Trade Deficits

Introduction

• President Donald Trump aimed to reduce U.S. trade deficits, which have grown in recent decades.
• Trump and his advisors believed renegotiating trade deals, promoting "America First" policies, and confronting China would reduce trade deficits, create jobs, strengthen national security, and restore America’s economic strength.
• Many economists disagree that trade deficits harm the economy and caution against trying to "win" trade relationships with specific countries.
• Others believe sustained trade deficits can be problematic, leading to debate over policies to reduce them.

What is a Trade Deficit?

• A trade deficit occurs when a nation imports more than it exports.
• In 2024, the United States exported nearly 3.2 trillion in goods and services but imported 4.1 trillion, resulting in a trade deficit exceeding 900 billion.
• The goods deficit was 1.2 trillion, partially offset by a surplus in services trade.
• Services (e.g., tourism, intellectual property, finance) constitute about one-third of exports.
• Major goods exported include aircraft, refined petroleum, and transportation equipment.
• Imports are dominated by capital goods (e.g., computers, telecom equipment), consumer goods (e.g., apparel, electronic devices, automobiles), and crude oil.
• It’s important to distinguish between a country’s overall trade deficit and bilateral trade deficits.
• The U.S. has a large overall deficit and bilateral deficits with specific countries.
• A country can have bilateral deficits with some countries and surpluses with others while balancing overall trade.
• Even if the U.S. fixed its overall trade deficit, it would likely still have bilateral deficits with some countries.
• Analogy: Individual consumers can spend no more than they earn overall but have “bilateral deficits” with their grocer or barber and a “bilateral surplus” with their employer.

What Causes a Country’s Overall Trade Deficit?

• The fundamental cause is an imbalance between savings and investment rates.
• The U.S. spends more money than it makes, leading to a trade deficit.
• This spending is financed by borrowing from foreign lenders or foreign investment in U.S. assets and businesses.
• Macroeconomic forces influencing the size of the trade deficit:
  • Increased government spending leading to a larger federal budget deficit reduces the national savings rate and increases the trade deficit.
  • A stronger dollar makes foreign products cheaper for American consumers while making U.S. exports more expensive for foreign buyers, increasing the trade deficit.
  • A growing U.S. economy often leads to a larger deficit because consumers have more income to buy more goods from abroad.
• Economists believe these factors are more significant than trade policy in determining the overall deficit.
• Trade policy changes with specific countries tend to shift the trade deficit to other trading partners.
• Economists caution against confusing bilateral trade deficits with the overall trade deficit, which reflects underlying economic forces.

How Has the U.S. Trade Deficit Changed Over Recent Decades?

• The current U.S. trade deficit is 918.4 billion, about 3.1 percent of GDP, down from a 2022 peak of over 944 billion (around 3.7 percent of GDP).
• The deficit has averaged 594 billion since 2000, much higher than in previous decades when it was well below 2 percent of GDP.
• The United States had a surplus or small deficit through the 1960s and 1970s, followed by a large deficit in the 1980s that continued to expand through the 1990s and 2000s.

U.S. Bilateral Trade Deficits

• The largest U.S. bilateral trade imbalance is with China.
• In 2024, the U.S. had a 295 billion goods deficit with China, partially offset by a 32 billion U.S. services surplus.
• The next largest contributors to the goods deficit are:
  • European Union: 235 billion
  • Mexico: 172 billion
  • Vietnam: 123 billion
  • Taiwan: 73.9 billion
• The United States has services surpluses with each of these countries, except for Taiwan.
• The trade deficit with China expanded dramatically starting in the early 2000s, from an average of 34 billion in the 1990s.
• Some economists call this the “China Shock,” attributing it to the rapid growth in China’s exports of manufactured goods to the United States in the late 1990s and early 2000s.
• This growth occurred as China undertook economic reforms and implemented policies to subsidize production, accelerate industrialization, and boost exports.
• The acceleration of Chinese export growth after China’s entry into the World Trade Organization (WTO) in 2001 is also noted.
• More recently, China has experienced another export surge, leading to what CFR senior fellow Brad W. Setser calls the “Second China Shock.”
• This second wave of Chinese exports is due to:
  • Increased global demand for goods due to the COVID-19 pandemic
  • Decreased domestic demand in China
  • China’s increased competitiveness due to government investments in high-growth sectors (e.g., semiconductors, clean energy, electric vehicles).
• These factors explain China’s contribution to the overall U.S. trade deficit and the deficit’s concentration in manufacturing.
• U.S. manufacturing employment dropped from 31 percent of private-sector employment in 1970 to 9.7 percent in 2023.
• Economist Kyle Handley says this decline was accelerated by Chinese competition, but most economists attribute the reduction to automation, productivity increases, and demand shifts from goods to services.

