Conflicting Policy Goals

As we reflect back on another year, we believe that 2018 will go down in history as the beginning of a long, tumultuous struggle between the US and the emerging power that is China. The Trump administration has made it a major focus of its foreign and economic policy to confront the Chinese on a range of issues affecting relations between the two countries. The administration’s complaints include China’s unwillingness to protect US intellectual property, its subsidization of Chinese companies, its unwillingness to fully open up its markets to US companies, its poor labor standards, its dumping of products in the US market, and its efforts to seek global dominance in several emerging industries – a policy known internally as Made in China 2025.
While each of these topics has been the subject of public consternation by various Trump administration officials, most of the President’s own rhetoric with regard to China has centered around the large, chronic trade deficits that the US runs with China each year. In response to the trade deficits, the administration has either imposed or threatened the imposition of tariffs on nearly all Chinese exports to the US. The President’s most recent comments suggest that the tariffs are no more than a means to achieving a larger goal: the complete elimination of all tariffs between the two countries. But most of the President’s public commentary does not suggest that the President’s goal is to completely eliminate all trade barriers. Rather, his comments suggest that his goal is to dramatically decrease the size (or eliminate altogether) the US trade deficit with China. These are two very different goals.
The President appears to believe that any and all trade deficits, especially with China, are inherently bad. He seems to believe that any US dollars that go to Chinese companies for products and services are dollars that could have been spent supporting US companies, US workers and the US economy. While this is true to an extent, this position also ignores the sizeable benefits to US consumers, businesses and the economy at large that come from paying low prices for all kinds of manufactured goods. These benefits need to be considered when crafting trade policy.
A second concern stems from the administration’s conflicting economic policies. In an effort to accelerate economic growth and job creation, the administration passed large tax-cut and spending bills last year. In general, these stimulus initiatives have been quite effective in the near term (although at the cost of dramatically higher budget deficits, but that’s a discussion for another day). However, the boost to demand created by the initiatives has also led to a boost in demand for imports. At the same time, higher rates of US economic growth have pushed up interest rates and the value of the dollar. The spike in the dollar has made US companies less competitive relative to their foreign competitors, resulting in lower exports than would have been expected absent the stimulus initiatives. As you can see in the flow chart below, the net effect of the fiscal stimulus has been higher trade deficits – exactly the opposite of the Trump administration’s goal of reducing the trade deficits.
The second chart below shows that, historically speaking, trade deficits have risen during expansionary times and fallen during recession times. So, if we desire a faster-growing economy, and one that is outperforming the rest of the world, we should expect to import much more than we export. Again, free trade is a vastly different goal than the reduction or elimination of trade deficits.