Trump's Unnecessary Trade War with China
The most tangible outcome of the Mar-a-Lago meeting between President Trump and his Chinese counterpart Xi Jinping was a one-hundred-day plan to reduce trade imbalances. China expressed a willingness to end its ban on U.S. beef imports and limit exports of steel to the United States along with loosening restrictions on America’s investments in China’s financial services sector. Taken together such measures are miniscule in value but symbolically important when compared with the bilateral trade deficit of $350 billion.
For China, the objective is to avoid an all-out trade war that would have a negative impact on both sides. But the one-hundred-day plan is unlikely to fully deflect protectionist sentiments from surfacing via other channels, especially if the White House uses trade issues to press China to take a more aggressive posture towards North Korea. A faction within the White House remains fixated on the view that trade deficits are a threat to growth, jobs and security, and much of the blame belongs to China. Recent executive orders taking a bilateral approach to trade deficits and intentions to target trade partners using subsidies to “dump” their products in the United States are likely to refocus attention on China as the major culprit.
Rather than focusing on trade frictions, America’s interests should be on strengthening investment relations by concluding a bilateral investment treaty (BIT). The United States can learn an important lesson from China’s past experience: the key to strengthening competitiveness lies not in protectionist measures but by increasing the productivity of a nation’s workforce through supportive infrastructure investments. But an “America First” agenda will not easily accept that promoting U.S. investment abroad supports that vision.
It is understandable why the White House obsession with trade deficits has popular appeal. Last year, the United States imported roughly $500 billion more goods and services than it exported, and trade with China accounted for more than 60 percent of that overall deficit. If exchange rate manipulation is not the culprit, then according to this way of thinking it surely must come from China’s unfair trade practices.
This line of reasoning on trade as well as investment issues being championed by President Trump’s more populist advisers is misguided.
First, a negative trade balance does not imply slower economic growth or a weaker job market. The United States has been running persistent trade deficits regardless of whether the economy was doing well or poorly. Nor is it true that a smaller deficit is necessarily better than a larger one. In 2000, for example, the U.S. economy grew at more than twice the rate it did last year, but the trade deficit at that time of 4 percent of GDP was considerably larger than last year’s 2.5 percent.
Moreover, there is no direct link between China’s trade surplus and America’s trade deficit. The U.S. trade deficit started to balloon in 1997, while rapid growth in China’s surplus didn’t start for another six years and its size didn’t surpass Japan’s until 2006. Logic dictates that China could not have retroactively caused America’s deficit to expand a decade prior to its own emergence as a trading powerhouse.
In fact, America’s trade deficit in manufactured goods with East Asia as a whole has been roughly constant since the mid-1990s. What has changed is that China became the final assembly point for most goods East Asian manufacturers ship to the United States, so China’s surplus now makes up the lion’s share of Asia’s total surplus with America. Importantly, much of the value added of these exports is the result of components manufactured in economies like Korea, Taiwan, Japan, or even the United States itself. Thus America’s trade deficit with China neither explains the size of America’s overall deficit nor which country benefits more from the bilateral trading relationship.
Put simply, bilateral trade balances do not matter. Overall trade balances do—but deciphering whether a trade deficit should be viewed with alarm or largely as a nonissue begins with understanding that a country’s trade balance is shaped more by capital flows than trade measures. The factors that shape capital movements and their impact on trade are complex but the outcomes must adhere to certain principles.
A country’s trade balance is always equal to the gap between what a country invests and how much of that investment is financed by domestic savings. That gap is filled by the excess savings of trade surplus countries, which typically show up in their purchases of U.S. government securities or other assets. But this accounting identity does not tell us much about causality.
Economists generally agree that America’s recent trade deficits are primarily the result of inadequate domestic savings driven by large budget deficits and low personal-savings rates. Budget deficits emerged in the aftermath of 9/11 with surging military expenditures and rising social benefits while household savings rates of around 5–6 percent of personal incomes are about half of what they were two decades ago. The decline was induced by lower interest rates and the aggressive consumer lending practices of U.S. banks and retailers.
Securing the additional savings needed for investment by borrowing from abroad is reflected in an overall trade deficit. Resorting to punitive trade measures to reduce bilateral deficits does not work because actions targeting imports of one country would only result in importing more from another and lower exports nurtured by exchange rate appreciation, leaving America’s overall trade deficit unchanged.