Global trade
Robert Lighthizer on the need for tariffs to reduce America’s trade deficit
The country’s deficits with China are so immense that new thinking—and hefty tariffs—are required, says the US trade representative under Donald Trump
INTERNATIONAL TRADE HAS largely failed America over the past three decades. Indeed, it is slowly bleeding the country to death. This is true not because the basic principle articulated by David Ricardo that there are gains from trade was wrong (it is not) but because a situation has developed that he never could have imagined. One country has become a great, persistent trade debtor. This has come about neither by intention nor by design. America became the world’s great consumer and borrower quite by accident.
The scale of the problem is hard to comprehend. America has rung up over $12trn dollars in accumulated global deficits since 2001. Thirty years ago the trade deficit was around $80bn a year: today it is eight times larger and likely to grow even bigger this year—some believe it may exceed $1trn. Over the same period, the economy’s nominal GDP merely grew by three and a half times.
People tend to think of trade deficits on an annual basis but the reality is that they are cumulative. Deficits in some years and surpluses in others are unimportant because they might even out. But that is not what is happening. The important issue is not America’s annual global trade deficit nor its bilateral trade imbalances but the decades-long trend of enormous deficits without any surpluses. The country has literally handed over trillions of dollars of its wealth to other countries, with China getting the lion’s share. This was never supposed to be able to happen under the theory of trade espoused by economists. But it has.
None of this is to denigrate the benefits of trade. International trade has clearly helped some parts of the United States. The country is the second-largest exporting nation after China, and overseas markets help to support millions of American jobs. For example, the profitability of the agricultural sector depends in large part on exports. The country’s services sectors run substantial surpluses every year and it is a leader in technology, financial-services exports and other areas. Clearly, America has many competitive advantages and often benefits from them.
The problem is that America is also by far the largest importer in the world—and that has contributed to making it the world’s largest debtor. The country has been running trade deficits averaging well over $500bn a year (or 3%-5% of GDP) for more than 20 years and the figure is growing. Deficits are bad for a number of reasons. They can be a drag on economic growth, they can negatively affect the composition of the labour force and wages, and they can lead to macroeconomic distortions.
Perhaps more important, with these persistent deficits America has shipped trillions of dollars of its wealth to foreign countries in return for goods, often short-term consumer goods. Those dollars don’t just sit in a foreign vault—our trading partners use them to purchase American assets and debt instruments. In a real sense, America is trading ownership of its productive assets and economic future for short-term consumption.
America’s net-investment figures—how much it owns in other countries compared to how much they own in the United States—show that America has gone from being the country with the largest net-investment surplus to the one with, by far, the largest net deficit of more than $15trn. (For perspective this figure is about one half the total value of America’s 100 biggest corporations.) Ten years ago, the number was less than $5trn. There are many reasons for this, including the recent increase in the value of foreign-owned US assets. But undoubtedly the principal driver is the trade deficit.
There is much discussion about the causes of this trade imbalance: an overvalued currency, America’s tax policy, unfair foreign trade practices, closed markets abroad, subsidies and so forth. But whatever the causes, the situation is unsustainable. A country cannot exchange future wealth for short-term consumption indefinitely.
Of course, not all foreign investment in America is bad. Some of it creates jobs and increases productivity. But most of the inflow is not for new factories or manufacturing. Indeed foreign direct investment is a tiny fraction of all capital flows into the country, on the order of 1%. These investments bid up our equity markets but also transfer to the buyer a right to future profits and national wealth.
Some have suggested that the longstanding trade deficit results from a low savings rate among Americans. But this claim simply renames the fundamental problem—it does not offer a solution. Whether the trade deficit results primarily from foreign countries using market distorting policies to put American producers at an unfair disadvantage—as I believe—or whether American policymakers should do more to encourage savings in the country, society still face the same challenge: how to create a more balanced global economy in which Americans are not giving away their economic future by selling assets to fund their short-term consumption.
