Debunking the Trade Deficit Myth
The US flag with market data for various markets (2021)
Credit: Wikimedia Commons
The Deficit
The United States’ trade deficit is often mentioned in discussions of the US’s manufacturing decline. Both politicians and media pundits have taken to pointing towards the seemingly stark state of American trade, highlighting the growing gap between our country's imports and exports as a warning sign of America’s decline. In effect, the trade deficit has been adopted as an unofficial measure of industrial health. To the credit of those ringing the alarm bell, the numbers are striking: in January alone the value of imported products outpaced that of exports by an estimated $130 billion, representing the largest single-month deficit in US history. While it's true that America's top manufacturers have seen better days, using the trade deficit as a measure of economic health is highly problematic as it leads to the misrepresentation of the American economy and options available to policymakers through the inherent framing of economic health as a purely trade policy issue.
An Imperfect Measure
What is often lost in talks on the trade deficit is that it is only one of many possible measures of economic health. What's worse is that it’s not a particularly accurate one. One widely accepted measure of economic health is the real gross domestic product, a measure of the cumulative value of all goods and services consumed in a given year adjusted for inflation. In Q4 2023, the US boasted a record-high real GDP of $29.297 (in trillions). Broken down into its largest contributors, consumer spending accounted for $19.682, government spending accounted for $4.815, and investment accounted for $5.063. Detracting from this was the trade deficit, which saw $0.791 trillion leave the American economy in 2023, a number that in isolation seems significant, but is quickly offset by other sectors of the economy. The reason why trade has relatively little impact in the broader context of the US economy is that it is a relatively small sector of the economy! The glory days of American manufacturing in the mid-1900s, a time when the US held unrivaled manufacturing capacity, left a lasting impression of the US as a leading manufacturer, but over the past 50 years, the American economy has undergone a gradual shift away from manufacturing towards service industries. In 2000, manufacturing accounted for 22.5% of the GDP and 17 million jobs, but by 2020 manufacturing GDP share fell below 18% and employment fell to just below 13 million. During this same period, the service industry rose to a record 77% of the US GDP and by 2023 employed over 135 million Americans. The difference in significance between manufacturing and services is striking, representing a tenfold difference in employment. With this in mind, using the trade deficit as the sole measure is highly inflammatory and misrepresentative of an American economy that has long since moved from the factory floor to a cubical.
Protectionism as The New Norm
The misrepresentation of the American economy isn’t just negligent, it generates real harm, incentivizing policy that actively damages the American economy. One of the most prolific critics of the United States trade deficit has been President Donald Trump, who co-opted surging support for protectionist policy as a core piece of presidential runs, with multiple swing states residing in the midwestern “Rust Belt” voting red on the promise of reversing the decades-long decline of American manufacturing following the 1994 implementation of the North American Free Trade Agreement (NAFTA). To Trump, NAFTA was a bad deal, perhaps even the worst trade deal in the history of trade deals. To his credit, this view is not entirely wrong. From 1994 to 2019, employment in manufacturing fell from a peak of 19.6 million to 12.8 million, a 6.7 million worker decline. During his first term, Trump renegotiated NAFTA-era agreements to offer more protections for American manufacturers as part of the USMCA. Since his second inauguration, Trump has made progress on his promise of reversing NAFTA era policy, elevating tariffs' role from a fair trade enforcement mechanism to a tool meant to fundamentally alter American industry. Trump has levied blanket tariffs on both Mexico and Canada, while also moving towards the resumptions of his 2018 trade war targeting China with a 10% increase in tariffs in addition to pre-existing measures and threatening similar action against the European Union. Across the board, Trump has taken aim to address America’s industrial decline through the use of tariffs. Unfortunately, these tariffs are likely to have unintended consequences. Immediately consumers will be hurt. Tariffs are a tax on imported products, paid for by the importing distributor and passed on to the consumer. As tariffs are imposed prices will rise, businesses will suffer as supply chains are complicated by trade restrictions leading to job loss and further price increases, and a decline of investor confidence with uncertainty about steel and aluminum tariffs alone being projected to cause a $40 billion annual decline in investment into the domestic economy. The effects of prolonged tariffs would be highly damaging with a recent study finding that between 1870 and 1909, a 10% increase in tariffs was associated with a 25-35% decrease in economic productivity.
An Unhealthy Obsession
Trump’s insistence on using tariffs as his first choice policy is a direct product of his fixation on the trade deficit. Targeting countries such as Canada, Trump uses the US’s ongoing trade deficit as a justification for implementing tariffs in the hopes of creating government revenue and incentivizing Canada to reach an agreement to import relatively more American products to the benefit of US manufacturers. Unfortunately, many of these tariffs are unlikely to have their intended effect. The potential for targeted countries to answer American tariffs with reciprocal tariffs and the complication of global supply chains means many manufacturers are likely to suffer. Additionally, with tariffs dominating policy narratives, other, far more beneficial options have been given far less attention. Experts warn that current plans to revitalize American industry lack a clear industrial policy that includes measures to attract investment and encourage development. By focusing on efforts to correct trade imbalances through the use of tariffs, policies such as targeted tax cuts, subsidies for key industries, and worker retraining programs, all policies that could be of great benefit to American manufacturers have been largely ignored outside of isolated cursory mentions. Trump has specifically proposed government support for both the American shipbuilding industry and the acceleration of plans for the domestic extraction of rare earth metals. While acting as the United States' preeminent geopolitical rival, a number of Trump's proposed policies hold a striking resemblance to many of the strategies used by China prior to their 2001 admission to the World Trade Organization to rapidly bring their industry up to international standards of competition. In the case of China, these policies have proven to be highly effective at rapidly developing globally competitive industries through the usage of policies aimed at encouraging exports while having a positive spillover effect on related fields. American manufacturers would see great benefit if more emphasis were to be placed on similar efforts, but as of now tariffs continue to dominate the industrial policy space.