Why We Must Fix the Trade Deficit

One of the biggest challenges facing the United States is something vanishingly few of our leaders talk about: the country’s massive trade deficit. The U.S. trade deficit, in which imports exceed exports and American currency flows out to foreign markets, shrinks our economy.

In fact, the trade deficit—which was $505 billion in 2014 compared to $39.2 billion in 1992—stifles America’s gross domestic product. The GDP is the sum of four components: consumption, investment, government spending and net trade (meaning exports minus imports). Therefore, a trade deficit shrinks the GDP while a trade surplus grows it. The Economic Strategy Institute, a nonpartisan public policy research group, has estimated that the trade deficit was shaving at least 1% per year off our economic growth.

So what can be done to rebalance U.S. imports and exports?

New Goal: Balanced Trade

Our core trade goal should be balanced trade, with fleeting surpluses and deficits rather than persistent deficits. Congress must decide that reducing the country’s reliance on exports is an issue of vital importance. It should then instruct the executive branch to pursue the goal of balanced trade.

The tools used to achieve balanced trade may change over time. But right now, the federal government should focus on remedies to the three biggest foreign trade problems:

Currency manipulation. China and 20 other countries representing one-third of global GDP manipulate their currencies to gain price advantages in trade. Congress can start by enacting laws that would establish trade duties to countervail these de facto foreign subsidies. Both the House and Senate passed bills to do just that—but in different legislative sessions, so they never became law. I expect them to be introduced again this year.

Consumption taxes. Over 150 countries have a consumption tax, which they apply to U.S. exports just like a tariff. They also rebate those taxes when their companies ship goods to us, just like a subsidy. When Europe, Mexico, Canada and Central American countries lowered tariffs through trade deals, they replaced the tariffs with consumption taxes, sometimes referred to as “value-added taxes,” or VATs.

How does this work? If a $100 American widget is sold to China, a 17% VAT is applied at the border to make the full price $117.

If a $100 Chinese widget is shipped to the United States, the Chinese government rebates the 17% VAT to the exporter so the price can become $83.

This practice is allowed by the World Trade Organization (WTO), so our only real option is to follow suit: We can create a U.S. consumption tax to neutralize the massive foreign consumption tax distortion to our trade performance. But this should be part of comprehensive tax reform that is revenue neutral. The new tax should be offset by equal reductions to corporate and personal income taxes and/or payroll taxes.

Industrial subsidies. We must aggressively fight rampant industrial subsidies, including the state-owned enterprises phenomena in China, Vietnam, Singapore, Japan and other countries. Current global trade rules don’t adequately deal with this major problem.

New Medicine Needed

Imported goods will always be part of our economy, of course. But it is important to realize that the United States is the biggest, richest consumer market in the world. Producing in the market where you sell the most is very advantageous and efficient.

As a general rule, industries that are highly capitalized, highly innovative and have high product transportation costs are more likely to come back to the United States. Conversely, industries that are labor-intensive, not innovative and have low per-unit transportation costs are less likely to return.

Germany, which had a record trade surplus in 2013, is a success story that we can learn from and tailor to the U.S. economy and political system. Taken together, German policies encourage supply chains that stay largely (though not exclusively) domestic, achieve continuous improvement, include the interests of workers, produce high wages and quality products and impose a measure of national loyalty on even Germany’s big industrial champions.

Even as the United States has signed more trade treaties, our trade performance has increasingly suffered. As noted above, our trade deficit in 1992 was $39.2 billion. We then signed various free-trade deals, including NAFTA, the Central America Free Trade Agreement and the U.S.-Korea Free Trade Agreement. We helped establish the WTO in 1995 and allowed China into that organization in 2001.

If the old medicine makes you sicker, or has no effect, the solution is not to keep taking it. The prevailing Washington view has been the idea that reducing any trade distortion, even if we did it unilaterally, was good. While plausible in theory, in practice our trade policies have enabled foreign governments to protect and subsidize their economy instead of achieving the promise of free trade—balanced trade.
 

International Whack-A-Mole

All of this is to say that U.S. trade negotiators focused only on eliminating this or that trade barrier are condemned to play a game of whack-a-mole. Whack one mole, and three come up somewhere else. And you can’t get to those three until the next round of trade negotiations years later.

This is why we need to pursue balanced trade over time. We can probably get more bang for the buck through domestic laws, rather than trade treaties, by neutralizing the effects of currency manipulation, fixing the troubled U.S. tax code and offsetting
foreign industrial subsidies.

However, there is a strong danger that President Barack Obama and the newly GOP-controlled Congress will instead pursue policies that continue the failed status quo. These could include the Trans-Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (T-TIP). Because these trade deals do not address currency manipulation, consumption taxes and industrial subsidies, the result will likely be more trade deficits and offshoring rather than lower trade deficits and stronger growth. 

The Coalition for a Prosperous America, the organization I lead, is pushing members of Congress to oppose these bad ideas. But other groups outside of Washington will have to help reframe trade policy debates and push lawmakers to choose a new path.

For example, American manufacturers should insist upon a national manufacturing competitiveness strategy that makes producing goods here more advantageous. Manufacturers operate in the context of policies that impact their costs, pricing ability and the relative prices between domestic and foreign goods. They must make day-to-day decisions that make sense for their company, their employees and their communities. To boost competitiveness, I would suggest a stronger effort to build supply chain clusters in the United States to improve coordination, lower costs (including but not limited to transportation) and improve quality.

As Germany’s economy makes clear, doing so is not a “closed-door” policy. We will always trade with the world, but should do so in a more balanced way. If we continue on the current course, our manufacturers—and the broader U.S. economy—will continue to pay a big price.