Mind the Trade Gap

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Donald TRUMP: We have almost an 800 billion dollar a year trade deficit...

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Donald TRUMP: In short, chronic trade deficits are no longer merely an economic problem, they are a national emergency that threatens our security...

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Donald TRUMP: We’re the piggy bank that they just keep taking, they take our jobs, they take our money, they don’t respect us...

No one hears the word deficit and thinks - oh that must be a good thing, I’d like one of those! Especially not anyone who has been listening to Trump discuss the United States deficit over the course of his second term as president.

The trade deficit is a key part of what's driving Trump’s global push for reciprocal tariffs on U.S. trading partners. And while economists disagree about how much deficits matter there has been more discussion about solutions, from bringing back jobs from overseas, to producing more goods to export, to reforming the tax code for big U.S. corporations operating abroad.

But of course, as with most things in international relations, the truth of it all is far more complicated. And the solutions have little to do with making enemies of our trading partners.

I’m Gabrielle Sierra and this is Why It Matters. Today, we’re talking about the trade deficit.

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The Simpsons: The trading gap shuffle, we’re in a heap of trouble. Doing the trading gap shuffle. Yes, sir!

He already sang this song.

No, that was about the budget gap. This is the trading gap...

Gabrielle SIERRA: So, is a trade deficit necessarily a bad thing?

Brad W. SETSER: No, it's not necessarily a bad thing. A fast-growing country that is investing a lot, and wants to live well while it's investing a lot because it's optimistic about its future and thinks it's going to have more income in the future, will reasonably run a trade deficit and import some savings from the rest of the world so that it can invest more.

This is Brad Setser. He is a senior fellow for CFR, focusing on global trade and capital flows. He has served as a senior advisor to the U.S. Trade Representative and as the deputy assistant secretary for international economic analysis in the U.S. Treasury. In short, he has spent a lot of time thinking about the trade deficit. 

SETSER: So there are certainly times when a trade deficit makes some economic sense. I think there are more risks when a trade deficit is associated with a high level of consumption or a high level of public spending rather than a high level of investment; and there are risks when a trade deficit lasts for a very long time because deficits by their nature have to be financed. But not every deficit is bad.

It’s probably not a surprise to hear this, but just like Madonna said...

We are living in a material world, and we’re importing most of it.

Currently, the trade deficit in the United States is the largest in the world, standing at $1.2 trillion at the end of 2024. But this has been the case for decades, and ever since U.S. manufacturing moved overseas, American consumers began spending more of their income on imported goods.

SIERRA: How would you explain the politics of the trade deficit to everyday Americans?

Heather HURLBURT: So you have two really different camps on this, and one camp says the trade deficit is like your family budget. 

This is Heather Hurlburt. She’s an associate fellow at Chatham House, a think tank based in London, and most recently served as Chief of Staff to former U.S. Trade Representative Katherine Tai.

HURLBURT: And you, a country can't spend more than you have. You shouldn't spend more than you have. So you shouldn't be buying more dolls than you earn money just to take something that was in the news recently. 

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Donald TRUMP: Maybe the children will have 2 dolls instead of 30 dolls, you know? And maybe the 2 dolls will cost a couple more bucks than they would normally.

HURLBURT: There is another way of thinking about it that says actually households are households and major continental powers with every kind of asset and every kind of need you can imagine are not households. And so it makes complete sense for us to run deficits in some areas and run surpluses in others. And some of it frankly even takes on a moral aspect in American culture. So one way of thinking about it is - trade deficits represent jobs flowing out of the U.S. and being taken away from Americans who want to do them. Another way of thinking about it is - trade deficits represent a kind of moral failing in our addiction or excessive addiction to stuff and to buying lots of cheap stuff from overseas. You know, your grandparents make do without 50 dolls and without plastic decor for every holiday. So you could make do without those things too. And then the third way of thinking about them is - trade deficits are just an economic artifact and they have no meaning in and of themselves. They're just one measure within a complex global economy in which you also have to take into account services and currency transactions.

SIERRA: So then why the big fuss? It just feels like there's been alarm bells ringing all the time lately about this?

HURLBURT: So for years, this view that the trade deficits had to balance out or that manufacturing trade had to balance out was kind of a fringe viewpoint. 

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Ross PEROT: If you want to get down to brass tax, first thing you ought to do is get all these folks who’ve got these one way trade agreements we’ve negotiated over the years and say fellas we’ll take the same deal we gave you. 

