Steel products are seen outside a steel pipe manufacturing plant in South Korea on February 13, 2025.JUNG YEON-JE/AFP/Getty Images
U.S. President Donald Trump is rapidly upending the global trading order. Since returning to the White House, he has promised to reinstate steel and aluminum levies on Canada and other countries, slapped higher tariffs on China and threatened “reciprocal” tariffs against all of America’s trading partners. Much of this is in the pursuit of a single goal: Shrinking the U.S. trade deficit.
A mercantilist, Mr. Trump sees international commerce as a zero-sum game. If a country imports more than it exports – as the United States has done since 1976 – it must be getting ripped off. In this view, America’s relatively slim trade deficit with Canada is a “massive subsidy” that must be eliminated. Tariffs are just the tool for the job.
Economists think about trade deficits very differently. Far from being a scorecard of economic strength or weakness, the bilateral trade balance between two countries means little from an economic standpoint.
A country’s overall trade balance with the rest of the world is more relevant. But it’s not clear that trade deficits are inherently bad. Moreover, most economists think a country’s balance of trade reflects its macroeconomic structure alongside its fiscal and monetary policies – not its trade policies. That suggests tariffs won’t shrink America’s trade deficit on a sustainable basis, although they will make Americans, and Canadians, worse off.
So what causes a trade deficit? What is the nature of Canada’s trade balance with the United States? And will Mr. Trump’s trade wars improve his country’s terms of trade?
What is a trade deficit?
A trade deficit happens when a country imports more goods and services than it exports. A trade surplus is the opposite: exports exceed imports.
In 2023, the United States sold roughly US$3-trillion worth of goods and services to the rest of the world and bought around US$3.8-trillion, giving it a US$773-billion trade deficit, equal to 2.8 per cent of the country’s GDP.
On a bilateral basis, America is running large trade deficits with countries like China (US$252-billion in 2023), Mexico (US$162-billion) and Vietnam (US$102-billion). The trade deficit with Canada, by contrast, averaged a comparably slim US$45-billion between 2021 and 2023.
The easiest way to understand the balance of trade is by tallying the flow of goods and services across borders. America exports gasoline, cars, aircraft and financial services, among other things. It imports things like computers, clothing, electronics and crude oil. On balance, more comes in than goes out.
Economists think about the balance of trade in a second way.
If a country buys more from the rest of the world than it sells, it essentially has to finance the difference by borrowing from abroad. That means selling more assets to other countries – government bonds, stocks, direct ownership stakes in companies – than it buys. In other words, the net inflow of goods and services is accompanied by a net inflow of capital.
Economists follow this line of thinking to arrive at a fundamental idea in international economics: A country’s current account balance – that is, its trade balance plus cross border investment income and transfers – is equal to the difference between savings and investment in the economy. A country that saves more than it invests will run a trade surplus. A country that invests more than it saves will run a trade deficit.
“You have an economy like China with a trade surplus because in the Chinese economy national savings are so high relative to investment that they have all this excess of savings that they are not absorbing in the economy and they are willing to lend it to the rest of the world,” said Raul Razo-Garcia, associate professor of economics at Carleton University.
“On the opposite side we have the U.S. economy with a trade deficit, because the national savings rate in the U.S. is low relative to investment. In some way what they are doing is they’re consuming more than they are producing.”
What causes a trade deficit?
The United States has had a persistent trade deficit with the rest of the world since 1976. The size of the U.S. trade deficit ballooned in the 1990s and early 2000s, peaking at over 5 per cent of gross domestic product in 2006. It declined after the 2008 financial crisis, but has been growing again in recent years.
Economists think trade deficits are largely the product of domestic consumption, savings and investment decisions, which are influenced by fiscal and monetary policies far more than trade policies. If a country consumes more than it produces, the difference is made up of imported goods and services. If investment opportunities outstrip savings, the difference is made up by capital inflows.
There could be multiple reasons for these imbalances – good and bad.
A mismatch of savings and investment could reflect something neutral like a country’s age-structure, or something negative like unsustainable government deficits. It could also reflect rapid economic growth, where a country is generating profitable investment opportunities and pulling in goods and capital from around the world.
“If you think about the industrial development of Canada and the U.S. in the late 19th century, they ran huge current account or trade deficits. They got massive net investment from the UK and Europe in order to finance their growth. So in that case, a trade deficit is definitely a good thing,” said Michael Devereaux, an economics professor at the University of British Columbia.
Most economists think the U.S. trade deficit today is tied to rapid growth, high consumption and massive federal government deficits, which topped 6 per cent of GDP last year.
“It’s structural because we’re going to continue to have large stimulus packages from the U.S. Congress in the form of tax cuts,” said Daniel Trefler, economics professor at the University of Toronto.
