Donald Trump is trying to slash his nation’s trade deficit. Australians may recognise this task: we tackled it in the late 1980s, failed, and found that it mattered less than we thought.
Hello, US readers! You’ve just started an interesting economic experiment to see whether government policy can change a trade deficit into a trade surplus.
My bet: you will find, just as Australians did, that the answer is “no”. Most people find it hard to think about trade in a very organised way, and end up doing things that have effects they didn’t expect. Effects like recessions..
Note 1: For some older Australians, this post will seem a nostalgic trip down the Time Tunnel to those kinder and gentler days when Treasurer Paul Keating ran the economy via a series of Question Time broadsides, and squadrons of media figures obsessed about the trade deficit the way they now obsess about housing forecasts. Sit back and enjoy the memories.
Note 2: The economic terms used here are well explained in this Reserve Bank of Australia document on the balance of payments.
Trade deficits excite attention
A nation runs a trade deficit when it spends more on imports than it earns on exports.
Which brings us to the modern-day United States.
For 2024, the US yearly trade deficit reached 3.9 per cent of gross domestic product (GDP), the sum of all economic value that a nation creates.
Now, as many people have noticed, the balance of exports and imports makes up part of GDP. A simple accounting identity expresses it: GDP = C + I + G + E – M. In this equation, C is consumption, I is investment, G is government spending (G), E is exports, and M is imports.
Trump is acting as if he thinks that by lowering the M, he can automatically raise GDP. He’s far from the first to do it. And it’s classically non-economic reasoning, accomplished by ignoring the possibility of second-round effects. In practice, the second-round effects are generally huge, The things you do to lower M inevitably and severely affect other elements in the right-hand side of the equation – notably, in most cases, I (investment), but also often E (exports).
Trump’s unusually attention-grabbing solution is to put relatively high tariffs on the goods that other nations ship to the US, at levels set in part by the size of those nations’ trade balance with the US. (The calculations he has presented are bad, and every country gets at least a 10 per cent tariff, but leave all that aside for now.)
The US policy justifications for this are all over the map. Trump himself has advocated tariffs for 40 years. He and his supporters sometimes paint his new US tariffs as designed to change long-term US investment patterns behind a defensive wall. At other times, they say the tariffs are short-term bargaining chips designed simply to help usher other nations to the bargaining table and create more open and freer trade. At a minimum, at least one of these views is almost certainly wrong, since a measure designed to create long-term investment cannot succeed when it is likely to be quickly withdrawn.
In practice, the method of their announcement makes it likely that these tariffs will fail, because they have been announced in a way most likely to:
- bring a defensive response from other nations — such as, already, Canada (reducing E), and
- make US investors decide to delay investment plans (reducing I).
Among other things, it’s a fascinating economic experiment. Trump has initiated what Nobel-winning trade economist Paul Krugman calls “the biggest trading shock in history“.
Of course, Australians await the results with more than just fascination. Those tariffs affect Australia. And if Trump screws this up, the entire world economy will likely cop it in the shorts too.
But this is not the first time a politician has promised to fix a trade “problem”. Trade debates have happened before.
Below is one example – and it may hold a few lessons for the current trade debate.
How John Pitchford changed Australia’s 1980s trade debate
Back in the late 1980s – excuse the technical economic language – Australia’s trade deficit ”blew out”, as trade deficits often do, in Australia and elsewhere. At one point in the late 1980’s Australia’s trade deficit reached three per cent of GDP – not much lower than the current US trade deficit of 3.7 per cent of GDP.
Many commentators thought this to be a serious problem. Some feared Australia could slide into a “debt trap” where the debtors would be unable to make good on their debts. A number, including many economists, wanted drastic action to forestall this fate. Newspaper editors worked themselves up over such a scenario: my local paper at the time, Adelaide’s The Advertiser, at one point splashed on its front page a story headlined “$100BN – HOW MUCH WE OWE THE WORLD”. (The author was slightly doubtful about giving his story this prominence; I know that, because the author was me, barely out of my cadetship.)
By the end of the 1980s, Labor treasurer Paul Keating and the Treasury officials who advised him looked at that simple accounting identity (GDP = C + I + G + E – M) and decided to target the M, imports. Keating’s reasoning was that consumer demand was “spilling over” into import demand. So, ever a man of action, he pushed official interest rates up – eventually, to 17 per cent. By suppressing consumer demand, he explained, he could eventually suppress imports.
By mid-1990, this triggered Australia’s 1990-91 recession.
But in 1988, while Paul Keating was raising Australian interest rates, Australia’s trade policy debate took an interesting turn. Though most people didn’t notice it at the time, a new school of thought emerged that suggested Australia didn’t need to do anything about its trade deficit.
ANU economics professor John Pitchford (pictured right) was the man to voice this idea. He was already an important influence on an entire generation of Australian economists, and so many of them took him seriously.
John Pitchford, sometime in the 1980s. Picture courtesy Rohan Pitchford.
