How do we know if the United States is “winning” at international trade? Most non-economists would probably answer, “The trade deficit!” This mercantilism reasoning suggests that if a country sells more than it buys, then it is winning since trade surpluses are good and trade deficits are bad. This view is based on the characterization of imports as a “drag on growth” as net exports has a negative value in the GDP computation when there a trade deficit. However, imports often complement rather than replace domestic production. In fact, more than half of US imports are intermediate goods, raw materials, and capital equipment, which American companies use to make their final products. Even imported consumer goods can complement domestic output by reducing retail prices and thus freeing consumer dollars for spending on domestic output.
As it turns out, the trade balance is a particularly bad measure of national well-being as it does not seem to correspond to measurements of other economic difficulties such as unemployment or diminished economic growth rates. Instead, the trade balance reflects the combined decisions on savings and spending by a nation’s firms and households. A nation that produces more goods and services than is domestically consumed will have more income than spending, which generates savings that must be invested somewhere. If instead the combined spending by households, firms, and governments exceed domestic production exceeds production and income there will be a shortage of savings. In the United States people tend to save a smaller share of their income, resulting shortage of savings relative to investment demand drives the deficits in trade and the current account.
In this sense, the U.S. trade deficit is a choice by its citizens, firms, and government, and the only solution to the perceived problem of the trade deficit would be to rebalance the American economy away from such heavy consumption towards a stronger focus on production. One way for the U.S. to achieve this is to deploy protectionism, such as tariffs, to reduce or consumption of foreign overproduction. This would transfer income from households to companies (in the form of higher prices) and companies use that windfall as savings to expand their investments into future production.
Discussion Questions:
1. Discuss what has caused the large U.S. deficits in recent years beyond the obvious discrepancy between exports and imports.
2. Explain both the benefits and drawbacks of trade deficits, as well as the benefits and cost of a trade surplus.
Sources| Cato: https://www.cato.org/publications/trade-balance-winning-trade#are-we-winning-trade; WSJ: https://www.wsj.com/opinion/the-trade-secret-of-intellectual-trumpism-policy-tariffs-protectionism-goals-c9a704d4; Unsplash: Photo by Pin Adventure Map on Unsplash