Since the 1980's Donald Trump has tried to tell everyone that America is being ripped off by every nation we have a trade deficit with. It is the foundation of his approach to tariff policy, international trade and economics.
And it is totally wrong.
Let's start with an example than any first grade public school student - or current member of Trump's administration - should be able to comprehend.
Suppose the United States buys $5 billion worth of bananas each year from Honduras. Honduras, on the other hand, buys $1 billion worth of American apples. In this example, we have a trade deficit with Honduras of $4 billion so they are ripping us off and we are stupid suckers.
So, we retaliate with a tariff that drives their exports of bananas down to $1 billion. Now Honduras and the U.S. will be equal - $1 billion for $1 billion, right?
Wrong. Honduras, a very poor nation that has far less purchasing power than the U.S. will now be poorer so their demand for American apples will fall. Let's say it falls to $500 million. We are back to a deficit, back to being ripped off, so we slap even more tariffs on them, making them even poorer, while American apple producers suffer along the way.
Second example: I use Google every day. Google charges me nothing. I benefit immensely from this search engine while I never click on any ads Google provides. According to Trump I am now ripping Google off because I am gaining information and Google gets no money. There is a "trade deficit" between me and Google.
It should also be pointed out, which it rarely is, that since the U.S. is the richest country in the world it stands to reason that we would buy a great deal more from other nations than they can buy from us. This makes much of the trade deficit a naturally occurring event.
It is also important to point out that the U.S. actually runs a trade surplus in the services market. Things like banking and communication services run perpetual surpluses with other nations. Does that mean we are ripping them off?
Donald Trump - and the millions of economically ignorant supporters who back him - see the world as a zero-sum game. If Honduras sells more bananas than they buy apples, Honduras wins and we lose.
That is not how trade works and it is not how the benefits of trade should be measured.
Honduras has a comparative advantage in bananas, just like China has an advantage in rare-earth minerals. The U.S. has an advantage in energy equipment, movies and energy.
Trade means that sometimes a nation will have more categories of comparative advantages than another nation. That means that they will sell more, in total dollars, to their partner than they will buy. This trade deficit is natural and simply means that the U.S. will have cheaper bananas and rare earth minerals even if Honduras and China run surpluses with us.
Trade deficits are only bad if a nation's exports are falling in areas where it has a comparative advantage.
Where China, or Japan, or any other nation truly shuts out U.S. goods that are superior, the Trump administration has a case for using tariffs until our products are allowed in.
But in the case of steel, aluminum and many other goods we have no argument and are inferior producers.
To prevent deficits the best course of action is to compete head to head and allow productive differences to reveal who is best.
To do otherwise is to simply reward ineffective U.S. companies while crushing the productive ones with higher costs. Ronald Reagan knew this all too well.
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