The Positives and Negatives of Trade and Tariffs

What is a Trade Deficit?

A trade deficit simply refers to a country’s balance of imports and exports. When a country runs a trade deficit, its imports exceed its exports. This is often referred to as a negative balance of trade. A trade deficit can occur either when a country does not produce enough goods and services on its own to meet the basic demand of its residents, or when the citizens of a country have enough wealth to buy additional goods and services beyond what that country makes itself.

Is a Trade Deficit a Bad Thing or a Good Thing?

While it may sound negative, it isn’t necessarily a bad thing for a country to maintain a trade deficit instead of a surplus. It is noteworthy that the U.S. has not had a single quarter with a trade surplus since the early 1980s.  Although the U.S. has seen a shift to a more services-driven economy and has registered a surplus in this area, it imports much more than it exports in the goods category, and that deficit is greater than the surplus in services exports.

When a country imports goods or services from overseas, it gains access to things that it wouldn’t ordinarily be able to obtain or cannot produce at home. The importing country benefits by receiving the items it wants or needs.

Further, if one country runs a trade deficit with another country, the country that has a trade surplus in that relationship needs to offset the inflow of that income into its market so it will not drive up the value of its currency. To do this, companies in countries with a trade surplus will invest capital back into the country from which they receive goods. This flow of capital back into the importing country can come in various forms, either by buying stocks or bonds in the exporting country, or by investing in the country itself. For instance, if a U.S. consumer buys a watch from Switzerland for $1,000, the Swiss company might purchase $1,000 in a U.S. certificate of deposit, a Treasury bond, or stock in a U.S. company, among other options.

As a trade deficit grows, a country’s currency should theoretically decline, making its goods cheaper to buy from overseas. However, as more and more of the home country’s relatively cheap exports are bought up, this in turn bids up the home currency. This bid-up of home country currency often means that trade deficits “self-correct” over time, or that the exchange rate adjustment should lead to more balanced trade between two countries.

However, In the U.S., the currency issue is more complicated. That is because the U.S. dollar (USD) is the major global reserve currency, so trade transactions occurring globally and not involving the U.S. still use the USD. This puts upward pressure on the dollar, and therefore makes U.S. exporters less competitive. This is part of what is known as the “Triffin dilemma,” named for economist Robert Triffin, and refers to the problem faced by U.S. policymakers about the fact that the U.S. will almost always have to run a trade deficit in order to keep the global financial system working. Hence, the three-decade-long U.S. trade deficit mentioned earlier.

Other decisions that countries make at a policy level affect trade deficits. For instance, a tax cut (like the one recently implemented in the U.S.) will make the budget deficit bigger and in the long run may lead to higher interest rates, a stronger USD and potentially a bigger trade deficit.

A trade deficit may mean fewer jobs for a country over time. If imports are in greater demand than exports, it is more likely that there will be fewer domestic jobs in industries where other countries can produce goods at a lower cost. If there is less demand for a country’s goods in a particular industry, that domestic industry will need to employ fewer people to make them. When a dislocation of this kind occurs, a country would need to retrain workers from the job-losing industry so they can be successful finding work in another field with better domestic prospects.

In the U.S., the reserve currency status also means that the country’s export industry may always be somewhat challenged. This means industries like manufacturing may be at a relative disadvantage in creating new jobs.

How Do Tariffs Affect a Country’s Balance of Trade?

Governments can add tariffs to the price of goods and services purchased abroad. Tariffs make those goods and services less attractive to domestic buyers, and can change the country’s trade balance equation. For instance, a country running a trade deficit can cause domestically made goods to become more appealing to its consumers by making foreign-made goods more expensive with the implementation of tariffs.

There are a few reasons to do this, especially as tariffs can help ease some of the negative effects of a trade deficit. Governments can protect their own countries’ industries, and safeguard the jobs of people who work in those industries. Also, making foreign-produced goods pricier is a political tool governments can use with other countries. Tariffs can also be a source of revenue for a government, and notably were the principal source of income for the U.S. government from 1789 until the Federal Income Tax began after 1913.

However, just as trade deficits can have negative consequences, adding tariffs to goods in order to reduce a trade deficit can have repercussions.

• Tariffs make imported goods more expensive, which obviously makes consumers unhappy if those costs result in higher prices.
• Domestic companies that may rely on imported materials to produce their goods could see tariffs reducing their profits and raise prices to make up the difference, which also hurts consumers.
• The benefits of tariffs may not be evenly distributed across the population, so benefits for workers (and political consequences for elected officials imposing tariffs) may be uneven as well.
• Countries are free to retaliate with tariffs of their own and if the retaliation escalates enough, it’s known as a “trade war.”

What Are the Implications of the New U.S. Tariffs?

Recently, the U.S. government has imposed tariffs on goods from several countries. In early July, it imposed 25 percent tariffs on $34 billion of Chinese goods, including various industrial parts, X-ray equipment and water boilers. On August 23, tariffs extended to a total of $50 billion in Chinese goods. The current administration has indicated that tariffs on a total of $200 billion in Chinese goods are under consideration.

It isn’t just China that the U.S. is targeting with tariffs—the U.S. had originally set aluminum and steel tariffs on Mexico, Canada and the European Union as well. Each of these countries has imposed retaliatory tariffs on U.S. goods in response. Of course, all of this is changing week by week. For instance, in late July the European Union and the U.S. government struck a deal to work toward “zero” tariffs, subsidies and barriers.

As we noted, some U.S. industries may benefit from these tariffs, but even for these industries, the picture is complex because their supply chains include imported materials. U.S. steel and aluminum firms stand to benefit, but some U.S. firms that use those metals to make their products have said that materials prices have increased and they need to charge customers more. Ford and General Motors will benefit from a tariff on EU car imports, but the tariff will hurt the U.S.-based suppliers to the European car market.

Meanwhile, in addition to proposing retaliatory tariffs to the ones imposed by the U.S., China’s currency has weakened relative to the USD over the last month or so. A weaker yuan means Chinese goods will become more attractive to overseas customers.

As the USD continues to strengthen in 2018, with more interest rate hikes predicted, it will likely make the dollar even stronger and U.S. exports more expensive. It is unclear at this point how the tariffs will help or hurt the economy, and which jobs may be gained or lost.

Fair and Free Trade: Economic Realities or Reveries?

A clear issue facing the U.S., however, is whether U.S. consumers, manufacturers, and service providers have a level playing field with trading partners. Despite the economic implications described above, unfairly disadvantaging American exports with restrictions and tariffs imposed by foreign countries should be addressed. It is not unreasonable to point to the elimination of most U.S.-directed tariffs beginning with the Reagan administration as one of the reasons that so many manufacturing jobs disappeared and moved to other nations. Yes, the result has been the consumer has had access to cheaper TVs, etc., but at the cost of shifting entire industries outside of the U.S. borders. 

“Free trade” in the purest sense of the term will be impossible to achieve politically – there are too many special interests that will prevent that – and probably isn’t economically feasible either. “Fair trade,” a world where agreements are reached resulting in a series of trade-offs, where no one country is at a net disadvantage to others, is certainly a plausible goal.

The long-term implications of all of this are unknown, and the tariff escalation has not yet reached “trade war” status. However, if the U.S. seeks to achieve a world where trade equality is paramount, it should recognize that the ultimate trade-off might be to sacrifice its role as the reserve currency more rapidly than anticipated. The consequences of that are the topic of another blog. Spoiler alert – it may not be so bad after all.