiscal choices.
A trade deficit is simply the result of a country spending more than it produces, which can arise in one of three general scenarios:
(i) If the public sector spends more than it collects (running a budget deficit) while the private sector invests exactly what it saves;
(ii) If the private sector invests more than it saves while the government's running a balanced budget; or
(iii) If the government runs a budget deficit that exceeds the net savings of the private sector.
All three depend more on the individual decisions and aggregate dynamics of a country's domestic players than on decisions trade partners make. One of the main players in this dynamic is a country's own government.
Public spending policy has a direct effect on the trade balance. All else being equal, increasing a country's budget deficit will result in a worsening of its trade balance, while promoting fiscal balance will improve it.
Economists have different ideas on how this occurs: Some point to the potential for rising interest rates to strengthen the dollar, which incentivizes imports; others attribute those same monetary impacts to rising real returns on domestic investments given a lower tax environment.
A third view, as described above, is simply that increasing public consumption faster than production can keep up means that some of that gap will be filled by imports.
According to Congressional Budget Office monthly figures, the US government in the fiscal year 2017 showed a deficit of $665 billion, amounting to 3.5% of GDP. The most recent 10-year economic outlook report sees this budget deficit reaching $804 billion in fiscal 2018, which will represent 4.0% of GDP.
Moreover, the upward trajectory of the deficit is expected to continue in 2019 and 2020, forecast to be $981 billion and $1,008 billion, respectively, equivalent in both cases to 4.6% of GDP. These forecasts are driven largely by government expenditures growing faster than the overall economy, as represented by GDP. And going forward, US government spending is set to rise uncontrollably higher without domestic reforms to the three areas that already make up more than half of its budget: retirement, health care, and growing interest payments on the debt itself.
This increase in the US fiscal deficit will eventually translate into a higher total trade deficit as well, exactly the opposite of President Trump's intentions. When that happens, it will not be helpful to blame Canada, Mexico, the European Union or China for US domestic choices.
Raising tariffs among the United States, Canada and Mexico will only weaken a well-oiled manufacturing machine that is driven by the high level of integration the three economies have in their supply chains. This integration makes the region as a whole more competitive vis-à-vis the world.
Today, US manufacturers incorporate Canadian and Mexican suppliers to be competitive and export their goods globally. Upsetting this integration with higher tariffs is a lose-lose for North America that would only benefit countries like China, which has shown little such regard for American supply chains.
So it turns out that President Trump can make a difference in American trade competitiveness. But he should make sure his choices will actually help get the results that he and his constituents want. Our response to the trade deficit? Get the government's own deficit under control.
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