Blog Post by Scott Kennedy and Ryan Featherston [See charts and graphs at URL]
Published April 15, 2025
The Trump administration appears to have given up its fantastical effort to fully remake the international trade order. Although 10% tariffs versus almost everyone and 145% tariffs against China are still in place, the administration has for the time put aside the revolutionary notion of substituting reciprocal tariffs negotiated country-by-country with basing trade in commonly applied tariffs and making modest adjustments, lower or higher, in exceptional circumstances. That said, the administration is still absolutely fixated on bilateral trade deficits – that they inherently represent a deadweight loss (despite U.S. companies and households receiving goods and services in return) and that those countries with surpluses are by definition scofflaws who are guilty of steeling American manufacturing capabilities, jobs, and wealth.
The original reciprocal tariffs announced on Liberation Day were based on a formula designed to impose a tariff that would result in eliminating trading partners’ surpluses and achieving balanced trade. According to the New York Times, this option was chosen over one proposed by the U.S. Trade Representative’ Office that combined the countries’ actual tariffs and an estimate of the tariff-equivalent value of their non-tariff barriers. The basic reason the former option was chosen is that this formula, despite its lack of connection to any supposed harm caused to the United States, would result in higher tariffs, which would create more shock and awe and increase American leverage in any negotiations. Unfortunately, from the administration’s perspective it was financial markets, not trading partners, who were shocked and lost their composure, or as the President said, got “a little yippy.”
A central problem with the Trump administration’s approach is not which formula to use, but the administration’s general allergy to bilateral trade deficits in the first place. Yes, a persistent global trade deficit may be concerning, and the U.S.’s long-term trade deficit in goods suggests it should find a way to reduce the overall gap between consumption and domestic production, but this is not a near-term problem as long as the U.S.’s overall economic health is solid and investors believe that holding American government debt is risk-free.
We offer a few thoughts – and data – to demonstrate why this infatuation with bilateral deficits is misplaced. On that basis we conclude with some suggestions about how better to approach trade policy.
Bilateral trade balances are the product of a combination of factors. Besides trade barriers, macro-economic circumstances, changing investment patterns, and relative comparative advantage also matter a great deal. Trade deficits go up and down; when they rise, that may be because a country’s business cycle is on the upswing and consumption generally is rising or because demand in a particular product from a particular country rises. When they go down, it very well may be that circumstances are reversed. The likelihood that they rise and fall as barriers rise and fall is less likely.
The U.S.’s deficit with China over the last 30 years has risen substantially (see Figure 1). There’s no exact math to say how much of this has been the product of reasonable economic forces and how much the result of unfair Chinese industrial policy and protectionism. China certainly has engaged in import substitution, which accounts for the growth in its imports consistently being lower than its rise in exports. At the same time, a significant portion of China’s rising exports is likely due to the shift in manufacturing investment from the U.S., Taiwan, South Korea, and elsewhere to China in the 2000s, which translated into production and exports to the U.S. entirely going into China’s trading column. Over the last 6 years, the U.S.’s trade deficit in goods has declined, but this is not because China has become more open; it’s more likely the result of slower economic growth (because of the pandemic and its lingering effects and a decline in two-way overall trade, not a reduction in the distorting effects of China’s non-market economic practices, which actually may have intensified in recent years).
If the U.S. government is fixated on trade balances, then perhaps it would be willing to admit that its own persistent trade surpluses with several countries indicate its unfair practices. As Figure 2 shows, over the past 5 years, the U.S. has had a consistent trade surplus with 10 countries, totaling $675.78 billion over that period. If the Trump administration’s logic holds, these countries should be livid that the U.S. supposedly has ripped them off for so long, and if so, they would have the right to similarly penalize the United States. I doubt we’ll see U.S. Trade Representative Jamieson Greer make any such admission or Treasury Secretary Scott Bessent cut checks to these countries for these amounts. In fact, the administration imposed tariffs on all of these countries, despite the U.S. having a surplus with each of them. And, of course, the U.S. would be right to object, because the U.S.’s surpluses are most likely the product of America’s comparative advantage in various goods, not protectionism. The same goes for most of the trade surpluses others have with the United States.
If one wants to emphasize trade balances, one should not focus on only trade in goods but instead also consider the impact of services. The combination of the two is closer to what is known as the “current account” balance. Services include: tourism, education, logistics, royalties and licensing fees, financial services, and other business services. The U.S. has long had a sizeable global trade surplus in services (Figure 3), and it also has a large surplus in services with China (Figure 4). The U.S. government, including both the executive and Congress, may call attention to the trade balance in goods, and not services, because its persistent deficit in goods makes the U.S. appear to be the victim for which other countries need to provide compensation. But in terms of the effect on the American economy, services are critically important. As of March 2025, the U.S. had 12.76 million people working in manufacturing, but over ten times that number, 161.31 million, working in services.
