No, that’s not what a trade deficit means – and that’s not how you calculate other nations’ tariffs
To calculate its ‘reciprocal tariffs’, the Trump administration has opted for a crude formula with no basis in trade theory. We are all going to pay the price.
Peter Draper, Professor, and Executive Director: Institute for International Trade, and Jean Monnet Chair of Trade and Environment, University of Adelaide, Vutha Hing, Lecturer in International Trade, University of Adelaide
5 April 2025
On April 2, United States President Donald Trump unveiled a sweeping new “reciprocal tariff” regime he says will level the playing field in global trade – by treating other countries the way (he claims) they treat the US.
First, Trump’s plan will impose a “baseline” 10% tariff on virtually all goods imported into the US, effective April 5. Then, from April 9, 57 countries will face higher “reciprocal tariffs”.
These vary by country, according to a formula based on individual trade deficits.
On face value, the new tariff regime might sound like a simple solution for fairness. If a particular country was taxing American imports with a 50% tariff, it might seem fair for the US to tax their imports at 50% as well.
But appearances are deceiving.
These new “reciprocal” tariffs ostensibly aim to eliminate the US trade deficit by making imports more expensive so that Americans buy less from abroad until imports equal exports.
But the Trump administration hasn’t directly matched specific foreign tariffs. Instead, they’ve opted for a crude formula based on bilateral trade deficits between the US and each specific country. Those aren’t the same things.
A country has a trade deficit when the total value of everything it imports from somewhere else exceeds the value of what it exports there. A trade surplus is the opposite.
Trade deficits and surpluses – the balance of trade – can be calculated between specific countries, but also between one country and the rest of the world.
Tariffs are different things altogether – taxes a country charges on imports when they cross the border, paid by the importer.
Trump’s new reciprocal tariffs have been calculated by taking the US trade deficit with each country, dividing it by total US imports from that country, then halving the resulting ratio and converting it into a percentage.
For example, in 2024, the US imported approximately US$605.8 billion from the European Union, but exported only $370.2 billion, resulting in a trade deficit of $235.6 billion.
Dividing the deficit by total imports from the EU gives a ratio of 39%. The White House interpreted this figure as the EU’s trade “advantage” and subsequently imposed a “discounted” 20% tariff on EU products – roughly half of 39%.
This same calculation led to a 34% tariff on China, 26% on India, 24% on Japan and 25% on South Korea. More export-dependent developing countries, including many in Southeast Asia, face some eye-wateringly high reciprocal tariffs.
Trade experts swiftly criticised the methodology behind the tariffs. James Surowiecki, a financial journalist, labelled it “extraordinary nonsense”.
While the use of economic formulas in the corresponding US Trade Representative document might give it an appearance of being grounded in economic theory, it is detached from the rigours of trade economics.
The formula assumes every trade deficit is a result of other countries’ unfair trade practices, but that is simply not the case. To see why, we need to understand why Trump’s obsession with trade deficits is wrong.
A government isn’t a household
Why does Trump detest trade deficits? He appears to think of the national balance of trade like a business or household’s finances.
Under Trump’s logic, if more money is leaving the “account” than coming in, that’s bad business. A $200 million trade deficit would mean the US is “losing” – with money and jobs being siphoned away.
Trump argues other countries have been taking advantage of America by running up big trade surpluses and “hollowing out” US industry. He has long argued that America’s massive deficits indicate unfair trade deals, foreign protectionism, and even a threat to national security.
Few economists share Trump’s view
The trade gap is not money simply being drained overseas by allegedly rapacious foreigners. Rather, it represents the exchange of value.
American consumer behaviour is a significant driver of the US trade deficit. As a consumption powerhouse, the United States sees its residents and businesses spending vast sums on imported products ranging from iPhones and TVs to clothing and toys.
Many of these are actually produced by US companies but made overseas. Moreover, those US companies licence foreign factories to produce these goods, and the intellectual property revenues earned make up a huge US surplus in services trade.
But services trade does not feature in the formula. This shows the singular obsession with tangible things, or goods trade. Yet in most supply chains it is the services components that yield the most value.
Back on the goods side, when the US economy is robust and people have disposable income, imports naturally increase. Ultimately, while trade deficits indicate economic dynamics, they are not inherently negative nor do they signify economic weakness.
Rather, they often reflect a nation’s economic structure and consumer preference for diverse global products. After all, Australia has run trade deficits for decades, including with the US, and is one of the wealthiest countries in the world.
The uninhabited Heard and McDonald Islands, home to a large population of penguins, were hit with tariffs in this week’s announcement.VW Pics/Getty
The real reason for the deficit
The formula used to calculate the reciprocal tariffs is highly misleading. Responsible policy makers would take account of many other factors in their calculations.
Among other variables, the US Trade Representative formula fails to consider strong US consumer demand for imports. It also overlooks the US government’s gigantic fiscal deficit. This requires it to borrow money from overseas, pushing up the value of the US dollar. This strong dollar supports US purchases of imports.
In other words, the US runs large trade deficits not primarily because other nations have high trade barriers but largely because Americans need to fund their debts and want to buy lots of imported goods. The misleading formula places the blame entirely on an ill-conceived notion, and we are all going to pay the price.
Peter Draper receives funding from the European External Action Service and Australian Department of Foreign Affairs and Trade, for project-specific work connected to trade policies. He is affiliated with the Australian Services Roundtable (Board Member); the International Chamber of Commerce (Research Foundation Director); European Centre for International Political Economy (non-resident Fellow); German Institute for Development and Sustainability (non-resident Research Fellow); and Friends of Multilateralism Group (member).
Vutha Hing receives funding from Economic Research Institute for ASEAN and East Asia. He is affiliated with Trade Policy Advisory Board, Royal Government of Cambodia.
This article is republished from The Conversation under a Creative Commons license.
