At the heart of President Donald Trump’s reciprocal tariff proposal lies a bilateral mercantilist fallacy: the assumption that trade surpluses are a sign of economic strength and deficits of economic weakness. This is contradicted by canonical models of the current account, which views trade imbalances as outcomes of saving and investment decisions rather than trade policy per se. A country with a trade deficit is typically saving less than it invests, not necessarily being "taken advantage of" by its trading partners. Thus, attempting to close trade deficits through tariffs misunderstands their origin and can distort capital flows, misallocate resources, and reduce welfare.
Pictured: Reza Ismail, Head of Bonds at Prescient Investment Management
Underpinning the reciprocal tariff proposal lies a non-standard formula to calculate tariffs: if Country X exports $100 billion to the United States and the U.S. imports only $50 billion from Country X, the trade deficit is $50 billion. The reciprocal tariff is then calculated as (Deficit / Imports) / 2, or ($50B / $100B) × 0.5 = 25%. A floor rate of 10% is enforced regardless of the computed value. The simplicity of this arithmetic masks the economic complexity of trade dynamics and ignores endogenous macroeconomic adjustments that shape bilateral deficits.
This approach lacks theoretical foundation. First, it ignores multilateral trade balances: bilateral deficits are neither necessary nor sufficient for national welfare. For instance, the U.S. may run a deficit with China but a surplus with others, consistent with equilibrium. Second, the formula fails to consider the elasticities of demand for imported goods. Imposing a tariff based on trade deficit magnitude, without assessing price responsiveness or substitutability, can result in large welfare losses without reducing import volumes or improving the trade balance.
Under classical optimal tariff theory, a large country may improve its terms of trade by imposing tariffs, provided its imports are price-inelastic. However, this gain is eroded if retaliatory tariffs are imposed by trade partners - leading to a terms-of-trade deterioration for both. In a globalized economy with complex value chains, reciprocal tariffs often trigger symmetric retaliation, nullifying potential benefits. Moreover, empirical estimates suggest that general equilibrium feedbacks - via input-output linkages - amplify the negative effects on output and welfare.
The logic of free trade is rooted in comparative advantage, where countries specialize in the production of goods in which they are relatively more efficient. Tariffs artificially re-allocate resources toward less efficient domestic sectors, reducing aggregate productivity and misallocating labour and capital. In Trump’s framework, reciprocal tariffs are not designed to respond to unfair practices or externalities but to equalize observed deficits—thus acting as an indiscriminate tax on comparative advantage. This leads to global inefficiencies and a contraction in welfare-maximizing trade flows.
Empirical studies show that tariffs rarely reduce trade deficits. This is because deficits are a macroeconomic phenomenon: unless saving increases or investment falls, tariffs will merely shift the composition of imports rather than the aggregate balance. Moreover, higher import prices may reduce the volume but raise the value of imports, worsening the nominal trade deficit. Even if import volumes decline, a currency appreciation (induced by lower foreign demand for U.S. assets in retaliation) could offset the competitiveness gains.
More specifically, in standard macroeconomic theory we have the identity:
Current Account Balance = National Savings−National Investment
This identity holds ex-ante (forward looking) and ex-post (historical) in any national accounting system. A country running a current account deficit must, by definition, be investing more than it saves; conversely, a surplus indicates excess national savings relative to investment opportunities. Seasoned economic academics and practitioners alike warn against the widespread misconception - propagated in both policy circles and populist rhetoric - that bilateral trade deficits are attributable to “predatory” trade behaviour. Rather, they are emergent properties of broader macroeconomic conditions and the global configuration of capital flows.
This argument strongly discredits the rationale for Trump’s reciprocal tariffs, a policy framework that seeks to impose tariffs on countries with which the United States has a bilateral trade deficit, proportionate to the imbalance. Such a policy not only misapprehends the origins of deficits but is analytically incoherent. Bilateral trade balances are not meaningful in a world of multilateral trade and global capital mobility. Imposing tariffs based on these balances may shift the geographic locus of deficits but cannot reduce their aggregate size unless accompanied by structural reforms that alter national saving or investment behaviour.
