Blame it on the trade deficit! Misconceptions about a complex macroeconomic concept edit

In his inaugural address, President Trump pledged to reduce his country's persistent trade deficit, which grew significantly in the late 1990s and which he blames for the decline in US industrial output and employment. In his view, this detrimental trend is the result of unfair practices by foreign partners and the free-trading naivety of his predecessors. He associates exports with a windfall or an income and imports with a burden or a cost. The imbalance - confounded with a loss - must be rectified by his favoured remedy: the imposition of customs duties. At first glance, the proposed policy seems to make perfect sense and has certainly won the support of large sections of the electorate.

Is this concern about trade deficits justified? The issue is much more complex than it appears[1]. A trade deficit occurs when a country imports more goods and services than it exports. In 2024, the US trade deficit amounted to 918 billion dollars, an increase of 133 billion dollars compared to 2023, accounting for 3.1% of GDP, up from 2.8% in 2023[2].

How does a trade deficit come about? It should be recalled that an economy simply cannot consume and invest more than it produces without importing more than it exports in order to redress the domestic imbalance. In other words, the trade balance refers to the difference between what a country produces and what it spends. The result closely depends on the saving and investment decisions of economic agents. If they invest more than they save, they will create a trade deficit and the balance of payments will be restored thanks to loans and investments from abroad. In macroeconomic theory, most economists argue that the trade balance is the difference between savings and investment, a fundamental accounting identity.

The US has been able to maintain a long-running trade deficit because other countries invest in its real estate and businesses and buy American debt and equities. The public and private sectors can borrow heavily from abroad because other nations, for example China and Germany, produce more than they spend. It should also be noted that imports, even if purchased on credit, consist of tangible goods that are useful to economic agents. There is no trickery involved in these transactions.

Intrinsically, a trade deficit is neither good nor bad. It would become problematic if it resulted essentially from borrowing for consumption and if it occurred at excessive levels leading to a crisis. Conversely, a deficit improves the well-being of society if the inflow of foreign capital is rather used to finance productive investment: factories, workforce training, new communication routes or upgrading of existing infrastructure. In this way, the country achieves a higher growth rate and the positive returns help service its debt profitably.

In most major industrial economies, the trade deficit is usually counter-cyclical: it tends to increase during periods of prosperity and decrease during economic downturns. The United States follows this pattern. A high deficit usually reflects strong demand, which supports income and employment growth as well as imports. In contrast, the deficit generally declines during recessions, when employment and spending, including those related to imports, diminish.

Since assuming office, President Trump has displayed a tariff activism as impetuous as it is unpredictable. Although his actions and threats may pursue a variety of objectives such as combatting drug trafficking and illegal immigration, the reduction of the trade deficit remains explicitly or implicitly one of the primary goals.

On 20 January, President Trump instructed his administration to “investigate the causes of our country’s large and persistent annual trade deficits in goods … and recommend appropriate measures, such as a global supplemental tariff or other policies, to remedy such deficits”[3]. With the same aim - and perhaps by way of a less frightening alternative for the markets — he commissioned another investigation on 13 February with a view to drawing up a ‘Fair and Reciprocal Plan’[4]. To put it simply, the principle of reciprocity referred to here stipulates that the levies of all kinds that American companies have to pay when they export a product to another country be imposed on products imported from that same country.

In related decisions, the President restored tariffs of 25% on steel imports and raised them to 25% on aluminium imports. He also enacted a 10% increase in US tariffs on all products from China.

Assuming that that the US trade deficit is unsustainable, which would be the best way to squeeze or wipe it out? Is the imposition of tariffs the panacea that President Trump has touted at every opportunity?

To answer this question, one needs to bear in mind the accounting identity whereby the trade balance represents the difference between national savings and investment. Consequently, tariffs can only alter a deficit if they change these two values. In the United States (and other countries), this is not the case. The two variables respond to economic cycles and behaviours that evolve slowly. Over the long term, they are determined by factors such as wealth, demographics, interest rates, tax receipts and public spending, and expectations of future income and profits. These parameters are likely to lessen or even eclipse the impact on the overall trade balance of an increase in tariffs[5] affecting all countries, especially if, like in the United States, imports represent only about 15 per cent of GDP.

