Trade Deficits Cost Jobs and Shrink GDP

The Trump Administration last week announced it would impose 10 percent tariffs on an additional $200 billion worth of Chinese goods—including many consumer goods that have been exempt until now. The rate would increase to 25 percent by year’s end. China responded by imposing new tariffs on $60 billion worth of American goods. Make no mistake: we are now in the midst of a tit-for-tat trade war.


It’s no secret that China has been, to quote President Trump, “ripping us off” for decades. Not only was our trade deficit with China $796 billion in 2017, our cumulative deficit since 1985 tops $5.2 trillion. Most of the imbalance occurred since 2001, when China joined the World Trade Organization.

Deficits aside, China is also a thief that steals some $400 billion worth of American intellectual property every year. This includes everything from trademarked corporate branding and copyrighted entertainment to precious military and industrial secrets. For example, China’s submersible fleet is the product of pilfered American technology, according to the written testimony of U.S. Navy Admiral Philip Davidson.

Unlike your garden-variety economist or Washington Post-reading dilettante, President Trump understands that economics isn’t just about wealth—it’s about power. There is truth in the aphorism “the rich get strong and the strong get rich.” As such, tariffs are not just economic shields, they are political swords: they impoverish and enrich, weaken, and empower. The case for tariffs is thus best made with recourse to realpolitik and national security.

Politics aside, free traders are also wrong on economic grounds. We hear it again-and-again: tariffs will cost American jobs and shrink our GDP. The pro-globalization noise is deafening, but it’s just that—noise. In reality, market asymmetries between America and many of its poorer trading partners (particularly China and Mexico) virtually guarantee trade deficits, which by definition destroy more jobs than they create and often diminish long-run economic growth.

Adios, America!
All economists acknowledge that trade deficits destroy jobs. The real question is whether trade deficits really do create more jobs than they destroy. Liberal economists think they do. I—and the preponderance of raw data—disagree. Take the North American Free Trade Agreement (NAFTA) for example.

In 1993, President Bill Clinton promised that NAFTA would create “a million [American] jobs in the first five years.” He also said NAFTA’s “side agreements” would “make it harder than it is today for businesses to relocate solely because of very low [Mexican] wages or lax environmental laws.”

Clinton was wrong.

America’s trade deficit with Mexico—which unequivocally was caused by NAFTA—displaces a net 840,000 American manufacturing jobs. How? Offshoring. Before NAFTA, tariffs protected American industries from asymmetrical Mexican competition by normalizing price externalities. That is, they raised the cost of Mexican goods to account for the fact that American goods were more expensive largely because American businesses were subject to higher labor, environmental, and quality standards. Tariffs basically penalized companies who moved abroad to avoid American laws. This regime resulted in balanced bilateral trade—America actually ran a modest trade surplus with Mexico in 1992.

NAFTA eliminated market barriers, forcing American workers to compete directly with far-cheaper Mexican workers. This created a powerful incentive to move American factories to Mexico—and move they did.

Lori Wallach, director of Public Citizen’s Global Trade Watch, estimates that NAFTA redistributed a net 840,000 American manufacturing jobs to Mexico. Meanwhile, the Economic Policy Institute estimated in 2013 that NAFTA displaced a net 700,000 American workers. Finally, U.S. Trade Representative Robert Lighthizer also noted in a press release that NAFTA cost the United States 700,000 jobs. Remember, these are net figures: they include the jobs NAFTA created by boosting American exports.

Not only does NAFTA displace at least 700,000 American manufacturing jobs, it also displaces a large number of service jobs. This is because manufacturing is an anchor industry upon which predicate industries depend. A factory is like an oil field or a mine; it brings wealth into a community and supports an ancillary service sector that otherwise would not exist. Hairdressers and accountants need factory workers and miners more than the reverse.

