October 06, 2016
The desire to beat up on Donald Trump is understandable, but it is important to realize that not everything he says is wrong. For example, according to press accounts he adheres to the belief that the world is round.
Anyhow, Greg Ip goes a bit overboard in a Wall Street Journal piece where he argues that Trump’s claim that a trade deficit can be reduced or eliminated with tariffs is wrong. Referring to Trump’s approach to the trade deficit, Ip tells readers:
“But that is out of step with standard economics, which predicts that a country’s trade balance is determined by the gap between what it invests and saves, not by tariffs.”
As an accounting identity a country’s trade balance is always equal to the gap between what it invests and what it saves. This means that if the U.S. invests $200 billion a year more than it saves, then it will by definition be true that it has a trade deficit of $200 billion.
However, this accounting identity tells us nothing about causation. If we are below the full employment level of output, and Donald Trump’s tariffs or threats of tariffs, reduce our annual trade deficit by $200 billion (@ 1.1 percent of GDP), then this would lead to additional employment, output, and savings in the United States. A standard multiplier would suggest that a $200 billion reduction in the size of the trade deficit would lead to a $300 billion increase in GDP. This higher GDP would lead to more corporate and individual savings, as well as more tax revenue, which also count as savings. (The growth in GDP would also led to more imports, partially offsetting the initial improvement in the trade deficit.)
In other words, it is totally possible to reduce the size of the trade deficit as long as the economy is below its full employment-level of output. This is basic economic theory. Folks should be clear on this point, even if it suggests that Trump might be partly right on something.
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