The US, despite anticipated agreements, is well along in its hot trade war with China, launched in 2018. And two years in, that landmark, along with a looming election, creates pressure to declare a winner.
What Is the Best Scorecard?
With the release of the November 2019 trade numbers, the Trump administration believes it can start to claim victory. Its reasoning runs as follows: In the first 11 months of 2019, the US trade deficit with China, in goods and services, was down $3.9B, or 0.7%. Exports weren’t up, but imports were down. That drives up gross domestic product (GDP) and leaves America better off, right?
As tempting as it may be to keep score with bilateral trade balances, it’s misguided for a number of reasons. First, bilateral trade deficits can just reflect the shifting around of trade—imports coming from Vietnam rather than from China, for example.
"Not only does the trade deficit not directly determine GDP, we usually see the trade deficit expand in good times and shrink in recessions," explains Dr. Phil Levy, Flexport Chief Economist.
Finally, there’s a fallacy about how shrinking trade deficits equate (mathematically) with a boost to GDP. This is simply not true. However, as we’ll see, it’s an easy error to fall into.
GDP is tabulated as follows:
Consumption (C) + Investment (I) + Government Spending (G) + Exports (X) - Imports (M).
The first three are domestic demand measures. The last two are adjustments to turn domestic demand into domestic production.
The Case of the Purple Widgets
Now, suppose a US importer orders a case of purple widgets from China. That’s consumption, so it goes in C. But that is not produced domestically, so we subtract it back out in M. Net effect on domestic production: zero.
When tariffs are placed on purple widgets from China, imports (M) likely go down, but because the US is no longer consuming the purple widgets, consumption (C) goes down in lockstep. You could presume that demand for the purple widgets will shift to a domestic source, but that would be presumptuous. At a basic level, the reduced imports are inextricably paired with reduced consumption, meaning there is no net gain or benefit to GDP.
Dr. Levy notes, "That does beg the question: If the trade deficit is not a good scorecard, what is?" Better indicators are starting to emerge—and they’re not flattering, according to Levy. For instance, The New York Times reported earlier this month that it's US voters and businesses that are bearing the brunt of this trade war.
To hear more analysis on the state of trade, be sure to watch Flexport CEO Ryan Petersen and Chief Economist Phil Levy on January 21, when they host a live webinar: The State of Trade: 3 Trends to Expect in 2020. Save your spot now.
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