Why Trump's tariffs aren't all bad

In a recent article, Ruchir Sharma points to some all-too-rare positive news for globalization, trade, and the world economy’s growth prospects: trade is playing a more important role in the economies of every four out of five nations globally.

This finding squares well with IMF research that geopolitical tensions have little to do bilateral trade compared to other factors, such as income levels and geographic proximity.

U.S. exceptionalism

The exception found by Sharma is, of course, the U.S., which has seen its trade-to-GDP ratio decline to about 25%.

So what makes the U.S. such an outlier? A simple way to answer that question is the chart below, which shows that the U.S. current account deficit - which is the trade balance plus other sources of foreign income - equates to around two-thirds of global CA deficits.

External deficits of this type are financed in three ways:

• borrowing

• decrease in savings

• increase in investment

Borrowing can occur in the form of government, corporate, and/or household debt.

In the U.S. case, external deficits do help explain such high debt levels in the country.

Savings are the difference between income and consumption, so a decline in savings is by definition some combination of lower income and/or higher consumption.

For the U.S., both factors are at play, with consumers favored over income-generating producers and manufacturers.

Investment is a bit trickier to untangle because all the foreign investment the U.S. receives (e.g. into Treasury bonds, equities, real estate) is often the counterparty to an American borrower.

Yet overall investment as a share of GDP is low. At around 20%, it is only a third of consumption levels, which helps explain the shabby state of American infrastructure.

The point is that there is a lot wrong with the U.S. economy with an external deficit of that size.

Exporters of weak demand

At nearly -$1 trillion, the American CA deficit is truly staggering, and points to fundamental global trade imbalances.

The chart above shouldn’t have aggregate external surpluses and deficits stretching past $1 or even $2 trillion, which is nearly 1-2% of global GDP.

As Michael Pettis explains, the problem is that consumers are favored over producers in the U.S., UK, and other Anglophone countries, where the rule of law, strong property rights, and economic dynamism attract significant foreign capital flows.

Whereas the export-oriented economies of China, Germany, and Japan favor producers over consumers. This occurs via relatively low wages in China and Germany.

And Chinese workers are encouraged to accumulate savings rather than consume, and then channel those savings into investments such as real estate.

The result is that these economies end up “exporting” their weak demand along with their manufactured goods to their trading partners, partly explaining why countries like the U.S. can’t export to them as much.

If demand weren’t so artificially low in these countries, they would consume more of their own domestic manufacturing, helping enable a manufacturing renaissance in the U.S. and elsewhere.

This underlying dynamic explains much of the Trump administration’s planned tariffs, which could turn out beneficial for the U.S. and the global economy - albeit to the detriment of Beijing’s approach to trade.

If the U.S. and other wealthy nations were to run moderate external surpluses, this would enable developing economies to run moderate external deficits and thus receive international financial flows at levels required to achieve the capital deepening they need.