Trade Deficits and Tariffs: A Deeper Dive

Shipping containers at a port. — *Image from Unsplash courtesy of* *Yoav Aziz.*

To understand America’s trade deficit, it helps to review some basic economics. We think about trade as a balance: I buy $1,000 worth of goods from you, and you buy $1,000 worth of goods from me. In this scenario, we have a trade balance. However, trade deficits occur when one trading partner doesn’t buy an equal amount. For example, if you only buy $500 from me, but I still buy $1,000 from you, then I have a $500 trade deficit and you have a $500 trade balance. That can feel unfair.

Now consider another scenario: buy $1,000 from you and you only buy $500 from me. I still have that pesky $500 deficit. But what if someone else buys $500 from me and I buy nothing from them? I now have a surplus with my new trading partner, even though I still have a trade deficit with you. At a global scale, trade balances become increasingly complex.

The Role of Economic Disparities in Trade Deficits

Trade imbalances get even more complicated when one trading partner is much wealthier than the other. For instance, if I am willing and able to spend $10,000, but you still only have $1,000 to spend, it's likely that I will buy more from you than you do from me over time. This dynamic explains much of America’s trade deficit with China - and, in fact, the entire world. The U.S. is the world’s largest economy and we spend the most money.

The U.S. has significantly higher average annual consumer expenditure than China (approximately 21 times higher), and China has a much larger consumer base (approximately 363 million more consumers). Despite the lower average spending per consumer, China's total consumer expenditure is still substantial, reaching 77% of the U.S. total consumer expenditure. However, the U.S. total consumer expenditure is still $2.1 trillion higher than China's.

Graph listing consumer expenditures for the US and China. — *Source: U.S. Bureau of Labor Statistics and World Bank*

China's GDP has experienced remarkable exponential growth since the 1960s while the U.S. GDP has grown at a steadier pace. However, because the U.S. economy in 1960 was more than nine times larger than China's, it remains $9.9 trillion larger today.

Graph of GDP in US and China in current USD-billions. — *Source: World Bank*

To put that into perspective, the U.S. economy is nearly as large as the combined GDP of Germany ($4.9T) and Japan ($4.4T), the world’s third and fourth largest economies, respectively. Closer to home, it's roughly 2.5 times California’s GDP ($3.9T).

Graph showing the top 8 economies vs. the US. — *Source: International Monetary Fund*

The vast size of the U.S. economy compared to others makes it unrealistic to expect a dollar-for-dollar trade balance with every country.

The Role of Tariffs in Trade

While trade imbalances can arise naturally, some countries engage in unfair practices, such as subsidizing their goods to make them cheaper than domestic products. In these cases, tariffs can help offset the advantages those countries gain by equalizing prices. However, tariffs aren’t always necessary, as subsidies are often an unsustainable tax on the subsidizing country’s economy in the long run.

The situation gets even more complex when considering not just prices but also the quality of goods. If products are cheaper (naturally or through subsidy) but lower quality, consumers must decide whether to pay less for low-quality goods or pay more for higher-quality goods. This is a hallmark of a free market system. Tariffs, however, distort the market and harm consumers.

If the goods are cheaper and higher quality, this reflects a free market condition called competitive advantage. In such cases, tariffs reduce market efficiency, harm consumers, and in the long run, make domestic goods less competitive. Rather than being a long-term solution, tariffs can act as a crutch that weakens the competitiveness of American products.

With all the changes happening at the federal level, we’re focused on ways we can help communities adjust to shifting market dynamics, including providing data-driven insights and context to current events. What questions are on your mind? What resources would be most valuable right now? Reach out today.