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Don’t use tariffs to close the trade deficit

Tariffs are economic self harm

When wars start, one of the first things the warring parties try to do is seal off their enemy, to prevent them from gaining access to the materials they need for the war. During the First World War, the Royal Navy did not fight the decisive battle with Germany’s High Seas Fleet that both had been planning for in the years previous. Even so, the Royal Navy did play a major role in winning the war by blockading Germany and helping to bring its economy to a halt in 1918.

So why is it that some policymakers think it a good idea to carry out these acts of economic warfare on their own countries? Because that is what tariffs are. To the extent that they hurt your ‘opponent’ they hurt you at least as much. As the economist Joan Robinson put it, “Even if your trading partner dumps rocks into his harbor to obstruct arriving cargo ships, you do not make yourself better off by dumping rocks into your own harbor.”

Trade deficits are not ‘lost’ money

You will often hear people complain about the trade deficit as though it is a bad thing which needs to be fixed. They talk as though it is money being somehow lost. But put yourself in China’s shoes. Does Xi Jinping worry about all the washing machines and TVs his country is ‘losing’ to the United States? He doesn’t seem to, but why not? After all, ‘losing’ actual goods is worse than ‘losing’ bits of paper issued by the US Treasury department.

In 2017, the US exported $2.3 trillion worth of stuff. In return, it got $2.9 trillion worth of stuff. The balance is the trade deficit. It is the excess of the value of imports over the value of exports. In other words, the US was able to consume about $600 billion more stuff than it sent to other people to consume. So the trade deficit is not a loss of money, it is a gain of consumption.

This is one of the older arguments in economics. In 1776, Adam Smith wrote The Wealth of Nations largely to debunk the doctrines of the Mercantilists. They believed that the purpose of trade was to run a surplus so you could accumulate the gold the other countries would send you to cover their deficits. But, as Smith pointed out, money is a means to an end, not an end in itself. The end is consumption of goods and services, not the stockpiling of money balances.

The US trade deficit isn’t even a thing

But, more fundamentally, the US trade deficit doesn’t really exist. Sure, it shows up in the national accounts, but this is just a statistical aggregate of the countless decisions decisions taken by individuals and businesses within the United States.

And all of us run trade deficits with some and surpluses with others. I, for example, run a hefty trade deficit with Target. They give me goods and all I give them in return are bits of paper with president’s faces on them. In turn, Target run trade deficits with their suppliers, taking produce from farmers, for example, and handing them dollar bills in return.

By contrast, I ran a heavy trade surplus with my previous employer. I provided services to them, researching and writing reports, and they give me cash in return. It was my trade surplus with that employer that allowed me to fund my trade deficit with shops like Target. And my old employer’s trade deficit with me provided them with product to sell to clients with whom they ran a trade surplus.*

All the US trade deficit is is an aggregate of all these decisions. If I buy English cheddar from Hy-Vee, Hy-Vee will send the English cheesemonger some cash and receive cheese in return. This will show up in the trade deficit. If I buy Wisconsin cheese, it won’t. The same goes if you buy a foreign car or DVD player. Add all these individual decisions up for the United States and you get either a trade deficit or surplus. Either way, it isn’t clear why you should be worried about it as long as you can pay for it.

Don’t worry about the trade deficit

I am old enough to remember when people were worried that Japan would end up owning America as a result of the US trade deficit with them. This was back in the late 1980s, and then businessman Donald Trump was one of them. Then the Japanese economy tanked and has flat-lined more or less ever since. Nobody worries about the Japanese owning the US anymore.

President Trump has overseen some good economic policies such as the tax cuts and deregulation. But his fixation with the trade deficit is misguided and his tariffs are bad policy. Perhaps they are just a negotiating tactic. Lets hope so. Either way, they will harm the strong economy which is his electoral trump card, pun intended.

John Phelan is an economist at Center of the American Experiment. 

*I also run a trade surplus with the Center of the American Experiment who, conversely, run a trade deficit with me. As a non-profit, however, the example is a little muddier than for my old commercial employers.