The Deficit in Focusing on Specific Trade Deficits

Overall trade deficits may pose a danger; bilateral trade deficits don’t. One can easily see how this can be confusing.

As Maurice Obstfeld of the IMF wrote recently,

A person who spends more than he or she makes either sells an asset to cover the difference or goes into debt. If the person goes into debt, that person is accessing the saving resulting from somebody else earning more than they spend. Much the same happens with countries.

The U.S. has run a substantial trade deficit for years, not because our trading partners don’t play fair, but because on the one hand U.S. businesses invest a lot in new plant and equipment while the Federal government runs large deficits. On the other hand, Americans collectively don’t save enough to cover all these needs and so we import the difference from investors overseas who save more than they spend.

Who causes America’s trade deficit? Americans.

Trade deficits may matter if they result in unsustainable levels of debt owed to overseas investors. Checking a patient’s temperature is a simple way to test for fever. The analog for countries running trade deficits is to check the interest rate being charged. Foreign investors are currently charging Americans low interest rates to use their saving, so for now the large U.S. trade deficit isn’t a concern. But if it were to become a concern in the future the solution would be simple enough – the private sector would need to save more and/or the public sector would need to dis-save less.

As Obstfeld further wrote, “the structure of bilateral trade reflects the international division of labour – based on each country’s comparative advantage.” The basic principle guiding international trade – comparative advantage – simply states that each country prospers best when each country focuses most on doing what it does best. This really is no different than the basic principle guiding all economic relationships in a free market economy. Why does Iowa produce corn while Maryland produces crab cakes? Why does Beyoncé sing while Steven Hawking did physics?

The macroeconomic dimension determines whether a country runs a trade deficit; comparative advantage dictates the composition of the trade deficit across goods and services and across the countries with which the United States trades. Whatever these bilateral patterns, they are at once interesting and harmless.

A simple example demonstrates. Consider three countries: A, B, and C. Each country is running a perfect balance in trade because in each country total saving equals the total demand for saving. Yet A runs a $1 billion trade deficit with B; B a $1 billion deficit with C; and C a $1 billion deficit with A. Should A complain to B about its trade deficit? Then how should A respond to C with which it is running a trade surplus?

Citing the trade deficit, President Trump has taken actions, and suggested more, to address various issues he sees in our trading relations. In principle, he is right to challenge China’s behavior with respect to excess capacity in some industries, with market access, and with intellectual property protections.

However, the proposed remedy – imposing tariffs on up to $150 billion of imports from China – would be an economic calamity. As U.S. Chamber President and CEO Tom Donohue has said,

Some other trade proposals have also been off base. The U.S.-Korea Free Trade Agreement was not being implemented as intended, but it is a remarkably strong agreement and did not need to be renegotiated. The North American Free Trade Agreement (NAFTA) could use some modernization, but there is strong opposition across the U.S. business and agriculture community to a number of the administration’s central goals in renegotiating NAFTA.

President Trump is not a traditional president, so he takes a somewhat different approach to the traditional diplomatic give and take. Trump’s approach is more akin to a two-by-four – as in, “How do you get a mule’s attention?”

He’s gotten the world’s attention. It’s time now, as NASA would say, to “work the problem” of improving the international trade regime, not with an eye to correcting bilateral trade deficits or even overall trade deficits, but with the goal of strengthening the international trade regime for America’s consumers and businesses.

With all due respect to Beyoncé and Iowa, we don’t really want her doing physics and we don’t really want Iowa crab cakes.

About the authors

J.D. Foster

Dr. J.D. Foster is the former senior vice president, Economic Policy Division, and former chief economist at the U.S. Chamber of Commerce. He explores and explains developments in the U.S. and global economies.