Why Are Some Policymakers Concerned About Trade Deficits?

• President Trump argued that trade deficits threaten U.S. economic and national security.
• He blamed “unfair and unbalanced” trade agreements with countries like Canada, China, and Mexico for the growing deficit.
• Peter Navarro believed the overall trade deficit threatens national security because the United States depends on foreign debt and investment to finance it.
• Navarro referred to the trade deficit as “a brake and bridle on both GDP growth and real wages in the American economy while encumbering the U.S. with significant foreign debt.”
• Trump cited large and persistent goods deficits as evidence of a lack of reciprocity in bilateral trade relationships.
• Trump blamed the deficits for hollowing the U.S. manufacturing base, hindering the scaling of U.S. advanced manufacturing, threatening critical supply chains, and reducing the U.S. defense-industrial base’s dependence on foreign adversaries.
• Trump’s team calculated reciprocal tariffs in addition to the standard 10 percent for every country by taking their bilateral trade deficit in goods as a share of their total exports to the United States and dividing by two.
• CFR President Michael Froman explains that the Trump administration’s approach assumes the bilateral trade deficit is “a catch-all quantitative measure of unfair trade practices, not a reflection of comparative advantage.”
• Some Democratic lawmakers, labor groups, and manufacturers criticize trade deficits because some foreign countries (especially China) have used unfair practices such as currency manipulation, wage suppression, and government subsidies to boost their exports while blocking U.S. imports.
• Brookings researchers Joshua P. Meltzer and Margaret M. Pearson identify China’s overcapacity as “linked to China’s increasingly mercantilist approach to trade.”
• They suggest the United States should “rebuild a global rules-based trading system” to address China’s practices while acknowledging the importance of a continued U.S.-China trade relationship.
• The deficit’s concentration in the manufacturing sector has heightened concerns over job losses and their repercussions in local communities.
• Research by the Economic Policy Institute suggests that the surge in Chinese imports lowered wages for non-college-educated workers and cost the United States 3.7 million jobs from 2001–2018.
• One study from Stanford University found that the China Shock accounted for 59.3 percent of all U.S. manufacturing job losses over a similar period (2001–2019).
• Some economists worry about the consequences of large and persistent imbalances.
• Joseph Gagnon warned in 2017 that the debt necessary to finance the overall trade deficit was heading toward unsustainable levels.
• Former Federal Reserve chair Ben Bernanke and Jared Bernstein have argued that the large inflows of foreign capital that accompany trade deficits can lead to financial bubbles and could have contributed to the U.S. housing crash that began in 2006.
• Jeff Ferry notes that a growing trade deficit has been associated with a weak economy, indicating the potential for a large trade deficit to drain demand from the domestic economy and slow growth when the economy is performing under its potential.

