Trade Deficits (Mostly) Don’t Matter

I’m in Victoria, British Columbia today to talk about trade with some young Canadians.

In doing some research about how to present the best case for free trade and against protectionism, I found some excellent commentary on why trade deficits don’t matter.

Here are some excerpts from a column by Don Boudreaux, a professor at George Mason University.

…the president’s trade policies are dreadful; they’ll reduce U.S. economic growth and diminish Americans’ spending power. …No myth about trade is more widespread than is the belief that imports reduce domestic employment. …trade is a two-way street. Non-Americans sell stuff to Americans only to acquire the dollars needed buy American exports and to invest in the U.S. — and each of these activities creates other particular jobs in America to offset those that are destroyed. …The reason trade deficits don’t reduce overall employment is that, in fact, trade deficits are not really deficits at all. Every cent that does not return to the U.S. as demand for American exports returns instead as investment in America. In economists’ lingo: the trade deficit (or, to be precise, the current-account deficit) is matched by a capital-account surplus of equal size. …Why should we be upset if foreigners continue to think highly enough of our economy to want to invest here?

And here’s some of what Greg Mankiw of Harvard wrote for the New York Times.

…the president’s overall approach to international trade is so confused. …When Mr. Trump discusses our trade relations with another nation, he often points to the bilateral trade balance — the difference between the value of our exports to that nation and the value of our imports from it. If imports exceed exports, we are running a bilateral trade deficit, which Mr. Trump interprets as a sign that we are the relationship’s losers. …consider some of the many bilateral trade deficits that I run. Whenever my family goes out to dinner, the restaurateur gets some money, and we get a meal. In economics parlance, the Mankiw family runs a trade deficit with that restaurant. But that doesn’t make us losers. …I can run persistent trade deficits with restaurants because I run trade surpluses elsewhere. Take The New York Times, for instance. It pays me more for my columns than I pay it for my subscription. That’s a bilateral trade surplus for me and a bilateral trade deficit for The Times. But nonetheless, we both gain.

I tried to incorporate these insights into my presentation, which has more than 30 slides.

Here are the ones that deal with the trade deficit, starting with some elementary observations.

I then pointed out that all of us have trade deficits in our daily lives.

Yet we understand this doesn’t hurt us.

Using trade with China as an example, I explain that money we send overseas only has value because foreigners can use it to purchase things in America.

Including investments.

And I recycled this chart from a column back in March.

For what it’s worth, understanding that a trade deficit is merely the flip side of a financial surplus is the key to recognizing that trade deficits (generally) don’t matter.

I’ll close with an important caveat.

I’m a big fan of foreign investment in the U.S. economy. Indeed, it’s one of the reasons why I’m happy America is a tax haven for citizens of other countries.

That being said, not all inbound investment is created equal. I’m delighted when foreigners buy stock and bond. I’m very happy when they make direct investments (one of the reasons I like the EB-5 visa program).

It’s not good news for our economy, though, when foreigners buy government bonds. But that’s the fault of our ever-expanding welfare state, not trade.