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January 19, 2017

The Fundamental Incoherence in Trump's Economic Policy

 

The two pillars of Donald Trump’s economic rhetoric on the campaign trail were clearly: 

1) Higher rates of economic growth and job creation through tax reform, and

2) Creating more American jobs by reducing trade deficits. 

In this rhetoric, higher economic growth is assumed good, while trade deficits are assumed harmful. 

It’s generally accepted that the right kind of tax reform can increase economic growth, and there hasn’t been any major tax reform since 1986. So Trump’s emphasis on tax reform engendered some hope and perhaps bought him some begrudging support from the traditional conservative and free-market policy crowd, which otherwise wasn’t very enthusiastic. 

But that same crowd has been put off by Trump’s skeptical and even harsh language about trade. And for good reason—there’s fundamental policy incoherence between these two planks.  

Here’s the problem—higher levels of economic growth are always associated with higher, not lower, trade deficits.

Indeed, beyond the correlation, it seems safe to say that higher economic growth causes larger trade deficits. 

One major reason is that when US economic growth increases, US consumption increases, and much of that consumption comes from overseas. 

While the US is still the world’s largest economy, we are only 22 percent of the global economy.  Since most of the world economy is outside of US borders, most US major companies do more business outside of the US than inside. So when US consumers and businesses increase their consumption, most of it will inevitably come from overseas, which will INCREASE trade deficits

Put simply, if Trump is successful in increasing economic growth, Trump will increase, not decrease, the trade “deficit.” 

This poses problems for Trump’s rhetoric, but it’s not a real problem at all. 

I’ve been itching to put the word “deficit” in quotation marks because there really is no deficit in trade deficit. Think of it this way: When you go to the grocery store, all the money flows from you to the store, and all the goods flow from the store to you. In other words, you have a 100% trade deficit with the grocery store. In my home, we have a significant trade “deficit” with Amazon.com 

But in reality there is no deficit—there is an exchange, but not a deficit. You have received value in goods, and the store has received an identical value in money. Both sides are happy. 

Concerns over our trade deficit are without merit. In fact, the United States has run trade deficits every year for the last 42 years. The trade deficit has consistently increased during economic booms, and only decreased significantly during recessions

And that’s the fundamental incoherence in the Trump economic policy. A faster growing economy will of necessity create larger rather than smaller trade deficits. And we should be fine with that.


 

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