Huge trade deficits reflect and create bigger problems

Massive trade deficits are dangerous, but not the way most think. They distort politics and enable harmful policies. They are also a symptom of unsustainable American profligacy. These trends threaten to leave America weak and isolated.

Consider the defense from Peter Navarro, assistant to the president for trade and manufacturing policy, of President Trump’s policies in The New York Times.  

{mosads}He made some good points. Prosperous allies are happy to let American taxpayers subsidize their security through forward-deployed U.S. forces. They should do more, but they won’t until U.S.troops start to come home.

Navarro also listed specific sectors or products where tariffs are higher on American products abroad than they are here on foreign products. They aren’t “reciprocal,” as President Trump wants. He did, after all, suggest that the G7 countries all eliminate tariffs and other trade barriers with each other.

Trump’s trade restrictions unfortunately impose costs on American consumers, downstream producers and others. They are roiling our longstanding alliances, even with Canada. Our global commitments and partnerships need to catch up to a changed world, of course, but other approaches may work better.

In short, the trade deficit encourages protectionism. It makes those arguments and proposals more plausible to U.S. taxpayers and their representatives, because most have an intuition that there’s a problem. It also increases the resistance to those who do or might otherwise oppose such actions. Few of today’s federal officials remain steadfast supporters of minimizing government obstacles to free exchange across borders.

Yet U.S. trade barriers — whether to retaliate or to foster better policies abroad — aren’t going to reduce the trade deficit. Tariffs, quotas and other barriers certainly do distort the composition of imports and exports in specific markets. But that’s not what drives aggregate trade imbalances. 

Net capital flows account for trade deficits or surpluses. The trade deficit results from domestic investment exceeding domestic savings. Funds come from abroad to fill the gap and the funds come from what Americans pay to import goods and services. 

If, say, America is a great place to do business, but its private citizens and public officials are happy to spend more than they earn or take in, the difference has to come from outside the country.

Perhaps the funds come from a developing country with comparatively poor investment opportunities but culturally-driven high savings rates. Maybe a place like China.

To reduce the trade deficit, the big-picture policy choice comes down to reducing the attractiveness of investment — a terrible idea — or increasing savings. Getting households, businesses and governments to save more and borrow less is the key.

Government inhibits household savings in two major ways. First, an income-based tax system discourages putting money aside for a rainy day compared to a consumption tax, in which savings isn’t taxed until spent.

Significantly expanding health savings accounts and establishing universal savings accounts are good steps in that direction.

Second, the government runs a slew of lending programs. Government-provided loans, loan guarantees and other borrowing subsidies push people to take on more debt. Rolling back lending subsidies would reduce indebtedness.

On the business side, the tax code continues to encourage debt finance (bonds) over equity (stock). Tax reformers attempted to narrow the disparity during tax reform but fell short.  

Even so, simply reducing the corporate income tax rate from 35 percent to 21 percent under the Tax Cuts and Jobs Act of 2017 helps. Several additional options remain.

Finally, government deficits reduce national savings. When outlays exceed receipts, the money comes from somewhere. Budget deficits are financed by borrowing from foreigners. Again, they get the money by selling more goods and services to Americans than they buy from us. Exchange rates adjust to make this all work.

State and local governments play a role, but the federal government’s $1 trillion — and ballooning — deficits are the main driver. Reducing the growth in debt and, ideally, working to balance the budget would increase national savings and reduce the trade deficit. 

Most economists don’t worry about the size of the trade deficit, but they should. Large trade deficits encourage destructive public policy and they reflect policies that foster a spendthrift and debt-laden society. 

Shrinking the trade deficit requires reducing subsidies for debt and not discouraging savings. At least as important, rebuilding our reserves would also increase Americans’ ability to take on whatever challenges come our way.

Kurt Couchman is the vice president of public policy at Defense Priorities. He previously served as a policy expert in congressional offices, most recently as a legislative director for a Republican member of the House of Representatives. Follow him on Twitter @KurtCouchman.