President-elect Donald Trump’s plan to impose tariffs on all foreign goods relies on an economic theory that challenges traditional thinking about what causes chronic U.S. trade deficits and what can — or should — be done to shrink them.
The unconventional economic theory behind Trump’s sweeping tariff plans
A Wall Street veteran who teaches finance in Beijing has a contrarian view of the root cause of trade imbalances.
November 17, 2024
The standard explanation for the chronic deficit blames Americans for living beyond their means, by consuming more than they produce. The U.S. personal savings rate is less than half what it was in the early 1990s, and government budget deficits are much larger, lending support to that assessment.
But an alternative view, championed by Michael Pettis, a Wall Street veteran who teaches finance in Beijing, holds that industrial policies that generate trade surpluses in countries such as China are the root cause of U.S. deficits.
China and other export powers invest most of their surplus in U.S. Treasurys, stocks, bonds and real estate. That pushes up the value of the dollar, which makes U.S. exports more expensive for foreigners and makes imports cheaper for Americans, fueling the trade gap.
“The imbalances have become so great, just like in the 1930s and in the 1970s, it sort of generated this real rethinking about trade. There’s a growing recognition that much of what we’ve been saying in the last 20 to 30 years just doesn’t make sense,” Pettis, 66, said in an interview.
Pettis, who has been a financial adviser to the Mexican and South Korean governments, is the rare economic thinker to enjoy influence with both the Trump and Biden teams. Robert E. Lighthizer, Trump’s first-term trade chief, who is expected to join the new administration, quoted him approvingly in his 2023 book “No Trade Is Free” and has discussed trade policy with him. So has Biden’s trade negotiator, Katherine Tai.
Pettis debuted his argument in a 2013 book “The Great Rebalancing.” But his views are drawing fresh attention as China tries to export its way out of an economic slowdown, prompting fears of a second “China shock” akin to the surge of goods that hollowed out U.S. factory towns in the early 2000s.
The unbalanced global trading system that Pettis describes leaves its imprint on both China and the United States. Chinese households suffer lower living standards while exporters prosper and, in the United States, exporters struggle and consumers benefit.
“The U.S. imports China’s industrial policy, but the mirror image [of it]. So just as China forces consumers to subsidize producers, that means in the U.S., the balancing act is that producers subsidize consumers,” he said.
Pettis’s writings offer intellectual grounding for the new president’s plan to remake global trade by imposing the most comprehensive tariffs in nearly a century.
Kicking off his presidential campaign in 2023, Trump unveiled tariff and tax proposals that he said would “rebalance the global trading system.” Trump promised to apply 60 percent tariffs on imports from China while levying a 10 to 20 percent tax on goods from all other countries. The president-elect says making foreign goods more expensive will encourage greater domestic production in the United States.
But the new tariffs would cost a typical U.S. household between $1,700 and $2,600 per year, depending upon whether the universal import fee is pegged at 10 percent or 20 percent, according to an August study by economists Kimberly Clausing and Mary Lovely of the Peterson Institute for International Economics.
A universal tariff is one way to reduce the trade deficit, Pettis said. But he prefers imposing a tax on the foreign investment flows coming from nations that generate a surplus from their trade with the United States.
Because the U.S. dollar is the global reserve currency, preferred by foreign central banks and investors, the United States bears an especially large burden among the nations with a trade deficit, he said.
“What the U.S. needs to do is stop playing that role,” Pettis said.
Though some Trump allies have talked of taking steps to reduce the value of the dollar, such proposals are unlikely to be enacted, according to Brad Setser, a senior fellow at the Council on Foreign Relations. Discouraging inflows of foreign capital would hurt the value of U.S. stocks and raise the cost of borrowed money for home buyers and the federal government, potentially plunging the economy into recession.
“Capital account charges are unlikely to be on the table for obvious reasons,” he said.
The classic view of trade is that countries export goods to earn money to pay for their import needs. If each country specializes in goods in which it enjoys a comparative advantage over others, all trading nations can become better off, according to David Ricardo, a 19th-century economist.
But today’s trading system does not operate that way, according to Pettis. Instead, surplus countries such as China subsidize production of many items far beyond their domestic needs while discouraging consumers from spending more of their income rather than saving it.
China, which is on track this year to post a record overall merchandise trade surplus of nearly $1 trillion, employs several policies that effectively shift resources from households to manufacturers.
Beijing keeps interest rates low, making it hard for savers to earn, and forbids independent labor unions and collective bargaining, which could push wages up.
Meanwhile, the government makes low-cost loans available to manufacturers and steers free land and discounted energy supplies to favored industrial sectors.
The resulting merchandise and financial flows effectively siphon demand from the United States to China or — to put it another way — export unemployment from China to the United States, according to Pettis.
In response, deficit countries such as the United States are forced to increase household or government debt to keep the economy chugging, he said.
Though China is the most prominent example, several other countries typically run trade surpluses, including Germany, Japan, South Korea, Singapore and Taiwan. Likewise, deficits are posted by Canada, the United Kingdom and Australia, as well as the United States.
In a recent opinion piece in the Financial Times, Lighthizer, who served as Trump’s chief trade negotiator for all four years of his first term, listed three ways to reduce the yawning trade deficit: Require importers to purchase government certificates before bringing goods into the country; charge a fee on inbound investment; or impose import tariffs.
Trump imposed tariffs liberally during his first term, hitting products from China, Mexico, Canada and the European Union. Yet the overall trade deficit widened to $901.5 billion in 2020 from $792.4 billion in 2017, according to the Census Bureau. This year, the U.S. trade deficit is on track to exceed $1 trillion for the fourth consecutive year.
Pettis’s unconventional views have drawn fire from International Monetary Fund economists, who called them “incomplete at best.”
Domestic economic conditions in China and the United States — not Chinese industrial policies — largely determine trade outcomes, according to a recent blog post by Pierre-Olivier Gourinchas, the IMF’s chief economist, and three colleagues.
“External surpluses and deficits in both countries are mostly homegrown,” the IMF economists concluded.
Trump’s objections to China’s industrial policies, which have led to enormous production capacity in steel, cement, electronics and electric vehicles, are shared by the Biden administration.
China’s trade surplus relative to the size of its economy has dropped in recent years. But because the Chinese economy has grown so rapidly, the surplus remains large as a share of global output. Last month, one of U.S. Treasury Secretary Janet L. Yellen’s deputies echoed Pettis in criticizing China’s emphasis on exports.
“China’s not small anymore. It’s the second-largest economy in the world,” Jay Shambaugh, the Treasury Department’s undersecretary for international affairs, said at an Atlantic Council event. “And when it has policy shifts, they affect everybody else. In particular, if it doesn’t have enough domestic demand, that affects everybody else. And I think that’s where I find myself very much in line with the types of things Michael’s talked about, which is that it is important to see major economies drive enough demand internally, or they’re relying on somebody else for that demand.”
Some mainstream economists, however, say Pettis is peddling a superficially compelling analysis that could lead U.S. officials to drive the economy into a recession.
There is no reason that global trade needs to be balanced, said Maurice Obstfeld, an economics professor at the University of California at Berkeley who disagrees with Pettis.
“He exaggerates the extent to which the supposed woes of the U.S. economy are due to what China is doing,” said Obstfeld, who was the IMF’s chief economist from 2015 to 2018. “You can’t blame China for the U.S. deficit or for the decline in U.S. manufacturing.”
@davidjlynch