A Better Alternative to a Trade War

Abstract

Reducing the U.S.-China trade deficit through the imposition of tariffs on Chinese exports to the U.S. risks retaliatory tariffs by China. The net result may be an involuntary reduction of trade between them, which lowers the aggregate welfare in both countries. It will be lose-lose. Moreover, the most likely net outcome of these new country-specific tariffs is the substitution of imports from China by imports from other countries on the part of U.S. importers. Thus, while the U.S. trade deficit with China falls, its trade deficit with other countries will rise. The overall U.S. trade deficit with the rest of the world will not be significantly altered. Almost all economists agree that the aggregate U.S. trade deficit with the rest of the world cannot be reduced without a corresponding reduction in the U.S. investmentsaving imbalance, taking the U.S. real GDP as given. However, there is an exception: if there is an autonomous (unanticipated) increase in the demand for exports from the U.S. which increases the real GDP of the U.S. in the process, it is possible for the U.S. trade deficit to be reduced. Indeed, huge potential exists for the U.S. to substantially increase its exports of agricultural commodities, energy, and education and tourism services to China. Finally, we address the question of what constitutes “fair trade”. There does not seem to be a generally accepted economic definition of “fairness”. Any completely voluntary and non-coercive trade at the prevailing market price should be regarded as “fair”.