Amid an ongoing trade war between the world’s two largest economies, reports emerged that China has offered to buy more U.S. products in the coming years to reduce the two countries’ bilateral goods trade imbalance.
Such a gesture may address one of President Donald Trump’s stated goals for U.S.-China trade negotiations, but experts say it’s addressing a metric that doesn’t matter very much.
That is, a bilateral trade balance — which measures the transactions between two countries — is an indicator that doesn’t adequately reveal who’s gaining or losing in a relationship, economists and trade experts said.
The arguments for and against relying on such metrics touch on multiple factors, but a frequently repeated view is that paying for goods does not automatically make the buyer a loser.
Pushan Dutt, an economics professor at business school INSEAD, put it this way: “If I pay my Pilates instructor every month for Pilates classes, then I run a ‘bilateral trade’ deficit. But that does not mean I am losing or that my instructor is winning in this relationship. After all, I am voluntarily paying for a service that I value.”
“A bilateral trade deficit is not a justification for a trade dispute.”
The U.S. has had a goods trade deficit with China — meaning a deficit for tangible products, as opposed to services — for the past 33 years, according to the Census Bureau, which only shows trade data between the two countries going back that far on its website.
And that imbalance has grown in a very big way.
The imbalance between the two countries’ flow of goods has grown from $6 million for the whole of 1985 to $301.37 billion in the first nine months of 2018, according to the Census Bureau. Trump has said that disparity is a sign the U.S. is being “ripped off,” and has used that to justify additional import tariffs on Chinese products. The resulting trade war has many experts warning of a drag down global growth.
Many have pointed out that Trump focuses only on the import and exports of goods, leaving out the services trade, which accounts for a larger share of the U.S. economy. Including services, the American bilateral deficit was only $275.02 billion in the first three quarters last year, data from the Census Bureau showed.
The trade-deficits-are-bad argument
Trump and his advisors have repeatedly argued that economic growth suffers when a country has a trade deficit. That is, when the total value of imports exceeds that of exports.
When Trump was campaigning for the 2016 election, advisors Peter Navarro and Wilbur Ross wrote in a paper outlining the candidate’s plan for the economy: “The growth in any nation’s gross domestic product (GDP) — and therefore its ability to create jobs and generate additional income and tax revenues — is driven by four factors: consumption growth, the growth in government spending, investment growth, and net exports.”
“When net exports are negative, that is, when a country runs a trade deficit by importing more than it exports, this subtracts from growth,” they added. Navarro is now a White House trade advisor, while Ross is commerce secretary.
And the view that trade deficits drag down growth is not relegated to the Trump administration.
For one, Michael Ivanovitch — a CNBC contributor who’s an independent analyst focusing on global economics, geopolitics and investment strategy — said the White House is not off base in pursuing a path to significantly reduce its trade deficit with China.
“Trade deficits mean that a country is spending more than it saves, and that it is increasing its indebtedness to the rest of the world,” he said, adding that significant and persistent deficits could ultimately “lead to a financial crisis” when the country runs out of lenders willing to fund that transfer.
Ivanovitch said trade imbalances are not always bad, but he told CNBC that the United States’ persistently large deficits have reduced the country’s economic growth by about 2 percentage points over the last five years.
In addition, a large portion of the United States’ overall goods trade deficit stems from imbalances with a small number of countries and economic blocs, added Ivanovitch, who formerly served as an economist with the Organisation for Economic Co-operation and Development (OECD) and the Federal Reserve Bank of New York.
China, Japan and a combined Europe accounted together for more than three-quarters of the $742.78 billion in Washington’s goods trade deficit from January to October last year. So, those particular “systemic and excessive” distortions can justify re-examining trade relations, he said.
“That is outrageous,” he told CNBC. “Trump is being incredibly gentle with those free riders on the U.S. economy. He should throw the kitchen sink at them, not just empty threats while they keep laughing all the way to the bank.”
Ivanovitch said surplus countries should be pushed to stimulate their domestic demand and widen market access to make it possible for deficit countries to sell more.
Other economists noted that trade imbalances could be symptomatic of one country seeking to cheat the international system. INSEAD’s Dutt told CNBC he does not consider bilateral trade deficits to be “a good starting point for negotiations,” but if an imbalance is caused by a nation breaking rules, then its actions are “fair game for negotiators.”
In the U.S.-China trade war, the Trump administration has accused China of “unfair” and “unreasonable” trade practices at the expense of American jobs and businesses, such as stealing intellectual property, forcing foreign companies to hand over their technology to their Chinese partners, and subsidizing Chinese industries.