Savings surplus countries such as China and Germany operate under domestic conditions - often characterized by financial repression, wage suppression, and low consumption - that generate excess savings. These excess funds are then re-cycled into global capital markets, most notably the United States, which possesses the deepest and most liquid asset markets. The influx of capital into deficit countries causes currency appreciation, reduces export competitiveness, and thereby entrenches trade imbalances.
Tariffs, including reciprocal ones, do not interrupt this flow. On the contrary, they may exacerbate imbalances by triggering safe-haven capital inflows into the United States, further appreciating the dollar and widening the trade deficit. Moreover, trade surpluses are not evidence of competitive virtue; they frequently arise from internal distortions that suppress consumption and constrain domestic absorption. As such, the only sustainable solution to global imbalances is symmetric adjustment: surplus countries must reduce savings by expanding domestic consumption, while deficit countries must raise savings and reduce excessive reliance on foreign capital.
Protectionist measures often serve as substitutes for politically costly domestic reforms. By externalizing blame for trade deficits, governments obscure the role of internal policy failures, such as fiscal profligacy, inadequate investment discipline, or income inequality that depresses household savings. Reciprocal tariffs may offer short-term political capital, but they do not resolve the structural imbalances they purport to address.
The empirical manifestation of these theoretical arguments is evident in China’s experience during the 2000s. The Chinese growth model, premised on suppressed wages, low interest rates, and capital controls, produced massive excess savings and a concomitant trade surplus. Rather than reflecting predatory export behaviour, this surplus emerged from domestic policies that constrained household consumption. Attempts to resolve the surplus externally, through currency appreciation or tariffs, would fail unless China undertook internal reforms to liberalize consumption and allow more equitable income distribution.
Equally, the presumption that trade deficits in the United States reflect excessive consumption or loss of competitiveness. In reality, the U.S. trade deficit is structurally linked to its role as the issuer of the global reserve currency and recipient of excess global savings. The demand for U.S. assets inflates the dollar, depresses exports, and sustains the deficit. Closing the trade deficit would thus require a reduction in capital inflows - via fiscal consolidation, higher household saving, or even capital controls—not the imposition of import duties.
The implications are especially salient for emerging markets, including South Africa. These economies are often price takers in the global capital system and are disproportionately exposed to the fallout of trade imbalances among major economies. South Africa, for example, runs a persistent current account deficit, financed largely through volatile portfolio inflows. These inflows are highly sensitive to global risk sentiment and U.S. monetary policy, rendering South Africa vulnerable to sudden capital reversals, exchange rate volatility, and surging sovereign yields.
In an international environment destabilized by reciprocal tariffs and the erosion of trade multilateralism, South Africa faces heightened uncertainty. If global trade volumes contract or capital flows become more erratic, the country may be forced into procyclical adjustment—tightening monetary policy to defend the rand or cutting expenditure to maintain external balance. This would reinforce the asymmetry whereby deficit countries bear the burden of adjustment while surplus economies delay reform.
Emerging markets like South Africa must pursue dual strategies: first, strengthening their domestic macroeconomic fundamentals to reduce reliance on external capital, and second, advocating for a more balanced international trade architecture. This entails a renewed emphasis on domestic savings mobilization, fiscal discipline, and productive investment, coupled with engagement in global forums that press surplus economies to address the sources of excess savings. Failure to do so risks locking South Africa and other EMs into a structurally subordinate position within the global economic order.
In the final analysis, the overarching contribution is to re-anchor the trade debate in macroeconomic identities. The focus on tariffs and bilateral deficits, exemplified by Trump’s reciprocal tariffs, obscures the deeper structural origins of trade imbalances. These are not anomalies to be corrected at the border, but systemic manifestations of domestic policy choices—on consumption, investment, distribution, and finance. Any attempt to resolve them through punitive tariffs or bilateralism is not only doomed to failure, but also corrosive to the international trading system.
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