Philip Coggan dismantles Donald Trump’s idea that America is being ‘ripped off,’ revealing how savings, investment, and budget deficits, not foreign cheats, really drive trade surpluses and deficits
Donald Trump has talked about the US being ‘ripped off’ and ‘pillaged’ by other nations in terms of trade. But how in practice is this supposed to happen? One obvious reason why US businesses and consumers buy imports is because they are cheaper. Some argue that China is selling the goods too cheaply. But is this ‘ripping off’ America? It is an odd concept in any other walk of life. Imagine saying ‘Hey, the local supermarket has cut the price of potatoes by 50 per cent. They are really ripping us off.’
A stronger line of complaint is that, while the US and other nations freely accept Chinese exports, China does not respond in kind. Foreign companies are shut out of the country by a series of government regulations. Those who try to get round the problem by allying with a Chinese partner risk losing their valuable intellectual property. There is undoubtedly justification for these complaints. But that is not the same as saying, as was the case with the Trump tariff formula, that all other nations are treating the US unfairly. As mentioned in Chapter 1, the 2 April tariff rates had no intellectual rationale; even countries with which the US has a trade surplus were hit with a 10 per cent tariff.
Mr Trump seems to take the mercantilist view that exports are good and imports are bad. But that is a very strange way to look at the world. It is a bit like saying that going to work to earn a salary is good but spending the money in a shop is bad. We take jobs so we can afford to buy things and, by the same token, we export goods and services so we can consume imports. Those imports may be things that can’t be produced at home (diamonds, bananas), of a better quality than can be made at home (French wine or Scotch whisky) or are simply cheaper (such as electronics made in Asia).
Trade deficits and surplus
The balance of trade in goods is only part of the flow of payments between a country and the rest of the world, captured in a nation’s current account. This consists of a number of elements: trade in goods, trade in services, net income from abroad (salaries, dividends etc.) and current transfers, which include remittances sent home by people working abroad, foreign aid and donations. These elements may be moving in quite different directions.
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The UK, for example, has long experienced a trade deficit in goods but this has been partly offset by a surplus in services. The same is true for the US. While President Trump complains about the trade deficit in the goods the US makes, he does not mention the surplus in the services the US sells. If the goods deficit indicates that other countries are cheating the US, does the services surplus show that the US is cheating other nations? And if not, why not?
If a country runs a current account deficit, that means it is paying more to foreigners than it is receiving in return. The result is that those foreigners have claims on the deficit country. These claims may be in the form of bank depos its, equities (shares), government bonds or property. Or it may involve an overseas company building a factory in the deficit country, which is known as foreign direct investment or FDI. According to Citibank, the US is the top destination for foreign direct investment in the world; much of this money is used to build factories, which create jobs.
All these transactions are lumped together in the capital and financial accounts. Since the balance of payments must balance (by definition), a deficit on the current account must be offset by a surplus on the capital and financial accounts.
Savings-investment relationship
It is easy to assume that it is the trade in goods and services that drives this relationship. But that’s not necessarily the case. Many economists think that the capital account is the driving force. To understand this, imagine an island economy that is cut off from the rest of the world and doesn’t have a government. People in that economy can either spend their money on goods and services or save it. The same goes for businesses; they can spend all the revenue they receive on wages and raw materials or they can save it. If they want to invest to expand production, they must use the money they saved, or borrow it from citizens (i.e. use the people’s savings). In aggregate, they can only invest as much as the island saves.
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Once a country starts trading with other nations, that restriction no longer applies. It can borrow money from abroad. In other words, if domestic savings are insufficient to fund desired domestic investment, then the country can import savings from abroad. This shows up as a surplus on the capital and financial accounts.
This explanation seems a perfect fit for the US. Its consumers tend to save less than those of many other countries. But its businesses, particularly in the technology sector, have ambitious investment plans. And its government regularly runs a big budget deficit. So, the US imports savings from abroad to finance these needs. And overseas savers are happy to oblige.
This savings/investment relationship has important implications for government policy. Three sectors save (or borrow): individuals, businesses and the government. The US government is a huge borrower, with a deficit reaching $1.8tn in 2024.12 Republicans have proposed (at the time of writing) a further $4.6tn of tax cuts, offset by only $1.6tn of spending reductions.13 Unless consumers and businesses start saving a lot more, this bigger budget deficit will make the trade deficit even bigger, the opposite of Mr Trump’s stated desire of eliminating it.
(Excerpted from The Economic Consequences of Mr. Trump: What the Trade War Means for the World by Philip Coggan, with permission from Profile Books)