A fresh look at trade deficits
For years economists concluded that trade deficits were unimportant. Goods come in, dollars go out. Ultimately there is balance because the dollars come back in the form of investment. This construct, however, is usually based on a static, one-year analysis. To appreciate the actual impact of these deficits we need to consider the nature of what is exchanged—often short-term consumption for a country’s wealth—and the long-term multi-year, dynamic effect. Specifically, the annual transfers of half a trillion dollars have a compounding effect: they result in progressively more investment, jobs and innovation for one’s trading partners and less for the debtor country. This sort of dynamic analysis provides a more accurate picture of the situation, albeit a darker one. If wealth is the life-force of an economy, America’s persistent, massive trade deficit means it is being bled to death.
Some people have warned about this for years. Almost 20 years ago the investor Warren Buffett was alarmed by these deficits and wrote an essay about two hypothetical lands, Thriftville and Squanderville. He described what happens when a country consistently runs trade deficits. It sells its assets to pay for short-term consumption and in the end the people of Squanderville are impoverished and working in a country owned by Thriftville. Mr Buffett often explains that by running huge deficits America is like a farmer who spends more than he makes and sells pieces of the farm and gives mortgages on other parts to pay for the excess consumption. That can’t end well. And there is a brutal intergenerational aspect to it: current consumers are impoverishing their children.
In 2003, when Mr Buffett wrote the article, he warned that “the rest of the world owns a staggering $2.5trn more of the US than we own of other countries.” As cited above, that figure now exceeds $15trn. Even then, Mr Buffett warned: “We have entered the world of negative compounding—goodbye pleasure, hello pain.”
It is interesting that very few countries run large trade deficits. Among the largest are Britain, France, Canada, India and of course America, whose deficit is eight times larger than the next highest. These numbers must be interpreted relative to the size of the economies but absolute numbers are also informative. On the other side of the coin, only two countries consistently run huge surpluses—China and Germany. Both benefit from what many believe to be an artificially weak currency, varying levels of industrial policy and citizens who are willing to forgo current consumption.
Another negative effect of this huge wealth transfer is that America’s biggest single bilateral trade deficit is with China. I am primarily focused here on the dangers of cumulating enormous global trade deficits and I don’t believe, generally, that bilateral deficits are a problem absent unfair practices or systemic issues. But the wealth transfer to China is another matter.
China is not only our global adversary but it is in a competition with the Western, free, democratic system to determine if it or their system will endure—whether liberal democracy or autocratic socialism is better. It is not an exaggeration to say that the hundreds of billions of dollars that we send to China every year has made the Chinese Communist Party much richer and helped pay for a great expansion of its military capability. This is neither in the interests of America nor the free world.
Not so long ago the view of classical economists prevailed. It was hard to fathom that one country could run up trillions of dollars in accumulated trade deficits year after year. The assumption was that when a country ran a trade deficit it would see its currency adjust. As one purchased from the surplus country, this bids up its currency; the converse is true of deficit countries. So as the deficit went up, the value of the currency would go down, and imports would be more expensive and exports cheaper overseas. In short, the situation would correct itself. Yet this mechanism has not worked for America. Its reserve currency status, the safe-haven effect of the dollar and foreign-currency manipulation have kept the dollar higher than it should be. The IMF estimated in 2019 that the dollar was overvalued by as much as 12% and other economists argue it is even higher.
During the period of the gold standard this chronic deficit situation could not have existed because the deficit country would see its gold reserves disappear and it would be left with no means to purchase imported goods. Under the postwar Bretton Woods system of fixed exchange rates, fears that accumulating trade deficits would lead to a draining of the American gold supply prompted the Nixon Administration to take the country off the gold standard and impose across-the-board tariffs on imports in 1971.
This persistent wealth transfer is fairly recent and unprecedented. It is worth noting that Ricardo himself always framed the trade debate in a balanced context. England would sell cloth and Portugal would sell wine. Experts who studied these matters always assumed balance over time. When John Maynard Keynes was outlining his thoughts for the International Trade Organisation after the second world war, he included a mechanism to allow countries to adjust their tariff rates to bring about balance when necessary. This concept was carried forward in a vaguer form in article 22 of the General Agreement on Tariffs and Trade (GATT) in 1947 and now in the rules of its successor, the World Trade Organisation. Countries facing balance of payment issues can suspend their GATT obligations following certain prescriptions. There was always an assumption that trade would be more or less balanced over time.
