Tariffs, deficits and debt – Econlib

Scott Sumner recently had a post discussing this a potential relationship between trade deficits and government debt. In summary, since debt must come from savings, foreign savings must come in and make up the difference if domestic savings are too low relative to domestic investment; the United States imports foreign savings. When the government runs up deficits and decides to finance those deficits by taking on debt, the savings used to pay off those debts can come from domestic or foreign sources. In the US, much of the trade deficit comes from foreign sources.

Some protectionists have used this relationship between trade deficits and government debt to argue that classical liberals (like myself) and others concerned about the government debt should support tariffs to reduce the trade deficit. Reducing the amount of foreign savings coming into the U.S. would raise interest rates and therefore make borrowing government money more expensive. The government would consequently reduce deficit spending. However, this argument is misleading for two reasons.

First, interest rates would likely rise, but it is not clear that this will reduce government deficits. The people who make spending and budget decisions are not confronted with the full costs of their decisions. This also applies to the voters (the costs are even shared among all taxpayers). The result is that we end up in a situation that James Buchanan and Richard Wagner ‘Democracy in deficit”: politicians prefer easy choices to hard ones, and will generally support higher spending and lower taxes.

Voters face similar incentives. Indeed, the absolute the amount of resources used to produce the same amount of spending will increase if rates are used to address the national debt (assuming the same amount of deficit spending, this will be financed at a higher interest rate than would have been the case larger trade deficits The amount needed to repay the debt would therefore be higher than otherwise). No one in the political process faces the incentive to reduce budget deficits even with a higher interest rate because ‘the government’ is not a monolithic voter like the individual in the market. Rather, it is a collective made up of many independent voters, each acting in accordance with their own will and self-interest.

Second, tariffs are a blunt instrument. Even if we assume (contrary to the evidence) that tariffs can reduce the trade deficit, there is no promise that debt reduction will come from a reduction in government deficits. This would (and perhaps would, given the constraints on public choice just discussed) come at the expense of private investment. Domestic business managers would find it more difficult to expand, hire, acquire and produce. Since domestic business managers Doing faced with the full cost of their actions, managers would feel the impact of higher interest rates more acutely than government voters. Using tariffs to reduce government deficits is like burning down a house to kill a spider: the spider may be dead, but the collateral damage is much worse.

Ultimately, using tariffs to reduce the trade deficit in the hope that this will reduce government deficit spending leads to confusion between the symptoms and the cause of the disease. Trade deficits be able to identify excessive government spending, but if that is the case, the goal should be to actually reduce government spending. That is of course a much more difficult problem for the reasons mentioned above. But just because it’s hard doesn’t mean you should choose an easier, but likely more harmful, option.

Many economists, by Adam Smith to this day we dismiss trade deficits as “absurd” and argue that their presence causes more confusion than clarity. The link between trade deficits and government debt supports their conclusion.