US trade policy is now creating more problems than it is solving. I continue to pound the table on the self-inflicted aspects of the US trade deficit and stress the unintended consequences of wrong-footed US trade policies. This runs against the grain of the Washington consensus which has long harbored the mistaken belief that squeezing a major trading partner will reduce a multilateral deficit with many trading partners. We tried this approach with Japan in the late 1980s, and now its China. It didn't work back then, and it won't work today.
My arguments are hardly profound — they reflect some of the very basic principles that we teach students in their first economics class. But they are very inconvenient for most politicians who are incapable of looking in the mirror.
The basic premise, in this case, follows from one of the inarguable features of national income accounting — namely, that a nation’s trade balance is arithmetically equal to the difference between investment and saving. That implies any saving-short nation that wants to invest and grow must borrow surplus saving from abroad in order to square the circle. To attract that surplus saving, nations must run balance of payments deficits with the rest of the world, which gives rise to multilateral trade deficits.
The US economy fits this conceptual framework to a tee. For starters, it has the greatest shortfall of domestic saving of any leading nation in history. In 2023, US net saving — the combined depreciation-adjusted saving of individuals, businesses, and the government sector — was negative, coming in at -0.3% of national income. Pick your time period — post-1947 or the final three decades of the 20th century (1970 to 1999) — and the net domestic rate averaged +6.3%. Only once before in post-World War II history had the United States run a negative net domestic saving rate; that was from 2008 to 2010, during and immediately after the Global Financial Crisis.
As seen through the lens of national income accounting, the trade implications of this profound shortfall of domestic saving are hardly surprising — massive US current account and trade deficits. In 2023, the current account deficit was -3% of GDP while the good trade deficit was -3.9% of GDP. This compares with the post-1947 imbalances that averaged -1.3% of GDP for the current account deficit and -1.7% for the goods deficit over same period.
Here's where the plot thickens and gets to the real point of this piece — shedding light on how China fits into this equation. From 1999 to 2015, China’s share of the US goods trade deficit more than doubled, increasing from 20% in 1999 to nearly 50% by 2015 and holding slightly below that for the next three years at around 47%. China must be the culprit, Donald Trump argued in the 2016 presidential campaign. The Trump tariffs were soon to follow, and the Chinese portion of the total US goods trade deficit fell sharply over the next five years, sinking to just 26% in 2023. Did the 45th president have the right strategy all along to cut the trade deficit?
Not for a second. Yes, since the onset of the trade war, the Chinese deficit shrank by $138 billion from 2018 to 2023. But over that same five-year period, the overall goods trade deficit widened by $181 billion, precisely what you would expect from a deepening shortfall of domestic saving. And here's the clincher, underscored in the chart below: excluding China, the goods trade deficit actually widened by $319 billion from 2018 to 2023, with deterioration concentrated in Mexico, Vietnam, Canada, South Korea, Taiwan, India, Ireland, and Germany.
This is one of Washington’s greatest delusions. Politicians want voters to think they are fixing America’s trade problem by going after China. While the imposition of tariffs reduced the Chinese piece of the overall trade gap, a saving-short US economy still needed surplus saving from abroad in order to grow. And so, it turned elsewhere in search of that foreign capital, diverting trade away from China to a host of other, largely higher-cost, foreign producers.
My point on the cost implications of trade diversion is especially important. We don’t have great data to measure relative wages across countries. The US Bureau of Labor Statistics used to provide an international comparison of manufacturing wages, but that effort was disbanded in 2011. Drawing on updated statistics from WorldData.Info and countryeconomy.com, it appears that more than 70% of the $319 billion in trade diversion away from China since 2018 can be attributed to higher-cost nations (Ireland, Germany, Canada, South Korea, and Taiwan) or comparable-cost producers (Mexico), whereas about 25% went to low-cost nations (Vietnam and India). That corroborates the point above — that trade diversion away from China has been costly. Add in the costs of sharply higher US tariffs on China, and there can be no mistaking the bottom line of anti-China US trade policies: the functional equivalent of a tax hike imposed on American companies and consumers.
I’m not done with Washington’s folly quite yet. Back to the saving shortfall. It has fallen like a stone since 2020, largely because of outsize federal budget deficits that are counted as negative saving in the national income accounts. After ballooning during the COVID recession to 13% of GDP during 2020-21, the budget deficit remained stuck at -5.8% in 2022-23, well in excess of the -3.2% average from 1962 to 2019; moreover, the Congressional Budget Office’s baseline projections call for the federal government’s shortfall to hold at -5.6% of GDP over the next decade.
Okay, enough of the numbers. The story I am telling is painfully obvious. Washington claims it can solve the US trade deficit by squeezing China. Don't believe this self-serving political rhetoric. All Washington is really doing is diverting trade away from a low-cost producer (China) to other higher-cost producers, while at the same time running massive budget deficits that will continue to depress domestic saving and force even greater trade diversion in the years ahead. Hooked on budget deficits and the saving (and trade) shortfall they spawn, the China blame game comes in very handy for US politicians.
America, because of its unprecedented shortfall of domestic saving, has a multilateral trade problem — trade deficits with 106 nations in 2023. Going after one of those deficits without addressing the saving shortfall is like squeezing one end of a big water balloon. The water sloshes elsewhere and no one is better off. The high cost of that diversion, in fact, suggests that most are worse off. I have said it for years and it bears repeating once again: There is no bilateral fix for a multilateral problem.
Very few in Washington have the intellectual honesty to admit that America’s trade problems are, in fact, made at home. Senior Republican officials, Martin Feldstein and George Schultz, were rare exceptions; in their famous 70-word op-ed in 2017 they wrote that, “If we manage to negotiate a reduction in the Chinese trade surplus with the United States, we will have an increased trade deficit with some other country.” Trade diversion fixes nothing. Not that it matters, I said it first!
