The writer is a senior fellow at the Peterson Institute for International Economics and formerly chief economist at the IMF
The Trump administration has embraced the view that the US is the victim of foreign trade surpluses, arguing that the world trading system has inflicted ills on society and tariffs are the remedy. However, tariffs alone will not reduce the trade deficit or restore manufacturing jobs. Even worse, tariff threats distract us from the true sources of America’s social problems and the policies that could help.
The balance of trade is not the defining feature of economic performance. For example, the US has run a current account trade deficit every year since 1982, while Germany and Japan have had surpluses — Germany since 2002 and Japan since 1981. And yet, the US consistently outpaces them in terms of growth. Measured in international dollars, real US GDP per capita grew on average by 1.8 per cent between 1980 and 2023. In Germany and Japan growth was 1.4 and 1.5 per cent respectively. These small differences add up over time. In 1980, US real income per head was roughly equal to Germany’s and 46 per cent higher than Japan’s; in 2023, it was 19 per cent higher than Germany’s and 61 per cent higher than Japan’s.
Of course, productivity does not automatically translate into happiness. Americans have good reason to be dissatisfied. Inequality has exploded; workers have lost good-paying jobs in manufacturing; real wages have stagnated and those without college degrees have lower life expectancies.
Fixing these ills would be a heavy lift for a tax on imports, even if supplemented by deregulation and tax breaks. But tariffs will not even have decisive effects on the trade balance and manufacturing employment.
The trade balance equals what an economy produces minus total spending on consumption and investment. It is therefore linked to manufacturing output and employment. This is not because importing more lowers GDP. Rather, when demand rises beyond output in an economy close to full employment, as in the US today, part of that higher demand is for non-tradeable goods. As supply expands to meet demand, production inputs including labour are drawn away from tradeable sectors like manufacturing. Demand for tradeable goods is thus satisfied by imports — the trade deficit grows and manufacturing shrinks.
Tariffs do not necessarily push the balance between income and spending in one direction or the other, which is why they don’t improve the trade balance or manufacturing employment.
Tariffs will cause the currency to strengthen, as we have seen in the dollar’s gyrations in response to levies threatened against imports from Mexico, Canada, China and now Europe. This both raises imports and harms exports. Tariffs also hurt exports by raising the prices of critical intermediate goods. The post-tariff trade balance will be little changed and possibly even lower. And if US spending beyond its income is roughly unaffected, the need to shift resources into services and import goods from abroad remains unchanged. Manufacturing employment will not expand.
Tariff talk distracts us from the appropriate economic policies to help America. Better targeted policies could include a more redistributive tax system, limits to corporate market power, further healthcare reform, and workforce development. The Trump administration is offering none of these.
It is true that the US has a big net liability to foreigners while Germany and Japan hold net foreign wealth. But more than half of those liabilities are portfolio equity or FDI investments that have helped to underwrite strong growth. Take the Nippon Steel equity stake in US Steel, which Trump himself has characterised as “very exciting”.
Some foreign debts can be attributed to “short-sighted” consumption. Borrowing temporarily palliates the challenges of lower-income households. US household debt, at 62 per cent of GDP at the end of 2024, is a disproportionate burden on the poor and is growing. The US federal government continues to live unsustainably beyond its means.
It is low national saving coupled with robust investment that drives the US external deficit. Serious action to curb the federal budget deficit would boost both the trade balance and manufacturing employment. This approach requires plans that reduce borrowing meaningfully while avoiding needless economic damage — not the chainsaw theatrics currently on display.
Those now in power in Washington see a powerful hammer in tariffs and the trade deficit is their biggest nail. But even if the hammer can drive the nail home — which is doubtful — America’s real problems will remain.