Do Trade Deficits Matter for the United States?

Do Trade Deficits Matter
for the United States?

Economics Without The B.S.**: 

[**  Double entendre intended.]

The manner in which a country conducts foreign trade is a reflection of its economy, its macro economy.  While the United States has run very high trade imbalances, about $500 billion each year or 3% of its real GDP, these deficits were primarily due to the trade of goods, a $700 billion deficit, not the trade of services which has consistently through the decades been in surplus, currently at approximately $200 billion. 

Our trade deficit position took a change after the Asian Financial Crisis of 1997 and the entry of China getting international trading status from the WTO (World Trade Organization) in 2001.  Since that time Asian countries, and in particular China, have adopted an industrial policy of being net trade exporting countries.  And the United States has willingly become the receptor of this international trade imbalance in goods by being the deficit nation; and, allowing itself to expand its consumption of goods beyond its productive capacity, which in the U.S. case is financed by the huge inflows of foreign investment in our productive assets at home as well as huge investments in our financial assets –  U.S. treasuries, currency, agency bonds and Wall Street created financial instruments (like CDOs, Collateralized Debt Obligations) and their derivative products.  In addition to trade deficits that need to be financed, the United States runs up huge Federal Government deficits of $400 to $600 billion each year which also need to be financed.

This situation is a reflection of the productive capacity – I would say a declining rate of productivity – of the United States.  The 1960s was the highest performing economy for a peacetime period in the entire U.S. history – as measured by real GDP per capita, averaging approximately 3.5% per year; over 5% per year on a real GDP basis.  Since that time we have been in a declining trendline in the rate of productivity each succeeding decade – the 1980s and 1970s are worse than the 1960s, the 1990s are worse than the 1980s, and the last 17 years are worse than the 1990s and approximately one-third of the growth rate of the 1960s.  While GDP is an imperfect measure of our productivity, it is still the main measure we use.  And while GDP is not a measure of our standard of living, it is closely associated with it – the more you can produce, the more you can consume.

We have had declining productivity growth since the 1960s (the best period for peacetime productivity growth in the 220+ years of history of the U.S. as measured by real GDP per capita) and trade has been a drag on our productive growth because we now have sectors within our economy which are less productive than what we had back in the 1960s – a larger consumer/retail/wholesale sector, more service industries; while having a smaller but highly productive industrial/commercial/agricultural sectors and a small sector of highly productive business/info tech service industries.  With fewer high growth opportunities to invest in the real economy, foreigners invest in financial assets.  Trade is not the only thing dragging down the GDP rate of growth, nor is it the most important; but, it is systematic of our productive base today.

When investment from foreigners come back into the U.S. to finance our twin deficits of trade and budget, it does make a difference how that investment is spent.  Just as a business evaluates capital spending to determine what the best investment return will be, so must the same be true for dollars coming back into the U.S.  Even when they come back into U.S. treasuries they are financing our government debt; so, that makes a difference if it is financing welfare or consumption spending or defense spending on military technology or some other capital improvement the government is making.  The foreigners investing in our government treasuries may be doing it because they seek safety rather than the risk associated with capital investments – that’s all well and good for them, but it is not the best outcome for us even though it is a positive outcome for us.  The better the return on the investment, the better off we are; and, usually that will mean an investment in highly productive resources rather than consumption spending.

In a world of limited resources, how those resources are allocated (over time) matters.  What individual actions acquire in a transaction and how they use that acquisition affects others in that society and determines the outcome for that society.  Our American predecessors took on an obligation, to themselves and their society, to strive for the best and be in the vanguard of leadership in accepting challenges.  Each generation of Americans that come along get to decide what path toward progress they will take.  The collective will of a people is not just decided by independent individual choices but by the interaction with others and the leadership (government, business, civic) in that society.