In fact, the balance between the two pairs (the difference between exports and imports and the difference between savings and investment) is restored by the corrective effect of the exchange rate. The negative impact of additional tariffs on imports will be partly offset by an appreciation of the dollar or a depreciation of the currency of the country or countries on which the tariffs are imposed[6]. At the same time, US exports will also decrease. As a result, the volume of trade will decline, but not the trade deficit, as long as Americans do not save more or invest less.

Moreover, in an economy that is already close to full employment (as is the case in the United States according to conventional criteria), the contraction in imports following the imposition of customs duties also tends to reduce exports. In these circumstances, companies are concentrating on producing goods for domestic consumers and devoting fewer resources to supplying foreign markets. This reallocation contributes to the inertia of the trade balance.

What happens if the tariffs are intended to reduce the deficit with a single partner? Under the first Trump administration, when US tariffs on many Chinese products rose sharply (2018-2019), there was indeed a decline in the trade deficit with China. On the other hand, the overall US deficit continued to grow due to an increase in investment in excess of savings. Rather than buying from China, Americans simply imported more from other nations (such as Vietnam and Canada), with which the trade deficit widened.

In the end, only tariffs that are sufficiently disruptive (or high enough) to trigger a recession are likely to improve the trade balance. Is this the desired outcome, a downturn in economic activity with its trail of layoffs and precarious conditions for the most vulnerable?

If tariffs are ineffective, are there other measures that would be better suited to curb the trade deficit, i.e. the difference between savings and investment? In the United States, the government's sustained budget deficit, which translates into massive indebtedness (including to foreign creditors), is one of the main causes of the trade deficit. The latter could be reduced by a policy of fiscal consolidation involving cuts in government spending and a reduction in the purchasing power of the private sector through higher taxes.

It would be surprising for President Trump to come to such a conclusion. While he is committed to reducing government spending, he is also determined to cut taxes significantly. On the assumption that tax breaks are deeper and/or implemented earlier than budget reductions, investment (businesses will have more resources) will grow faster than savings. Thus, fiscal policy would inflate the trade deficit.

The concept of a trade deficit is often negatively connoted and distorted by approximate, erroneous or contradictory conceptions. It is obviously complicated to explain to a wide public that imports are necessary for the proper functioning of an economy, that a trade deficit can result from a phase of prosperity and that tariffs can only effectively reduce a deficit at the cost of a recession. Furthermore, should the foreign debt become unbearable, the best way to reduce it is to contain national spending, save more and invest less - in other words, to embrace frugality. Few politicians seeking popularity are inclined to advocate such a programme.

[1] The author drew in particular on the pertinent analyses of Richard Baldwin and Maurice Obstfeld (Cf. Factual Friday with Richard Baldwin, 6 December 2024, “The Tariffs and Balance of Trade Paradox: Why Macro Always Wins (in Pictures)”, LinkedIn;  Factual Friday with Richard Baldwin, 15 November 2024, “Trump Tariffs, Season 2: 10% and 60% tariffs are not the same”, LinkedIn; Obstfeld, Maurice (2024), “Mistaken Identities Make for Bad Trade Policy", Peterson Institute for International Economics, Policy Brief 24-13 and Obstfeld Maurice (2024), “America’s Deficit Attention Disorder” by Maurice Obstfeld - Project Syndicate).

[2] Cf. https://www.bea.gov/news/2025/us-international-trade-goods-and-services-december-and-annual-2024.

[3] Cf. America First Trade Policy – The White House.

[4] Cf. https://www.whitehouse.gov/articles/2025/02/reciprocal-trade-and-tariffs/

[5] President Trump mentioned additional customs duties of 10 to 20 per cent, Cf. Chambovey, Didier (2024), A President and customs duties: is a major trade conflict imminent? - Telos.

[6] Cf. Olivier Jeanne and Jeongwon Son John, “To what extent are tariffs offset by exchange rates?”, Journal of International Money and Finance, Volume 142, April 2024.