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It’s clear that Donald Trump has no idea what he is doing with his trade policy. His seemingly random, on again, off again tariffs are virtually the most destructive trade path imaginable. If the point of tariffs  is to boost domestic production, then there must be some confidence that the tariffs will remain in place for many years to come. No one is going to invest hundreds of millions of dollars in building a factory based on tariffs that could be gone next week after Donald Trump’s latest “deal”. 

But the confusion on trade goes well beyond this, both for Trump and policy circles more generally. The basic question is, what do countries get by selling stuff to the United States? Trump seems to think he has enormous leverage because we buy more than $4 trillion of goods and services from the rest of the world every year. 

By contrast, we sell a bit more than $3 trillion, leaving a trade deficit of $900 billion. Trump claims this gap is evidence that we are being ripped off, a problem he tells he will fix.

Tariffs (import taxes) are his route for fixing this problem. He is imposing high taxes on imports from pretty much every country in the world, along with randomly chosen goods (steel, aluminum, heavy trucks, prescription drugs). 

There can be some logic to pursuing an industrial policy that would seek to build up a specific industry, as Biden tried to do with advanced computer chips, EVs, batteries, and other industries associated with a green transition. That is a plausible path forward, although the specifics can be debated. 

However, you don’t promote an industry — for example, cars or shipbuilding — by imposing a large tariff on essential inputs like steel and aluminum. That is what Trump has done.

But moving beyond the illogic of Trump’s trade policy, it is important to do a serious rethink of what our imports mean to our trading partners. This goes back to a very basic question of whether the core economic problem is too much or too little demand.

That may sound stupid, sort of like “which way is up?,” but the confusion arises endlessly in policy debates among ostensibly serious people. To take the most obvious one, we see almost daily pieces in major news outlets about the disaster facing us because AI will take all the jobs. These pieces alternate between the ones telling us that we are running out of workers because people are not having enough children. 

It should be obvious that these concerns are 180 degrees opposite. One or the other can be true, but both cannot possibly be true. 

The problem of AI taking all the jobs is a problem of too little demand. It’s a story where AI has made our workers so productive that we need very few to produce all the goods and services we are buying. 

The problem of too few children is a problem of too much demand. The story is that the old-timers are demanding more goods and services than our dwindling workforce can possibly produce. 

This contradiction should be pretty obvious, but unfortunately many people in policy circles seem to have trouble grasping it. The issue comes up again with trade policy.

Trump seems to think that he holds enormous leverage over other countries because they sell us so much stuff. But what does this mean? 

Imagine we just stopped buying stuff altogether from Japan, Europe, or China. They would suddenly have way more capacity to produce goods than they have demand for goods. This is a problem of too little demand.

Keynes taught us how to fix a problem of inadequate demand, have the government spend money. This is important to keep in mind in assessing Trump’s leverage over our trading partners. 

Trump apparently thinks that by making it more difficult for them to sell stuff here (by charging us high taxes), he is putting enormous pressure on our trading partners. He definitely is putting some pressure, but Trump seems confused on the size of the impact. 

Take the case of China, Trump’s archenemy. They sold $440 billion worth of goods to the US last year, about 2.2 percent of its GDP measured in dollar terms. (Their GDP measured in purchasing power parity terms is over $40 trillion, but for this calculation, the dollar value is more appropriate.) 

If Trump were to cut off all imports from China, this is the amount of demand in the economy they would have to replace. (Their exports to the US are already down to $330 billion.) By contrast, the United States lost an amount of demand of more than 6.0 percent of GDP when its housing bubble collapsed in 2007-09.  

The collapse of the bubble was a huge hit to the US economy, but we did get through it. And in the case of China, the hit would be one-third as large in the extreme case where their exports to us went to zero. The cost to the United States from this cutoff would be much higher prices on a wide range of goods and services. 

To maintain demand in its economy, China’s government would have to spend more domestically, something it can easily do at present, since it is more worried about deflation than inflation. It could also look for other markets, which it is already doing. (Its exports are running above the year ago levels.) 

This is why Trump is actually pointing a big water pistol with his tariff threats. They can certainly disrupt other countries’ economies, but those countries have the means to adjust in a relatively short period of time, if they pursue the right policies. On the other hand, for people in the United States Trump’s tariffs mean permanently higher prices and a reduced standard of living. But I guess that’s MAGA!

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