US and UK deficit strategies

The US is threatening to introduce more tariffs on imported goods from 2 April. The president wants to continue targeting certain countries such as China and sectors like steel and aluminium. He also wishes to launch the idea of reciprocity, matching the higher tariffs the US encounters abroad with similar tariffs on imports into the US.

There are varied views of a country running a large and prolonged balance of payments deficit. Some see it as an advantage that the country can live beyond its immediate means. By running a deficit on trade account, it can suck in capital to invest in that country. The money flowing out to pay for the extra imports must be matched by money coming in as loans or purchases of assets boosting investment.

The US, as a faster growing economy with plenty of investment opportunities, can afford to run a large trade deficit, it argues. Others warn against a large and lengthy period of deficit as that may be financed by running up large borrowings which prove difficult to service and repay, or by selling too many productive assets leading to too much profit and dividend then flowing out of the country.

There are similarly agonised views over the wisdom of countries such as China and Germany running continuously high surpluses. On the one hand, they have strong finances as they can place the surplus money from the trade account into investments around the world strengthening their future investment account. On the other hand, they sacrifice current consumption at home to feed the export machine and have forced savings to square the accounts. There is a danger they under invest at home.

US President Donald Trump thinks the US is running too large a deficit and seeks to move the US closer to the China/Germany model – and away from the import and borrow model. He tried to bring US/China trade into better balance in his first term in office – but failed. He imposed some tariffs and got China to agree to buy more US products, but the deficit has remained very large.

Using tariffs to redress has its disadvantages and will make the world a bit worse off. The cost of the tariff is either passed on as a price rise for US consumers who still need the foreign product, or it hits the profits of the exporter who must cut their costs and prices. If, in the medium term, the policy succeeds in increasing US production capacity to replace imports, then the US economy gets some offset to the possible higher prices and the investment costs of making the provision.

Trump’s trade pre-occupation

President Trump has made trade his main preoccupation. He is alarmed by the growth of a very large deficit on the trade account and is seeking to alter this by negotiating with the main countries running large surpluses with the US. He has imposed some extra tariffs on China, Mexico and Canada when he does not see sufficient response to his concerns. He has also imposed a general world tariff on steel and aluminium. The main surplus countries that he is targeting are listed beneath with their 2023 surplus

Germany’s trade is arranged under European Union (EU) rules, and other countries (including Ireland within the EU) also run large surpluses with the US, so President Trump now targets the EU. These figures are US government figures from US Census. They show US/UK trade with a small US surplus.

Reflecting this order. President Trump has so far taken action over China, Mexico and Canada and is planning action against the EU to cover Germany and Ireland.

UK Trade

The Office for National Statistics provides summary figures for the last nine years, covering the period of the Brexit vote in 2016 and the exit in 2020. It shows that total exports in cash terms have risen by 45%, well ahead of inflation since 2016. They have also risen by a third since 2020, which was affected by Covid-19. The main growth has come in services, now representing 56% of the total.

Growth has come more from trade with non-EU countries. Both these trends of bigger increases in services and in exports to places outside the EU were trends whilst the UK was an EU member. This reflected the growing shift of the UK economy away from industry to services, and the larger market for services in the English-speaking common-law world outside the EU.

The UK struggled to export more services within the EU given the range of languages used and the dominance of EU code law. There remained several non-tariff barriers to service trade within the EU. Since exit, the UK has been able to add service sector easements into some of the trade deals with non-EU countries that it used to enjoy as a member of the EU when rolling them over for UK continued use. It has added services to the large TPP Trade Partnership Agreement negotiated since exit. The leading sectors for UK services include business advisory, financial services and legal.

The UK has continued to run a large trade deficit with the EU for many years. The overall UK deficit is all with EU countries, and is concentrated in industrial products, energy and agriculture.

The UK was not competitive enough with Germany on vehicles and machinery. The UK has opted to deindustrialise to reduce carbon-dioxide emissions, so it is increasingly importing energy from the EU and more manufactured products. It is likely to stay in large deficit with its European neighbours. The closure of Grangemouth will reduce exports of refined oil products, the rundown of the North Sea reduces oil exports and the need to import more energy when the wind does not blow and the sun does not shine will add to the import bill.

The overall trade deficit has been much reduced by the great success in boosting service exports to the rest of the world. The UK government does not see the need to reduce the big deficit with the EU in the way the US wishes to and is not proposing any measures to curb the growth of the EU trade deficit.

The UK has removed tariffs from intermediates and from products the UK does not make when it left the EU. It is planning a similar carbon border tax or tariff to that designed by the EU. These extra taxes could be an additional provocation to the US. The EU single market takes the form of a customs union with most product lines attracting tariffs from outside.

Trade turbulence to continue

There will be some more turbulence as President Trump tries to push other countries into exporting less or importing more in their bilateral trade. Targeted high tariffs can be very damaging to individual countries and sectors. Overall, the impact on world gross domestic product is diluted, as most business is domestic within an individual country with overseas trade a minority of the activity. The tariffs will generate some higher prices and some lower margins amongst producers. They may also stimulate some offsetting investment in additional capacity in the US.

The countries most at risk from US tariff action are China, Mexico, Canada and the EU. It is unlikely the policy will reduce the US deficit by much any time soon. So far, President Trump has ridden out the negative impact this is having on US stock-market sentiment, but he and his advisers will not want tariff wars to so damage confidence that talk of recession becomes self-validating.

The UK has reduced its own deficit through service export success but will continue with a large deficit with the EU as the economy moves further away from industry and energy. Current levels of vehicle exports are vulnerable to the move to ban diesel and petrol models, and oil and oil products will decline from their present position amongst the leading exports as the ban on new drilling bites.