There’s been a lot of focus on trade deficits in recent years. Politicians lament our high trade deficits as lost opportunities to both create more jobs and generate more business for US companies. Technically, they may be right in some cases. But that doesn’t mean that our labor force, corporations and economy would be better off if we were to pursue policies that simply minimize our trade deficits. Trade can be, and usually is, mutually beneficial to both trading partners, and economists generally agree that freer trade policies usually lead to better economic growth and higher living standards. Are there problems associated with the free flow of goods and services between countries? Absolutely. Countries need to be held to the same standards with regard to things like intellectual property, government subsidies, dumping, and labor conditions. In other words, there should be a level playing field for all who seek to compete internationally. But pursuing policies for no other reason than to reduce trade deficits is generally not economically justifiable.
International trade has expanded greatly over the centuries, and for good reason. Trade allows individual countries with particular skills and/or resources to specialize in producing those goods and services. And when each country is specializing in what it does best, we are better able to maximize our aggregate productive capacity. In this sense, trade is really no different than competition among different companies within the same country. If US Company A can produce widgets more efficiently than US Company B, then Company B had better improve its proficiency or else pursue a different business. This is the essence of capitalism. And provided that everyone is playing by the same rules, the same applies to international trade. Through specialization, trade increases the size of the global economic pie.
In recent decades, many US manufacturers have lost market share to international competition largely because many countries, especially in Asia, have vast pools of low-cost labor at their disposal. The transfer of production outside the US, along with increased automation and other factors, has contributed to the loss of jobs and economic vitality within the US manufacturing heartland. But this transfer of production overseas also has benefits that must be considered as well. The low cost of international production has allowed US consumers to pay much lower prices for all kinds of consumer goods. Consumers enjoy new 45″ HDTVs for $300 that would cost more than twice that amount if they were manufactured domestically. Policymakers must consider these economic and social benefits when considering the imposition of trade restrictions.
If you’re not convinced, maybe we should look at some data. Over the past two years in the US, policymakers have injected a large dose of fiscal stimulus into the domestic economy in the form of tax cuts and increased government spending. I think most economists would agree that the stimulus has been responsible, in large part, for the better economic growth we’ve enjoyed over the past few quarters. In particular, the US consumer appears to be doing a lot better. Unemployment is very low, wages are rising at a better rate, stock and housing prices are up, and confidence is near multi-decade highs. Consumer spending, which is responsible for over two-thirds of US GDP, has grown at an average rate of over 3% for the past four quarters. A stronger, more confident US consumer has led to increased demand for, you guessed it, imported goods. But because the governments of other countries across the globe, including our trading partners, have not passed massive fiscal stimulus packages, they have not enjoyed the surge in growth that we’ve seen in the US. Therefore, the gap between US economic growth and that of many of our trading partners has expanded. In the process, our trade deficits have been going UP, not down, to reflect stronger demand in the US.
Many who fixate on trade deficits do not seem to understand that this stimulative fiscal policy is at odds with efforts to reduce our trade deficits. In fact, these policies are diametrically opposed. Should one prefer a less healthy, slower-growing economy coupled with smaller trade deficits? Or should we be celebrating our current situation – an economy that is the envy of the world, including low unemployment and increasing wage growth, AND larger trade deficits? You see where I’m going with this?
In the chart below, I show two lines. The first line (blue) represents trailing four quarters average GDP growth if we exclude the drag (or contribution) from net exports (the trade deficit) . The second line (orange) represents the drag (or contribution) from net exports. It is clear to see that these two data sets are inversely correlated. In other words, US trade deficits are higher when the economy is growing faster, and vice versa. High trade deficits are coincident with economic booms, and low trade deficits are coincident with weak economic growth or contraction. It is unrealistic to expect the US to have both superior economic growth than its trading partners AND still reduce our trade deficits.