Trump’s looming deficit disaster

WASHINGTON, DC – The Spanish philosopher George Santayana famously warned that those who fail to learn from the past are doomed to repeat it. Judging by US President Donald Trump’s continued insistence that he can eliminate the trade deficit through import tariffs, one cannot help but wonder whether he has learned anything from his failure to do so during his first term. If he had, he might have recognized a basic economic reality: tariffs alone will not reduce the trade deficit, especially when paired with massive tax cuts that cause the budget deficit to balloon.

The belief that the United States’ trade deficit is a problem has been a defining feature of Trump’s economic worldview. In his telling, foreign countries have taken advantage of the US by exporting more to it than they import, siphoning off US manufacturing jobs and accumulating wealth at America’s expense. His solution? A relentless push for import tariffs, which he sees as the most effective tool to correct this imbalance.

During his first term, Trump pursued an aggressive trade policy, imposing 10-20 per cent tariffs on approximately $350 billion worth of Chinese imports, along with similar tariffs on steel and aluminum. But instead of shrinking, the trade deficit increased by nearly 40 per cent from $480 billion in 2016 to $680 billion in 2020.

What is often overlooked is that the real reason the trade deficit widened under Trump was not tariffs but tax cuts. While Trump was raising import duties, he was also aggressively slashing taxes. The 2017 Tax Cuts and Jobs Act had two major effects: incentivizing investment by lowering the corporate tax rate and increasing the budget deficit, thereby reducing the national savings rate. Consequently, even before the COVID-19 pandemic caused the deficit to surge, it had already jumped from $584 billion in 2016 to $984 billion in 2019.

The key economic lesson Trump should have taken from his first term is that trade deficits aren’t determined by tariffs but by a country’s spending relative to its production. Or, as John Maynard Keynes put it, trade deficits are driven by the gap between savings and investment. As long as a country saves less than it invests, it will run a trade deficit, no matter how high its tariff wall may be.

Fast forward to today, and Trump is once again pushing the same failed policies, this time on steroids. In the first three weeks of his second presidency, he imposed a 10 per cent tariff on Chinese goods, announced (and then paused) 25 per cent tariffs on Canada and Mexico, and slapped 25 per cent tariffs on all steel and aluminum imports. He has also signaled plans to impose punitive tariffs on the European Union and Japan if they continue to run trade surpluses with the US. At the same time, he remains committed to a radical tax-cut agenda, vowing to extend his 2017 cuts and eliminate income taxes on Social Security benefits and tips.

The consequences could be severe. Over the next decade, according to the Committee for a Responsible Federal Budget, Trump’s proposed tax cuts would add $7.8 trillion to the budget deficit – already at 6.5 per cent of GDP. This raises a fundamental question: Since Trump’s tax cuts are likely to incentivize investment while reducing national savings, why wouldn’t they widen the trade deficit, just as they did during his first term?

If Trump is serious about reducing the trade deficit, he should rethink his planned tax cuts and focus on devising a coherent strategy to shrink the budget deficit by increasing revenues and reining in public spending. Such an approach could be coupled with pressure on China to reform its economy in ways that boost household spending and curb its savings glut, which has long contributed to global trade imbalances.

Instead, Trump’s current policies risk triggering a trade war, derailing the global economic recovery, and reviving the destructive beggar-thy-neighbour policies of the 1930s. Having seemingly learned nothing from his first term, he seems determined to double down on his aggressive trade policies despite the widening trade deficit. This, in turn, would almost certainly provoke America’s trade partners to retaliate.

Given the stakes involved, we can only hope that Trump changes course before his policies push the world toward an economic downturn. So far, however, there is little indication that he intends to do so.

Desmond Lachman, a senior fellow at the American Enterprise Institute, is a former deputy director of the International Monetary Fund’s Policy Development and Review Department and a former chief emerging-market economic strategist at Salomon Smith Barney. Copyright: Project Syndicate, 2024. www.project-syndicate.org