Does Addressing Bilateral Trade Imbalances Work?

CAMBRIDGE – Politicians and economists view trade imbalances very differently. Consider the United States’ trade deficit. Economists emphasize that the total US trade deficit with the rest of the world is the result of policies and actions at home. Simply put, if the US invests more than the country as a whole saves, it must import the difference from the rest of the world, creating the existing trade deficit.

But politicians (and the general public) tend to focus on bilateral trade deficits with individual countries, like the $300 billion imbalance between the US and China. They blame the bilateral deficit on Chinese policies that block imports of US products and subsidize Chinese exports to the US.

Economists explain that those policies affect the composition of the US trade imbalance, but not its size. If China changed its trade policies in ways that reduced the bilateral deficit, the US trade deficit with some other country would increase, or its surplus with some other country would shrink. The overall US trade deficit with the world, however, would not change.

Economists also like to stress that free trade raises a country’s overall income. There are winners and losers, but the winners from free trade could in principle compensate the losers by enough to make everyone better off. Economists don’t talk very much about such compensation, because governments don’t do much to arrange it for the losers.

The US has policies like the Trade Adjustment Assistance program, which provides more generous unemployment benefits for workers who lose their jobs because of competition from imports. But the federal government doesn’t provide such assistance on a large scale, presumably because it makes no effort to provide compensation to those who lose their jobs because of technological change. And rightly so.

Imports cause losses to particular industries, occupations, and geographic areas. And those who lose – or stand to lose – from imports demand protectionist measures, in the form of tariffs or quotas, against those specific products. Adam Smith recognized this even before David Ricardo explained the virtue of free trade.

We saw this response explicitly in US President Donald Trump’s election campaign, during which he threatened to impose high tariffs on products from China, Mexico, and other countries.

But now that he is president, those high tariffs or quotas are nowhere to be seen. Instead, we see trade negotiations being conducted under the threat of such tariffs – and leading to market opening for some products and services in countries with which the US has a bilateral deficit.

China is a good example. After originally threatening a variety of negative changes in US policy toward China, Trump invited Chinese President Xi Jinping to his Florida estate for what both countries agree was an amicable visit. After that, the Chinese agreed to start importing US beef this summer, rescinding protectionist policies that had been in place for several years. China also agreed to open its market to a range of US financial services. And the US agreed to sell natural gas to China, something that the Chinese wanted but that the US previously had refused to do.

The result of these policy changes will be to reduce the US trade deficit with China. Although this will not change the overall US trade deficit, it will raise the real incomes and profits of US producers of beef, financial services, and natural gas. Chinese consumers will also benefit.

So, in this case, the focus on the bilateral trade imbalance has led to desirable policy changes, even though the US trade deficit with the world will not decline.

But negotiations in response to bilateral trade imbalances may not always have positive effects. The US is currently threatening to impose tariffs on softwood lumber from Canada. If the US does impose such tariffs, the result would be a reduction in the US-Canada trade imbalance. But the tariffs would hurt American builders and homeowners, as well as Canadian timber companies.

The bottom line is that bilateral trade imbalances are not irrelevant and can be useful in directing attention to policies that reduce the real incomes of consumers and businesses. But remedying those bilateral imbalances has to be approached with caution.