On December 5, the Bureau of Economic Analysis (BEA) released the October data for the US trade deficit. Compared to September, when the trade deficit was $83.8 billion, this figure has fallen to $73.8 billion.

But is this a good thing, a bad thing, or just… a thing? To answer this question, we need to break trade deficits down into their constituent parts, contextualize them into an overall picture, and then discuss what the figure actually means.

First, it is important to note that October’s trade deficit falling by $10 billion relative to September’s does not mean that the overall trade deficit fell by $10 billion. It simply means that the increase in the trade deficit was smaller in October than it was in September. We understand this in other contexts perfectly fine. When we get off the highway, for example, we slow down but we do not suddenly start driving backwards. We drive forward, just more slowly than we were on the highway. The same is true here: the trade deficit continued to rise in October, it just did so less quickly than it did in September.

However, this does afford an opportunity to explore trade deficits in more detail and to discuss the serious challenges of being overly focused on trade deficits and their effect on the overall economy.

So what is a trade deficit? Simply put, it’s nothing more than a specific term for a value of net exports. Net exports, as anyone who has taken an Econ 101 course can tell you, is defined as the total dollar value of a country’s exports minus the dollar value of that country’s imports. Because we’re subtracting two numbers, net exports can be positive, which would be a “trade surplus,” if exports are greater than imports. Net exports can also be negative, which would be a “trade deficit,” if imports are greater than exports. Net exports is also sometimes referred to as “the balance of trade.”

At present, the US is experiencing a trade deficit, with the 2024 figure so far at $734.41 billion. If the November and December data are similar to the rest of the year, the US trade deficit will be higher than last year’s $773.4. China, by contrast, is experiencing a trade surplus of $1 trillion.

This matters because net exports is a component of our measures of GDP. Therefore, the common thinking goes, a trade deficit must be a drag on our economy and a trade surplus must therefore be a terrific boon. This is just not the case. 

Trade deficits (and trade surpluses) are an accounting identity, not an economic one. We subtract imports from our GDP figures because we have implicitly added them elsewhere and we must, by the definition of GDP, subtract them. To not do this would be tantamount to counting other countries’ production as our own, which is clearly false. Further, thinking in these terms confuses benefits and costs. Exports are the cost of imports, not the other way around.

With this background out of the way, we can now answer the question: is reducing trade deficits a good thing, a bad thing, or just… a thing? Regrettably, life is not that simple, for as an economist, I have two hands and there are a number of ways in which net exports can fall, some of which are good, others are bad, and some just… are.

The first is the easiest one to imagine: imports decreased and exports stayed the same. If that were the case, then we would add less spending to GDP as consumption, investment, or government spending and would subtract an equal amount from imports, leaving total GDP completely unchanged despite a decreasing trade deficit.

Similarly, the second is also fairly easy: what if exports rose and imports stayed the same? In that world, we would be richer, but not because the trade deficit fell. We’d be wealthier because exports rose! Exports are what we sell to other countries. Exports entail production and production generates income. More production means more income for the nation as a whole.

The third way would be a combination of the first two: decreasing imports and increasing exports. Separately, both of these changes act to reduce the trade deficit, but only the increase in exports results in increased wealth for the US. Because of this, we can say that GDP will increase in this scenario, but the reduction in the trade deficit would be larger than the increase in GDP.

But what about a situation where exports fall but imports fall even more? In that world, the trade deficit would be reduced, but GDP would actually decrease as well. Changing imports alone, whether an increase or a decrease, does not affect overall GDP. But falling exports will cause GDP to fall.

In the latest trade deficit figures, it was revealed that exports fell by 1.6 percent while imports fell by a much larger 4.0 percent. The result of this was an 11.9 percent decrease in the October trade deficit relative to September’s trade deficit. Again, the trade deficit continued to rise in October, albeit more slowly than in September. But even if this trend were to continue, the result would be an overall reduction in GDP despite a falling trade deficit.

All of this belies a simple truth that frustrates non-economists and policymakers alike: more often than not, the answer to any question in economics is going to be, “it depends.” But to pretend that the relationship between the trade deficit and GDP is straight-forward, as both President Biden and President Trump have done, is foolish, even if doing so has rhetorical (and electoral) flair.

Instead, what elected officials should worry about is the ability of citizens to engage in exchange with others. Exchange, as we know, is mutually beneficial. There are no “losers” in an exchange, only winners. This is not obviated by the fact that sometimes we trade with people who are in other countries.

With tariffs, a popular policy proposal of both the American Left and the American Right, the most obvious result will be reduced imports. Scholars can quibble about how much of a reduction tariffs will cause, but the answer is clearly not “zero.” However, if we were to stop our analysis here, we would fall victim to the “folk economics” to which good economists have relentlessly disabused. Henry Hazlitt explains it this way:

The bad economist sees only what immediately strikes the eye; the good economist also looks beyond. The bad economist sees only the direct consequences of a proposed course; the good economist looks also at the longer and indirect consequences. The bad economist sees only what the effect of a given policy has been or will be on one particular group; the good economist inquires also what the effect of the policy will be on all groups.

By applying tariffs broadly and on “all imports” as President Trump has promised to do on multiple occasions, the result would also be reduced exports. This is because the bulk of the goods that the US imports are not final goods destined for purchase by consumers but are intermediate goods that are used in the manufacturing of final goods both for domestic consumption and for export. By levying a tariff on all imported goods, policymakers effectively raise the cost of production in the US, meaning that the cost of producing goods for exports also rises. This will reduce our ability to export goods to the rest of the world.

So yes, while tariffs can and likely will reduce the trade deficit that the US experiences, they will also reduce GDP (or more accurately, reduce GDP growth) as well.

Tariffs have been and remain a rotten deal for Americans, consumers and producers alike. If we want to grow the US economy, we need to be tearing down barriers to trade, not erecting new ones.