Is It Necessary to Cut Trade Deficit and Achieve Trade Balance?

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While the Trump Administration is seeking to reduce the U.S. trade deficit and achieve a more “balanced trade” with its trading partners, a newly-released World Economic Forum (WEC) paper questions the necessity and economic rationale of doing so. As argued by the paper:

First, a country’s trade balance is NOT a measurement of its international commercial success. Neither is the case that “imports are bad and exports are good. “Instead, the paper says that “it is more accurate to think of imports as the benefits of trade, and exports as the cost that needs to be paid to obtain these benefits.”

Second, it is a misconception that “trade deficits cause a reduction in employment and production and trade surplus increase them.” Rather, imports could  increase because of an increase in domestic income thereby increasing the aggregate demand. Empirical studies also overwhelmingly find that rapid economic growth and larger trade deficit are associated with faster employment growth in the United States in history (see the graphs above).

Third, as the supply chain goes global, a tax on imported inputs can reduce rather than promote a country’s exports, particularly manufacturing goods (for example high tariffs on imported fabrics will reduce the price competitiveness of clothing exports). Likewise, trade barriers could disrupt production and reduce domestic employment in both the “protected” industries and those downstream sectors that use their outputs.  

Fourth, primarily trade balance is a function of a country’s national saving and investments, not of trade policies. In other words, trade policies, such as higher tariffs and quantitative restrictions, will have no impact on a country’s trade balance. Interesting enough, countries like Singapore which maintain fairly low trade barriers, run a trade surplus equal to as high as 20% of its GDP. In comparison, India was one of the most highly protected economies in the early 1990s when it experienced unsustainable large trade deficits. Further, there is a dynamic balance between a country’s trade balance and exchange rate: in an open economy, reducing a country’s imports could lead to an appreciation of its currency and eventually hurt its exports as well.     

What is your view on the trade deficit and trade balance? Why do you agree or disagree with the arguments of the WEC paper? Do you find any evidence that challenges the findings of the paper? Please feel free to leave your comments.