NEW YORK (Project Syndicate[1]) — What was at first a trade skirmish — with U.S. President Donald Trump imposing tariffs on steel and aluminum — appears to be quickly morphing into a full-scale trade war with China.
If the truce agreed by Europe and the U.S. holds, the U.S. will be doing battle mainly with China, rather than the world (of course, the trade conflict with Canada and Mexico will continue to simmer, given U.S. demands that neither country can or should accept).
Beyond the true, but by now platitudinous, assertion that everyone will lose, what can we say about the possible outcomes of Trump’s trade war?
Trade deficit
First, macroeconomics always prevails: if the United States’ domestic investment continues to exceed its savings, it will have to import capital and have a large trade deficit. Worse, because of the tax cuts enacted at the end of last year, the U.S. fiscal deficit is reaching new records — recently projected to exceed $1 trillion by 2020[2] — which means that the trade deficit almost surely will increase, whatever the outcome of the trade war. The only way that won’t happen is if Trump leads the U.S. into a recession, with incomes declining so much that investment and imports plummet.
The “best” outcome of Trump’s narrow focus on the trade deficit with China would be improvement in the bilateral balance, matched by an increase of an equal amount in the deficit with some other country (or countries). The U.S. might sell more natural gas to China and buy fewer washing machines; but it will sell less natural gas to other countries and buy washing machines or something else from Thailand or another country that has avoided the irascible Trump’s wrath. But, because the U.S. interfered with the market, it will be paying more for its imports and getting less for its exports than otherwise would have been the case. In short, the best outcome means that the U.S. will be worse off than it is today.
National savings
The U.S. has a problem, but it’s not with China. It’s at home: America has been saving too little. Trump, like so many of his compatriots, is immensely shortsighted. If he had a whit of understanding of economics and a long-term vision, he would have done what he could to increase national savings. That would have reduced the multilateral trade deficit.
There are obvious quick fixes: China could buy more American oil and then sell it on to others. This would not make an iota of difference, beyond perhaps a slight increase in transaction costs. But Trump could trumpet that he had eliminated the bilateral trade deficit.
In fact, significantly reducing the bilateral trade deficit in a meaningful way will prove difficult. As demand for Chinese goods decreases, the renminbi’s exchange rate will weaken – even without any government intervention. This will...