Pitchford made his case in terms of the broader “current account deficit”, a national accounts concept that includes not just the trade balance but also the outgoings and incomings from previous investment decisions (including, in particular, stock dividends and interest payments). Because investment flows change only slowly, in the short term the current account deficit moves largely in line with the trade balance.
Pitchford argued lucidly that Keating, politicians more generally and most of the financial community were all looking at the current account deficit and the trade balance wrongly – as direct indicators of Australia’s collective economic health that needed to be directly targeted. He effectively argued that they were seeing the elements of the GDP accounting identity as viable targets of government policy, rather than mere elements of a descriptive term. In this sense, they were making a the same brand of mistake that Trump is making now – assuming that targeting policy to one element of GDP would not have problematic second-round effects.
Pitchford instead looked at the current account deficit and the trade balance first as the aggregate outcome of a bunch of private-sector decisions. He argued that people wanted overseas goods for a reason – maybe for building a business and getting work done, like a rail-laying machine, or maybe just for consumption, like a slice of French brie. If people they reckoned they could afford these things, he said, government should not get in the way without proving that citizens as a group were making bad decisions. Until that proof appeared, Australians were best treated as consenting adults who could trade without supervision.
Pitchford concluded the deficits had not yet been established as a genuine problem. And that meant they were best not targeted by policy.
Why Pitchford failed, then triumphed
Pitchford’s argument first came to public attention when he wrote a tightly argued four-page article in the Centre for Independent Studies’ journal, Policy. The article remains online and is still a great read if you like to see a good economic argument made well.
Pitchford’s idea, however, never really took off in the popular debate.
That was partly because Pitchford was running in exactly the opposite direction to almost everyone else in the national debate. Labor and Liberal figures might differ on the policy remedy, but they all thought the trade and current account deficits were a problem. (One indicator: when I pitched Pitchford’s Policy article as a story idea to the then business editor of The Advertiser – a man generally very open to new ideas – he told me Pitchford’s notion was fringe nuttiness. By the time it ran, my resulting article was neither long nor prominent.)
But Pitchford’s idea also, I think, failed to take off with the public because it was fighting some of the deepest and worst instincts that we all have about trade. The central idea of trade theory is that when we trade with someone and get something, the people we trade with get something too, and so trade is good for both sides.
Many people seem to hate, hate, hate this idea when it is applied to anything much larger than their purchase of tomatoes. so whenever someone comes up with a plan that says we’re getting ripped off by people we trade with, they immediately have a large audience. Most of us can’t help but be at least a little attracted by this line of argument. Heck, I’m slightly attracted to it, and I am pretty committed to open trade. Someone who says “no, trade is not ripping us off” – someone like Pitchford – will always struggle for much of an audience.
But if you keep thinking about trade long enough, you generally start to come around to the view that trade is, in fact, better than most people think. Today’s global economy is, after all, built on it – and it’s hard not to notice, eventually, that more parts of the world than ever before are prospering, from Australia to South Korea to Poland. And once you accept that individuals generally make decent decisions about their commercial dealings inside their borders, then as Pitchford asked, why should their decisions on dealings outside their borders be any worse?
So amongst economists, Pitchford’s idea didn’t disappear from view. He had early support, notably, from another prominent Australian economist, Tony Makin. And you could tell that other smart economists were mulling it over: even if they did not embrace it, they couldn’t get it out of their heads. A smart young Reserve Bank economist called Jerome Fahrer wrote a Reserve Bank discussion paper in 1990 titled Is Pitchford Right? – and concluded that the “debt trap” was overhyped and could happen “only the most implausible of circumstances”. By 1993 Fahrer’s Reserve Bank colleague David Gruen (brother of Troppo’s Nick) confessed: “I have spent a lot of time in the past few years trying to decide what I think about Pitchford’s ‘consenting adults’ view”.
Meanwhile, an odd thing happened to trade in the popular debate in the early 1990s: most Australians just decided we’d no longer fuss about the trade deficit.
It’s not that the 1990-91 recession fixed Australia’s trade deficit. It went down for a while after 1990, then bobbed back up and even topped three per cent again under the conservative Liberal/National government that replaced Keating’s Labor Party in 1996. But some of Keating’s toughest conservative critics were supporters of the new government, and Labor’s leading economic lights were kind of embarrassed about crashing the economy in 1990, and all that contributed to an unexpected new silence on the trade deficit. Neither side had great new ideas about what to do next, either. Tariffs were not considered: the Liberals had long opposed them, usually without summoning the political nerve to act, and Labor had actually acted to cut them dramatically through the 1980s and into the 1990s. (This was an example of the only-Nixon-can-go-to-China principle at work in economic policy.)
Also, although it was no long the prime target of any policy, the trade deficit started to fix itself. And as it did, even non-economists who still thought about the problem began to think, often reluctantly, that maybe that egghead Pitchford wasn’t such a weirdo after all.
