Up and Up: The Growing Trade Deficit

The 2018 data for U.S. international trade was released today after a delay due to the government shutdown. The report from the U.S. Census Bureau contains numbers for both how the U.S. trade deficit fared in December as well as completing the full picture of trade in 2018, a hallmark year for trade negotiations, tensions, and agreements. The trade data highlights a quickly rising trade deficit despite President Trump’s policy efforts to achieve one of his intended goals—the reduction of the deficit. Moreover, other policies implemented by the administration, such as the 2017 tax cuts, seem to have directly contributed to the explosion of the trade deficit.

Q1: What was announced today?

A1: Today’s report showed that the United States reached a number of records in 2018 when it came to trade. As it currently stands, the total U.S. trade deficit in 2018 for goods and services was $621 billion, the highest it has been in 10 years. That amount is a nearly $70 billion jump, up from $552.3 billion in 2017. In total, the United States exported $2.5 trillion in goods and services in 2018 and imported $3.121 trillion in goods in services.

When measuring trade just in goods, the trade deficit was $891.2 billion, the largest ever in U.S. history. 2018 also saw the largest ever trade surplus in services, at $270.2 billion. The deficit in goods grew faster than the surplus in services, at 10.4 percent and 5.9 percent respectively as compared to 2017. The country exported 6.3 percent more and imported 7.5 percent more in the 2018 calendar year.

Despite the administration’s imposition of tariffs on $250 billion worth of Chinese imports, the goods deficit with China reached an all-time high in 2018. The $419.162 billion deficit in goods with China, a $43.6 billion increase, accounted for nearly half of the total goods deficit. The deficit with Mexico and the European Union also reaching record highs at $81.5 billion and $169.3 billion respectively. The United States did, however, increase its surplus with South and Central America by $7.3 billion over 2018.

Q2: Why did the trade deficit grow so much? What does it mean?

A2: One reason it grew is the overall strength of the U.S. economy. The U.S. economy grew at a 2.9 percent rate in 2018, up from 2.2 percent in 2017, while both the European and the Chinese economy experienced economic slowed down. During times of economic growth, there is greater demand for imports by U.S. consumers looking to buy cheaper foreign goods. Conversely, the deficit drops significantly during recessions. During the Great Recession, the trade deficit dropped by nearly $300 billion as domestic demand for goods dropped dramatically.

The 2018 trade deficit was likely particularly large because of the effect of the tax cuts passed last year. The tax cuts helped to fuel increased economic growth and demand for imports. With businesses and households taking home more money, spending increased. This bump from tax cuts may not carry over into 2019 though.

The U.S. dollar is also particularly strong, which can increase the deficit. As the world’s reserve currency, investors frequently flee to the dollar as a safe investment, driving up the value. With a strong currency, consumers armed with dollars can buy more globally, increasing imports. Conversely, foreign consumers will buy less from the United States since their money does not go as far, driving down global demand for U.S. goods and services and thus U.S. exports. Combined with a weaker Chinese yuan, the strong dollar contributed particularly to the widening trade deficit with China.

The United States is also known for its low overall savings rate, which stood at 7.6 percent in December 2018. With U.S. citizens spending far more than they save, that will push up demand for imports. The tax cuts last year exacerbated this problem. By comparison, China’s national savings rate was an astonishing 46 percent in 2016 according to the International Monetary Fund, among the highest in the world. Therefore, the Chinese are consuming fewer U.S. products and services by comparison.

Q3: Does the trade deficit matter?

A3: Economically, not particularly. While a constant source of frustration to President Trump, few economists view the trade deficit as a good overall arbiter of economic health or an overtly negative thing. Most nations carry a trade deficit as a natural part of modern trade. As stated above, trade deficits are influenced by economic growth rates, currency values, savings rates, and other macroeconomic factors.

The United States also maintains a large trade surplus in services like higher education, tourism, and medical care. This reflects both the comparative economic advantage the United States maintains in these sectors and the modern reality of the U.S. economy: we are no longer solely a nation of manufacturers, and the economy has shifted towards services while developing countries maintain a comparative advantage in manufacturing.

Additionally, a growing trade deficit usually represents a growing economy—a good thing overall. This does not necessarily mean a stable or healthy economy, however, as the bubble years leading up to the Great Recession demonstrate.

While not economically significant, the data point has gained political importance as President Trump ties his success to the trade deficit. It has become a number that fundamentally matters because it is a statistic to which Trump is accountable. The data released today indicates that President Trump has not yet lived up to the promises he has made to reduce the deficit.

Q4: How do we reduce the trade deficit?

A4: The short answer is we don’t. Total elimination of the U.S. trade deficit imminently is highly unlikely. The only thing that could quickly and drastically cut the U.S. trade deficit is an economic recession. During the Great Recession, the trade deficit decreased by 40 percent. Surely, few would wish such a thing though just to lower the trade deficit.

Due to the numerous factors at play, there is little that the U.S. government can do to reduce the trade deficit significantly. There are some policies, however, that could be implemented to encourage more exports and fewer imports. Nearly all economists agree that the tariffs the president has implemented are not a useful tool to do so. As Peterson Institute for International Economics senior fellow Joseph E. Gagnon has noted, “if you look across countries, there’s no evidence that high tariffs reduce your trade deficit.”

A more effective route would be to encourage other nations to allow their currencies to rise against the dollar. A consistent complaint with China is that it artificially devalues its currency against the dollar, encouraging more Chinese exports and fewer foreign imports. China’s undervalued currency has been linked to one-third of production and employment losses in U.S. manufacturing caused by increased imports from China to the United States between 2001 and 2007. A higher value Chinese yuan could cut that $419 billion deficit as the United States buys fewer (now higher priced) Chinese goods and China can buy more goods and services from the United States. The average U.S. citizen could also buy less and save more. Increasing our national savings rate would be good in the long run for a whole host of reasons and would lower the demand for imports from nations like China.

Overall though, we should not be too concerned about reducing the trade deficit. The newly released data confirms what most economists have consistently argued—that the trade deficit is largely determined by macroeconomic factors and that simply imposing tariffs does not reduce the deficit. The deficit we should truly be worried about is the federal budget deficit, but that’s a whole different issue.

William Reinsch holds the Scholl Chair in International Business at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Jonathan Robison is a program coordinator and research assistant for the CSIS Scholl Chair. Jonas Heering and Madeleine Waddoups are interns with the CSIS Scholl Chair.

Critical Questions are produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

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Jonas Heering

Intern, Scholl Chair in International Business

Madeleine Waddoups

Intern, Scholl Chair in International Business

Jonathan Robison