Arguments Against Focusing on the Deficit

• Many economists argue that the overall trade deficit is not a problem for the U.S. economy.
• A larger trade deficit can result from a stronger economy as consumers spend and import more, and higher interest rates attract foreign investors.
• CFR Fellow Inu Manak challenges the idea that “trade deficits mean you lose, and surpluses mean you win.”
• She says Trump's focus on trade in goods, disregarding the services surplus, is unhelpful.
• Manak argues that the trade deficit does not necessarily reflect trade barriers and questions the legal basis of Trump’s tariff policies.
• Some economists argue that the U.S. economy's role in providing liquidity to the global economy and driving demand makes a U.S. trade deficit important for global economic stability.
• The dollar’s role as the global reserve currency means that many countries rely on holding dollar reserves, creating demand for U.S. financial assets.
• This allows the United States to finance its consumption at a low cost, boosting global demand.
• Increasing trade restrictions to move toward U.S. trade surpluses could lead to lower global growth, inflation, and economic instability among U.S. trade partners.
• CFR’s Benn Steil and Elisabeth Harding flag the potential reduction in real GDP growth due to protectionist trade policies.
• Many economists worry that focusing on trade deficits could lead to protectionism and a global trade war.
• Maurice Obstfeld challenges the idea that job losses in manufacturing are connected to the trade deficit and that tariffs will improve the trade balance or create manufacturing jobs.
• Stephen J. Rose says that promises that restrictions on imports will revive manufacturing ignore that technological progress plays a larger role in deindustrialization than trade.
• Mary Lovely says that trade deficits are neither all good nor all bad but involve trade-offs: the U.S. economy benefits from foreign goods and investment even as a high deficit displaces some workers and adds to the national debt.

Policy Options Proposed to Reduce Trade Deficits

• Imposing High Tariffs:
  • President Trump promised to reduce trade deficits by imposing high tariffs on foreign trading partners.
  • Commerce Secretary Howard Lutnick says broad-based tariffs will create “reciprocity, fairness, and respect.”
  • Some economists say negotiating better access to the Chinese market for U.S. exporters could help, but additional tariffs may hinder this.
  • Gagnon says that data show “tariffs have little direct impact on deficits.” Higher tariffs reduce both imports and exports, leading to less total income, slower productivity growth, and lower household living standards.
• Reducing the Fiscal Deficit:
  • As an alternative to tariffs, Gagnon argues for using fiscal and exchange rate policy.
  • He emphasizes “reducing the fiscal deficit and pushing down the overvalued dollar,” arguing that a weaker dollar would likely boost U.S. exports.
• Boosting U.S. Exports:
  • Shannon O’Neil emphasizes the importance of boosting U.S. exports to reduce deficits, return higher-paying jobs, and increase innovation.
  • She argues that pulling back from trade agreements and using sweeping tariffs on imports undercut the potential for U.S. exporters to succeed because they are excluded from access to cheaper inputs.
  • Instead of focusing on reducing imports through protectionist policies, a more effective strategy could be to increase U.S. exports.
• Amending U.S. Tax Law:
  • Alexander Raskolnikov and Benn Steil write that one way to address the deficit with China is by amending American tax law.
  • Current U.S. tax law treats foreign investors more favorably than domestic investors, contributing to the trade deficit.
  • Raskolnikov and Steil suggest that eliminating the U.S. tax subsidy for foreign capital import would reduce the motivation for Chinese investors to outbid Americans for U.S. assets and lower the incentive to “dump goods” in the U.S. in return for dollars.
  • Amending U.S. tax law and eliminating subsidies for foreign portfolio investment could moderately reduce the deficit without the downsides of tariffs and other protectionist measures.
  • Brad Setser argues that the United States should reform its corporate tax code to limit offshoring and disincentivize profit shifting, especially in the pharmaceutical industry.
  • The United States and its allies should create subsidy-sharing agreements in key sectors (e.g., electric vehicles and steel), expanding the market share for both U.S. and allies’ firms while lowering costs.
• Pressing for Reforms in Surplus Countries:
  • Economic reforms in surplus nations could also help.
  • Gagnon and C. Fred Bergsten argue that the United States should pressure countries that use foreign reserve purchases to manipulate their exchange rates by having the U.S. government counter-purchase the foreign currencies of manipulating nations.
  • Setser says that policymakers should pressure China and other Asian countries to enact policies to raise their domestic consumption.
• Cutting U.S. Domestic Spending and Boosting the Savings Rate:
  • Boosting the U.S. savings rate could also bring down the trade deficit.
  • Reducing the government budget deficit is one of the most direct ways to do that.
  • Trump established the Department of Government Efficiency (DOGE) to reduce federal spending and lower the budget deficit.
  • Most federal spending goes to defense, entitlements, and interest on the debt make many question whether efforts like DOGE will make much of a dent in the overall budget deficit.