Beijing, for its part, has repeatedly denied those charges.
Getting to the full picture
Many economists, however, have disputed the arguments made in the 2016 Navarro-Ross policy paper, arguing that the relationship between net exports and GDP is not so straightforward as a direct transfer of wealth out of the country.
Their argument is that the four factors that count toward GDP — consumption, government spending, investment, and net exports — are inter-connected in complicated ways. So, they say, simply turning net exports into a positive number may result in the other three factors going up or down — and not directly add to GDP.
The equation for gross domestic product:
GDP = Consumer Spending + Government Spending + Investment + (Exports – Imports)
In fact, economist Noah Smith argued in 2016 that the net exports portion of the gross domestic product calculation is “just to avoid bad accounting” and shouldn’t be understood as an independent factor influencing a country’s growth. Imports, he explained, are subtracted from the overall equation (see above) so as to prevent domestic spending on foreign-made products getting counted in the final sum, which is meant to tabulate a country’s production.
The argument, in other words, is that imports don’t detract from growth, they just don’t add to it, so economists should be determining how to boost production at home — not focusing on the trade number.
That’s part of why many economists and trade experts told CNBC they don’t usually study bilateral trade data on its own.
They said they prefer assessing countries’ overall import-export balances alongside other indicators such as government budgets, investment climates and savings rates. Doing that allows them to have a better idea whether an economy has a trade-related problem that needs fixing, the experts said.
“It’s possible that you can reduce the Chinese bilateral trade deficit but only by pushing the balloon in a certain way. It’s just going to pop up somewhere else, for example, the Vietnamese or the EU surpluses with the U.S. will increase. So, bilateral can change but not the overall.”
So, the fact that the U.S. has been running a combined goods and services trade deficit for much of the last 50 years does not immediately mean America has been hurt by its trading partners. Many economists also agree on the cause of that deficit: American consumers, businesses and governments have been spending more than the economy can produce.
“The productive capacity of the economy can’t meet consumption needs, so you have to import the difference,” said Simon Baptist, global chief economist at the Economist Intelligence Unit in Asia.
That means attempts to alter the U.S.-China bilateral trade balance — through tariffs, or by forcing Beijing to buy more American products — will do little to change the overall economic situation if consumption patterns stay the same, Baptist added.
“It’s possible that you can reduce the Chinese bilateral trade deficit but only by pushing the balloon in a certain way. It’s just going to pop up somewhere else, for example, the Vietnamese or the EU surpluses with the U.S. will increase. So, bilateral can change but not the overall,” he said.
So, many economists say, the way the situation needs to be tackled — if it needs to be addressed at all — is by looking at the way the American economy is consuming and producing, and not by pressuring specific trading partners to buy up more goods.
That’s the argument, anyway, if other countries are giving American products a fair chance to succeed in their own marketplace. Most analysts outside of China do agree, however, that Asia’s largest economy is limiting the success of foreign goods within its borders with artificial and systemic barriers — such as quota systems and steep tariffs.
That’s why many of the same economists and analysts who disagree with Trump’s focus on the trade deficit, still support his overall push to change how China treats international companies.
Even when drilling down on bilateral trade balances, economists caution that the data can mislead. For one, there are discrepancies in how countries measure and record goods that cross their borders, said Stefan Legge, an economics researcher and lecturer at the University of St. Gallen in Switzerland.
Citing trade data in 2017, Legge said China reported $430 billion worth of exports to the U.S. — but in America, $526 billion worth of Chinese imports were recorded. So, the total trade imbalance between the two countries that year was $275 billion based on Chinese data and $396 billion according to American statistics, he told CNBC.
“The difference is well known among trade economists and reflects the fact that imports are typically recorded more carefully than exports since they are potentially subject to import duties,” he said.
Modern, global supply chains complicate matters further. An iPhone sold to American consumers may be assembled in China and recorded by the U.S. wholly as a Chinese import — but many parts of the phone are actually made in other countries and then exported to China to put into the final product, Legge said.
One example is South Korean semiconductor chips sold to China to produce many consumer electronic products, he said. Those are not reflected in bilateral trade data between South Korea and the U.S., even though the final destination of those Korean chips is America, he explained.
Taking all those limitations into account, Legge said trade balances — if measured properly — would not be as large as what Trump has claimed.
“Hence, a bilateral trade deficit is not a justification for a trade dispute. It would be far better to understand the underlying causes of the trade deficit and explore whether some distortion — like an overvalued dollar — is in place,” he said.