US Bilateral Trade Balances: A New Guide to Trade Policy?

“Trump proposes eliminating America’s $500 billion trade deficit through a combination of increased exports and reduced imports.”

“Reducing this ‘trade deficit drag’ would increase GDP growth.”

These statements were offered prior to the election by President-elect Donald Trump’s economic advisors, Peter Navarro and Wilbur Ross. They focused on the elimination of the aggregate US trade deficit in their paper, “Scoring the Trump Economic Plan: Trade, Regulatory, & Energy Policy Impacts.”¹

During the presidential campaign, Trump forcefully blamed US trade deficits for US job losses and lower wages, promising renegotiation on the North America Free Trade Agreement (NAFTA), withdrawal from the Trans-Pacific Partnership (TPP), and stern policies toward China. Trump also asserted, during the Republican Presidential debate on November 10, 2015, that he would be willing to negotiate trade deals with individual countries. Putting these themes together, it appears that Trump envisages reduction of the aggregate trade deficit through forceful negotiations with individual trading partners, starting with Mexico and China.

Bilateral trade balances seem to reflect Trump’s judgment as to whether the foreign country is a “good” or “bad” partner for the United States. The accompanying table summarizes US trade balances with major trading partners in 2015. Most US trading partners fail Trump's test since, as mentioned, the United States ran a $500 billion trade deficit in 2015. Conspicuous “bad” partners are China, Mexico, Japan, and possibly Germany individually and the entire European Union. On the other hand, Brazil, Hong Kong, and most of South and Central America rate as “good” partners according to the trade balance test. Canada and the United Kingdom seem acceptable, since US trade balances with those countries are slightly positive.

But this type of classification is not a useful guide for formulating trade policy. Trade policy should seek to expand multilateral trade between all parties, not to redress bilateral imbalances.  Other economic tools should be deployed when the objective is to shrink one nation’s aggregate trade deficit—in this case the US figure of $500 billion. 

As summarized by Gary Hufbauer and Zhiyao (Lucy) Lu, the aggregate US trade deficit is determined by broad macroeconomic forces, notably private savings and investment, government deficits, and the exchange rate for the dollar, rather than by trading conditions with individual countries. The United States runs an overall trade deficit with the rest of the world because the combined net savings of the household, business, and government sectors are negative, and the dollar is persistently overvalued in foreign exchange markets. 

Free trade agreements (FTAs) have a second order impact on the size of the US global trade deficit, as shown here. Contrary to FTA opponents, the experience of 37 countries and the United States shows that FTAs have no long-term impact on the size of national trade deficits or surpluses. In plain language, US FTAs have not enlarged the US trade deficit.     

Given these facts, bilateral trade balances make little economic sense as a guide to trade policy in the 21st century, nor as a focal point for shrinking the US trade deficit. The bilateral balance approach recalls mercantilist doctrines of the 17th century, and should not become a political litmus test in the Trump administration.

Note

1. PIIE Senior Fellow Marcus Noland criticized the Navarro-Ross economic plan as “magical thinking,” especially the suggestion that eliminating the trade deficit would produce $1.74 trillion of new revenues over a period of 10 years.