Stop Worrying About The Trade Deficit
For the past few years, media outlets and TV news networks have given significant amounts of coverage to America’s trade deficit. Usually the stories and headlines give the news consumer a sense that the growing trade deficit is something to fear (see here, here, and here). Many politicians, other critics of free trade, and most Americans for that matter, believe large trade deficits are evidence that American companies are failing to compete in global markets or that U.S. exporters face "unfair" trade barriers abroad, or both. Solutions for this supposed problem include large tariffs or subsidies for manufacturing industries that cannot compete with cheap imports. However, the trade deficit is one of the most misunderstood phenomenons in economics.
Most people, if they understand the trade deficit at all, realize that a trade surplus is created by exporting more goods to foreign countries than are imported from foreign countries, while a trade deficit occurs when a country imports more than it exports. Today, and for most of the past several decades, America has run a trade deficit. To take a recent example, the trade deficit for the month of February in 2006 was $65.7 billion. In other words, Americans spent $65.7 billion more on goods and services produced by foreign countries than the rest of the world spent on American goods and services.
The reason that most Americans freak out over large trade deficit numbers such as these is because they perceive the American economy as a large bank vault with a fixed supply of money. They believe that if more money is going out of the vault to buy things from other countries than is going back in from sales to foreign consumers, then eventually the vault will become empty and America will be bankrupt.
However, this reasoning is extremely faulty. Most importantly, it does not take into account the savings American businesses reap by importing cheap goods. A simple illustration is helpful here. Consider a large construction company that needs massive amounts of steel to build buildings and houses. American steel suppliers cannot accommodate the needs of all American consumers, so steel must be imported from other countries. This action obviously increases the trade deficit, but it allows the construction company to erect buildings. These buildings not only expand and enrich its business, but allow other American companies to do the same. The construction company doesn’t export anything to decrease the trade deficit, but its business decision increases the size of the American economy significantly. By using cheap imports that American suppliers cannot provide, American wealth is expanded.
On a larger scale, cheap imports from abroad allow America to produce the technology and financial services jobs that are needed within America. In addition, American consumers get the benefit of low-priced products overseas and these savings can be used to raise the standard of living or reinvest in the American economy.
Therefore, a trade deficit is not necessarily a bad thing for a country and it can be a sign of a strong economy. Every year for the past 20 years America has run a trade deficit, but over the same period of time the American economy has more than doubled in size. In addition, there is a significant positive correlation between the size of the trade deficit and the rate of economic growth. In essence, the trade deficit has risen when the economy has grown and receded when the economy has faltered. In fact, the lowest annual U.S. trade deficit in recent times was recorded in 1991, a recession year. This is evidence that by importing cheap goods from abroad and, as a result, increasing the trade deficit, the internal American economy is able to grow at an impressive rate.
Concern over the trade deficit is often linked to the rise of China’s economy and its ability to import cheap goods and services due to its inexpensive labor costs. Yet, as a factual matter, concern over Chinese imports is overblown. Chinese imports remain modest in the context of overall trade and the U.S. economy. In 2005, China accounted for less than 15 percent of our overall imports and Americans spent only 2 percent of what they earned on imports from China. This is no cause for alarm, even if trade deficits were, in concept, significant.
In the late 1920s, the American government became concerned about cheap imports and “unfair labor” practices abroad and implemented the Smoot-Hawley Tariff Act of 1930. This increased tariffs on foreign imports dramatically and is widely recognized as one of the main reasons for the Great Depression. As the trite saying goes, “those who cannot learn from history are doomed to repeat it.” Today, the American economy is growing a phenomenal rate. It is a $12 trillion economy and increases in size $600 billion every year. This economic activity is roughly the equivalent of adding one whole new Brazil or Australia to global economic activity every year. The last thing America needs is to implement high tariffs or other protectionist measures in an attempt to solve a phantom crisis. The trade deficit is a symptom of a healthy economy, so stop worrying about it.
Any comments or questions can be received at whyyouareaconservative@gmail.com
~ The Conservative Guy
Most people, if they understand the trade deficit at all, realize that a trade surplus is created by exporting more goods to foreign countries than are imported from foreign countries, while a trade deficit occurs when a country imports more than it exports. Today, and for most of the past several decades, America has run a trade deficit. To take a recent example, the trade deficit for the month of February in 2006 was $65.7 billion. In other words, Americans spent $65.7 billion more on goods and services produced by foreign countries than the rest of the world spent on American goods and services.
The reason that most Americans freak out over large trade deficit numbers such as these is because they perceive the American economy as a large bank vault with a fixed supply of money. They believe that if more money is going out of the vault to buy things from other countries than is going back in from sales to foreign consumers, then eventually the vault will become empty and America will be bankrupt.
However, this reasoning is extremely faulty. Most importantly, it does not take into account the savings American businesses reap by importing cheap goods. A simple illustration is helpful here. Consider a large construction company that needs massive amounts of steel to build buildings and houses. American steel suppliers cannot accommodate the needs of all American consumers, so steel must be imported from other countries. This action obviously increases the trade deficit, but it allows the construction company to erect buildings. These buildings not only expand and enrich its business, but allow other American companies to do the same. The construction company doesn’t export anything to decrease the trade deficit, but its business decision increases the size of the American economy significantly. By using cheap imports that American suppliers cannot provide, American wealth is expanded.
On a larger scale, cheap imports from abroad allow America to produce the technology and financial services jobs that are needed within America. In addition, American consumers get the benefit of low-priced products overseas and these savings can be used to raise the standard of living or reinvest in the American economy.
Therefore, a trade deficit is not necessarily a bad thing for a country and it can be a sign of a strong economy. Every year for the past 20 years America has run a trade deficit, but over the same period of time the American economy has more than doubled in size. In addition, there is a significant positive correlation between the size of the trade deficit and the rate of economic growth. In essence, the trade deficit has risen when the economy has grown and receded when the economy has faltered. In fact, the lowest annual U.S. trade deficit in recent times was recorded in 1991, a recession year. This is evidence that by importing cheap goods from abroad and, as a result, increasing the trade deficit, the internal American economy is able to grow at an impressive rate.
Concern over the trade deficit is often linked to the rise of China’s economy and its ability to import cheap goods and services due to its inexpensive labor costs. Yet, as a factual matter, concern over Chinese imports is overblown. Chinese imports remain modest in the context of overall trade and the U.S. economy. In 2005, China accounted for less than 15 percent of our overall imports and Americans spent only 2 percent of what they earned on imports from China. This is no cause for alarm, even if trade deficits were, in concept, significant.
In the late 1920s, the American government became concerned about cheap imports and “unfair labor” practices abroad and implemented the Smoot-Hawley Tariff Act of 1930. This increased tariffs on foreign imports dramatically and is widely recognized as one of the main reasons for the Great Depression. As the trite saying goes, “those who cannot learn from history are doomed to repeat it.” Today, the American economy is growing a phenomenal rate. It is a $12 trillion economy and increases in size $600 billion every year. This economic activity is roughly the equivalent of adding one whole new Brazil or Australia to global economic activity every year. The last thing America needs is to implement high tariffs or other protectionist measures in an attempt to solve a phantom crisis. The trade deficit is a symptom of a healthy economy, so stop worrying about it.
Any comments or questions can be received at whyyouareaconservative@gmail.com
~ The Conservative Guy
posted by The Conservative Guy at
11:04 PM
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