Even Friedrich Hayek, Keynes’ adversary in debates over the role of the state in the economy, assumed that trade imbalances would be temporary, not perpetual. Hayek would never have approved of any mechanism to bring about balance but, as Oren Cass points out in this essay “Hayek’s Broken Promise”, the great man always believed a country needed exports and imports and that balance would come from natural forces. After decades of accumulated trade deficits, we are entitled to question Hayek’s confidence in natural forces and explore other ways to bring about needed balance.
Furthermore, trade deficits create political problems as well as economic ones. America’s trade situation has contributed to a hollowing out of manufacturing capabilities, loss of millions of jobs, wealth inequality in the country and damage to the cities and towns that have relied on these jobs. There is a strong sense in the American body politic that something is very wrong. This is part of the reason why Donald Trump was elected president and populism is on the rise. Economists can debate the importance of savings rates and productivity but voters have their own instinctive reaction.
President Trump followed through on his campaign promise in 2016 and radically changed the trade agenda. He raised tariffs, renegotiated agreements and threatened to do much more. The populist, worker-first United States-Mexico-Canada Agreement passed a historically divided Congress a year before the presidential election in 2020 with 90% of lawmakers, both Republicans and Democrats, in favour. The backlash from farmers and others that was predicted by pundits never happened.
In fact, both presidential candidates ran on essentially the same trade platform. Joe Biden abandoned his past support for comprehensive trade deals like TPP. Both emphasised the need to bring back jobs that were outsourced overseas and to reduce dependency on China, even if their tone and preferred tactics differed slightly (though there has been little discernible difference so far). In short, the public demands balanced trade and politicians of both parties are responding.
New thinking for novel problems
There are a number of possible ways to achieve greater balance. In his article in 2003, Mr Buffett suggested that America require import certificates. These would be issued to those who export and would be sold by them to importers. This system would be effective because it would penalise imports and subsidise exports. Yet it also might be quite disruptive. It would create a market for these certificates with possibilities for manipulation and speculation.
Others have suggested that America implement a so-called “market-access charge”. Essentially, the Federal Reserve would impose a variable tax on capital flows into the country from foreign persons. It would raise or lower the tax to disincentivise foreigners from buying American assets; this drop in demand for the assets would lower the value of the dollar. The idea is that this would “realign” (that is to say, “weaken”) the dollar and bring about trade balance. This mechanism also would work but the process is complicated and easily misunderstood. Some might argue that it would discourage investment.
A third approach, more consistent with Keynes’s notion, would be for the United States or any country that experiences the emergence of a huge, regular trade deficit to impose a temporary tariff on all imports and gradually increase it or decrease it depending on the level of the deficit. For example, a 10% tariff could be applied to all imports. If the deficit did not go down in a couple of years, the tariff would be increased to 20% for several more years. If this did not have the needed effect it might go up to 30%. (Of course, the programme would make exceptions for critical goods.) When the deficit was substantially reduced, the tariffs would also decline and eventually be eliminated.
All three of these approaches would reduce the trade deficit. They all would have costs too. They would raise the price of imported goods (both for personal use and as inputs for companies) and discourage consumption. They would add regulation to the economy and they would be opposed by our trading partners. These downsides, however, would be temporary and surely would be outweighed by the benefits of balanced trade. It would improve economic growth, encourage manufacturing and job creation and put upward pressure on wages.
Of the three approaches the best one would be that which would have the least interference with markets: yes, tariffs. The mechanism is already in place to collect them. As every ornate custom house in every international port attests, governments have collected tariffs for over a millennium and economists know their effects. None of this is likely to reverse the negative net foreign investment that resulted from trade deficits in the past, but it may reduce or stop the outflow.
Most importantly it represents a vital shift in thinking. America’s cumulative deficits hurt the country: the pain is apparent even if the reason is camouflaged. Policymakers, business leaders, economists—and the public, most of all—need to abandon the dogma of trade from 18th-century philosophers of the political economy, and embrace new thinking for novel circumstances.
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Robert Lighthizer was America’s trade representative in 2017-21 in the administration of President Donald Trump, and the deputy trade representative in 1983-85 under President Ronald Reagan.