A New Trade Paradigm

American Compass is a policy think tank that was established in 2020 to restore an economic consensus that emphasizes the importance of family, community, and industry to the nation’s liberty and prosperity. To that end, American Compass submits the following comment in favor of the administration’s proposed efforts to eliminate the U.S. trade deficit, support high-quality jobs, and expand domestic manufacturing through fair and reciprocal trade policies.

Addressing the U.S. Trade Deficit

The tariffs President Trump implemented during his first term have raised over $230 billion in revenue and reduced imports of targeted goods without causing inflation. Having once again placed rebuilding domestic industry at the center of his economic agenda, the president should pursue the significant changes necessary to restore balance to U.S. trade. A survey published by American Compass in January 2024 found that 47% of Americans feel the nation has “suffered” from globalization while only 33% said it has benefited. The respondents also affirmed that “we need a stronger manufacturing sector” by a margin of 10-1. While many will lobby against taking action to restore balanced trade, the administration should remain confident that the American people support its larger aims.

For most of the twentieth century, the United States was the world’s leading manufacturer and innovator, consistently running trade surpluses until the mid-1970’s. After the World Trade Organization (WTO) was established in 1994, the U.S. trade deficit rose from a recent low of $28.6 billion in 1991 to $377 billion in 2001, the year China was admitted. Last year in 2024, the U.S trade deficit reached $918.4 billion.

Data from the Bureau of Economic Analysis show our massive deficit was driven by significant bilateral trade deficits with the following countries and trading blocs: China ($295.4B), the European Union ($235.6B), Mexico ($171.8B), Vietnam ($123.5B), Taiwan ($73.9B), Japan ($68.5B), South Korea ($66.0B), Canada ($63.3B), India ($45.7B), Thailand ($45.6B), Switzerland ($38.5B), Malaysia ($24.8B), Indonesia ($17.9B). While trade balances will naturally vary across trading partners, a persistent and growing overall deficit driven by large deficits with most major trading partners should be of concern to U.S. policymakers.

Over the past three decades, free trade advocates have argued that further opening U.S. markets would only expose low-value manufacturing to foreign competition, allowing the United States to focus on advanced industries. That is not what happened. America’s advanced technology manufacturing dropped from a surplus of $38 billion in 1991 to a deficit of $299 billion in 2024. High-technology exports have even fallen as a share of U.S. manufactured exports from 30% in 2007 to 22% in 2023.

U.S. trade deficits have been driven by the feckless trade posture of U.S. leaders, which has left the United States exposed to abusive and distortionary economic policies of its trading partners. Recent data from the Observatory of Economic Complexity (OEC) and data analytics firm Datawheel found that average world tariff rates, at 6.7%, are more than double the U.S. average of 2.7%. Further OEC data show average tariff rates on U.S. goods of 17% in India, 13.4% in Argentina, 12% in South Korean, 7.5% in China, and 7% in Mexico. Many countries also target specific U.S. goods, including motor vehicles and agricultural products, with even higher tariff rates. 

While these disparities in tariff rates remain important, the administration’s memorandum on “Reciprocal Trade and Tariffs” rightly recognizes the need for a “comprehensive” view of policies that contribute to sustained and growing trade imbalances. These policies include not only tariffs against U.S. exports, but discriminatory taxes and regulations, subsidies and state-directed lending, wage suppression, currency manipulation, and other non-market barriers, written or unwritten, which often affect U.S. competitiveness in foreign markets even more than baseline tariff rates. Assessing reciprocal treatment under this wider scope is key to understanding persistent trade imbalances and determining appropriate reciprocal tariff rates. 

While some economists argue the U.S. dollars used to pay for our disproportionate level of imports make their way back to our economy as “investment,” this characterization of capital flows obscures the reality that less than 5% of such “investment” goes toward supporting increased industrial capacity in the United States. The overwhelming majority goes toward acquisitions of U.S. assets like stocks, bonds, treasuries, intellectual property, real estate, and other dollar-denominated instruments. This has driven down the U.S. net foreign asset position to -$20 trillion.