A more complete picture of the bilateral economic relationship would also take into account sales of American companies in the target countries. As of 2022 the U.S. has 1,961 majority-owned foreign affiliates operating in China. Over the 13 years from 2010 through 2022, they sold a total of $4.39 trillion in goods and services in China, with the amount reaching $490.52 billion in 2022 alone (see Figure 5). If one also were to include firms in which a U.S. entity has a minority stake, their sales in 2022 were $617.12 billion. Meanwhile, in the same year, Chinese firms in the U.S. sold a total of $78.64 billion.
If we combine these insights, the picture of the U.S.’s commercial relationship with China looks different from the typical interpretation (see Figure 6). While the U.S. has had a persistent deficit in goods, it has had a substantial surplus in services trade, and an even bigger advantage when it comes to firms’ on-the-ground sales.
What the U.S. Should and Should Not Do?
Given that the U.S.’s international economic relationships are not captured in goods trade, governments and analysts would all do well to ignore bilateral trade balances in goods. Deficits aren’t necessarily proof of unfairness; conversely, surpluses are not proof of “winning.” If one just can’t take their eyes off of balances, then look at the balances for goods and services. Services are a much larger share of the American economy, and their rise and fall has an even larger effect on the country’s employment and growth.
This critique on trade balances is by no means meant to give China a pass. As noted above, China’s non-market economic policies and practices have grown, not shrunk, even as the bilateral deficit has gone down in the past six years. The deficit is not a synonym for unfair trade and a focus on reducing it will not eliminate unfair behaviors and distortions. In fact, reducing the trade deficit was a large motivation behind the Phase One Agreement, which with its focus on Chinese purchases of U.S. goods failed to resolve more fundamental problems in China’s economic governance that pose challenges for the rest of the world. Instead of the trade balance, attention should be focused on specific measurable signs of unfair behavior and their direct consequences on the well-being of American firms and households, including: excessive and distorting industrial policy spending, blocked market access, abnormally low market shares across sectors in China and third markets, built-up inventories and depressed prices, intellectual property theft, abnormally low licensing and royalty payments, and falling profitability.
Policies should then be crafted to tackle these more direct metrics. The U.S. has a variety of robust tools to deal with unfair trade practices and industrial policy, including antidumping tariffs, countervailing duties, and safeguards. The last, safeguards, could be utilized far more than they have to date. As Chinese firms grow and their market share beyond China grows, the U.S. could also make greater use of antitrust policy. In addition to acting on its own, history has shown that acting collectively, in concert with others who are suffering from the same unfair practices, is central to successfully constraining Chinese misbehavior. Japan, South Korea, the European Union, and increasingly many countries in the developing world are feeling the negative effects of a huge jump in Chinese exports in manufactured goods and its other non-market practices. Joint defenses, informal and formal, would reduce China’s ability to circumvent American restrictions and help restore some discipline to the international trading system.
Not only should the U.S. play smart defense, it also needs to play more aggressive offense, fostering the domestic environment for strengthening its economic foundations, but also promoting exports of goods and services, and reducing barriers to outbound investment (which typically generates further employment and production opportunities at home). As the data above suggest, as important as manufacturing is, the U.S. should continue to strengthen its advantages in services. One critical services “export” is overseas students studying in American colleges and universities. They contribute to research in science and technology fields in labs, which boosts the U.S.’s competitiveness in key industries of the future, from artificial intelligence to quantum to biotechnology.
Finally, many of the commercial challenges the U.S. and others face with China are not issues of fairness, but are the product of having major differences on national security. These “economic security” problems – transfer of advanced dual-use technologies, over-dependence on China for inputs and markets, vulnerabilities to critical infrastructure, economic coercion, etc. – cannot be addressed by a focus on the trade balance or through typical fair-trade mechanisms. Instead, they must be addressed through more appropriate tools, including export controls, investment screening, and stockpiling of critical inputs. The last few U.S. administrations have substantially built up these tools. That said, such tools also require the buy-in and cooperation of America’s allies, as semiconductor controls have demonstrated. Policymakers need to be sure they strike the right balance by doing whatever is necessary to protect America’s national security while also doing so in a way that minimizes the disruption to trade and commerce. If this balance is not struck, the U.S. will be trading one set of problems for another.
Related Trustee Chair Activity
Scott Kennedy, “Why Beijing Thinks It Can Beat Trump,” Foreign Policy, April 10, 2025.
Scott Kennedy, Ilaria Mazzocco, and Ryan Featherston, “China and the Impact of ‘Liberation Day’ Tariffs,” CSIS Critical Questions, April 4, 2025.
Scott Kennedy, “The United States’ Illiberal Turn Recasts a Potential Deal with China,” CSIS Commentary, March 13, 2025.
Scott Kennedy, “Markets Are Underpricing the Possibility of a U.S.-China Economic War,” Foreign Policy, October 31, 2024.