The terrible consequences of trade deficits that were so feared in the late 1980s never came to pass. It turns out that the trade deficits that “can’t go on forever” … didn’t go on forever. Instead, helped by all the business investment that had happened during the years of trade deficits, and by a boom in commodity prices, Australia’s trade balance turned long-term positive in the late 2010s; instead of trade deficits, we started running an ongoing succession of trade surpluses. Those soon helped to turn our current account balance positive too, though it has now gone back into deficit. (Probably the last politician of any significance to make a big deal about the trade deficit was Simon Crean, who had drawn from the 1980s debate the lesson that trade deficits were bad, and kept right on obsessing about them when Kevin Rudd made him trade minister in 2007, to no noticeable effect.)
Slowly but quite comprehensively, Pitchford triumphed. As someone who found his arguments powerful from the moment I read his 1988 Policy article, I can’t help but be pleased.
A lesson the US might learn from Australia’s trade policy errors
So, what did Australia learn that might help the US?
The obvious lesson – the one many people already know – is that it’s hard to get economic policy right and easy to get it very wrong, even if you’re an expert.
But a deeper lesson might be that trade aggregates are not a good target for policy. They can certainly help tell you something about your economy, but you’ll struggle to extract these messages. Was the message of Australia’s 1980s trade deficit that we needed to make consumer savings more attractive? Or was it that businesses were investing a lot of capital in soon-to-be-productive assets? Or both? Or something else? You can make a case for each of these alternatives; indeed, the consumer savings explanation fuelled the 1990s GST push. But I’m not sure we really know the answer even now, after the original problem has disappeared.
Trump, of course, has absolutely no deep economic theory about how to target US trade aggregates, and neither do his advisers, to the extent that they matter. Trump has simply targeted US imports in the crudest, most simplistic way imaginable. When in April 2024 he announced a huge new round of global tariffs, he span them as “reciprocal”; it quickly became obvious that some junior adviser in the administration had calculated those tariffs simply by dividing the US trade deficit with each country by total imports. Even more stunningly, the adviser seemed to have got this formula from popular AI engines like ChatGPT and Twitter’s Grok. Perhaps weirdest of all, that unknown adviser generated this list from a list of ISO country codes, so that there’s a separate tariff for tiny places like Australia’s Heard and McDonald islands. (More here from the US Center for New Liberalism’s entertaining Jeremiah Johnson.)
Are people just weird about trade?
So Australia’s experience suggests trade aggregates are not a good target for policy. But a deeper lesson may be this: there’s some mysterious quality of aggregate trade figures that spurs people to make grand pronouncements about the necessity for Action to Preserve the Nation, without thinking through the full meanings or likely effects of their prescriptions. I have no really useful idea how to talk people out of this, short of asking them to take an economics degree.
Indeed, even asking people to take an economics degree won’t always help. Donald Trump graduated with a Bachelor of Science in economics from the highly-ranked Wharton Business School. Yet he appears to believe that every time the US runs a trade deficit with some nation, the US is being ripped off. The likeliest explanation for this is simply that trade is a win-win commercial exercise, and Donald Trump just doesn’t see commerce in those terms. According to his vice-president, J.D. Vance, he thinks the US will be strongest if it is self-sufficient. That’s barely economics; it’s mostly tribalism.
And Trump has thought this way since at least the late 1980s. While Paul Keating was ramping up interest rates to fight Australia’s trade deficit, Donald Trump was decrying the fact that the US was running a trade deficit with Japan.
The story of Australian trade policy a third of a century ago suggests that Donald Trump is far from alone in thinking about trade like this. Most people struggle to see international trade as a win-win. Indeed, many people struggle to see commerce generally as a win-win, at least once the people they are trading with are no longer in view. Many people, for instance, think their local greengrocer is terrific, while happily deriding the retail giants that earn three cents on a dollar of revenue selling people all the fruit and vegies they need at $1 a kilogram less than the greengrocer charges.
People are weird about trade. The rules of social co-operation through trade, established at great cost over thousands of years, remain tenuous. A part of our brains still thinks, as Trump appears to, that if the other side of a transaction is happy, we must be getting ripped off. Trump’s not that far from suggesting it might be simpler to just overwhelm the other guy and take what the US thinks it needs, by force. I doubt he’s alone.
The real miracle is that sensible trade policy ever happens at all, at almost any level.
Note 3: One irony of the Pitchford episode was that a decade or so on from Pitchford’s paper, citizens as a group would make some demonstrably bad decisions in the US, in the lead-up to the 2008 financial crisis. But the bad decisions were about housing debt, not purchases of foreign goods and services. This sort of thing, folks, is one reason why economics is harder than you may think.
Comments: As usual, yes, I’m an idiot about a lot of things. I really will be grateful if you can point out in the comments specifically where my idiocy lies, and detail the huge mistake(s) I’m making.
About the author: David Walker is the principal of Shorewalker DMS, an editorial advisory firm. Shorewalker DMS specialises in helping organisations make their reports clearer , more complete and more persuasive. See its work, check out its podcasts, and hire it: https://shorewalker.net.
Twitter: @shorewalker1