Are trade deficits good or bad? It depends!

August 15th, 2017 at 10:38 am

In light of this silliness in the WaPo today (which Dean Baker already jumped on), I’m compelled to repost this piece from a little while back, explaining why and when trade deficits are problematic and when they’re not.

Summarizing, it’s just as wrong to claim trade deficits of any magnitude are always a negative as that they’re always a positive. Like Neil Irwin said, motivating my earlier piece, “they’re not scorecards.”

When are they problematic? In two situations: first, when we’re not at full employment, and policy makers can’t or won’t make up the slack. The GDP identity–GDP=Cons + Inv + Gov’t spending + Trade balance–provides a simple way to show that a negative trade balance drags down growth.

Other components can make up the difference. However, in recent years, in periods of slack, the monetary authorities–central banks–have been increasingly likely to be stuck at zero on their interest rate, undermining their contribution to offsetting a trade deficit. And the fiscal authorities have been either stuck in austerity ideology (Europe), dysfunction, or both (that would be us).

The figure below shows that, in fact, trade deficits have been the norm over the period when we’ve been at full employment less than 30 percent of the time, so in this regard, our persistent trade deficits have been problematic more often than not in recent years. Note that I’m not drawing any causality here between trade deficits and the absence of full employment. My point is that the former (trade deficits) are more of a problem when we’re not at full employment and neither fiscal nor monetary policy is working to offset them.

Sources: BEA, BLS, CBO

The second way in which trade deficits are harmful is a bit more subtle. When we consume/invest more than we produce, we must borrow from abroad to make up the difference. On the other side of the ledger from the trade deficit is the “capital account surplus,” which simply represents the flow of capital into deficit countries to finance their spending beyond production.

The trade-deficits-are-always-and-everywhere-benign team argues that this is a feature, not a bug. Hey, if foreigners want to lend to us so we can spend more than we produce, that’s great!

But it’s only great if there are truly productive uses for the capital. If there aren’t, those flows can inflate…oh, I dunno…let’s say a real estate bubble. Or a bubble. See both Michael Pettis and Ben Bernanke on this point. No less a mainstream stalwart than the Lord Mervyn King, former governor of the Bank of England, recently held forth on the macroeconomic problems of persistent trade imbalances, linking them to countries that manipulate their exchange rates to preserve their trade surpluses (and therefore, other countries’ trade deficits; the system has to balance).

I think both of these conditions at which trade deficits are problematic–labor markets that are slack more often than not and the absence of productive investments–can be hard for people to wrap their heads around. We’re taught, against fact, that full employment is the natural state of affairs, and that productive investments are always there for the taking.

But especially in the age of financial engineering, where non-productive but potentially high ROI investment opportunities abound, that assumption just doesn’t hold.

What about now? We’re closing in on full employment so I wouldn’t invoke the trade deficit as a negative in that regard, though it took us too long to get here, due to the combination of the zero lower bound at the Fed, inadequate fiscal policy, and yes, the trade deficit, which has averaged -3.1% of GDP in this expansion.

On the investment side, if you believe we’re in a period of secular stagnation, which implies too much savings given desired investment (and remember, trade deficits occur when countries export their excess savings to us), then that’s a problem right now, putting downward pressure on interest rates, inflation, and demand. BTW, the logic of this suggests a smart solution to this part of the problem: investment in public infrastructure. On that, see dysfunctional Congress.

Finally, of course, our trade deficits are always in manufactured goods, so they invoke a sectoral problem for communities and families that depend on factory jobs. It is left as an exercise for the reader to connect the dots between that problem and our current political sh__show.

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15 comments in reply to "Are trade deficits good or bad? It depends!"

  1. spencer says:

    If you assume that the Federal deficit has been in balance at zero since 1980 savings would have exceeded investment throughout that era except during the investment led boom under Clinton when the federal budget actually was in surplus. So in that time the foreign capital inflow was actually used to finance greater investment
    when business investment as a share of GDP rose sharply. Otherwise, the foreign capital inflow was used to finance the federal deficit. So if the federal budget had been in balance the US would not have run a structural trade deficit.

    Interestingly, in the 1980s under republican administrations the cause of the deficit was more unusually high federal spending –federal spending was over 20% of GDP — while federal revenues remained close to the long term average of 17% of GDP. Just another example of republican economic theory being directly contradicted by the data.

