Ending the U.S. Trade Deficit with Europe: Inevitable, or Unnecessary?
“If something cannot go on forever it will stop.”
– Herbert Stein, Chair of the White House Council of Economic Advisers 1972-74
When seeking to understand U.S. trade policy toward Europe, it may be helpful to recall “Stein’s Law,” named after the late Nixon and Ford administration economist Herbert Stein. Stein postulated that once a policy or reality becomes unsustainable from the perspective of economic logic, it will end—either because domestic policymakers make changes in the face of adverse developments, or because private sector actors or foreign governments take actions to force a course correction.
Perhaps the Trump administration’s approach to the EU—the June 1 steel and aluminum tariffs and the threat of new tariffs on automobiles—is merely a sign that we have reached a Stein’s Law tipping point with regard to the U.S. current account (or trade) deficit with Germany and the European Union. It couldn’t go on forever, so it is coming to a stop.
External forces could in principle correct the imbalance. If change were inescapable, then Europeans would already be less willing to hold dollars, or the European Central Bank would be moving to hike interest rates substantially. Both scenarios would drive the U.S. currency’s value down vis-à-vis the euro, make U.S. exports more competitive in the EU, and reduce the deficit.
But neither of these things is happening so the U.S. is naturally stepping in—or so the thinking might go according to the inevitability principle inherent in Stein’s Law.
So here we are with the early battles of a looming transatlantic trade war. Or, put another way, in the first phase of the stop to something that couldn’t go on forever.
But has the U.S.-EU trade relationship reached the threshold of Stein’s Law? Has the U.S. trade deficit with Europe really gotten so bad that its reversal has become both ineluctable and imminent, something akin to a force of nature?
First, new research by the Ifo Institute in Munich using U.S. Department of Commerce figures reveals the U.S. runs a small bilateral surplus with the EU if all three components of the current account (goods trade, services trade, investment income) are taken into account. The fact is, there is no U.S. deficit with Europe.
Second, to the extent a balance sheet approach to trade policy makes sense (questionable except when imbalances become excessive), it is the U.S. or EU global trade position that matters, not their individual bilateral relationships. Looking at import-export statistics through a two-way lens misses the dynamic, multi-party nature of trade.
Third, and perhaps most important, even if the U.S. managed to engineer equilibrium in its exports and imports with the EU, then what? Should the goal of U.S. and EU trade policy officials be to micro-manage every step taken by their citizens to ensure that balance is maintained?
Of course not.
Current account balances between countries that trade fairly (which includes the U.S., Germany, and the other 27 EU countries) are the result of millions of freely taken decisions by consumers and businesses. Governments should make the rules that frame those decisions, but not the decisions themselves.
Remember, Stein’s Law also applies to policies, not just economic conditions. A U.S. administration intent on distorting otherwise fair transatlantic trade through tariffs may find its policy approach, not the U.S. trade deficit with Europe, is what cannot go on forever.