Trading Deficits- Free Trade Math & Deficit Myth

Much has been made as sundry populists have rushed to the President’s side in defense of tariffs about the trade deficits the US is purportedly running with other nations. I have good news. There are no trade deficits. Never have been. Never will be. I’m here to help you understand why.

First, imagine your neighbor is having a garage sale. He has a leaf blower marked at $15. You give him $15, and he gives you the leaf blower. Is there a trade deficit created here? Your garage has become glutted with cheap, used leaf blowing goods. Your neighbor has purchased nothing from you. Nope, no trade deficit here. The trade was in one sense perfectly equal, and in another sense was net gain for you and your neighbor.

It’s equal because before the trade you had fifteen dollars and your neighbor had a used leaf blower. After it’s over, you had a used leaf blower and your neighbor has fifteen dollars. There was no deficit before the trade; there is none after. That said, when you had $15 on your ledger and no used leaf blower, and your neighbor had a used leaf blower. You valued the leaf blower more than the $15, or else you wouldn’t have made the trade. He valued the $15 more than the leaf blower, or he wouldn’t have made the trade. Both sides profit.

Second, now imagine the same scenario, but with the border between the United States and Canada running between your house and your neighbor’s house. Has anything changed? Does that line create a deficit? Of course not.

Ah, but what if the Canadian government imposed a tariff? Suppose your neighbor says, “Sorry, neighbor, but my government insists that you pay them $5 before you can buy my leaf blower for $15.” Now if you want the leaf blower it will cost you $20. The question is, would you rather have the leaf blower, or your $20? If you’d rather have the leaf blower, you’ll give the $20. If not, no trade happens.

Suppose you make the purchase. Has this created a deficit? No. The same principles apply. You traded your $20 for the leaf blower. You profited from the deal. You valued the leaf blower more than the $20. On the other side your neighbor has the $15 he valued more than the leaf blower, and the protection racket known as the Canadian government has its $5. But still no trade deficit.

Hang with me now. Suppose you have a used fondue set in your garage. Your neighbor spies it, and says, “Hey, would you take $15 for your fondue set?” You’d rather have $15 than the fondue set, so you say yes. But, before the deal can happen, sirens start ringing and US Customs screeches on to the scene. “Stop right there. We can’t have trade deficits with Canada. We’ve imposed reciprocal tariffs. We’re taking $5 out of this deal.”

You now have a choice. Do you take $10 for the fondue set and give the other $5 to Uncle Sam, or do you demand $20 for the fondue set so you get your $15 and Uncle Sam gets his vig? Suppose your neighbor says, “Yeah, $20 is too much for me for a used fondue set. Never mind.”

You have either lost the deal or, you have lost $5 on the deal. All because, supposedly, there was this mythical trade deficit. The glory of economics is you can take the same principle and multiply by a trillion and nothing changes. Neighbor to neighbor or nation to nation, it’s all the same.

Note too that while everyone is better off if neither side has to pay tariffs, the citizens of the nation that doesn’t impose the tariff is better off either way than the one in the nation that does impose the tariff. Tariffs, used by 170 countries are not used because it’s good for the citizens of those countries. They are used for the same reason taxes are used by every country, to enrich those in political power.

If you want to defend tariffs, you’ll need something other than “trade deficits” to do it. But I wouldn’t spend too long looking for another defense. Because there isn’t one.