  2. Smith says:

    1) There seems to a complete omission of the effect of 3% extra demand on the economy already officially at full employment (though I claim you should view the rate as no less than 5% presently). When you look at previous growth, and labor force participation, and wage growth, and productivity, then it might dawn on you that the missing 3% demand means more than extra cash that might create bubbles.
    2) In the case where there was even higher unemployment, are you really claiming there is no repercussion for increasing debt by 3% every year if there is slack in the economy? Was the stimulus measure, necessary and beneficial as it was, not without cost? Even 2% a year, no cost to adding each year to debt? Even if it’s money we owe ourselves? There may be no cost if the government (in effect) just prints money. But otherwise rich investors reap a windfall do they not?
    3) Bubbles are really not the issue for unspent dollars in foreign hands. Why do we want to grant any foreign entities to buy up American companies? Think about working for a company owned by a quasi private Chinese (or any big deficit country) conglomerate and say it wouldn’t make a difference without gagging. Granted some workers might benefit from some German firms, but I’d still say no way to the basic principal or expected result.

    • Smith says:

      I’m not clear enough in 1) but the point is you need some or all of that 3% demand to create conditions that foster rapid growth, wage increases, productivity growth, and other good things.

  3. dwb says:

    What about now? We’re closing in on full employment so I wouldn’t invoke the trade deficit as a negative in that regard, though it took us too long to get here, due to the combination of the zero lower bound at the Fed, inadequate fiscal policy, and yes, the trade deficit, which has averaged -3.1% of GDP in this expansion.

    I agree 99% with most of post. Where I diverge is that even if we are now in the “30%” time where we have a trade deficit and full employment, we should do something about it while the political will exists. Not sure I agree we are really at full employment yet, but lets set that aside.

    The problem I see with Baker’s nitpicking is that the only plan I see on the table to address the persistent trade deficit is some sort of consumption tax, “border adjustment” tax, or “territorial tax” system. Technocrats and academics care that the OK Senator Lankford mis-characterized the economics. Real people care about jobs and what the action plan is. What is the alternative plan? I don’t see one in the midst of all the complaining about the wordsmithing. A bad plan beats no plan every single time. Lankford and Baker are both wrong, just not for the reasons they think.

  4. Nick Batzdorf says:

    “our trade deficits are always in manufactured goods”

    Economics 101 question I hadn’t considered: what about goods that don’t fit in a shipping container, for example customer service and tech support, web design, computer code, page layout – that kind of thing? Do they not factor in the trade deficit?

  5. William Miller says:

    A major gap in economics and financial accounting has been supporting unjust trade agreements, trade deficits, and income/wealth inequality in America for decades. The gap ignores public and many private investments in intangible capital. Here are three examples of the gap and its impact.
    First – Free trade agreements and financial accounting that enable and encourage offshoring currently don’t recognized the crime of theft in offshoring because the gap ignores the transfer of public and private investments in intangible capital which is a theft that has caused a loss in manufacturing jobs in America since 1980 and a large loss of 5 million jobs between 2000 and 2014 according to the EPI due to trade deficit.
    A change in trade policy can return many manufacturing jobs and restrict additional losses.
    The legal argument that properly recognizes the extent of crime as theft in offshoring requires a new law that would identify the theft of public intangible capital (IC) in offshoring financed with $trillions of public investments. Economics, financial accounting and capitalism currently ignore the theft of public IC by any company that does offshoring where the IC is a product of public investments in national defense, federal R&D, domestic security, healthcare, public education and infrastructure. Public IC is largely public (American) intellectual property (IP).
    Trade policy and law currently protects the crime of theft of many types of private IC such as patents as IP but ignores the theft of public IC. The theft of public IC occurs when business operations at a company with jobs and factories are first established in a country supported by public IC created as a result of public investments in IC that get translated into business IC and then moved offshore with proven business capabilities (both tangible and intangible capital) consisting of knowledge, tools, technology and processes.
    Since 1992, IC has been a larger part of business investments as a part of GDP in America than tangible capital (largely money and physical assets such as land, buildings and tools – computers, networks and other machines)
    Theft of public IC in offshoring creates a negative externality in economics that is nearly identical to the crime which is pollution of public resources penalized in environmental regulation laws. Governments currently don’t measure the flows of IC in trade. Measuring the flows of IC created with public investments is a prerequisite for properly governing offshoring in globalization. The new international activity in Integrated Reporting is attempting to change financial reporting in governments and businesses (and fix injustice in capitalism) to measure both tangible capital and IC.
    Regulations on offshoring should require repayment of the apportioned public investments that produced the IC used for manufacturing operations at a company with fines of at least 50% on the value of traded goods by companies that sent goods back to the United States from offshored factories.
    Second – The availability and pricing of licenses based on patents should be regulated because all patents are created using a large amount of public IC. This regulation would greatly reduce the price of products such as drugs because licenses at a regulated much lower cost should be available to create competitive products.
    Third – The value of private IC contributed by employees which is ignored in financial accounting for proper and fair determination of compensation is a major reason that wages for most workers have been suppressed by decades. The current excessive level of CEO pay couldn’t be justified with proper consideration of the actual value of IC contributed by CEO’s.