HURLBURT: It had been shoved to the side in the post-Cold War globalization. Again, the U.S. dollar can be everybody else's currency and there's so much demand for that that there was much less concern over trade deficits. But President Trump has brought back to power folks who see that as much more centrally important. So what really changed in the conversation is the politics and the politics are now driving changes in the economics rather than the other way around.

SIERRA: I see. So you would definitely say the nuance is missing from this conversation.

HURLBURT: This is just a terrible age for nuance. Nuance is following satire into the grave is what I would say about this topic.

SIERRA: That's a great way, a great and depressing way to put it. What do you see missing from how policy officials are talking about the deficit?

HURLBURT: So the thing that I think makes the solution so hard is that when we say trade, the actual exchange of goods and services between nations is kind of the least of what we're talking about. And we're talking a lot more about how Americans earn their livings, number one, and how deeply enmeshed we are with other countries, number two. And both of those are bigger, more complex, challenging phenomena than tariffs. And so tariffs, I mean, the president loves tariffs because they're easy to use and easy to understand, but really somewhat tragically, they don't, at the end of the day, get at the problems that we're trying to get at.

SETSER: Look, President Trump just likes tariffs.

SIERRA: Most beautiful word in the English language...

SETSER: I think he may like tariffs more than he cares about the trade deficit. I mean, he's articulated a bunch of different reasons why he likes tariffs. But certainly one of them is that he worries a lot about trade deficits in general - doesn't like them, he thinks they're evidence of unfairness. He thinks fair trade is balanced trade. And then he tends to think any bilateral deficit is evidence of unfairness on the part of our trading partners. Now, most economists would say bilateral trade deficits reflect a lot of different things and are a very unreliable gauge of whether trade is unfair. But for President Trump, any bilateral imbalance is, in his personal view, evidence of unfairness, and he's introduced tariffs that are based on that principle. There's not a lot of merit in putting tariffs on countries which have surpluses just with us. There are countries that run surpluses with us simply because they're too poor to afford our goods. We're rich. We sell the kind of goods that other rich countries want to buy, as a general matter. There are countries that run surpluses with us where the surplus is a reflection of a broader problem. I would say that's the case with China. I would actually say that's the case with Ireland, which is tied to tax, not so much trade. But as a general matter, putting tariffs on a country as a function of its bilateral surplus with the U.S., our bilateral deficit with them is a bad policy, in my view, and in the view of most economists.

HURLBURT: At some level, you do sometimes get the sense with President Trump that it is all about who has more and who has less. And anytime you can document that the U.S. has less and someone else has more, that might mean that we're being taken advantage of. That might mean we're being played for a sucker. There's kind of a lot of just fantasy around. I mean, trade deficits have been very stubborn under both Republican and democratic presidents because it is much cheaper to make some things in other parts of the world where folks have much lower living standards and where folks earn less money and have frankly fewer job protections, health and safety protections, and that you can get at some of that with tariffs, but not all of it. It's very unlikely that you're going to move all of those things back here. And so we actually have an environment where neither the folks who care about trade deficits as an economic matter nor folks who genuinely want to move manufacturing back here are able to have a realistic conversation about what kinds of manufacturing can we move back here? What would it look like if we said, "Okay, high-end or very technically intense manufacturing, we can move back here." Again, like dolls and pencils and some of the things that have been cited recently, unlikely. Also, many, many high-end manufacturing jobs are now done by robots and require quite a bit of technical skills. So if you want to create better jobs for Americans, you have to twin anything you're doing in the tariff space with investment in education, investment in tech training, incentives for factories to come and set up in a community and a stable environment. And right now, education, training, stable economic environment. We're kind of going the wrong way on all of those things. And the people who actually want the jobs, who want to live in their communities and have jobs that feel good and meaningful to them in their communities, they get left out of all of this at the end.

SIERRA: When does having a trade deficit become something that is harmful to a country's economy?

SETSER: A trade deficit becomes a real problem first when it gets to be too big. Very few countries run trade deficits over 5 percent of GDP because that's just too big. And a trade deficit is clearly a problem if it corresponds to a boom in consumption, a lot of public borrowing, and not a boom in investment. And then finally; this gets kind of technical, but it's important; trade deficits are much more problematic when a country has to borrow in some other country's currency. So the U.S. can run bigger trade deficits than poorer countries because we can borrow in dollars. So I think it's a function of the size of the deficit, what you're borrowing for, and how you're financing it.

Let’s think about this as if the U.S. is a superhero.

When it comes to the trade deficit, a common argument is that the U.S. is protected by the Captain America shield of the global dollar. 

