President Donald Trump has promised to fix the country’s growing trade deficit since the election last year. But what’s often lost in the conversation is how complex the issue actually is.
The trade deficit is used in international trade to measure when a country imports more goods than it exports. The United States currently has a trade deficit of $42.4 billion. Trump hopes to reduce the trade deficit by renegotiating international trade agreements. But that approach may overlook other ways that might actually be better for addressing the trade imbalance.
The North American Free Trade Agreement (NAFTA) has become the main target as the administration looks to reintegrate current trade deals. NAFTA was implemented 1994 as a free trade agreement between North American countries. Trump has argued on numerous occasions that NAFTA and other trade deals have put American workers at an unfair disadvantage against foreign competitors.
The trade deficit is determined by other factors beyond what trade agreements the country has. A widening trade deficit might actually be a good thing depending on what underlying economic conditions are causing it. American Enterprise Institute scholar Claude Barfield believes a better approach would be looking at trends within the economy that are likely impacting how exports perform in international markets.
“Ultimately, your trade balance, whatever it is, is determined by macroeconomic factors,” Barfield told InsideSources. “That gets to such things as taxes, getting a handle on entitlements, federal budget questions, things like that, and not, as the administration keeps saying, the reason we have a trade deficit is because of bad trade agreements. They don’t have much of an effect one way or another.”
The U.S. Bureau of Economic Analysis and the U.S. Census Bureau released numbers Thursday which showed the trade deficit decreased in August. It went from $43.6 billion in July down to $42.4 billion for the month. Barfield notes that the monthly numbers won’t provide much information because they tend to fluctuate.
“The trade deficit went down a little,” Barfield, a former consultant to the office of the U.S. Trade Representative, said. “I would say first that monthly figures are not ultimately very important. It’s not very important on its own whether the trade deficit goes up or it goes down. That varies in terms of working conditions, business cycle, in terms of the U.S. dollar.”
The country has faced a growing trade deficit since last year following some improvements. It has generally trended around the $40 billion range since it suddenly dropped around the last recession in 2009. The trade deficit was approaching $70 billion before the economic downturn. It dropped to $25 billion before settling around its current average.
“You really don’t want to pay attention to the ups and downs for the month to month,” Joe Gagnon, a senior fellow at the Peterson Institute for International Economics, told InsideSources. “I think the bigger picture is the trade deficit has been slowly growing. If you look back over the last 12 months it’s been going up, it’s been getting larger. That’s because the dollar has been strong for a while, ever since like late 2014.”
The U.S. dollar has strengthened over the last few years because of several economic factors. The dollar strength is measured by how it’s valued relative to other currencies. A strong dollar means that exports become more expensive for foreign buyers. The current strengthening of the dollar and weak demand overseas has likely contributed to the increased trade deficit.
“The trade deficit has been growing slowly and steadily over the last couple of years,” Economic Policy Institute economist Robert Scott told InsideSources. “That follows a sharp jump that happened in 2015. I think that due to some long-running trends in the economy, the most important of which is we’ve had a sharp jump in the value of the dollar beginning in late 2013. And that has affected the lag on the trade deficit.”
Gagnon believes that a good approach would be to get the dollar closer to its true value. The value of the dollar is determined by how much it’s in demand which is measured by factors like the exchange rate and demand for treasury notes. Some economists believe that the dollar is overvalued relative to how much it’s actually in demand.
“From the U.S. point of view, the strong dollar, over the past three years now, has been a drag on growth,” Gagnon, a former associate director at the U.S. Federal Reserve Board, said. “It’s actually been holding back growth by about a half a percentage point a year, and that probably will diminish. It won’t turn positive, but it will be smaller. The best it could be would be neutral on growth. But I suspect it might just slowdown.”
The trade deficit might not necessarily be a sign that the economy is doing poorly either. A strengthening economy could cause the trade deficit to widen as consumer demands increase. The U.S. economy could also see an increase in the trade deficit because of foreign investments. Barfield notes the last time we got the trade deficit down was during the last recession because there was less economic activity.
“If the U.S. economy seems to gain strength in a more rapid fashion later in the year, the Fed is likely to raise interest rates, which will have the impact ultimately of raising the value of the dollar, which would put a dampening effect on exports to some degree,” Barfield said. “That would not be, however, a sign the U.S. is losing competitiveness. It would be a sign the economy is doing quite well.”
Scott counters that the trade deficit is a huge problem because it likely shows structural problems within the economy. He notes one issue is good traditional jobs like manufacturing are being replaced with low-wage jobs in retail trade and restaurants. Those jobs tend to contribute less to how much the country is exporting.
“Now other economists will tell you the trade deficit tends to be cyclical,” Scott, who serves as the director of trade and manufacturing policy, said. “It goes up when the economy is growing fast, and goes down when the economy shrinks. Now that may be true, but we’ve had significant trade deficits for more than two decades now. That, to me, is a fundamental problem.”
Gagnon expects the growing trade deficit will likely slow in the coming year because the dollar has stopped strengthening as much. A more balanced dollar will mean exported products will become less expensive to foreign buyers. Demand for domestic products might also increase because of improving and emerging economies across the globe.
“The U.S. economy has been doing pretty well, but other countries have been catching up,” Gagnon said. “Going forward I would say the trade deficit might widen a little bit, but not as much going forward in the next year as it did in the last couple of years. The reason is the dollar has fallen back a bit from its peak over the past couple of months.”