Trump Gets Trade Balance Wrong, Very Wrong

06/02/2017 03:25 EDT | Updated 06/02/2017 04:22 EDT

During the recent G7 Summit in Sicily, U.S. President Donald Trump called Germany "bad, very bad" because of its strong car exports to the USA. German Chancellor Angela Merkel responded by saying that Mr. Trump criticizing her country's trade surplus was "inappropriate."

Who's right here? Let's try to understand the problem.

A trade surplus happens when a country exports (sells to other countries) more than it imports (buys from other countries). A country has a trade deficit when the opposite happens, i.e., it imports more than it exports. Currently, Germany is running a trade surplus with the rest of the world, whereas the United States has a trade deficit.

However, Mr. Trump seems preoccupied by something more precise than global trade balances: the trade deficit or surplus between two specific countries, Germany and the USA. Here, Mr. Trump is definitely wrong.

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Germany's Chancellor Angela Merkel and U.S. President Donald Trump hold a joint news conference in the East Room of the White House in Washington D.C. March 17, 2017. (Photo: Jonathan Ernst/Reuters)

Let's try to understand, by taking the case of Carol, a person who works for someone else and sells her services for a wage. She buys from other people the food, clothes, and most of the rest of the goods and services that make up the total of her consumption. Carol is certainly interested in the level of her total spending (her imports) compared to her income (which she earns from her exports of services). But she has absolutely no reason to be annoyed by a possible trade deficit with individual partners.

Let's be clear: you don't care, nor should you, if you run a deficit with your dentist (you buy more from her than she buys from you) or a surplus with your employer, who buys more from you than you buy from him. What is really important is your overall trade balance, i.e., the fact that you spend more or less than your income.

For a country such as the United States, being preoccupied by a trade deficit with Germany specifically makes no more sense than a person being scared by her deficit with a specific merchant. Here, I believe we can say without a doubt that the score is 1-0 for Ms. Merkel.

[Mr. Trump] should look for ways of eliminating the federal budget deficit rather than turning to protectionism.

The larger question of a country's global trade surplus or deficit is also a topic that seems to preoccupy Mr. Trump. However, the overall trade balance of a country is a very different question from a specific bilateral trade balance, and as such merits a more nuanced discussion.

Let's go back to Carol, who works for an employer and buys from other people the goods and services she consumes. Her global balance of trade depends on whether she spends more or less than her income. In the same way, a country's global trade balance depends on whether it spends (imports) more or less than its revenue (from exports). A trade deficit means that a country is spending more than its revenue; a trade surplus means that a country is spending less than its revenue.

So Germany has a global trade surplus for a simple reason: its citizens and government are running a budget surplus. Mr. Trump's America has a trade deficit with the rest of the world because its citizens and government collectively spend more than their revenue. In the United States, it is the federal government that is responsible for this situation, as it has an annual deficit of more than three per cent of the GDP. In other words, even if the American public spends less than its income, the government does the opposite. The overall result in the U.S. is a deficit of revenue overspending and a trade deficit.

The global trade balance of a country has little to do with whether other countries are acting fairly or not. Rather, it's the level of revenues versus spending (including the government) that counts. If Mr. Trump wants to eliminate the American global trade deficit, he should look for ways of eliminating the federal budget deficit rather than turning to protectionism.

2-0 for Ms. Merkel.

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