President Donald J Trump and his minions are celebrating the great win they achieved in the trade war they set off. The win is that, by statute, they raised the average tariff rate the US charges for the importation of goods from Europe from something like 3% to 15%. Which is to say that US consumers will pay higher prices for those imports. In other words he is raising taxes.
In return for raising taxes on US consumers, representatives of the European Union (EU) promised to invest some thing like an additional $750 billion in America. Two things are of note here. First, EU countries were bound to invest more in America anyway, although the exact amount is in doubt. Secondly, additional investment by foreigners will raise the trade deficit, not lower it.
The trade deficit and foreign investment simply offset each other; they are two sides of the same coin. Say Foreign Country X sells Y products to the US for $1 million dollars. What then does country X do with the money? Essentially, it has 2 choices. It can either take the money and spend it in the US, or it can invest it in the US. Or it can combine the two. But it can’t avoid transacting in dollars. Nor can it avoid the issue by repatriating the funds. It got paid in dollars, it has to use those dollars one way or another.
If it decides to spend the money in the US, there is no trade deficit. But it will have to spend less than it otherwise would have because the higher prices that result from the tariffs will surely dampen demand. This will be only partially offset by the cut the US government takes (the tax). Economists refer to the difference between what consumers pay in aggregate and the combination of the tax take and country X’s revenues as a dead-weight loss.
On the other hand, country X could decide to invest the proceeds in the US either by (for instance) building factories (direct fixed-investment); by investing in US securities (passive investment) or some combination of each. But in either case the trade deficit rises, and the dead weight effect still applies.
In addition, there are other non-trivial considerations. The US may suffer a reduction in its competitiveness because of a perception that it has reduced its reliability as a supplier. Similarly, the US dollar may be damaged in FX markets, although its status as the world’s reserve currency probably won’t be challenged. At least not yet. But it is worth noting that the dollar has already depreciated about 10% since Trump took office.
We also frequently hear the refrain “Where’s the recession?” from Trump’s acolytes. But that is not necessarily the right measure to use. The imposition of tariffs on the global trading system will surely reduce growth rates, and may increase the inflation rate by more than just a one-shot. Those effects may not be instantly noticeable, depending on their severity. But the compounding effects over the years of either (or both) reductions in growth and increases in inflation can be very large.
Finally, the reduction of trade barriers and of tariffs ushered in a world of greatly increased prosperity. In 1990 about 36% of the population of the world (1.9 billion people) lived in extreme poverty with income of about $2.15 per day measured in 2022 dollars. By 2019, that number was reduced to about 650 million people from 1.2 billion or about 8.4% of the world’s population.
So the Trump trade agenda, even if successfully implemented, will necessarily fail according to its own criteria. If, for instance, foreign investment in the US increases, so will the trade deficit. If trade barriers (like tariffs) are erected and successfully implemented, global trade will slow more than it ordinarily would have and the world, including the United States, will be poorer. While the affluent countries of the West, including Japan, may feel a pinch, the brunt of the effects of slower growth are likely to be felt by countries in the global south. In turn that may produce political instability.
The geopolitical victors from a growth slowdown could very well be the elites, but not the people, of China, Russia, North Korea, Iran and Venezuela.
Congratulations Mr. Trump.
JFB
