WTO-Trade imbalances and the limits of trade policy

July 31, 2025--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.

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Source: World Trade Organization (WTO)