According to the Department of the Census, in 2018 the U.S. trade deficit, which measures what the country exports versus imports, ballooned to $621 billion, meaning that the U.S. imported $621 billion more than it exported. Last year, we exported $2.5 trillion, while importing $3.1 trillion of goods and services. This is the largest trade deficit since this figure hit $708.7 billion in 2008. The U.S. has run a trade deficit since 1975.
One of President Trump’s most passionate objectives is to reduce the trade deficit, and his preferred method to do this has been by imposing tariffs on trading partners he perceives to be responsible for the majority of the deficit. Thus, he has imposed billions of dollars of tariffs on a wide variety of Chinese imports, and Mexican and Canadian imported steel and aluminum. In spite of the tariffs, the trade deficit continues to grow. So, what is occurring that keeps pushing this indicator to new heights?
First, let’s look at the countries with which the U.S. runs the highest trade deficits. With China, the U.S. traded $660 billion in 2018 with the result of a $419 billion deficit – by far accounting for the largest component of the overall trade deficit. Approximately 18 percent of China’s total exports are destined for the U.S. These include consumer products, medical equipment, textiles, industrial products, and raw materials such as steel.
Other top-five U.S. trading partners adding to the trade deficit do so at a much lower level: Canada ($617 billion traded with a $20 billion deficit); Mexico ($611 billion traded with an $81 billion deficit); Germany ($184 billion traded with a $68.2 billion deficit); and Japan ($218 billion traded with a $67.6 billion deficit). The goods and services imported from these countries are widely varied. However, looking at the products imported by Americans, consumer products and automobiles are the largest factors behind our trade deficit with the world.
If we indeed are running trade deficits with the above-mentioned countries, why isn’t Trump’s logic of slapping tariffs on their imported goods in an attempt to chip away at the trade deficit working? First, slapping tariffs on goods from other countries results in these countries retaliating and slapping tariffs on our exported goods, thus curtailing our exports in their markets. The national agricultural sector is well aware of this phenomenon, having found itself caught in the middle of the massive trade war the U.S. has started with countries such as China.
Secondly, import tariffs are not proving to be a worthy opponent to a much more powerful factor, which is the cyclical nature of investment in the U.S. and the strength of the U.S. dollar. Americans have a tendency to spend more than we earn, creating a situation in our country where foreign capital fills the gap. This can be in the form of instruments such as loans and the purchase of U.S. government T-bills and other securities by foreign entities. The massive flow of foreign capital converting itself into U.S. assets has the effect of making the U.S. dollar strong in world markets. This strong dollar makes it easier and much more economical to purchase and import foreign goods into our country.
Third is the American propensity to buy foreign goods, as is the case with most developed countries that have moved away from the manufacturing of basic items such as televisions, cell phones, and other household items. These items are generally produced more economically in countries with emerging economies, such as those in Asia and Latin America. The U.S. economy has developed comparative advantages in high-tech products, pharmaceuticals, medical devices, and services. In fact, the U.S. is a net exporter of services, which resulted in a net $270 billion surplus in this category last year. Financial/insurance services, patents, royalties, and business services are examples of categories that chip away at the overall trade deficit.
Finally, Americans are used to popping in to WalMart and the Dollar Store in search of economically priced items, many of which are imported from other countries. If an import tariff on a broom increases its price by a dollar, we are probably not going to grieve too much about the price differential. We also have preferences when it comes to larger items such as automobiles. A loyal Toyota owner, who has had very good results with this brand in the past, is probably going to keep purchasing Toyotas in the future. This is especially true when considering that credit is generally cheap in the U.S., and amortization periods to pay back a car loan are very long.
The biggest factor that could quickly reduce the trade deficit is a weakening U.S. dollar. This would result in a lower trade deficit, but it would also signal problems in the U.S. economy, and the lack of enthusiasm of foreign money to flow into our country. It also would make foreign imports more expensive because the dollar would buy less, causing Americans to spend less on these types of products.
Slapping tariffs on foreign imports is a method to try to address the widening U.S. trade deficit. However, this action is more than neutralized by other more powerful economic factors.