This concept is well understood. In fact, the Bureau of Economic Analysis estimates that each dollar of manufacturing output supports $1.48 in spinoff service output. Thus, one factory job supports roughly 1.5 other jobs. This multiplier effect is real, and not subject to Henry Hazlitt’s popular “broken windows fallacy” critique for the simple fact that factories don’t redistribute wealth, they generate it. Accounting for this means NAFTA likely costs America a net 1.7 million jobs.

The geographic concentration of unemployment in America’s industrial heartland—now known as the rustbelt—magnified the problems. Factory closures impoverished whole towns overnight, flooding the labor market with jobseekers. This tidal wave of unemployment reduced wages for transient employees and stagnated the wages of those with permanent positions.

The failure of NAFTA cannot be overstated: millions of Americans lost their jobs permanently, and millions more saw their wages stagnate or decline.

Unfortunately NAFTA by itself is not the problem—the problem is the whole idea of free trade between asymmetrical markets. Whenever America trades with a poorer country the inevitable trade deficit destroys more American jobs than it creates, simply because labor-intensive industries are those most-likely to move abroad. After all, they have the most to gain from lower wages.

Some economists do acknowledge this, but then turn around and suggest that it is good because it makes America’s economy more efficient. Maybe. But the economy doesn’t exist in a vacuum: people who lose their jobs are more likely to vote for social welfare programs that benefit them. This is what happened in the Midwest: once the Republican heartland, the region now votes reliably Democrat—or did, until Donald Trump.

My question: were the gains from free trade worth decades of socialist governments? I doubt it.

A (Smaller) Pie in the Sky
Trade deficits not only cost Americans jobs, they also decrease our GDP and hamstring our long-run economic growth. Trade deficits necessarily decrease gross domestic product because they displace domestic production abroad—production that otherwise would count towards GDP. This sounds tautological because it is.

Here’s how it works: GDP measures the value of all output produced within a country during a specified time period. For example, America’s GDP was $19.4 trillion in 2017. That’s how much we made. We consumed $796 billion more than we produced, however. How do we know this? Because that’s the value of our 2017 trade deficit. Assuming that consumption, not production, is the limiting economic factor then it becomes clear that the trade deficit actually decreased America’s GDP by $796 billion in 2017. Why? Because America would have needed to produce the value of this consumption in the absence of imports.

There is good reason to believe that consumption is the limiting factor by virtue of the fact that industrial production is subject to increasing returns, meaning that each additional unit of production decreases the average cost per unit. This implies that at a certain level of consumption the difference in price between American and Chinese manufacturing would disappear—the only reason Chinese goods are cheaper is because we (paradoxically) don’t consume enough to erase the price difference.

Likewise, Americans pay for the current trade deficit by selling assets and debts, which could just as easily be sold to American producers in a closed system. Never mind the fact that the Federal Reserve prints virtually unlimited money and American banks are more-than-willing to loan to Americans with bad credit. Americans consume as much as possible, and would do so no matter where the goods originated.

Because consumption is GDP’s limiting factor, it’s likely that GDP would rise to match America’s consumption in the event that tariff walls isolated our economy—as opposed to our consumption falling to match our production. Eliminating the trade deficit would (almost by definition) increase our GDP.

Some economists attempt to bypass this logic by arguing that the benefits of “cheap” imports increase America’s GDP more than the value of said imports. That is, the $796 billion trade deficit increases America’s GDP by more than $796 billion. This is objectively untrue for the simple fact that we don’t pay for the deficit with production—we trade assets and debt (which is literally non-production). Furthermore, the average American’s real income has actually decreased since 1973, meaning that most Americans are economically worse-off today than they were 45 years ago (better technology aside).

Lastly, the offshoring of America’s advanced industries undermines our long-run economic growth. Why? Because the invention and adoption of better technology is what generates growth, thus moving technology-generating industries abroad ipso facto diminishes growth.

The logic and data unequivocally agree: trade deficits destroy millions of American jobs and shrink our GDP, now and in the future. The economists lied.

Photo Credit: Lars Hagberg/AFP/Getty Images

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