Focus on Real Deficits, Not Trade Deficits

Since the release of this month’s trade balance figures showed an increased U.S. trade deficit in June, the anti-trade folks have been on the offensive. Fair trade advocates, such as Tim Robertson of the Huffington Post, have warned us that the free trade agreements pending in Congress will increase unemployment. Others have reminded us that the trade deficit inhibits economic growth and destroys jobs. Given the popularity of this perception, it seems worthwhile to point out just how false it is, and why.

First, there are some fundamental misconceptions about what our trade deficit actually represents. It does not mean that we are in debt, nor does it mean that the U.S. sends more dollars abroad than it receives. Rather, it reflects the fact that foreigners invest heavily in the U.S. economy. 

That may seem counterintuitive, but consider this example: An American college student buys an imported computer from a Japanese company for $1,000. The company can do one of three things with its earnings. It can spend them on goods or services from the U.S., it can invest them in the U.S., or it can exchange them with someone who wishes to do one of those two things.

Keep in mind, however, that the trade deficit only accounts for the exchange of goods and services. So, even if the company chooses to invest its earnings directly back into the U.S. economy, we still have a $1,000 trade deficit — and our fair trade friends are upset. But the trade deficit simply reflects the fact that many companies choose to invest their earned dollars in the U.S. by purchasing stocks, bonds, and other investment products, rather than by purchasing physical goods or services.

It is important, then, to illustrate clearly what trade deficit opponents are actually proposing. They would prefer that, for every import that we purchase, we give up an export of equal value. This would create the desired balance of trade in goods and services. The alternative is that we purchase an imported product and then get our own money back as an investment in the U.S.economy - but an artificial government document will tell us that we have a trade deficit. Needless to say, the second alternative doesn’t sound so terrible.

This relationship between trade deficits and investment may explain why, over the past thirty years, the economy has grown three times faster on average during periods in which the trade deficit was expanding, compared to periods in which it was contracting as a percentage of GDP.

Second, the proposed solutions to our trade deficit “problem” make little sense upon close inspection. Some, like Ian Fletcher at the Huffington Post, suggest that the U.S. impose an across the board tariff on all imported goods and services. Economist Paul Krugman seems to agree, arguing that “a countervailing duty on Chinese exports would be job-creating.” With so many Americans out of work, after all, it seems to follow logically that restricting imports would create jobs here at home. Every product that we import is a product that we could be making here in America, the argument goes.    

This is a half-truth. Sure, we may encourage domestic production by restricting imports. But that would leave foreigners fewer dollars with which to purchase our exports. If we are not buying as much from foreign producers, they will, in turn, have less to spend on American products. The resulting job losses in export intensive sectors will cancel out job gains in sectors facing import competition. This is, of course, not to mention the fact that foreigners would have fewer dollars to invest in the U.S. economy. 

This is not to say, of course, that lawmakers won’t be temped to enact such policies.  Protectionism will always be attractive to politicians. It enables them to justify policies that benefit large, concentrated domestic interests, while the costs are conveniently diffused amongst the general public. Not surprisingly, lawmakers consistently misrepresent the trade deficit in order to drum up public support for such measures. Rather than misleading people about an imaginary deficit which does our economy no harm, they should focus on more pressing matters. Their non-imaginary $1.6 trillion deficit would be a great place to start.

Photo Credit: Wikimedia Commons

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