Why Trump’s fixation on trade balance is absurd
Since his election, Donald Trump and his officials have been playing a game of good cop-bad cop with Canada over trade. One day an official will warn that NAFTA is in line for a comprehensive renegotiation, that everything is on the table, etc. The next, another will reassure us that Trump loves Canada, that all this renegotiation talk is really about Mexico, that we should not be “enormously” worried. Lather, rinse, repeat.
The goal as in all such games is to wear down resistance by constantly refreshing the capacity for terror — that’s the bad cop’s role — even as the good cop encourages the prisoner to identify with his captors. Responding to this challenge will not be easy, but the one thing we can do is not accept our adversary’s logic: that trade is a zerosum game in which each side tries to sell more to the other than it buys from it, or (slightly less crudely) that the two should be in balance.
Have another look at those reassuring statements about Canada’s good standing issuing from the new administration. They are invariably accompanied by some reference to CanadaU.S. trade being very nearly in balance, as indeed it is. The implication is that Canada should enjoy a privileged trade status as a reward for its good international trade citizenship — unlike, say, the perfidious Chinese. But the corollary is equally clear: should trade between the two countries stray out of balance, should we start running trade surpluses, we might not be looked upon so favourably.
So it was that the news that Trump would revive the Keystone XL pipeline project, allowing hundreds of thousands of barrels of Canadian oil to flow across the border every day, was greeted not by unalloyed cheers in this country, as one might expect, but in some quarters by misgivings, even alarm.
For what if the result of all those Canadian oil sales was to push our trade into surplus? Then where would we be?
This is madness. It is nonsense for the Americans to make the trade balance the objective of their trade policy, and it is even greater nonsense for us to adopt it as our own, out of deference. Whether a country has a trade deficit or a trade surplus, that is — with the world in general, let alone with individual countries — does not make the slightest difference to its welfare. It is a primitive fallacy to think that it does.
To see this, it helps to remember that the balance of trade in goods and services, what economist call the current account, is only one type of international payments flow. The other is the capital account: the money we lend to or invest in other countries, or that they lend to or invest in ours. The two, current and capital, must sum to zero, a surplus on the current account matched by a deficit in the capital account and vice versa, not coincidentally but as an accounting identity: foreigners can only lend to us the Canadian dollars they earn from us on trade.
In today’s world of high capital mobility, trade deficits are more often driven by capital surpluses than the reverse. So, to take the United States as an example, high fiscal deficits (and low domestic savings rates) sucked in capital from abroad, much of it from China. To make that possible, China was obliged to run large trade surpluses with the U.S., which in turn required the U.S. dollar to rise against the yuan. That, rather than sneaky Chinese currency manipulation or subsidies, is the primary driver of the U.S. trade deficit.
Sometimes trade deficits can arise from other factors, such as shifts in the relative prices of traded goods. It still makes no sense to obsess about them. Suppose China were to amass a trade surplus with the U.S. on this basis. Great — that entitles China to hold lots and lots of U.S. dollars, which are good for precisely two things: buying U.S. products, or lending to those who would like to do the same.
There’s no sense, then, in which China’s gain is America’s loss. They both gain. That’s how trade works: it only takes place if both sides gain. The point of exporting goods and services is not to pile up mountains of foreign currency reserves, as if these were desirable in themselves. It is so that we can purchase other country’s goods and services: the things that can more efficiently be made elsewhere.
Where did Trump (and others) get the idea that the purpose of trade was to run a surplus? Perhaps, as a businessman, he equates a country’s trade balance with a company’s profit and loss statement. More likely, it is a matter of mistaking accounting for economics. Every first-year economics student is taught that national income equals consumption plus investment plus government spending plus the difference between exports and imports: the trade balance.
That’s true, as a matter of accounting. But it does not follow that an increase in the part results in an increase in the whole. Why? Because the items in that list are not necessarily independent of one another. An increase in consumption, for example, might be at the expense of investment. An increase in government spending, likewise, has to come from somewhere: either from domestic sources (consumption and investment) or from a deterioration in the trade balance.
The trade balance is no different: other things being equal, a larger trade surplus adds to national income. But other things are rarely equal, and aiming for a trade surplus as a matter of policy is likely to do more harm than good.