Trade Deficits: An Introduction | The Free Market Center Journal

President Trump’s threat to impose tariffs on steel and aluminum has triggered a blizzard of articles for and against the proposal. Instead of parroting what has been said by others — mostly empirical evidence, I want to give you the tools with which to understand the issue behind the proposed tariffs: “trade deficits.”

Definition

To discuss the issue intelligently we must first come up with a definition for a trade deficit. In the simplest terms:

A nation incurs a trade deficit when it exports less than it imports.

Problems with the Definition

Nature of Exchange

To test the logic of the concept of trade deficits we must examine the nature of exchange. I plan to discuss exchange in far more detail in future blog posts. For now, I consider it sufficient to state that in every exchange both parties gain. Each party values what it gets more than what it gives. Otherwise no exchange will occur. Thus, neither trader could suffer a deficit. Each ends up better off than before they made the trade.

Measure of Trade

I have been careful not to use a unit of measure in stating a simple definition of trade deficits. I have done that because no unit of measure exists for quantifying the goods and services imported and exported. Bureaucrats and most economics express trade deficits in terms of the amounts of money that change hands. Not the amount of goods.

Those figures describe only that—the amount of money that changes hands. They tell us nothing definitive about the benefit (or detriment) to the general economy. They simply cannot tell us that.

Individual Transactions

The definition of “trade deficit,” as normally stated, presumes that the nation trades as a monolithic entity. Trades, however, do not occur between nations. Trades occur between individuals within nations.

I repeat. Aggregating the amount of money that crosses international boundaries provides no useful information about the benefits of individual trades.

The Consumer Pays

All economic transactions ultimately serve to satisfy the needs of consumers. If consumers do not have the willingness or ability to pay for lower order goods (“consumer goods”), transactions involving higher order goods (“producer goods”) would not occur. A market for steel exists only because steel ultimately contributes to the production of consumer goods. Rolled steel produced by a steel plant has no market value, if it ultimately doesn’t produce a product purchased by a consumer.

This means that not only do consumers ultimately pay for all voluntary transactions, they suffer the negative influences of intervention in this voluntary process. Income taxes, sales taxes, use taxes and — important for this discussion — tariffs, all distort the costs incurred by consumers. Taxes also distort the prices of goods. As a result, they distort the distribution of the resources used to produce those goods.

Complexity

Economies and markets all exhibit an irreducible level of complexity. This means that no one can accurately predict the effects of market intervention. Tariffs, for example, may have the direct and immediate effect of prolonging the life of inefficient domestic operations. When all the influences and feedbacks are taken into consideration, however, no one can predict for certain who will bear the ultimate cost. We can only say with certainty that some consumer, in some market, will bear the burden of tariff imposition.

Political Language

Politicians love to throw around phrases like “level playing field” or “trade deficits.” By doing so they manufacture nonexistent problems. No such thing as a “level playing field” exists in any market. Markets by their very nature work to level the playing field, but, like the mythical idea of equilibrium, they never achieve that objective.

The “trade deficit” also has a misleading connotation.

When you look behind the shroud of rhetoric, you realize that no such thing as a trade deficit exists. The idea only manifests in the minds and books of accountants (a topic for another day). In the process of trying to solve nonexistent problems we usually make problems worse.

Conclusion – Your Decision

I would say unequivocally that tariffs inflict damage on the members of any economy.

I don’t want you to take my word for it. Ask those who believe in trade deficits how either party in the exchange of goods suffers a deficit. Ask them how any intervention that helps one group of people, by force, does not simultaneously harm another group of people. Asked them how only politicians have the mental capacity (or clairvoyance) to understand all aspects of highly complex systems.

Ask these questions and then decide whether you believe in the concept of trade deficits.

Then you can judge whether tariffs will help anyone.

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