A tax plan to explode trade deficits

Does the president know the GOP proposals will prevent him from achieving another of his economic goals?

There’s a time bomb inside President Trump’s economic policies, and almost every economist knows it. What they don’t know is when it will explode.

Trump has spent decades blaming America’s economic woes on the trade deficit, which measures the difference between the exports the United States sells to the rest of the world and the imports we buy.

“We can no longer tolerate unfair trading practices that steal American jobs, wealth and intellectual property,” he said after his trip to Asia this month. “The days of the United States being taken advantage of are over.”

Contrary to the president, however, trade deficits aren’t caused primarily by unfair practices or poorly negotiated agreements. They’re caused mainly by economic fundamentals. And if Congress passes the tax plan that’s the centerpiece of Trump’s economic program, one of its effects will be to make the trade deficit even worse.

Right now, the U.S. trade deficit is about $800 billion a year. Economists at the University of Pennsylvania’s Wharton School of Finance (“the best school in the country,” Trump, an alumnus, once bragged) have estimated that the Senate tax bill would make the deficit grow by about $60 billion a year, a number about as big as last year’s U.S. trade deficit with Mexico.

“If we’re going to have tax cuts, the trade deficit will get bigger,” Ann Harrison, a Wharton professor, told me last week. “There’s really no controversy about that.”

The reason, she explained, is that the tax cuts will be paid for partly by deficit spending — an estimated $1.5 trillion the federal government will borrow over 10 years. Much of that money will be borrowed from foreigners, and that will make the trade deficit deeper.

One way to explain the connection is through the effect of borrowing on exchange rates and exports. When the United States borrows money from abroad, that means investors in other countries are buying dollars.

“When all those foreigners want more dollars, that makes the dollar appreciate,” Harrison said. “When the dollar goes up, that makes our exports more expensive around the world.” As a result, U.S. exports go down — and the deficit deepens.

Or, if you prefer, you can look at the problem in terms of U.S. imports. “When foreign investment flows in, it’s offset by Americans buying more foreign goods, and that grows the trade deficit,” said Kimberly Burham, another Wharton researcher.

Paradoxically, she noted, that means a bigger tax cut will produce a bigger trade deficit. “To get a bigger growth effect, you need more foreign capital coming in — and that, by definition, has an equal effect on the trade deficit,” she said.

At that moment, I began to remember why I had a hard time surviving international economics in college.

The point, though, is that Trump is heading toward a collision between two major parts of his economic policy. If he wins a big tax cut, the trade deficit will get worse. A year from now, he’ll look at the numbers and discover that he isn’t winning on trade after all. What will he do then?

His first impulse has been to demand better trade deals from other countries. But they aren’t biting so far.

During his Asia trip, Trump told trading partners like Japan and Vietnam that he wants to launch negotiations toward new bilateral agreements, but nobody signed up.

Meanwhile, the administration is in talks to rewrite the NAFTA agreement with Canada and Mexico, but those talks haven’t been going well, either.

The alternative to new agreements, which Trump has already threatened, is trade war — a U.S. withdrawal from NAFTA or punitive tariffs on China.

But those measures would be costly to American businesses, too. U.S. automakers, which have factories in both Canada and Mexico, have warned that withdrawing from NAFTA would cause chaos. Tariffs on Chinese imports — Trump has mentioned numbers has high as 45% — would lead to retaliatory measures against American farmers who export to Asia. A broader trade war would soon affect U.S. manufacturers who export too. It’s not a promising path.

At any rate, as mentioned, neither of those strategies would solve the fundamental problem. The trade deficit would still be there — as long as the United States remained a net borrower in the global market.

“The only sure way to reduce the trade deficit is to balance the federal budget, or at least to focus on reducing government debt,” argued Joshua Meltzer, an economist at the Brookings Institution.

And that’s not happening any time soon.

Trump doesn’t seem to know it, but by making the trade deficit an important measure of success even as he pushes for tax cuts, he’s guaranteeing his failure.

He’d be better off relearning the economics he should have absorbed at Wharton. That shouldn’t be too burdensome. After all, he’s told us he was “a really good student.”