Tariffs on imports have been at the heart of Donald Trump's economic policy since the start of his second term in the White House. And while the president believes that tariffs will be beneficial to the US economy, many eminent economists disagree . Here are three reasons why.
Author
- Luis Angeles
Professor of Economics, Adam Smith Business School, University of Glasgow
The first reason is that a US trade deficit should not necessarily be seen as a negative economic outcome. Trump certainly thinks it is. As he reportedly told Karin Keller-Sutter, president of Switzerland, earlier this year: "We have a US$41 billion deficit with you, madam….[and] we lose, because I view deficit as [a] loss."
A trade deficit only means that one country buys more goods and services from another country than it sells to it. As a result, more money flows out of the country, to pay for the imports, than comes into the country, as a payment for exports.
Money flowing out of the country may sound bad, but for every dollar that the US spends abroad there is something else coming in: the goods and services it buys, which Americans get to consume. A "trade deficit" could very well be renamed a "surplus in goods and services consumed" - a positive outcome, reflecting the expressed preferences of the American public.
The second reason is that tariffs change what the economy produces - for the worse.
Tariffs are eventually passed on to consumers , making imported goods and services dearer. Trump's hope is that making, say, Swiss watches more expensive will shift demand towards US-made watches, whose price remains the same. The US's watchmaking industry would grow and employ more people, which sounds like a solid gain for the US economy.
Unfortunately, that is not the end of the story. Foreign countries need to sell goods and services to the US in order to obtain the dollars that pay for American exports. If foreign countries sell less because of tariffs, they are also going to buy less American products.
This means that any expansion of the US watch industry would be matched by a contraction in other American industries, such as aircraft manufacturing or financial services, which the US successfully exports. Employment may increase in one sector, but it will decrease somewhere else.
And that's not all. The reallocation of labour across industries is costly , as people lose industry-specific skills and need to be retrained. But more important, consider why the US was importing foreign watches in the first place. Clearly, because foreign manufacturers are better at watchmaking: they produce watches of any given quality for a lower price than America can.
The same is true for American export industries, which sell abroad because they are more productive than their foreign counterparts. The reallocation of labour away from American export industries, and towards other industries such as watchmaking, is a shift away from what Americans can do best. It renders the whole country less productive, making everyone poorer in the process.
Be grateful for the dollar
The third reason, finally, is that the US gets a very good deal when it comes to paying for its trade deficit.
When country A wants to buy goods and services from country B, a difficulty arises. Country A has its own currency to pay with, but this currency has no value in country B.
If trade is perfectly balanced between the two countries (they buy and sell the same amounts to each other), an easy solution is at hand. Country B will accept country A's currency and immediately give it back, as payment for the goods and services it buys from country A, which are of the same value.
If there is a trade deficit, where country A imports more than it exports, country B will still accept country A's currency if there is something else which can be bought with it. That "something else" is assets, which can be financial (stocks or bonds) or real (such as property). So a country with a trade deficit must sacrifice some of its assets to foreign ownership.
In the case of the US, however, there is one important difference. If a foreign country ends up with a positive balance of dollars because it sells more to the US than it buys, it may not use all these extra dollars to buy US assets.
Instead, it often wants to keep those dollars, in the form of banknotes, within the local economy. This happens because people around the world trust and value US dollars , often more than their own currency, and may prefer to use American notes for purposes such as savings and large transactions. A vast amount of dollar banknotes - currently worth over 1 trillion dollars - are in circulation outside the US economy.
This phenomenon translates into a great bonanza for the US. It has the unique privilege of being able to run a trade deficit with the rest of world, consuming more goods and services from other countries than it provides to them, and yet does not compensate those countries entirely with American assets.
Instead, it compensates them with pieces of paper it produces at essentially no cost. Foreigners are happy to hold these American pieces of paper because they have monetary status in their countries - something that would not be true for any other currency. Trying to shut down the US's trade deficit also means trying to cut off this substantial source of wealth for the country.
Luis Angeles does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.
