US trade deficit: are the EU and China to blame? (No)

If Donald Trump manages to win the November US elections, one of his priorities appears to be to put an end to decades of trade deficit, for which he not only intends to target China with increased tariffs but also the EU.

As he put it in his Bloomberg interview, ‘the European Union sounds so lovely. We love Scotland and Germany. We love all these places. But once you get past that, they treat us violently. But I was changing all of that and that culture. Return me to the White House and I’ll finish the job’. And he is also straightforward that Trumpnomics will mean tax cuts, more oil, less regulation, higher tariffs and fewer foreign financial commitments.

But let’s begin with the concept. What is a trade deficit?

The trade balance is the most relevant part of the current account balance and measures the exports and imports of goods and services of a country. A trade deficit means that the value of imports of a country exceeds that of exports, i.e. a country consumes more than it produces.

For decades, the US trade balance was in equilibrium, but towards the end of the past century, deficits started to increase, reaching a record level of $945bn [€873bn] in 2022, which significantly decreased to $784bn in 2023.

In nominal terms, the US trade deficit is the largest in the world. But there is a huge difference between goods and services: whereas the US balance of goods records a deficit (1.06 trillion in 2023), the balance of services is in surplus ($279bn in 2023). Therefore, the imbalance lies with goods. Country-wise, the largest US trade deficit is vis-à-vis China, hence the rhetoric emerged on the US side: in 2022, the US trade deficit with China accounted for more than $367bn, before moving to $287bn in 2023.

The decrease in the US trade deficit with China in 2023 came together with a record trade deficit with Mexico ($152bn in 2023), testifying for the ‘nearshoring’ strategy of the US. US trade shortfalls also reached annual records with Germany ($83bn), South Korea ($51BN), Taiwan ($48BN), Italy ($44bn) and India ($43.6bn).

The current account balance of a country is broadly equal to the financial account with an opposite sign. And the financial account of a country basically comprises foreign direct and portfolio investment.

This means that the current account deficit of the US (owing to its balance of goods deficit) gives place to a financial account surplus, that is, to incoming foreign direct and portfolio investment to their economy. It is no coincidence that for more than a decade, the US has been the top destination for inward foreign direct investment.

This makes perfect sense since investments are needed to compensate for the additional consumption and investment of the public and private sectors.

While it is true that China’s economic model is based on state-subsidised over-production, presumably with the intention to flood international markets with their artificially price-competitive products, it is not least true that the US trade deficit is mostly explained by its economic fundamentals.

Indeed, economic theory shows that the current account balance of a country equals the differential between private savings and investments plus the differential between public income and public expenditure.

The US has high levels of public deficit (i.e. a negative differential between public income and public expenditure), which according to the Congressional Budget Office, will remain above six percent of GDP by 2034. And Trump’s plans to cut taxes would only increase this figure.

So if Trump aims to reduce the US trade deficit as well as to cut taxes, the only possible adjustment can come from the private sector, which would see its savings massively increase and investment decrease, with the subsequent impact on economic activity.

There is an intrinsic contradiction in Trumpnomics: tariffs are a tax on imported products or services. So even if he cuts taxes, any tariff elevation will lead to the opposite effect, spurring inflation and damaging households’ purchasing power and companies’ performance.

And this is under the assumption there would be no retaliatory measures from other jurisdictions, which could only worsen the situation of US households and companies and even the US sovereign or the dollar a world currency.

In a nutshell, the US trade deficit is far from being the fault of the EU or China. It is the result of economic fundamentals and the rest of the world funding the US’s spending and investment activities, both private and public.

While it is good to detect and counter any anticompetitive trade practices, one should be careful with the policies implemented, which could not only be detrimental to the EU and China but also to the US.

It is also legitimate to want a shift in the productive model of an economy, but neither the initiation of a trade war nor expansionary fiscal and monetary policies seem the best recipe for the purpose.

The US should not lose sight that China is, after Japan, the second largest foreign holder of its public debt, which is already above 100 percent of GDP and is expected to keep on increasing in the coming years. If a possible new Trump administration wants to set the record straight on trade policies, they’d better focus on reforming the World Trade Organization.