Trade imbalances and the limits of trade policy

By Marc Auboin, Eddy Bekkers, Ralph Ossa and Donal Smith

Trade imbalances have long been a concern for policymakers, prompting calls for corrective trade measures. Recent tariff actions – framed in part as efforts to reduce bilateral deficits – fit this established pattern.

Notable precedents include the United States–Japan trade tensions of the 1980s and the global imbalance debates following the 2008 financial crisis. The connection is not merely anecdotal: empirical research shows that trade imbalances, particularly at the bilateral level, are strong predictors of trade action.

Interpreting trade imbalances

From an economic perspective, trade imbalances are not necessarily problematic. Sectoral imbalances arise from specialization: a country with a comparative advantage in services may run a surplus in services and a deficit in goods. Aggregate imbalances, in turn, reflect differences between national saving and investment. If a country invests more than it saves, the additional investment goods must come from abroad. From this perspective, trade imbalances are not signs of dysfunction, but channels through which economies realize the gains from trade, across sectors and over time.

While trade imbalances can therefore reflect healthy economic forces, they are not immune to policy distortion. Tariffs can alter sectoral trade patterns, reducing the deficit in a targeted sector at the expense of other sectors. They can also distort bilateral flows, narrowing the deficit with a targeted partner while widening it with others. Industrial policy, now central to many policy debates, can have similar effects. Long-run broad-based industrial policy intervention can significantly influence the allocation of resources across sectors, often promoting tradable manufacturing over non-tradable services.

What is less clear is the extent to which tariffs can distort aggregate trade imbalances. In terms of national accounting, the overall trade balance (plus factor incomes) reflects the gap between national saving and investment. Tariffs can influence this balance, but only indirectly – for instance, if firms accelerate imports ahead of expected tariff hikes, or if heightened policy uncertainty leads to greater precautionary saving or reduced investment. But these are roundabout channels, and there are more direct ways to influence national saving and investment; trade policy is a blunt tool for managing aggregate imbalances.

Correcting trade imbalances with trade policies

To explore how trade imbalances might respond to policy intervention, simulations were run using the WTO Global Trade Model, specifically the comparative static version with standard long-run trade elasticities.

Setting aside the question of whether such imbalances are inherently problematic, the analysis focuses on how they might be reduced through trade policy – specifically, by imposing tariffs to eliminate sectoral or bilateral deficits. The effects of tariffs on aggregate trade imbalances are not analysed, as the model assumes a fixed savings rate and therefore cannot capture all possible tariff-induced changes in national saving and investment behaviour. The scenarios are illustrative in nature and use stylized aggregate regions from the WTO Global Trade Outlook and Statistics report.

To begin with, the use of tariffs to eliminate bilateral trade imbalances was simulated. North America runs a substantial merchandise trade deficit with Asia, which prompted the simulation of a scenario in which North America imposes additional tariffs on goods imports from Asia. The simulations indicate that, to eliminate the bilateral deficit, tariffs would need to be raised by around 40 percentage points. However, this would also increase trade deficits with other regions – for example, the bilateral merchandise trade deficit with Europe would rise significantly. Moreover, the policy would come with sizeable economic costs, including a reduction in North America's GDP of about 0.8 per cent.

Next, the economic effects of eliminating sectoral trade imbalances were considered. A key feature of the data is that North America runs a merchandise trade deficit with the rest of the world. A scenario was therefore considered in which North America raises tariffs on goods imports from all trading partners. The simulations show that eliminating the merchandise trade deficit would require an across-the-board tariff increase of about 45 percentage points. However, because the overall trade balance is determined by saving and investment decisions, and remains largely unchanged, the services surplus would decline proportionally and turn into a deficit. This policy would also entail greater economic losses than the bilateral case, reducing North America's GDP by around 1.5 per cent. That said, policymakers may have non-economic motivations for promoting manufacturing production. Such externalities are not captured in this analysis.