  6. William Miller says:

    A chart of the BLS data on manufacturing jobs in the USA between 1950 and 2017 illustrates the growth of jobs from 1950 that peaked in 1980 and then declined to 2017 with acceleration of decline after 2000.
    This chart complements the chart from this post on OTE. Conclusion – Trade policy that encouraged deficits including offshoring played a major role in the decline of manufacturing jobs since 1980 as illustrated in the OTE chart.

  7. Smith says:

    Why is my well researched comment pointing to the remaining 1 percent gap in prime age labor force participation still in moderation? I’m claiming this shows we are not near full employment, and if you add that 1 percent to the 4.3 unemployment rate, the resulting 5 percent is a truer measure. This also helps explain lackluster wage gains.

    It’s 81.8 now. Before the recession, it never dipped below 82.6. It dipped below 83 to 82.9 only once in the 1990s. Previous to the start of the Great Recession in 2008, the last time it was this low was 1986. Why isn’t this relevant?

    • Jared Bernstein says:

      Sorry–don’t see it. Can you repost? I’ve approved all your comments I’ve seen.

      • Smith says:

        1) How are we closing in on full employment when prime age labor force participation is missing a million people?
        It’s 81.8 July 2017, it was 81.8 in October 2010 rising from 80.6 September 2015. It was 83.3 in January 2008 when the recession hit. Before the recession, it never dipped below 82.6 throughout the 2000s, It dipped below 83 to 82.9 only once in the 1990s. Each percent coincidentally comes out to a 3/4 of a percent additional unemployment if they were in the labor force. 120/160 derived from 120 million prime age population over 160 million workforce made up of full time (132 million), part time (21 million) and unemployed (7 million)
        Up until the Great Recession, the last time the prime age (25 to 54) participation rate was this low was May 1986. You want to make a case this is unrelated to the Recession and poor recovery, go ahead. I’m saying it is related, and more, and so add at least the .75 percent MIA to the 4.3 and you got a not so great, not so full, 5.0 unemployment rate. Corresponds to poor wage growth too.

        125 million strong
        Less 27.2 percent
        Not in, but would like a job now even

        • Smith says:

          The Times gives this view prominence:

          The Opinion Pages | Editorial
          Why Is the Fed So Scared of Inflation?
          By THE EDITORIAL BOARDAUG. 22, 2017

          “Another sign of weakness is that eight years into an economic expansion, the share of employed workers ages 25 to 54 is less than before the Great Recession.”

          You want to say we’re near full employment, I can give you a million reasons why we’re not. Cause that’s how many people age 25 to 54 are still not back in the worker force, that’s how many the Times is talking about. It’s at least worth further study, before declaring they don’t matter.

  8. Serene says:

    Trade deficits are harmful if they drive down wages and cause unemployment over a long period of time. Period. Nobody cares about GDP. Nobody. Democratic voters care about wages and unemployment.

    The refusal to recognize this by both party fascist establishments is the cause of most of the world and domestic turmoil.

    Good luck to those who have hope for a near-term fix. Nobody is talking about the proper solutions. Nobody.

  9. Smith says:

    I would like to propose that Jared Bernstein could be fundamentally wrong about trade deficits in two ways.
    1) Instead of his observation that trade deficits are more of a problem in times of elevated unemployment, maybe they are in fact a cause. It’s almost a throw away line at the end about manufacturing being hurt more by trade deficits, but maybe that’s part of the key. If your trade deficit is caused mostly by $100/barrel oil, there is a different effect than a trade deficit caused by millions of manufacturing jobs. How is an extra 2.5% of missing demand not a problem even if we are at full employment? How does one stay at full employment and return growth to pre 2000 or pre 1976 post WWII levels? Maybe what’s missing is excess demand. Pressure beyond full employment is perhaps what fuels and is necessary for a healthy economy. This implies also inflation should not be primarily controlled by raising unemployment.
    2) Overseas money chasing greater returns than 2.5% from T-Bills and so creating bubbles might be a concern. But why wouldn’t the accumulation of 2.5% of our income, and the power that gives be a greater concern? Why give the foreign countries dollars to buy up American firms? How is that not a huge concern? Ultimately isn’t that the most likely and best place for foreign dollars to return? It’s like acquiescing to 1/2 trillion dollars of control every year.