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Trade Deficit: Ask the Wrong Questions, Get the Wrong Answers

Daniel R. Pearson

President Trump signed an executive order on March 31 requesting
an “Omnibus Report on Significant Trade Deficits.” This
report “shall identify those foreign trading partners with
which the United States had a significant trade deficit in goods in
2016.” The policies of those countries are to be examined,
including among others: tariff and non-tariff barriers, dumping,
government subsidization, intellectual property theft, and
“other factors contributing to the deficit.”

Thank heavens for that final clause, “other factors
contributing to the deficit.” Looking at other
countries’ policies may tell us something about bilateral
trade flows, but it will tell us very little about the overall U.S.
trade deficit. With the exception of “other factors,”
the executive order is asking the wrong questions, so the report
almost certainly will provide the wrong answers.

Trump’s executive order
seems premised on the mistaken notion that fixing trade-distorting
policies of other countries would reduce the U.S. trade
deficit.

The trade deficit is driven by U.S. government policies that
influence domestic savings and investment, not by the policies of
governments overseas. The United States simply doesn’t save
as much as it invests. This leaves America with a massive
financial/capital account surplus — people in other nations
send a lot of money to this country every year to build factories,
buy stocks, and fund the federal budget deficit. By definition, the
balance of payments must balance, so the United States runs a
current account deficit equal to the financial/capital account
surplus. The trade deficit is the largest component of the current
account, so the trade deficit also is large — $502 billion in
2016.

If the United States really was serious about reducing its trade
deficit, it would curtail its demand for borrowed money by
eliminating the federal budget deficit. The Congressional Budget
Office reports that the 2016 budget deficit rose to $587 billion
— even larger than the trade deficit. For good measure, the
U.S. government also would reform the tax code to stop the taxation
of interest earned on deposits, as well as ending the deductibility
of mortgage interest. That would shift the policy bias away from
borrowing, and instead would favor saving.

Unfortunately, the executive order seems premised on the
mistaken notion that fixing trade-distorting policies of other
countries would reduce the U.S. trade deficit. True, there are an
abundance of government policies — both overseas and in the
United States — that distort the flow of goods and services.
Seeking their reform is entirely appropriate. However, those
distortions largely have the effect of rearranging trade flows
among countries, not increasing the size of the U.S. trade
deficit.

As a hypothetical example, If China was to end a policy that
subsidized the production of T-shirts, it might lead to higher
prices. That price signal could cause a reduction in U.S. T-shirt
imports from China. However, U.S. demand for affordable T-shirts
would remain unchanged, so importers likely would increase
purchases from Bangladesh. Reform of a trade-distorting policy
easily could shift the origin of T-shirts entering the United
States from one country to another, but the effect on the overall
U.S. trade balance would be nil.

Many trade flows have very little to do with policies and much
to do with economics. Comparative advantage still works in the 21st
century — countries simply are better at producing some
things than others. Even most protectionists recognize that America
is better off importing coffee from efficient producers such as
Colombia rather than trying to grow it here. Imports raise living
standards; we shouldn’t be afraid of them.

So what will the executive order accomplish? By identifying
troubling policies overseas, it might help to determine future
negotiating priorities. More likely, though, its built-in emphasis
on other countries will tend to misinform the public and the White
House itself regarding the root causes of the trade deficit.

Perhaps there is yet a glimmer of hope. Knowledgeable economists
are employed at Commerce and USTR, as well as other departments
involved in preparing the report. They may face pressure to produce
a study consistent with the biases expressed in the executive
order. Will those professionals stand aside and allow the real
causes of the trade deficit to be swept under the rug? They would
do a great service to the United States and to the global trading
economy by looking beyond the wrong questions, focusing on
“other factors contributing to the deficit,” and
striving to provide the right answers.

Daniel R.
Pearson
is a senior fellow in trade policy studies at the Cato
Institute. He served a two-year term as chairman of the U.S.
International Trade Commission during the George W. Bush
administration.