Why the Trade Arithmetic Favors China

Kaushik Basu, PhD.
Former Chief Economist of the World Bank and former Chief Economic Adviser to the Government of India

B.Zhou / Shutterstock.com

The biggest risks facing the world economy today stem from the escalating trade war between the United States and China. In the past few weeks, the threat has gained greater salience: As negotiations have stalled and tariffs have risen, markets around the world have registered tremors of concern. Yet most commentators fail to recognize the kind of effect an all-out clash would have on the U.S. economy, and on the world.

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It is true, as U.S. President Donald Trump has repeatedly pointed out, that his country runs a large trade deficit with China. In 2018, the U.S. exported goods worth $120.3 billion to China—a substantial amount, but dwarfed by the $539.5 billion of goods that it imported from China. And while firing the latest salvo on May 10, when the U.S. hiked tariffs on $200 billion worth of Chinese goods from 10 percent to 25 percent, Trump threatened to impose the same rate on virtually all imports from China. In retaliation, China imposed reciprocal tariffs on $60 billion worth of U.S. exports, scheduled to take effect on June 1.

No one doubts that China has historically flouted many of the global norms of trade and exchange-rate management. But trying to correct this now by raising tariffs on Chinese goods is futile. Worse, it would disproportionately harm the U.S.

Trump’s tariff policy is rooted in a fundamental misunderstanding of what bilateral trade deficits mean. Consider a simple example. I am now in Nuremberg. When the bus that brought me here stopped at a service area, I went into a store and bought snacks and coffee. Because the store bought nothing from me, I ran up a trade deficit with the store, and the store had a surplus with me. By Trump’s reasoning, I would have to rush back to the store, complain about this imbalance, and insist that the store now buy an equivalent amount from me.

If every country followed that logic, we would quickly return to a world of barter, and the quality of our lives would be vastly diminished. One reason the world is prosperous today is that countries can run a deficit with one trading partner and a surplus with another.

There are many issues on which the U.S. should take a strong stand toward China, not least over the latter’s silencing of its own ethnic and religious minorities. But raising tariffs should not be America’s instrument of choice, especially now that China has moved largely to a market-based exchange-rate system.


About the Author
Kaushik Basu, former Chief Economist of the World Bank and former Chief Economic Adviser to the Government of India, is Professor of Economics at Cornell University and Nonresident Senior Fellow at the Brookings Institution. *This article  was originally published by Project Syndicate.