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Want To Cure The Trade Deficit? Increase Domestic Savings

Hale Stewart
10.49K Followers

Summary

• Tariffs on imports don't solve the problem of the trade deficit.
• National Accounting identities indicate that the current account deficit can also be defined as the difference between savings and investment.
• Research from the Boston Fed bears this out.

The administration's increased tariffs have once again sparked a discussion about the US trade deficit. The administration is probably working on the assumption that after the US raises tariffs, trade treaty counterparties will renegotiate the conditions of their US trade treaty, but include provisions that will reduce the US trade deficit.

This is, however, the wrong way to go about solving the problem, because the trade deficit is really about the low rate of US savings. "How can that be?" you ask. "Those two economic numbers have no relation to each other!"

Actually, they do. To begin the explanation, here's a diagram of the US economy (from page 39 of Macroeconomics by Robert Gordon, (c) 1990):

Any economy is actually a circular flow between businesses and households. Consumption expenditures = the income paid by businesses to households in the form of income. Every month when the BEA reports GDP, they're reporting on the lower part of the circle -- that is, consumption expenditures (personal consumption + Investment + Government Spending + Net Exports). At the same time, they're also reporting on gross national income or GNI (in general, this is income from a variety of sources + transfer payments).

We can convert the above diagram to a simple equation:

Q (income) = E (Expenditures)

Now we begin to substitute various identities for Q and E, starting with Q (income). Looking at the diagram we see that Q = Consumption + investment. We express this mathematically as Q=C+I. So, we can rewrite Q=E as:

C (consumption) + I (Investment) = E (Expenditures).

With me so far? Good.

Now, let's attack the E side of our equation. Looking back at the circular flow, we see that S (Savings) equals [Q (income) - C (Consumption)]. Expressed as an equation, we get S=Q-C. We