A more accurate term for these transactions is U.S. “dissaving,” as assets that would have formerly appreciated or accrued interest to the benefit of U.S. citizens now redound to foreign nations. As Warren Buffett warned shortly after the United States welcomed China to the WTO, “our country has been behaving like an extraordinarily rich family that possesses an immense farm” and, through our trade deficit, we are “both selling pieces of the farm and increasing the mortgage on what we still own.” These floods of foreign savings can also inflate asset prices, causing bubbles like the one that drove the 2007 financial crisis, as well as our currency, which is now substantially overvalued.

The Current Paradigm is Broken

Under the WTO agreements of 1994, countries are expected to default to a “Most-Favored Nation” (MFN) paradigm that requires consistent application of tariff rates and market access across all WTO members. This model has worked poorly for the United States, which committed to the lowest bound tariff rates and fewest market barriers of any signatory, yet has faced the most trade litigation under the WTO’s dispute settlement system. It also defies common sense to maintain a system that requires the United States to apply the same treatment to nations as distinct in both economic and geopolitical terms as Great Britain and China. This system reflects a post-Cold War optimism that global integration would spur democratic reforms and incentivize the further elimination of worldwide trade barriers and distortions over time. That is not what happened. 

This system has been catastrophic for U.S. workers, industry, and growth. The United States now accounts for roughly 78% of the world’s accumulated trade deficits, while mercantilist China accounts for nearly 45% of the world’s trade surpluses. Excluding semiconductors, U.S. industrial production fell by roughly 10% between 2000 and 2020 after increasing nearly 94% during the previous twenty years. The U.S. now represents around 16% of global manufacturing output compared to 23% in 1990, while China accounts for 32% today compared to 3% in 1990. This situation is expected to worsen by 2030 with China increasing its share further to 45% and the U.S. share dropping to 11%.

The decline of American manufacturing and its corresponding rise in China has created significant threats to U.S. national security. China now accounts for nearly 100% of graphite production for battery anodes, 90% of rare earth element processing, and 95% of shipping containers. China also produces over half of the world’s ships while the United States produces hardly any. It enjoys similar outsized capacity in steel and aluminum, pharmaceutical precursors, nuclear power components, LCDs, cranes, motor parts, drones, and legacy semiconductors. Were conflict ever to arise between the United States and China, the relative weakness of our industrial base would severely undermine U.S. defense. Already, efforts merely to maintain our current defense posture and supply allies have come under intense strain.

While many on the upper end of the income scale have benefited from the United States’ broken trade policy, the typical male worker now needs to work the equivalent of 62 weeks to attain the same middle-class security for a family of four that 40 weeks of work would have delivered in 1985. Extensive research by David Autor, David Dorn, and Gordan Hanson has shown the free trade paradigm has erased millions of manufacturing jobs and devastated thousands of communities over the last twenty five years. In their most recent paper, they show that, for workers without college degrees, new jobs of lower quality have replaced the ones that were lost.

These trends have triggered an enormous spike in what Anne Case and Angus Deaton have termed “deaths of despair,” which include suicides and deaths driven by drug and alcohol abuse. The increase has been large enough to cause an unprecedented decline in life expectancy in the United States in recent years, which is concentrated among the working class. The two-thirds of Americans without college degrees now live 8.5 fewer years on average than the third of Americans with degrees. The death rate from drug abuse is now similar to the rate from alcohol abuse in post-Soviet Russia.

A New Trade Paradigm

The trade paradigm embodied in the WTO agreements has demonstrably failed to account for non-tariff trade barriers, subsidies, and other mercantilist trade behaviors by surplus nations that undermine industry across the WTO’s membership. The WTO’s rigid “rules-based” system for achieving non-discrimination relies on subjective and biased assessments, transparency problems, litigation that stretches over years or decades, and baseline parameters that haven’t been updated in 30 years. This slow, ineffective, and naïve paradigm continues to undermine both the U.S. economy and the wider integrity of the world trading system.

