There are some concepts that seem so obvious as to need no explanation. But once in a while I discover that not everyone views the world in the same way, and the obvious may require a bit of explanation.
Let’s start by considering a world with no money, relying on barter. Suppose Australia wishes to buy some big Caterpillar tractors and Boeing jets. Unfortunately, the US is not particularly interested in buying the stuff that Australia exports, such as iron, coal and beef. We already have plenty of those commodities. So no trade occurs.
Now let’s introduce money. Australia can pay for those US exports with money. The US can use that money to buy clothes, consumer electronics and home appliances from China. China can then take that money and buy iron, coal and beef from Australia. The use of money facilitates a three-way trade that would have been almost impossible under a system of barter.
You might also notice that each of the bilateral trade relationships is unbalanced, with one country in deficit and one country in surplus. But for the world as a whole there’s no obvious problem. Those bilateral deficits and surpluses are no more meaningful than if I had a deficit with my grocery store and a surplus with the students I taught. Individuals, cities, states and entire nations always have lots of bilateral deficits and surpluses. That’s what it means to move beyond barter.
Some are now advocating that we move back closer to barter, that we try to balance every bilateral trading relationship. Well, not every relationship, but at least every trading relationship between countries.
Although no serious economist worries about bilateral trade imbalances, a few do worry about the overall trade deficit. Of course when all types of trade are taken into account (goods, services and financial assets) trade always balances. But we may end up selling more of less of one particular type of good than we buy. The Trump administration has recently begun worrying about bilateral trade in goods, while ignoring services and assets. They worry that this hurts manufacturing.
Instead of focusing on the overall trade balance, they decided to focus on our bilateral trade balance (in goods only) with our trading partners. They decided that each bilateral trade balance should move to zero, i.e., that we should move closer to a system of barter. As we saw from the three-way trade example above (which could not occur under barter), that’s not the most efficient way to organize international trade. Indeed, even if the goal were to achieve a zero overall trade balance between the US and the rest of the world, there would be no obvious reason to focus on eliminating bilateral trade deficits.
Part of the confusion revolves around the myth that bilateral deficits reflect “unfair trade practices”. That’s clearly not true, and at a certain level the administration understands that it is not true. If it were true, the trade problem could be quickly resolved by negotiating an end to all trade barriers, including both tariffs and non-tariff barriers. But the Trump administration is strongly opposed to free trade agreements, even to free-trade agreements negotiated by Trump himself (such as USMCA).
So how did we end up in this mess? I suspect the problem relates to the interrelationship of three facts:
- All wars (including trade wars) require the demonization of the enemy. To enlist the public in a long painful campaign it is necessary convince voters that America is being taken advantage of by nefarious foreigners. No one wants to be told that we need tariffs because we are losing the competitive race in foreign trade due to the fact that we just aren’t as good at it as our competitors.
- The unfair trade myth leads to a set of tariff rates that are far from optimal. If these tariffs begin to hurt the economy, the administration faces several choices, none of which are pleasant. They can maintain them indefinitely, but the slower growth and higher prices will tend to make tariffs less popular with voters.
- Another option is to “negotiate” with foreign countries, and eliminate the high tariffs in exchange for token concessions. But that approach fails to address the trade balance, as the trade deficit was not caused by foreign unfair trade practices. A political win, but an approach that throws the administration’s mercantilist supporters under the bus.
At some point an administration must decide between being popular and sticking to the plan.
Ironically, as I was writing these final words, I saw a story that the administration was changing course. So 5 minutes after completion, this post is already out of date. Welcome to the world of 2025!
