A Better Alternative to a Trade War

Abstract

Reducing the US-China trade deficit through the imposition of tariffs on Chinese exports to the US 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 US importers. Thus, while the US trade deficit with China falls, its trade deficit with other countries will rise. The overall US trade deficit with the rest of the world will not be significantly altered. Almost all economists agree that the aggregate US trade deficit with the rest of the world cannot be reduced without a corresponding reduction in the US investment-saving imbalance, taking the US real GDP as given. However, there is an exception: if there is an autonomous (unanticipated) increase in the demand for exports from the US which increases the real GDP of the US in the process, it is possible for the US trade deficit to be reduced. Indeed, a huge potential exists for the US 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”.