Yes, The US Trade Deficit Is A Problem. But Not For The Reason You Think.

A debate over US trade deficits has been raging online, especially in the wake of the ongoing discourse about tariffs. Much of the conversation has focused on whether tariffs are a suitable tool for managing trade imbalances, with notable contributions from commentators like Oren Cass. In a recent article for The Atlantic, Cass defended tariffs on the grounds that unquantified benefits from domestic production justify some form of protectionism—a position that, he argues, addresses market failures often overlooked by mainstream economists. While I disagree with Cass’s conclusion, there is more to his argument than meets the eye, and many of his critics have gone off on tangents that miss the broader issue.

One of the most prominent—and, frankly, distracting—threads of criticism concerns the way MAGA advocates and others interpret the national income accounts. Many on social media have argued that protectionist supporters are making a mistake by believing that tariffs can boost GDP simply by reducing imports. It’s true that imports are subtracted from GDP, but this subtraction is merely an accounting adjustment to avoid double counting, as GDP accounts for domestic production only and some government spending, investment and consumption expenditures are spent on goods and services produced abroad. Taxing imports with tariffs will therefore not miraculously lead to higher GDP.

But focusing solely on this logical error (which may or may not be influential among MAGA proponents) is not a sufficient rebuttal to the real issues with the US trade deficit. In fact, many online commentators ignore a key problem at the heart of the debate, namely that the persistence of the US trade deficit is symptomatic of deeper structural issues in the economy. These issues are not easily remedied by tariffs, yet still deserve serious attention. In a way, MAGA supporters and Cass have a point: trade deficits can indeed be a problem. The critical question is why.

The Trade Deficit: Borrowing to Consume

A trade deficit, at its core, means that a country is importing more goods and services than it is exporting, effectively spending more than it is earning. From a national accounting perspective, this is akin to a household spending beyond its income. Imagine earning $100,000 a year while spending $120,000. The gap between income and spending must be financed through borrowing or by depleting savings.

There is nothing inherently wrong with borrowing. In many instances, borrowing can be productive. Consider a business owner who takes out a loan to buy new equipment that boosts productivity, leading to higher future income. Similarly, there have been times in the history of the United States when borrowing has led to significant economic growth. However, the current nature of US borrowing is less encouraging. When borrowing is used for consumption—analogous to taking out a loan for a vacation rather than investing in education or business expansion—it becomes problematic. The vacation offers no future return, so the loan must be repaid through other sources of income.

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This is where the US runs into trouble. The trade deficit is essentially the flip side of the financial account surplus. This means that foreign capital is flowing into the United States, largely in the form of investments in US Treasury bonds and other financial assets. These funds are used to finance federal government spending, which usually exceeds revenue, leading to large budget deficits. The trade deficit and the budget deficit are related—economists call this a “twin deficit.”

The nature of these twin deficits in this particular instance is that the US is borrowing not to invest in future growth but, in large part, to fund current consumption, much of which is driven by federal spending. This is the “bad” kind of borrowing, similar to borrowing for a vacation, and it underscores an underlying vulnerability in the US economy.

Why Tariffs Don’t Work

Given these dynamics, it’s tempting for policymakers to reach for simple, seemingly intuitive solutions—such as tariffs. The rationale is straightforward: if the country has a large trade deficit, simply make imports more expensive and reduce the volume. But this approach misses the bigger picture.

The evidence is clear that tariffs are not an effective means of reducing trade deficits. During the Trump administration, substantial tariffs were placed on a wide range of imported goods, with the explicit goal of reducing the trade imbalance. Yet, instead of shrinking, the trade deficit expanded. Part of this was due to the underlying macroeconomic environment, which included a significant increase in government spending and corresponding budget deficits. Tariffs may have reduced imports in certain sectors, but they did nothing to address the broader economic forces that were driving the trade deficit. In fact, tariffs often lead to retaliation, reducing exports, and ultimately worsening the balance of trade.

This points to a fundamental truth: trade deficits are not just about trade policy. They are about the broader economic context, particularly fiscal policy. As long as the US continues to run large budget deficits, financed in part by foreign capital, the trade deficit is unlikely to shrink in a meaningful way.

What’s the Solution?

If tariffs aren’t the answer, what can be done about the trade deficit? The most effective solution would be to address the root cause: excessive government spending. By reducing the budget deficit, the need for foreign capital inflows would diminish, and the trade deficit would likely follow. However, cutting government spending is easier said than done, especially in a political environment where both parties have shown a preference for fiscal expansion.

Another potential solution is to change the way foreign capital is utilized. Currently, much of the foreign capital flowing into the United States ends up in Treasury bonds, effectively financing government consumption. An alternative approach would be to channel these funds into productive investments. For example, the US could establish a sovereign wealth fund that invests capital in assets abroad, similar to the approach taken by countries like Norway. This would help ensure that the inflows are not only converted into outflows, but also used in a way that contributes to future income, rather than merely funding current consumption.

The Need for Nuance

The debate over trade deficits and tariffs is often framed in simplistic, binary terms: either trade deficits are harmless, or they are disastrous and must be addressed with protectionist measures. The reality is more complex. The MAGA movement is right to point out that persistent trade deficits can be a problem, but wrong in thinking that tariffs are the solution. Critics of this view, on the other hand, are wrong to dismiss the issue entirely, failing to recognize the broader macroeconomic imbalances at play.

What is needed is a more subtle understanding of the current U.S. trade deficit—one that recognizes it as a symptom of deeper fiscal imbalances rather than a problem that can be solved through trade policy alone. Addressing the trade deficit will require addressing the budget deficit, reducing excessive consumption, and finding ways to channel foreign capital into productive investments. Until then, we are likely to see the same mistakes repeated, with neither side of the debate fully grappling with the real issues at hand.