Tariffs and deficits – why the U.S. policy approach failed to fix external trade imbalances
Jack L
Introduction The policy mix of increasing tariffs to decrease a bilateral trade deficit whilst also running a large public spending deficit has been used by the United States under President Trump. This aims to shrink the large U.S.-China trade imbalance, while the tax cuts and the expansion of fiscal spending led to an increase in government borrowing. Modern macroeconomic theory suggests that this approach is inherently contradictory. Current-account deficits are fundamentally a result of national investment and savings decisions by members of the public, not a result of trade policy. As Krugman and Obstfeld note, ‘the [trade] deficit is the macroeconomic outcome of an economy’s collective decisions to save and invest’ (Krugman & Obstfeld, 2018, p. 115). A large fiscal deficit decreases public saving, which leads to an increase in the overall current-account deficit. This essay will assess the results of using policies for the overall current account, its composition, the effect of the exchange rate and domestic employment. I will argue that the U.S. highlights how protectionism and fiscal profligacy can lead to worsening external imbalances and to the appreciation of the currency, and result in limited or negative effects of domestic employment.
Saving and investment
CA = S - I In the equation above, CA represents the current account balance, while S is national saving, and I is domestic saving. This equation shows that a balance of trade is not caused by a tariff or bilateral deficit, but rather by the difference between national saving and investment. As Altenberg highlights, ‘a nation’s current account equals domestic savings minus domestic investment. It does not require empirical validation – it is simply a fundamental accounting identity’ (Altenberg, 2025, p. 4). A large fiscal deficit can lead to a reduction in public saving, which lowers the total national saving and results in a worsening trade deficit. This occurrence of ‘twin deficits’ has been seen in the U.S. ever since the 1980s: in which budget and trade deficits tend to have a positive correlation. As Obstfeld observed, ‘imports rise with total aggregate domestic spending’ and ‘the dollar’s foreign exchange value tends to rise when total spending rises’ (Krugman & Obstfeld, 2018, p. 317). Therefore, fiscal expansion which has been financed by debt leads to not only a reduction in saving but also increases the exchange rate, further worsening the external balance. Tariffs and the current account balance Tariffs are often used as tools to fix bilateral deficits, despite being unable to alter the underlying saving-investment gap. The Lerner symmetry theorem highlights that the taxation of imports has the same effect as the taxation of exports as both relative prices but have no effect upon the overall balance of payments. As Bellocchi and Travaglini argued, ‘efforts to reduce the trade deficit through protectionist policies may backfire, ultimately widening the deficit’ (Bellocchi & Travaglini, 2025, p. 229). In the case of the U.S., tariffs placed upon Chinese imports during 2018-2019 merely shifted the
24
Made with FlippingBook - PDF hosting