The macroeconomics of aggregate trade imbalances

While trade policy can, in principle, influence aggregate trade imbalances, macroeconomic factors tend to play a far more decisive role.

A case in point is the global response to the COVID-19 pandemic. Many economies deployed large-scale fiscal stimulus, financed through public borrowing. As shown in Figure 1, those economies that expanded their fiscal deficits the most also tended to experience the sharpest deterioration in their current account balances, regardless of whether they had entered the crisis with a surplus or a deficit. Trade is the largest component and typically the main driver of changes in the current account balance.

Figure 1: Fiscal deficit and current account dynamics are related (comparison 2015-19 and 2020-24)

Source: Authors' calculations using World Bank Data.
Note: CIS: Commonwealth of Independent States.

This macroeconomic view is reinforced by recent International Monetary Fund (IMF) analysis on China’s growing trade surplus and the widening US trade deficit since the pandemic. The findings point to domestic macroeconomic drivers: in China, weak household demand and a property market downturn boosted saving and suppressed imports; in the United States, expansive fiscal policy and strong consumption raised imports and widened the trade deficit.

It is also worth noting that the geography of surplus and deficit countries has remained relatively stable over the past two to three decades. This persistence reflects the interplay of structural and macroeconomic factors, including social safety nets, national pension systems, demographic trends and growth differentials.

Long-run econometric evidence offers further support. Drawing on decades of data, Furceri et al. (2022) find that trade policy changes have had little impact on current account trends, with fiscal and monetary variables accounting for the lion’s share of variation.

Correcting aggregate trade imbalances with macroeconomic policies

To explore the role of macroeconomic policy in addressing aggregate trade imbalances, illustrative simulations were again conducted using the WTO Global Trade Model. In this context, macroeconomic forces are represented by shifts in the savings rate – a stylized way to reflect the combined impact of fiscal policy, taxation, financial regulation and other structural factors. While not a standard exogenous shock, such a shift provides a useful benchmark for comparing macroeconomic and trade policy interventions.

The results suggest that North America's overall trade deficit could be eliminated through a modest realignment of global saving behaviour. Specifically, a 2.5 percentage point increase in North America’s gross savings-to-GDP ratio, matched by a corresponding decline in the main surplus regions, Asia and Europe, would be sufficient to close the aggregate trade gap.

Merchandise trade deficits, however, prove more persistent. In this scenario, North America’s aggregate imbalance is closed primarily through a larger services surplus and a narrowing, but not fully closed, goods trade deficit. This underscores a key point: macroeconomic rebalancing through changes in saving can eliminate aggregate trade imbalances, but may not fully resolve sector-specific imbalances such as those in merchandise trade.

The case for policy coherence

A foundational principle of economic policy design is that each distortion should be addressed with the instrument that targets it most directly. This targeting principle, formalized by Jan Tinbergen and widely applied in public economics, suggests that trade distortions are best addressed with trade policy, while macroeconomic imbalances are more effectively handled with macroeconomic instruments. Using one to address the other is not only inefficient, but may also have unintended consequences.

This insight was already acknowledged at the creation of the WTO when trade ministers affirmed that, "Ministers recognize, however, that difficulties the origins of which lie outside the trade field cannot be redressed through measures taken in the trade field alone".

In today’s interconnected global economy, this insight remains as relevant as ever. Addressing persistent trade imbalances will require coherence across policy domains, as well as deeper cooperation among institutions with complementary mandates and a shared stake in global economic stability.

---

1. This blog has been prepared under the WTO Secretariat’s own responsibility. It does not necessarily reflect the positions or opinions of WTO members and is without prejudice to their rights and obligations under the WTO agreements. The opinions expressed and arguments employed herein are not intended to provide any authoritative or legal interpretation of the provisions of the WTO agreements and shall in no way be read or understood to have any legal implications whatsoever. The terms and illustrations used in this publication do not constitute or imply an expression of opinion by the WTO Secretariat concerning the status or boundaries of any territory.