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Your guide to what the 2024 US election means for Washington and the world
Is Donald Trump to be taken literally or seriously? Salena Zito offered these alternatives in a column in The Atlantic published in September 2016. Today, before he obtains power for a second time, Trump must be taken more seriously and more literally than last time. The evidence comes from his nominations, notably Robert F Kennedy Jr at health, Pete Hegseth at defence, Tulsi Gabbard at national intelligence and Matt Gaetz at justice. These people show that Trump will be far more radical. Moreover, trade policy has long been the area where he is to be taken both seriously and literally; protectionism is not just a long-standing personal belief, but one that he was already dedicated to last time.
Unfortunately, the fact that Trump needs to be taken literally and seriously does not mean that he (or those around him) understand the economics of trade. If he is prepared to buy into Kennedy’s “anti-vaxxer” nonsense, why should he care about what economists think about that? He makes two big mistakes: first, he has no inkling of comparative advantage; second and worse, he does not understand that the trade balance is determined by aggregate supply and demand, not by the sum of bilateral balances. That is why his tariff war will not reduce US trade deficits. On the contrary, especially in the current context, it is more likely to lead to inflation, conflict with the Federal Reserve and a loss of trust in the dollar.
If one wants to produce more of something — import substitutes, for example, as Trump desires — resources must come from somewhere. The questions are “from where?” and “how?”. The answer may be “from exports, via a stronger dollar”, as tariffs lower the demand for foreign currency, with which to buy imports. In this way, a tax on imports ends up as a tax on exports. The trade balance will not improve.
Fundamentally, macroeconomics always wins, as Richard Baldwin of the IMD in Lausanne reminds us in a note for the Peterson Institute for International Economics. The balance of trade is the difference between aggregate incomes and spending (or savings and investment). So long as this is unchanged, the trade balance will be unchanged, too. The US has spent appreciably more than its income for a long time. This is shown in the consistent net supply of foreign savings, which averaged 3.9 per cent of GDP, between the second quarter of 2021 and 2024. So domestic sectors must in aggregate have been running counterpart deficits. In fact, the surplus of savings over investment in the household sector averaged 2.3 per cent of GDP and that of the corporate sector 0.5 per cent. In sum, only the government ran a deficit, which averaged an enormous 6.7 per cent of GDP. If one wants to eliminate the external deficits, domestic sectors must adjust in the opposite direction, towards higher surpluses of savings, with the biggest adjustment surely coming from these huge fiscal deficits.
Yet, as Olivier Blanchard notes in another paper for the Peterson Institute, Trump has promised to extend the tax cuts enacted in 2017. In addition, he has suggested that Social Security benefits and tips become fully non-taxable, that the state and local tax deductions be increased, and that the corporate tax rate, which was reduced from 35 to 21 per cent in 2017, be further decreased to 15 per cent for manufacturing firms. He has also suggested mass deportation of some 11mn undocumented immigrants.
In brief, he plans to shrink supply and stimulate demand. This will worsen the trade balance, not improve it. Moreover, it will also create inflationary pressure, which the Fed will have to repress. Meanwhile, federal debt will continue on its explosive path, maybe threatening confidence in the dollar itself.
In sum, there is no possibility of reducing the overall trade deficit with the policies Trump proposes. Reducing the bilateral deficit with China would merely increase deficits with others. That is inevitable, given the persistent macroeconomic pressures. Moreover, his discriminatory trade policies, with 60 per cent tariffs on China and 10-20 per cent on others, are bound to spread. Trump and his henchmen will see that exports from other countries are replacing those from China via trans-shipment, assembly in other countries, or straightforward competition. The answers will either be imposition of “rules of origin”, with all the bureaucracy that requires, or a rise in tariffs towards 60 per cent on all imports of manufactures. Meanwhile, no doubt, there will also be retaliation.
Such a spread of high tariffs in the US and across the world is likely to lead to a rapid decline in world trade and output. The UK’s National Institute of Economic and Social Research forecasts: “Cumulatively, US real GDP could be up to 4 per cent lower than it would have been without the imposition of tariffs.” My guess is that this is too optimistic, given the uncertainty that would also be unleashed. Yet even then US external deficits might not shrink. That would depend on whether spending fell even more than output. If it did, the trade balance would improve. But this would also mean a deep recession.
Last week, I pointed out that trade policy is most unlikely to reverse the long-term decline in the share of jobs in US manufacturing. This week, I add that tariffs unsupported by a reduction in aggregate spending relative to output will not eliminate external deficits. Tariffs alone, especially discriminatory tariffs on one country, will just cause an economic and political mess, as they spread like weeds across the globe.
When England’s King Canute supposedly sat before the incoming tide, he did so to prove he could not command the sea. Donald Trump believes he can. He will be disappointed. So, alas, will we.