Why is that important? Because the dollar is used as the world’s reserve currency. It offers higher interest rates than other currencies. It’s stable, it’s trusted, and everyone wants it. So, when we go shopping on the global market, we don’t really need to worry about whether we have enough gold bars in the vault or if we’re exporting enough soybeans and jet engines. We throw that Captain America shield out and, most of the time, it works.

But even superpowers can’t ignore a growing trade deficit forever, especially as debt piles up and other countries start to question the value of that shield.

SIERRA: So how long has the U.S. had a trade deficit?

SETSER: Basically since the 1980s. So for a very long time.

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Ronald REAGAN: My fellow Americans, despite a growing trade deficit we've gained over 7.5 million new jobs since 1980.

SETSER: What has varied is the size of that trade deficit. It got big in the early 1980s, it shrank; it got big in the late 1990s...

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Bill CLINTON: Our major trade deficit in the world, except for our oil imports, has been with Japan, and of course now with China and other countries in Asia combined.

SETSER: It got even bigger in the early 2000s before the global financial crisis, it shrank...

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George W. BUSH: It is true that this crisis included failures by lenders and borrowers, by financial firms, by governments and independent regulators. But the crisis was not a failure of the free market system.

SETSER: ...and now it's big again. There are different ways of measuring it. The way I would tend to measure it, you know, accounting goods and services, puts it over 4 percent of GDP. That's relatively big. I wouldn't worry so much about a 2 percent of GDP trade deficit, but we're back at 4 percent of GDP. And the amount of interest that we're paying on our external debt is going up.

For context, the U.S. is running a trade deficit equivalent to 1 percent of the world’s GDP - which is huge.

SETSER: Now it's offset by the fact that our companies make a lot of money abroad. But even with that extra profit we earn abroad, we're starting to make net payments to the world in dividends and interest, largely because we're paying more interest. But yeah, look, it isn't healthy that the bulk of the world's trade deficit is now found in the United States. It isn't healthy that we've basically run trade deficits of decent size for most of the past 30 years. It isn't healthy that our external debt is going up and that our external interest payments are going up. There's a set of indicators that one would look at and say, "Hey, maybe we should change a little bit." And since the trade deficit in the U.S., the main counterpart of that, the main reason why we're borrowing from the world in aggregate is not a really high level of investment, it's a really big fiscal deficit, you might say that's not the best reason to be borrowing from the rest of the world. So I do think there's a basis for concern, but not a basis for panic.

SIERRA: Is this a distinctly U.S. thing, or does every country have some level of a deficit?

SETSER: No. By definition, the world economy has to be balanced. Despite Elon Musk's best efforts, we don't currently trade with Mars. And it's going to be a long time before we trade with Mars and it's going to be really expensive. So if the U.S. is running a deficit, someone else is running a surplus. Right now I think the big issue for the world economy is that most of the world's deficit is found in the United States. If I want to be perfectly accurate, I would say most of the world's deficit is found in the U.S., the United Kingdom, India, and Turkey.

As Brad alluded to, following the United States, India has the second largest global trade deficit at over $26 billion as of this April. 

SETSER: And that means most countries around the world are running surpluses. Most countries around the world are exporting more than they import. Most countries around the world have had, over the past few years, some trouble generating internal demand, particularly in Asia. 

SIERRA: Which country do we have the biggest trade deficit with?

SETSER: It's a trick question, right?

SIERRA: Okay.

SETSER: Because you're moving to bilateral balances. How much do we export with country A compared to how much we import from country A?

Most economists prefer to look at the trade deficit as an aggregate, as a global lump sum. But the trade deficit can also be looked at as the trade relationship between two countries, aka bilateral trade.

SETSER: Up until now I've been talking about the overall trade deficit. And if you want to ask which countries in the world run the biggest overall trade surpluses, not just with the U.S., but with the world, the biggest surplus is clearly in China. Not even close right now. We have over a trillion dollar deficit; China in aggregate has a surplus of over a trillion dollars. And the big change in the global economy has been that more of the surplus is now found in China than five years ago, and more of the surplus is now found in East Asia. Less of the surplus globally is found in the oil exporting economies.

Countries that primarily export oil, like Saudi Arabia and Russia, used to have large surpluses because oil was in high demand throughout the early 2000s into the 2010s, and prices were especially lofty after the invasion of Ukraine in 2022. 

Now, as global trade has shifted from oil dominant to manufacturing dominant, these countries share a smaller portion of the world’s surplus, and titans like China have come out on top.

SETSER: If you just look at bilateral trade, how much we directly trade with any given country, I think Mexico has overtaken China. Now that's a little deceptive because Mexico's overall trade is pretty balanced. Mexico doesn't run a big surplus in aggregate. But because of Mexico's pattern of trade, it runs a decent sized surplus with the U.S. Because of the tariffs that were introduced in Trump's first term, direct trade with the U.S. and China is down, and a lot of Chinese goods are exported to Vietnam, to Taiwan, to Thailand, to the Philippines, to Malaysia, and then they're assembled and sent to the U.S. So the other big U.S. deficits are found with Vietnam, strangely with Ireland, with Germany, with Japan, and with Korea. We run a trade surplus with Brazil; a pretty big trade surplus actually with Brazil. Brazil structurally actually competes with us in a lot of third country markets for agricultural exports. But because Brazil and the U.S. Midwest are both agricultural superpowers, we don't trade much with each other. So the bilateral trade data will miss more complicated trading patterns. We don't tend to buy much from Brazil. And we sell Brazil planes and agricultural equipment. So you can get a distorted picture just looking at bilateral trade.

Along with Brazil, Australia also runs a trade deficit with the U.S. And if you take oil out of the picture, Canada actually has a trade deficit with the U.S. in manufacturing. 

But since the United States runs arguably one of the largest trade deficits, in total, we end up running trade deficits with most countries around the world.

SIERRA: So Trump paints the trade deficit as other countries having an unfair advantage over us. Has he been steadfast in this perspective? Has he always been fixated on this?

HURLBURT: It's really interesting that one of the first ways Trump comes to the larger public eye outside the New York real estate scene is that he gets very active in the eighties and I think already in the seventies, protesting what he sees at the time as the unfairness of U.S.-Japan trade. 

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Donald TRUMP: We let Japan come in and dump things into our market, it’s not free trade. If you ever go to Japan right now and sell something, forget about it. Just forget about it. It’s impossible.

HURLBURT: And in some ways some of the core things he says now, you could take out Japan and slot in China, Vietnam, Germany, and it's basically the same line. And he's not alone in this, by the way. There is a generation of folks whose mindset on trade was founded in the fifties, really when U.S. manufacturing power just astonishingly outstrips the rest of the world in large part because we hadn't had a war on our territory in the forties. And that, not coincidentally, is a moment where you can run a family on one manufacturing job. So one manufacturing wage earner gives you enough money to have a house, maybe have a little boat, go on vacations, send your kids to college, or importantly get your sons jobs in the factory at 18. And it's that vision of the social order which didn't hold for all that many people, really only held for white men and wasn't so great for everyone. But it's that vision of the social order that many of Trump's policies in many areas harken back to.

What does it mean exactly for our economy to be less resilient because of the trade deficit?

According to many economists and experts, the U.S. could face longer periods of recession and reliance on foreign suppliers. Americans would be hit with shortages and subsequently high inflation. And there would be less investment in technology and development. But, as we learned, the consequences aren’t zero sum, and the domino effect of current trade and tariff policy, intended to shrink the trade deficit and help the U.S. economy, could do just the opposite.

SIERRA: So where do we go from here? Is the impact to our economy and trade relationships able to be minimized? You know, what does the future look like?

HURLBURT: My answer is different from what it would've been six months ago because the U.S. remains one of the world's two largest economies, one of the most desired places to invest, and a regulatory system that most of the rest of the world looks at and says, "Yeah, I'd love to put my money there." And we had an economy, frankly, up until earlier this year, that was the envy of the rest of the world that had recovered much faster from COVID than others. Now with the tariffs introduced tremendous uncertainty. And that does a couple things. One, it has knocked down the dollar relative to other global currencies, which should help U.S. exports by making them less expensive relative to, so if you're spending U.S. dollars, you buy more of a thing now than if you're spending some other country's currency. So that should help. On the other hand, our manufacturing is really interlinked with everybody else's in the world. Can you get the materials you need here to manufacture? What is it going to look like in six weeks? You see the bond market is uncertain. Is this a good place to invest anymore? Should we be buying dollars? Should we be buying euros instead? And you're starting to have real questions about the quality of our regulatory market and our justice system here at home. So frankly, I'm worried that our economy will be a lot less resilient than we have grown used to it being in the past.

SIERRA: What do you think is missing from top level discussions of the trade deficit? 

SETSER: Yeah, look, what I think has been often overlooked has everything to do with incentives in tax codes that allow companies to avoid tax by producing often outside the United States. So one of our biggest trade deficits is in pharmaceuticals. We have a lot of good companies that produce and do the R&D and have invented some of the world's best drugs. But because of the way the U.S. tax code is set up now, the net effect is that we end up importing a lot of pharmaceuticals. So Ireland, Singapore, Switzerland. They're not low cost countries, they're low tax countries. And those countries account for the bulk of our trade deficit in pharmaceuticals.

SIERRA: So how do you solve that problem?

SETSER: Change your tax code, our corporate tax code. I do think that the distortions associated with Ireland's tax system; and with our own tax system. Ultimately we fix this not by changing Ireland's tax, but by changing our own tax; have become so big that you can no longer ignore it. At some point something becomes a little out of control. And the tax avoidance through Ireland, tax avoidance incentivized and caused not just by Ireland's tax but by our own tax system, has gotten out of control.

In recent months, Ireland has accounted for 40 to 50 percent of the United States’ total trade deficit with Europe, largely due to exports from its booming pharmaceutical industry. And there’s no question why. Ireland currently has a 12.5 percent corporate tax rate, which is nearly half of the U.S.’s which stands at 21 percent.

But there is a new deal in the works to reform this issue. The Organization for Economic Co-operation and Development has proposed a global tax reform deal which aims to establish a global minimum corporate tax rate. This would attempt to balance global tax revenues after companies around the world have largely shifted profits to low-tax regions. However, on Trump’s first day back in office, he issued an executive order rejecting the international initiative.

SETSER: Our biggest bilateral trade deficit with any European country now is with Ireland. It's not with Germany. It sounds crazy-

SIERRA: It does.

SETSER:...But little Ireland has become this huge tax center because of this crazy pharmaceutical trade to get in ahead of the tariffs in the first quarter. Like our imports of pharmaceuticals from Ireland in one month are normally like five, six, seven billion. In one month, they were $27 billion just from Ireland alone. This one month jump has had an impact on U.S. overall GDP growth, reported GDP growth, on Euro area reported GDP growth. And just for a whole range of global statistics, you kind of need to exclude Ireland to get an accurate picture.

SIERRA: So I'm going to throw the "why it matters" at you. You know, we've hit a bunch of points, but why does the trade deficit matter to everyday Americans? Does it come down to jobs, taxes? What is it?

SETSER: I mean, if you're a consumer, the fact that we run relatively large trade deficits has enabled us as a country to get access to a lot of goods cheaply and it has increased a lot of people's living standards. The fact that we don't export that much, that exports as a share of our GDP are a little small compared to the rest of the world, that means that there are fewer jobs in sectors of the economy that trade a lot. And one sector that trades a lot where we're not doing as well as we used to do is agriculture. It means fewer manufacturing jobs. Not a lot, but because we run a trade deficit in manufacturers, in a sense because we import without exporting as much, we don't have as many of the high paying export jobs as you might expect. And there's not a lot of them, but if we were going to get rid of the trade deficit in a healthy way, not just by bringing down our imports, but by growing our exports, we would have more jobs making computer chips, more jobs making pharmaceuticals. Boeing would have to make more planes. Generally we'd make more aircraft engines, we'd make more gas turbines, we'd make more big diesel engines. There's a bunch of parts of the U.S. economy which would be bigger if we had a smaller trade deficit. For everyone, as I mentioned earlier, the trade deficit is a reflection of foreign demand for our bonds. So to some degree it's keeping borrowing costs in the U.S. a little lower than they would be without the inflow of money into the U.S. And so therefore, it impacts the cost at which the US government borrows. Now you can say that's a good thing; "Hey, why pay more to borrow?" Or you can say it's a bad thing; it's made it too easy for the U.S. government to borrow, too easy for the U.S. government to run big deficits. And that has led us down the road to temptation and it has taken away pressure for us to bring our fiscal deficits into balance. And then I think you can say generally as a society, we're running a bit of a risk just because our external debt has gotten to be kind of big. And when your external debt is kind of big, the risk is that you're going to all of a sudden no longer going to be able to afford all these imports. You're going to have to just become a society that exports to pay off your debt rather than exporting to bring goods in. So I think there's a set of reasons why people should care.

For resources used in this episode and more information, visit CFR.org/whyitmatters and take a look at the show notes. If you ever have any questions or suggestions or just want to chat with us, email at [email protected] or you can hit us up on X at @CFR_org.

Why It Matters is a production of the Council on Foreign Relations. The opinions expressed on the show are solely that of the guests, not of CFR, which takes no institutional positions on matters of policy.

This episode was produced by Molly McAnany, and me, Gabrielle Sierra. Our sound designer is Markus Zakaria. Robert McMahon is our Managing Editor. Our theme music is composed by Ceiri Torjussen.

You can subscribe to the show on Apple Podcasts, Spotify, YouTube or wherever you get your audio. For Why It Matters, this is Gabrielle Sierra signing off. See you soon!