Among the many economic things I worry about is X-M, or net exports (X=exports, M=imports).
As I’ve stressed in these pages, and in joint work with Dean Baker, trade deficits—(X-M)<0—have been a significant drag of growth for many years in recent decades and thus one reason why job markets have been more slack than tight. Yet much of the policy conversation ignores these deficits.
ASK most people in this city [DC] what the most important step is to increasing economic growth and job creation, and they’ll reply, “Reduce the budget deficit!”
They’re wrong. So-called austerity measures — lowering budget deficits while the economy is still weak — have been shown both here and in Europe to be precisely the wrong medicine. But they could be on to something important if they popped the word “trade” into that sentence.
Simply put, lowering the budget deficit right now leads to slower growth. But reducing the trade deficit would have the opposite effect. Not only that, but by increasing growth and getting more people back to work in higher-than-average value-added jobs, a lower trade deficit would itself help to reduce the budget deficit.
So it is with these dynamics in mind that I took note of the greater-than-one-percentage-point contribution to overall growth from net exports in the advance 2013Q4 GDP report from last week. In fact, for most of the past few years, net exports have contributed to GDP growth. Switching to annual averages to smooth out some noise, net exports added an average of a bit more than 0.10 of a percentage point to growth each of the past three years. That’s not a lot but at least it’s pushing in the right direction.
Yet, the trade deficit remains negative and not small, e.g., 3% of GDP, or about $500 billion last year (2013).
So what gives? Should we stop worrying about X-M? After all, the figure below—net exports as a share of GDP—shows relatively large trade deficits in recent years. In fact, we’ve stressed that it’s not a coincidence that the decades of large trade deficits are the same ones where full employment’s been the exception as opposed to the norm and inequality has increased. But what about these recent GDP growth contributions? Since negative net exports are a drag on growth by definition, has arithmetic been revoked?
Nope. To the contrary, what you’re seeing here is that a shrinking trade deficit has been pro-growth, as per the arithmetic. Any year that we buy more from abroad than we export, the level of GDP will be lower than would otherwise be the case. But if the trade balance improves—even if remains negative—it means that this year’s GDP level is less whacked by imbalanced trade than last year’s, and that shows up, as it should, as contributing to growth.
The next figure shows what a tight relationship this is. It plots the annual change in the trade deficit (NX, or net exports, as a share of GDP, the same series as in figure 1, but in yearly changes) against the GDP contribution or subtraction to growth that year. In 2009, for example, the trade deficit fell pretty sharply from about 5% of GDP to about 3%, and the net export contribution to real growth that year was more than one percentage point.
The trade deficit often falls in recessionary years as domestic consumers demand fewer imports, but what about going forward? Can we count on a declining trade deficit to extract less demand from GDP in coming years, even as consumer demand returns?
I’m still worried; even more so in recent weeks. A key determinant of our net exports is the value of the dollar in international markets (a weaker dollar leads to more competitive exports). Very low interest rates and global flight to the safety of the dollar has put downward pressure on the dollar in recent years, but as rates go up and, importantly, global currency flows shift from emerging markets to the US, the dollar will strengthen. And then there’s the on-going problem of competitors who manage their currencies to get a competitive edge on their trading partners, including us.
So stay tuned, and in particular, stay tuned into the trade deficit. As Dean and I argue in the oped to which I link above, despite the protestations of those who’d like to believe otherwise, it too is a policy variable with the potential to help achieve full employment.