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The theory of trade deficits and Trump's war on tariffs with China

The United States has been a country with a trade deficit every year since 1976, and this process accelerated when China joined the World Trade Organization in 2001. Until before the start of the pandemic, China was responsible for 50% of this deficit; Japan second with 11%; Germany third with 10%; and Mexico fourth with 7%. Totally, it represents around 5% of its GDP, about 700 billion dollars every year.

To import more than it exports, a country has to resort to an increase in national debt or to foreign investment. The agents of an economy must borrow abroad or it is the foreigners that acquire assets in the country. This is known as the balance of payments, and capital flows have to match with commercial ones.

A commercial deficit is not necessarily a bad thing:

1. It is the direct result of international economic specialization through which each country produces and/or exports what is 'good producing at' and importing what is 'bad producing at'.

2. It can be a sign of a healthy economy in which buying more imported products is the consequence of an increase in the purchasing power of the population.

3. The foreign investment that results from importing more than what is exported can be used to finance projects that improve the productivity of an economy. The United States, for example, ran trade deficits continuously between 1830 and 1875, but European investments helped to build railroads and electrify the entire country, allowing the US to become the richest country in the world. This was also the case with many Southeast Asian countries and their economic growth between 1970 and 1990.

4. The fact that the dollar is considered the most important reserve currency in the world is a vote of confidence in the US economy, and this necessarily tends to cause a trade deficit.

Now, if this imbalance is very large and lasts for a long period of time, it can pose some risks to an economy:

1. It gives to investing countries unquestionable geostrategic power over the trade deficit country. If for whatever reason China and Japan, which are the largest international holders of US debt, decide to sell their assets during a complicated situation, the US economy could take a severe hit.

2. It implies almost necessarily a decrease in the productive diversification and economic complexity of a country, which according to the most recent economic theory, ensures sustainable growth and the strenght of an economy in the long term.

3. Some sectors of the population and areas of the country can enter a circle of systemic economic decline, dragging with it problems of social marginalization. For the United States, the case of mining areas and industrial centers such as Detroit are notorious, although this is also due to the natural process of technological transition in an advanced country.

4. The increase in the national debt resulting from fiscal and trade deficits modifies interest rates, thus reducing the room for maneuver of the Central Bank's monetary policy. It also happens the other way around, that due to a very lax monetary policy, the population obtains additional income that it uses to buy imported products, so a trade deficit is simply the reflection of a particular monetary policy.

5. Excessive debt increases a country's default risks, negatively affecting public and private investment, the stability and sustainability of an economy.

There is not a strong correlation between trade surpluses and economic growth, but there is a strong one between large and prolonged trade deficits with national debt and long-term vulnerability of an economy.

Donald Trump has been attacking the United States trade deficits since the 1980s, calling them 'the greatest plunder in history'. In the recent years, he has especially accused China of manipulating its currency and selling its subsidized products at a lower price than its cost of production in order to drive international competition out of the market. China has also imposed a condition on foreign companies wishing to establish themselves in its territory by which they must first form a consortium with Chinese companies, which are often state-owned, as well as to share their intellectual property, known also as obligated transfer technology. Presidents G.W. Bush and Barack Obama complained about these practices and both imposed tariffs on Chinese steel, among other things. When Trump was elected, he went further and started a total trade war with China in 2018:

1. He set tariffs worth $300 billion, so many products went from having a negligible tariff to 25%. China reacted by imposing tariffs worth $110 billion dollars, raising the tariffs of many American products from 8 to 25%, at the same time that reduced it for other countries from 8 to 6%.

2. Trump and Xi Jinping agreed shortly afterwards to mutually reduce tariffs and in 2020 a commitment was signed by which China would have to buy an additional $200 billion in US products over the 2017 level.

3. China announced a judicial reform that would protect the intellectual property of foreign companies, causing Trump to publicly thank Xi Jinping for his 'enlightenment and wisdom'.

Now with Joe Biden, the current US administration has declared that it does not plan to eliminate Trump's tariffs for the moment and that it wants to coordinate joint actions against China with US allies. The first high-level talks between the two governments took place in March in Anchorage, Alaska, with the participation of Janet Yellen, secretary of the Treasury and former president of the Federal Reserve, and Katherine Tai, United States Trade Representative, who has Chinese and Taiwanese ethnic origins. On behalf of China, members of the Communist Party participated in the meeting.

Trump's tariffs have been negative for the United States in the short term because almost all sectors of the economy have been affected. The deficit with China was temporarily reduced but has now returned to pre-2018 levels, and with respect to the rest of the world the trade deficit has increased. Trump's intention was to use the tariffs to force a renegotiation of the trade relationship with China. In that sense, Trump has achieved his goal as Biden has established that he will force China to fulfill its promise to buy an additional $200 billion worth of American goods.

Finally, Tai and Biden have said that they hope to reach a trade agreement with China but that the United States 'must defend its economic interests to the maximum and that means taking all necessary measures regarding the damage inflicted over the years by unfair competition from China'. Although Biden harshly criticized Trump's economic nationalism and tariff war with China, nothing seems to indicate that the bilateral trade relationship will go back to the way it was before, and his current stance on this issue does not seems to be different at all from his predecessor in the White House.


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