An investor views stock market data on an electronic board at a securities brokerage house in Beijing, China, 08 January 2016. EPA/ROLEX DELA PENA

The US-China trade dispute reshaped the world’s economic and financial landscape in 2018, and it might continue to do so for years to come. That’s not how it looked as recently as May, when a bilateral trade deal was almost within reach. But the United States backed out at the eleventh hour, and tensions have since flared, with President Donald Trump’s administration imposing tariffs on a wide range of Chinese exports, and China responding in kind.

With an unprecedented $600 billion worth of goods potentially affected, it is worth considering how useful tariffs really are for correcting current-account imbalances, which is Trump’s stated goal. Most economists view trade from a multilateral perspective, focusing on an economy’s overall balance with the rest of the world. And the US has been running overall trade deficits since 1976.

The US deficit peaked at 5.5% of GDP in 2006, but usually amounts to around 3% of GDP. At $552 billion in 2017, it is the world’s largest deficit in absolute terms. Deficits rise when a country spends more than it produces, which means that they are rooted not so much in trade as in domestic savings and investment behavior. In the US, investment accounts for 21% of GDP, in keeping with the average across advanced economies (22%), whereas savings account for less than 19%, which is far below that of America’s peers.

The US saving rate reflects both public- and private-sector behavior. The personal saving rate was as low as 3% in the run-up to the 2008 financial crisis, after which it edged up to 7% – a rate still far below that of the early 1990s. Meanwhile, the public sector has historically saved even less. The US has had a federal budget surplus in only five of the last 50 years, and it has maintained deficits averaging more than 4% of GDP since 2002. In 2018, the deficit rose by 17% on the back of tax cuts and increased defense spending, further dampening public savings.

Underlying the low US saving rate is the dollar’s status as the main global reserve currency. The dollar’s dominance confers on America what Valéry Giscard D’Estaing, then France’s finance minister, famously dubbed an “exorbitant privilege,” insofar as it allows the US to finance its deficits with little external constraint, borrowing ever more from abroad while saving less at home. By the end of 2017, foreigners owned half of the $12 trillion worth of privately held US Treasury securities that are currently outstanding.

As the multilateral perspective makes clear, the US current-account deficit can be reduced only through structural reforms to address the imbalance between domestic savings and investment. Such reforms have become all the more urgent with the unchecked growth of entitlement spending, and with US unilateralism on trade now testing global confidence in the dollar.

Notwithstanding these economic realities, the Trump administration has embraced a bilateral perspective. Its tariffs on Chinese exports are meant to improve the US trade balance vis-à-vis China specifically. But if the US imports less from China, it will simply import more from other countries. Its overall trade deficit will likely remain the same or grow even larger, as the latest data suggest.

Worse still, tariffs come with far-reaching costs. As the American economist Henry George observed 132 years ago, “What protection teaches us is to do to ourselves in time of peace what enemies seek to do to us in time of war.” Indeed, history is filled with cases of high tariffs turning economic slumps into major depressions. And even at a time of growth, the Trump administration’s tariffs will not just force Americans to pay more for imports; they will also undermine US production, by distorting business incentives and misallocating resources. Moreover, tariffs are hard to reverse, because they breed special interests and invite retaliation.

Yet, despite their high long-term costs, tariffs are addictive as a political device, because they allow governments to offer short-term sweeteners instead of more difficult structural reforms. But even if politicians are willing to turn a blind eye to the risks of protectionism, markets will not, as evidenced by the volatility in US stock markets in October 2018.

As for China, its adherence to the multilateral perspective on trade has led it to reduce its external imbalance through structural reforms. Unlike the US, China has had too much saving and too little spending. But in the decade since the global financial crisis, it has introduced policies to narrow the urban-rural income gap and strengthen the social safety net, thereby boosting consumption and reducing saving.

Such reforms have brought China’s current-account surplus down from nearly 10% to 1% of GDP over the past decade. In the first three quarters of 2018, final consumption expenditure accounted for nearly 80% of Chinese GDP growth, reflecting the fact that the economy is increasingly driven by domestic demand. By actively reducing its external surplus, China has demonstrated that it is not a mercantilist power, but rather a responsible global stakeholder pursuing balanced and sustainable long-term growth.

Looking ahead, China should continue to pursue structural reforms that open up its economy, not least by improving intellectual-property protection and creating a level playing field for competition between domestic and foreign firms. Such goals are firmly in line with the objective of balanced, sustainable growth.

To be sure, China has been accused of merely paying lip service to openness, particularly by foreign investors who have found it difficult to enter the Chinese market. The real problem, however, is not a lack of commitment to reform, but rather administrative red tape, which domestic constituents also complain about. Recent measures, such as the “one stop, one trip, one paper” program in Zhejiang province, demonstrate that China is serious about improving the business environment for all.

Whether the multilateral perspective prevails over the bilateral approach will have significant consequences over the medium and long term. Obviously, the multilateral view offers a better understanding of trade imbalances than the bilateral perspective, just as structural reforms are a better alternative than tariffs. At the end of the day, external imbalances can be addressed only by correcting domestic imbalances. Because China has embraced this principle, its economy will continue to become more balanced and sustainable, regardless of the path the US chooses.

Zhu Min, a former Deputy Managing Director of the IMF, is Chair of the National Institute of Financial Research at Tsinghua University.

Miao Yanliang, Chief Economist at China’s State Administration for Foreign Exchange, has been a member of the China Finance 40 Forum since 2015.