Image Source: Unsplash

There’s a fundamental misconception at the root of President Trump’s tariff policies, which is the mistaken claim that the existence of a US trade deficit proves that trade is unfair. There are two related mistaken claims. One is a claim that if tariff and non-tariff barriers to trade were removed, then trade would be balanced. Another is that if the US trade deficit persists, then it proves that trade barriers remain.

As an illustration of this mindset, President Trump said to reporters in the aftermath of his tariff announcement a few days ago: “I spoke to a lot of leaders — European, Asian, from all over the world. They are dying to make a deal, but I said ‘we’re not gonna have deficits with your country’ … to me a deficit is a loss. We’re gonna have surpluses or at worst we’re gonna be breaking even.”

But tariffs do not in fact cause trade deficits. The existence of a US trade deficit does not prove in any way that other countries have larger (or smaller) tariffs. Whether the end result of Trump’s trade negotiations is higher tariffs or a return to the pre-existing tariffs, it’s not going to fix the US trade deficits.

A first key insight here is that tariffs (and other trade barriers) can shift the composition of an economy, but these shifts in composition are not related to the existence of trade deficit or surplus. Think of it this way: When a national economy starts to engage in international trade, it will alter the shape of that economy. Sectors of the economy that are well-suited for exporting will expand; sectors of the economy where other countries are well-suited for exporting will contract.

These trade-induced shifts away from some sectors and toward others can be painful. Indeed, many economic shifts–like automation or other new technologies–can be painful as well. But shifts toward higher-productivity areas is the source of economic growth, and trade-induced shifts toward the areas where an economy has an advantage and away from areas where other countries have an advantage is actually why both sides benefit from trade. Conversely, the proposed new tariffs would cause a high level of economic pain to the US economy, because they are also an attempt to shift sectoral patterns. However, the tariffs seek to shift the sectoral patterns toward areas where the US has less or no global advantage and–necessarily–away from areas where it does.

Whether you agree with my negative view of tariffs or not, here’s the key point: the trade-induced shifts across the size of economic sectors do not require there to be an imbalance of trade. Even if US imports and exports were equal, there would still be US domestic producers who feel a competitive threat from foreign producers of very similar goods. (For example, in the early 1970s when US trade was roughly balanced, or in the late 1980s when trade was near-balance for a few years, there were still concerns over imports.)

In short, trade shifts the mixture of good and services produced in a domestic economy. Conversely, when a nation imposes barriers to trade like tariffs, it shifts the national economy back toward the sectoral patterns that would have existed in the absence of trade. But although these shifts will make some sectors relatively larger or smaller, the shifts are not actually related to trade deficits–not at the bilateral level and not at the overall level.

The misconception that differences in tariffs are the cause and the solution of trade deficits comes in a silly version and a deeper version. The silly version is that if all countries removed their trade barriers, the US would then have a bilateral trade balance with every individual country. But in a global economy, there is no reason why every single pair of countries should have balanced trade–as opposed to countries having trade surpluses with some partners and trade deficits with others. Indeed, although the US has consistently had overall trade deficits since the late 1970s and early 1980s, it has bilateral trade surpluses with a number of economies. In 2023, for example, the US had a surplus in goods trade with Belgium, the United Kingdom, Australia, and others. Indeed, the US had an overall trade surplus in 2023 with the South/Central America region, including trade surpluses with Argentina, Brazil, and Chile.

If you believe that bilateral trade imbalances are caused only by trade barriers, then you need to look at the mixture of US trade surpluses and deficit across countries, and believe that all the countries where the US has a with bilateral trade deficits are treating the US unfairly, and also that all the countries where the US has a bilateral trade surplus are being treated unfairly by the US. But there is literally no evidence that levels of trade barriers match up to trade surpluses. The US has trade deficits with countries where it has already negotiated free-trade agreements. Even the Trump administration doesn’t believe this is true: it has sought to impose tariffs on all US trading partners, not just those where the US has bilateral trade deficits. And one suspects that the Trump administration would be deeply unamused if the countries where the US has bilateral trade surpluses used that as a reason to limit US exports.

So let’s set aside the peculiar and ridiculous claims about bilateral trade deficits and surpluses, and focus instead on the overall US trade deficit. Maurice Obstfeld tackles these issues in “The U.S. Trade Deficit: Myths and Realities” (Brookings Papers on Economic Activity, Spring 2025, presentation of this paper, along with comments and discussion is available here).

As a starting point, consider the pattern of the overall US trade deficit over time. As you can see, the US trade deficit as a percent of GDP was near-zero from the 1950s up through the mid-1970s, and has been mostly in deficit since then.

If the US trade deficit is caused by the tariffs and barriers to trade from other countries, then changes in the trade deficit must be caused by changes in barriers to trade. Thus, the larger trade deficits from the mid-1970s to the mid-1980s must reflect greater barriers to trade from US trading partners, followed by lesser barriers to trade as the US trade deficit declines in size from the mid-1980s to the early 1990s. As the trade deficit then gets larger through the 1990s, this must reflect greater barriers to trade at this time, and the decline in US trade deficits around the time of the Great Recession from 2007-09 must reflect smaller barriers to trade.