“When you stimulate the U.S. economy, the U.S. consumers buy more from abroad. So what’s going to happen in Trump’s second term is exactly what happened in his first term: He made zero progress in getting rid of the deficit.”
What role do exchange rates play?
America’s big trade deficits are also tied to the unique status of the U.S. dollar in global financial markets.
The U.S. dollar is the world’s reserve currency, which means foreign investors want to hold U.S. dollars as both a safe asset and a medium of exchange. That creates a nearly-insatiable international demand for U.S. dollars and dollar-denominated assets, putting upward pressure on the currency exchange rate. The subsequent overvaluation of the U.S. dollar (from a trade perspective) makes American goods and services less competitive in international markets.
On the flipside, having a reserve currency lowers America’s borrowing costs – something Valéry Giscard d’Estaing, France’s finance minister in the 1960s, called America’s “exorbitant privilege.” That’s because foreign demand for U.S. dollars and treasuries puts downward pressure on long-term bond yields, which lowers borrowing costs for businesses, homeowners and the U.S. government.
“Instead of tariffs, the U.S. could improve its trade balance by repositioning its economy to draw in less of those investment flows, thereby weakening the greenback,” Canadian Imperial Bank of Commerce chief economist Avery Shenfeld wrote in a note to clients.
“To do that, it might have to tax its citizens more (it has a lower tax burden than most OECD countries), cut government spending, and thereby reduce its need for foreign borrowing. With a less-stimulative fiscal policy, it could have lower interest rates that are less of a magnet for the foreign capital inflows that keep the U.S. dollar elevated, and the weaker greenback would improve its trade balance,” Mr. Shenfeld wrote.
The emergence of a massive trade imbalance between the United States and China in the early 2000s – which has become known as the “China shock” – was fuelled in part by Chinese monetary policy. From 1997 to 2005, China’s central bank pegged the renminbi at an artificially low level against the U.S. dollar by buying dollars and selling renminbi. That led to accusations of “currency manipulation.”
Mr. Trump continues to rail against currency manipulation, although it is less clearly a problem than it was two decades ago. Starting in 2005, China let its currency appreciate roughly 25 per cent against the U.S. dollar. This has helped shrink the size of China’s current account surplus from a peak of 10 per cent of GDP in 2007 to around 1.5 per cent in 2023.
What’s the nature of Canada’s trade surplus with the United States?
Mr. Trump has repeatedly complained about America’s “tremendous deficit” with Canada, which he calls a “massive subsidy.” In fact, the trade relationship between Canada and the U.S. is fairly balanced, particularly when you look at both goods and services.
In 2023, Canada exported US$482-billion worth of goods and services to the U.S. and imported US$441-billion, according to U.S. data. That meant the United States had a relatively slim US$41-billion trade deficit with Canada – a far cry from the US$200-billion number Mr. Trump keeps throwing around.
The balance of trade has shifted in recent years. After running trade deficits with Canada in 1990s and early 2000s, U.S.-Canada trade was essentially balanced between the 2008 financial crisis and the COVID-19 pandemic, with the U.S. posting small surpluses during Mr. Trump’s first term. This turned to a deficit coming out of the pandemic, as the U.S. economy grew rapidly and Canada ramped up oil shipments south across the border.
Indeed, much of the recent trade imbalance is the result of Canadian oil and gas exports, which make up almost a third of the country’s total exports to the United States. Canada ships more than 4-million barrels of oil to the U.S. every day, which accounts for around one-fifth of U.S. daily consumption.
“Remove Canadian energy exports from the equation and the trade story flips. Ex-energy, the U.S. enjoys a trade surplus with Canada of around $60-billion,” Toronto-Dominion Bank economists Marc Ercolao and Andrew Foran wrote in a recent note to clients wrote. Trade in autos is essentially balanced between the two countries, and the U.S. sells more manufactured goods to Canada – a particular focus for Mr. Trump – than it buys.
“In any event, a trade deficit is not a subsidy,” Mr. Ercolao and Mr. Foran wrote. “That would ring true, if for example, the U.S. government transferred US$45-billion annually to Canadian companies out of goodwill, but Americans are receiving value for the dollars spent in the form of goods and services. The trade deficit the U.S. runs with Canada reflects their economic outperformance and above-average spending of Americans, that’s driving a hunger for energy products.”
Looking under the hood, the trade relationship is even more complex and interconnected. Car parts, for instance, move back and forth across the border multiple times before final assembly. And Canadian exports to the United States are dominated by inputs that U.S. companies use to make their own products.
“Over 63 per cent of Canadian exports to the United States were composed of intermediate inputs, and nearly 16 per cent were classified as capital goods,” University of Calgary economics professor Trevor Tombe noted in a recent report.
“This leaves only 21 per cent — or roughly $1 in every $5 — of Canadian exports to the U.S. being used as final consumption goods by American buyers. This indicates that Canadian exports are disproportionately used by U.S. businesses as inputs to produce other goods. This significantly enhances the competitiveness of U.S. producers, as they can secure high-quality inputs at competitive prices, which boosts their productivity and international competitiveness.”
Are trade deficits bad?
In Mr. Trump’s worldview, a country is like a business. By buying more than it’s selling, the United States is losing jobs and national wealth. This echoes an old mercantilist view that saw the purpose of international trade as earning gold to fill the royal coffers.
Empirical evidence, however, doesn’t back up the idea that trade deficits are inherently bad for an economy. Trade deficits tend to rise during periods of rapid economic growth, as consumers spend more on both domestically produced goods and imports. They tend to shrink during recessions.
“Across most major industrial economies, the trade balance is usually somewhat countercyclical, with trade deficits rising during booms and falling during downturns,” Maurice Obstfeld, former chief economist at the International Monetary Fund, wrote in a recent paper for the Peterson Institute for International Economics.
“There is no tendency for unemployment to rise when the trade deficit rises, except over a few relatively brief periods,” he added. “Instead, the correlation between the trade balance and unemployment is positive, such that manufacturing unemployment usually falls in sync with the goods trade balance.”
Increased trade can certainly displace jobs in a given industry, as has happened in a number of U.S. manufacturing industries during the “China shock” of the early 2000s. That can lead to geographically concentrated pain, as in the midwestern Rust Belt states, with important political consequences.
But economists don’t think the steady decline in manufacturing jobs is mainly driven by trade policy, or the existence of a trade deficit. Japan and Germany, which run consistent trade surpluses, have seen even larger declines in the share of their workforce employed in manufacturing in recent decades. The bigger culprit is factory automation.
“The decline in manufacturing employment as a percentage of total employment is being driven by the same secular forces that caused employment in agriculture during the 20th century to fall from 40 per cent to 2 cent of the labor force: a vast increase in labor productivity and a decline in the demand for manufactured products relative to services,” economists Phil Gramm and Larry Summers wrote in a recent letter published in The Wall Street Journal. “This is a worldwide phenomenon occurring in both developed and developing countries.”
This is not to say that trade deficits are inherently good, either.
When a country consumes more than it produces, it racks up debt to the rest of the world which needs to be paid back eventually. If external debts reach an unsustainable level, a country can become vulnerable to a balance-of-payments crisis, as happened in Latin America in the 1980s and across Asia in the 1990s, where foreign investors lose faith in the currency and send a country’s finances into a downward spiral.
“It’s plausible that the U.S. [trade] deficit is a problem and will have to be corrected at some time,” said Prof. Devereaux of UBC. “But what is not plausible, and it’s completely counterfactual with respect to the data, is that the U.S. deficit is impeding U.S. productivity and growth. It’s rather the opposite. The deficit is actually a reflection of very high growth rates in the U.S.”
Can tariffs impact a country’s trade deficit?
Tariffs can redirect trade, but they’re unlikely to do much to change a country’s overall trade balance with the rest of the world. When Mr. Trump put tariffs on Chinese goods during his first term in office, U.S. companies started importing less from China and more from Vietnam and Mexico. And while American imports of Chinese goods have declined since 2017, the country’s overall trade deficit has grown.
There’s a fundamental problem with using tariffs to shrink the deficit: they impact both imports and exports.
If imports become more expensive due to tariffs, American consumers will buy more locally made goods, leaving less to be exported. And if the U.S. economy is running near full-employment, as it is now, an increase in jobs in import-substitution industries will pull workers away from export-oriented industries, while also putting upward pressure on interest rates, as the U.S. Federal Reserve tries to contain inflation.
Tariffs also make U.S. products less competitive in international markets. That’s because imports are also frequently used as inputs in American products which are then exported. If the cost of these inputs rise because of tariffs, it will push up the price of U.S. exports making them less desirable to international buyers.
This situation would be compounded if other countries retaliate with their own tariffs – as Canada has threatened to do – and exchange rates adjust. There has already seen a significant appreciation of the U.S. dollar since Mr. Trump’s election.
“The U.S. dollar will appreciate against the other currencies and that will make U.S. goods more expensive in the international trade market and it’s going to make the foreign goods in the U.S. more affordable. So that is going to decrease even more exports in the U.S. right on top of tariffs imposed by the other countries,” said Prof. Razo-Garcia of Carleton.
Economists think the only way to sustainably shrink a trade deficit is through policies that alter the rate of savings and investment. That could mean reducing government deficits or introducing measures to encourage more savings. Trade wars simply shift around pieces on the economic chess board without ultimately changing the game.
“What we know from these trade wars is that eventually we’re going to end up in the same equilibrium, but the problem is we are going to end up with lower trade,” Prof. Razo-Garcia said. “And if we end up with lower international trade, we are going to all end up, in the long run, with lower welfare.”