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The Dark Matter of Trade

Donald Trump has argued that trade wars are easily won by the country with the deficit, because the other party has more to lose. But just as trade has moved from goods to services and on to knowledge, so may trade wars, with a tariff on steel answered by a tax on Amazon or Google.

CAMBRIDGE – If you are flying a plane, it is useful to know how to keep it level. To do so, you must be able to read the instruments. If the plane is flying level, but you think it is heading down, you may pull back on the yoke and put the plane into a stall. This is what may be happening today with US trade policy.

At the core of the problem are two questions: whether the United States has a trade deficit, and, if so, what to do about it. The Trump administration says the US does have a deficit, and that the solution is an easy-to-win trade war.

Economists tend to dispute Trump’s answer to the second question. They argue that external imbalances are the reflection of domestic imbalances. In every transaction, what one party calls spending, the other calls earning. So, the sum of all market participants’ earnings must equal their total spending. But if you divide the world into two types of people – residents and non-residents – then the only way that non-residents can earn more than they spend in your country is if the residents are spending more than they earn. So external deficits reflect residents’ spending in excess of income – in which case the problem will not go away through a trade war, unless it forces residents to spend less, by, say, taxing them with tariffs. But the government is doing everything it can to achieve the opposite: it is lowering taxes and increasing spending by record amounts, thus aggravating the imbalance. Trade policy is not the answer to trade deficits.

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