China’s mercantilist policies remain the preeminent driver of the U.S. trade deficit, but in today’s globalized trading system, the effects of those policies spread systemically through world markets. In part, China has pursued illegal transshipments through third countries and expanded cross border production of goods made by Chinese-owned and -operated firms. This has exposed vulnerabilities in current “rules of origin” determinations and enforcement capabilities under U.S. trade agreements. But also, world trade flows must ultimately balance. As the world’s two largest economies, China’s and the United States’ trade and economic policies will continue to affect each other beyond direct trading routes. 

China is also far from the only abuser. Yes, it has suppressed consumption as a share of its GDP, using its surplus productive capacity to capture entire industries. In 2023, Chinese consumption made up only 39% of GDP compared to 68% in the United States and the world average of 63%. But in Germany and South Korea, for example, respective consumption rates are also far below the world average at 50% and 49%.

As American Compass has argued since publication of its 2021 collection, Regaining Our Balance, balance should be the watchword that shapes American trade policy. The principle of balance should stand at the center of the administration’s estimation of reciprocity and as the ultimate benchmark of our trading relationships. The long-term benefits of trade are only realized when goods and services produced relatively more efficiently in one place are consistently traded for goods and services produced relatively more efficiently in another, not when they are purchased on credit or exchanged for assets year after year. Market interventions that disrupt imbalanced arrangements and level the playing field for domestic producers move us closer to that model and should be considered an integral component of “free trade” properly understood.

The simplest way to achieve trade balance would be through a global tariff that adjusts up and down periodically based on whether the United States is running a trade deficit. American Compass has long advocated for this or a similarly broad approach to address our chronic trade deficit. Recent legislation to establish such a tariff—the BUILT USA Act—was reintroduced this Congress. The Congressional Budget Office estimates such a proposal could raise $2.2 trillion in revenue over ten years.

This administration has signaled interest in pursuing a reciprocal tariff framework that addresses trade deficits bilaterally, which has advantages and disadvantages compared to a global tariff. On the downside, this approach runs the risk of being more complicated and less predictable than a simple global tariff. It might also leave less room for scenarios where it makes sense to allow some countries to run surpluses with the United States if they are balanced by countries that run deficits. On the upside, a bilateral approach would create incentives for each country to individually square its trade relationship with the United States and receive comparative advantages in our market for doing so over countries that do not. This would allow the United States to more immediately reward fair market actors rather than treating all trading partners the same regardless of whether they pursue abusive and distortionary trade practices. This approach might also allow a smoother transition to a new trading bloc centered on balanced trade, replacing the failed model of the status quo. 

Regardless of the approach taken, it is important to bear in mind that disrupting the existing system has costs that policymakers should seek to minimize, and that success depends on creating a stable and predictable business environment that will encourage long-term investments in the domestic industrial base. Care should be taken to ensure Americans are aware of the short-term costs of transition and the larger case for balance should be made consistently and ardently by the plan’s advocates.

The long-term benefits of achieving greater balance far outweigh the costs. While there may be supply chain disruptions and retaliation by some U.S. trading partners, the relatively small share of GDP made up by trade in the United States—roughly 25% compared to the world average of 59%—will allow the U.S. market to better weather these short-term challenges. Nations that have structured their economies around U.S. consumption of their overcapacity are also likely to find retaliation is not in their best interest.

Domestically, businesses will have greater incentives to make real investments in U.S. industrial capacity, train and employ more of our citizens, and rebuild American communities. Over time, our exports will also become more competitive as trade abuses and distortions decline. The disastrous trends mentioned above will start to reverse, fostering greater U.S. production and growth, middle class stability, and long-term economic security. 

In sum, the United States must take a more comprehensive approach to addressing its trade deficit that holds both our allies and adversaries accountable. The reciprocal tariff paradigm proposed by the current administration offers an opportunity to pursue balance with our trading partners, addressing specific trade barriers as well as more significant structural barriers that drive up the U.S. trade deficit. If carried out consistently and effectively, such an approach could rectify a world trade order that severely disadvantages the United States and yield enormous benefits to our economy, industries, and workers.