Just to be clear, no one actually believes that movements in unfairness of trade explain movements in the US trade deficit. Concerns about unfair Japanese trade barriers were strongly expressed in the early 1970s when overall US trade was close to balance. No one was saying in the late 1980s or in the Great Recession–times when the US trade deficits declined in size–that the cause was a sharp reduction in foreign trade barriers. When US trade deficits rose in the 1990s, the concern was that trade barriers had been reduced because of the North American Free Trade Agreement–not that global trade barriers had gone up. When US trade deficits rose in the early 2000s, the concern was that trade barriers had been reduced when China entered the World Trade Organization, not that global trade barriers had gone up.

More broadly, the the overall argument that the US has larger trade deficits than a half-century ago is because trade barriers around the world are higher than a half-century ago doesn’t pass a basic reality check. As any anti-globalization protester will be happy to tell you, the overall thrust of trade policy around the world in the last half-century has been toward reducing barriers to trade: the World Trade Organization, the US-Mexico-Canada Agreement (USMCA, offspring of NAFTA) and the other 13 “free trade agreements” the US has signed, along with any number of trade-encouraging treaties on issues from taxation to intellectual property.

So if tariffs (and other trade barriers) are not the cause of US trade deficits, what is the cause? If it’s not tariffs, what causes US deficits to rise and fall. The key point here (and this is a standard intro-econ argument, not a personal theory of mine) is that a trade deficit reflects a macroeconomic imbalance. Obstfeld goes through the argument in some theoretical detail. Here, let me illustrate the theory by offering some potential alternative (and partial) explanations changes in the US trade deficit that are unrelated to tariffs.

Here’s a first episode: Back in the 1980s, the federal government ran budget deficits which at the time looked quite large, and the US trade deficit also got larger. At the time, these were sometimes called the “twin deficits.” The intuition went like this: the buying power from the large budget deficits of the 1980s could in theory have gone to buying domestically produced goods, but in fact a lot of it went to buying imported goods. The high US budget deficits of the 1980s were thus a primary cause of the US trade deficits of that time

As a second episode, consider the sharp decline in the size of the US trade deficit around the time of the Great Recession of 2007-09. During a recession, household buying and investment decrease, and as part of that, imports also fall, which leads to a reduced trade deficit. (The recession of 1990-91 also helps to explain the pattern of a smaller trade deficit at that time.)

As a third episode, consider the larger trade deficits that the US economy experienced in the 1990s. This was during the “dot-com boom,” when investors all over the world were eager to put dollars into US-based information technology startups for this new thing called the World Wide Web. To put it another way, the rest of the world shifted to some extent at that time toward investing in the US economy, and to some extent away from buying US-produced goods and services.

Of course, each of these episodes is considerably more complex than my quick discussion here. But My hope is to illustrate that there are a variety of macroeconomic reasons why trade deficits rise and fall that have nothing to do with levels of tariffs in other countries, like surges of US government borrowing, US recessions, and surges of capital inflows from other countries. Conversely, one can also look at countries with consistent trade surpluses and find explanations in their patterns of domestic saving and borrowing, business cycles, and changes in flows of foreign capital. (And in addition, tariffs bring with them factors like retaliation from other countries and shifts in exchange rates that will greatly reduce any effect they can have on trade balance.)

Again, my point in this particular post is not to argue whether tariffs are good or bad. It is just to point out that tariffs are not the likely cause of US trade deficits, nor are they a likely answer. The US government is running enormous budget deficits, and like in the 1980s, the buying power of these deficits as they flow into the economy is keeping purchases of imports high–along with the trade deficit. This is one reason why Obstfeld writes: “U.S. trade deficits are high and likely to rise, notwithstanding new and prospective tariffs.”

Of course, it’s a lot easier politically to blame the unfairness of dastardly foreigners, rather than to get serious about the details of an agenda to reduce US budget deficits or to increase US productivity.

This post is already overlong, so I won’t seek here to spell out the arguments about when it is a good or a bad thing for a nation to have trade deficits or surpluses. The short answer is that trade deficits and surpluses can be good or bad for different nations at different times, and the subject has long been controversial among economists. For example, here’s a post of mine from back in 2012 laying out reasons for concern. Or back in 2008, the Journal of Economic Perspectives (where I work as Managing Editor) had a pro-and-con on the sustainability of US trade deficits with Richard Cooper and Martin Feldstein.

But it’s perhaps worth noting that trade surpluses are not necessarily a sign of economic success, and trade deficits are not necessarily a sign of economic failure. To cite just one prominent example, Japan’s economy has had trade surpluses for most o the last half-cnetury decades and also ultra-slow and near-stagnant growth since the early 1990s, while the US economy has had trade deficits and has been leading the high-income countries of the world in its growth rate.

More By This Author: