Now that 30 days have passed since the Wall Street Journal‘s publication of Phil Gramm’s and my February 21st, 2025, piece titled “Trump’s Myth of the Trade Deficit,” I share the full text of that piece here beneath the fold.
Trump’s Myth of the Trade Deficit
Economic growth depends on deregulation, tax cuts and the budget deficit, not on the balance of trade.
By Phil Gramm and Donald J. Boudreaux
Feb. 20, 2025 at 5:05 pm ETIt seems to be a matter of faith among protectionists that trade deficits make the U.S. an economic loser. President Trump considers America’s trade imbalances with Canada, Mexico and China a matter of grave concern. At the same time, since taking office he’s announced several ambitious plans to increase foreign investment in the U.S. economy. The commitment both to eliminate trade deficits and to pursue foreign investment shows the inconsistency of the Trump administration’s policy. Trade deficits and capital surpluses are two sides of the same coin.
The value of the dollar is set on the foreign-exchange market, where the daily trading volume is $6.6 trillion. Americans exchange dollars for foreign currencies to buy goods and services from abroad and engage in foreign capital transactions. Likewise, foreign entities and individuals exchange their money for dollars to buy American goods and services and invest in the U.S. If for a nanosecond the supply and demand for dollars are not equal, the value of the dollar changes to bring them into balance. Therefore, if the U.S. has a surplus in its capital account balance, it must have a corresponding deficit in its trade balance.
Protectionists can’t turn the tide of markets. If Japanese tech-investing firm SoftBank fulfills its Dec. 16 commitment to invest $100 billion in the U.S., as SoftBank acquires dollars to fund the investment, the value of the dollar will rise relative to what it would have been without the investment, the cost of U.S. exports will rise, the cost of U.S. imports will fall, and the country’s trade deficit will rise. Fortunately, foreign capital investment creates American jobs and fuels economic growth no less than do foreign purchases of American exports.
Trade deficits don’t stifle growth, nor do trade surpluses foster it. In the 29 years after the end of World War II, during which the U.S. had a virtual monopoly in heavy manufacturing and regularly ran trade surpluses, real per capita gross domestic product grew 2.1% a year. Over the next 29 years, from 1976 through 2004, the U.S. ran chronic trade deficits, and the average annual growth rate of real per capita GDP was virtually identical: 2.2%.
During the Reagan administration, as economic growth surged, foreign investment flooded into the country and the trade deficit soared. The trade deficit similarly grew during the economic boom of the Clinton administration. In the high-growth years from 1998 to 2001, when the federal government ran a budget surplus, the annual trade deficit more than doubled. And when economic growth ramped up in 2017 and 2018 due to Mr. Trump’s deregulation and tax cuts, foreign investment surged and the trade deficit rose—despite Mr. Trump’s 2018 tariffs.
During 102 of the 120 months of the Great Depression, the U.S. ran trade surpluses. From 1900 to 1929, years of high economic growth, it also ran trade surpluses. From 1830 to 1860 and 1870 to 1890, when average tariff rates on imports were falling and the rate of industrialization was rapidly increasing, the U.S. generally ran trade deficits in goods and services.
Between 1890 and 2024, it is impossible to find a statistically significant correlation between America’s trade balance and its economic growth.
Has the expansion of global trade “hollowed out” U.S. manufacturing, as Joe Biden claimed in 2022? No. U.S. industrial production today is more than double what it was in 1975, the last time we ran a trade surplus. It’s 55% higher than in 1994, when the North American Free Trade Agreement went into effect, and it’s 18% higher than it was when China joined the World Trade Organization in 2001. Real wages are up 19% from 1994 and 10% from 2001. The inflation-adjusted value of America’s capital stock is 36% higher today than it was in 2001, 66% higher than it was in 1994, and 178% higher than it was in 1975.
Manufacturing as a share of total nonfarm employment peaked during World War II and has declined ever since, following the pattern of employment in agriculture, which fell from 40% of the labor force to 2% over the course of the 20th century. This is attributable not to globalization, but to the spread of modern technology and the rise in demand for services relative to goods. Neither Nafta nor China’s membership in the WTO notably increased the secular rate of decline in the share of workers employed in manufacturing.
The U.S. economy grew by only 2.3% in the fourth quarter of 2024, fueled largely by consumer spending at rates that current income growth won’t sustain and record government spending, which Congress and the Trump administration have pledged to reduce. The University of Michigan’s Jan. 24 Surveys of Consumers reveals that consumer confidence is falling and the expected inflation rate is rising, in part because of uncertainty surrounding the Trump administration’s tariff policies. Mr. Trump and Congress should focus on advancing economic growth by deregulating, controlling the budget deficit and extending the 2017 tax cuts. Fixating on the trade deficit, an imagined problem, will only draw the nation into a trade war that could overpower the positive effects of the Trump economic program.
Mr. Gramm, a former chairman of the Senate Banking Committee, is a nonresident senior fellow at the American Enterprise Institute. Mr. Boudreaux is a professor of economics at George Mason University and the Mercatus Center. This article is based on their forthcoming book, “The Triumph of Economic Freedom: Debunking the Seven Great Myths of American Capitalism.”
