Thinking About the Trade Deficit

George Mason University economics professor Russell Roberts, who runs the CafeHayek blog along with his colleague Don Boudreaux, has put together a short but sophisticated presentation about the trade deficit and its effect on domestic employment.  Roberts seeks to rebut the common claim that the trade deficit leads to a loss of American jobs (recall Ross Perot's "gaint sucking sound" comment).  Roberts' analysis is convincing.  I won't repeat his analysis here, but I would like to make a few related comments.

As any reader of CafeHayek knows, the "trade deficit" does not represent a draining of wealth from the United States economy.  On the contrary, our purchases of goods, services, and raw materials from overseas suppliers adds to our overall level of prosperity.  Indeed, if they didn't, we wouldn't make the purchases.  After all, no one forces millions of Americans to buy Toyotas, for example.  They do so because they prefer the price-quality mix of Toyota automobiles to those offered by other manufacturers.

The evidence shows that, despite the persistence of large trade deficits since 1976 (see Russell's report for the data), American society has become much, much richer in the past thirty years.

According to statistics from the federal Bureau of Economic Analysis (see here), Gross Domestic Product in 1976 was $4.54 trillion (in 2000 dollars), whereas in 2005 it was $11.05 trillion.  Spending on personal consumption saw a similar jump between 1976 and 2005, from $3.04 trillion to $7.84 trillion.  Adjusted by population, per capita GDP in 1976 was $20,825, and in 2005 it was $37,080, nearly twice as much.

As Jack Risko of Dinocrat.com and other astute analysts point out, moreover, these bare income statistics do not begin to show how much richer we have become.  Our homes are larger and full of more and better appliances; our cars are more reliable and have more sophisticated features; computers, the internet, and consumer electronics (e.g., DVDs and iPods) have transformed our everyday lives, both at work and at home; domestic and foreign travel is cheaper and available to more and more Americans; there has been an explosion in the variety of just about everything available to consumers; and on and on and on.  All this while we have been running annual multi-billion dollar "trade deficits."

In fact, our "trade deficits" are one of the sources of our prosperity.  Not only do they reflect the availability of cheaper and/or more desirable foreign products, which increases the quantity and quality of American consumption, but the competition from foreign firms (again, think Japanese auto makers) has spurred developments and improvements in our own firms beneficial to consumers.   

Furthermore, the term "trade deficit" itself is misleading, because it usually refers to the merchandise trade deficit (i.e., trade in such things as autos, steel, and textiles).  As Roberts points out, when capital accounts and services are added to the mix, our imports and our exports are almost perfectly in balance, as economic theory postulates.

So much for the notion that trade deficits undermine domestic prosperity.

But what about the idea that they undermine national security?  This was a common argument in the 1980s when a wave of fear about Japanese imports swept over the country.  The argument goes that American "dependence" on overseas suppliers (whatever this means in practice) could lead to shortages of vital products or raw materials in a time of war or other crisis.  While there is some hypothetical plausibility to this argument, that's about it.  The concern in the 1980s, for example, was that our military technology was too dependent on computer chips and other electronic components supplied by Japanese firms.  Supposedly Japan was going to use this "dependency" as leverage against us.  Needless to say, this concern was much ado about nothing.

Today the concern is mainly about oil.  Granted, there are many compelling reasons why we should reduce our use of oil from the Middle East.  (Query whether buying oil from Norway or England or Mexico is problematic.)  More generally, there may be moral or political reasons why we should limit our trade with certain totalitarian countries like Cuba or China -- although trade also can have a liberalizing effect.  In any event, a careful cost-benefit analysis should be done to evaluate the merits of such policies, which likely will require accepting certain economic costs (to us and to them) for the possibility of obtaining whatever moral or political benefits the policies hope to achieve.

But there is no support for the notion that American national security has suffered as a result of our "trade deficits" per se.  Arguably, the late 1970s, during the Carter Administration, represented the nadir of America's post-World War Two military and diplomatic strength.  Since then, the United States military has become far and away the most advanced and powerful fighting force on earth, and the United States today is the world's sole superpower.  There are many reasons for these developments, of course.  My point is simply that America has grown enormously in strength at the very same time that we have been running supposedly harmful (merchandise) trade deficits. 

In sum, there is no good reason to fear the trade deficit and many reasons to appreciate the considerable benefits of free trade, both at home and abroad.

Steven M. Warshawsky 
George Mason University economics professor Russell Roberts, who runs the CafeHayek blog along with his colleague Don Boudreaux, has put together a short but sophisticated presentation about the trade deficit and its effect on domestic employment.  Roberts seeks to rebut the common claim that the trade deficit leads to a loss of American jobs (recall Ross Perot's "gaint sucking sound" comment).  Roberts' analysis is convincing.  I won't repeat his analysis here, but I would like to make a few related comments.

As any reader of CafeHayek knows, the "trade deficit" does not represent a draining of wealth from the United States economy.  On the contrary, our purchases of goods, services, and raw materials from overseas suppliers adds to our overall level of prosperity.  Indeed, if they didn't, we wouldn't make the purchases.  After all, no one forces millions of Americans to buy Toyotas, for example.  They do so because they prefer the price-quality mix of Toyota automobiles to those offered by other manufacturers.

The evidence shows that, despite the persistence of large trade deficits since 1976 (see Russell's report for the data), American society has become much, much richer in the past thirty years.

According to statistics from the federal Bureau of Economic Analysis (see here), Gross Domestic Product in 1976 was $4.54 trillion (in 2000 dollars), whereas in 2005 it was $11.05 trillion.  Spending on personal consumption saw a similar jump between 1976 and 2005, from $3.04 trillion to $7.84 trillion.  Adjusted by population, per capita GDP in 1976 was $20,825, and in 2005 it was $37,080, nearly twice as much.

As Jack Risko of Dinocrat.com and other astute analysts point out, moreover, these bare income statistics do not begin to show how much richer we have become.  Our homes are larger and full of more and better appliances; our cars are more reliable and have more sophisticated features; computers, the internet, and consumer electronics (e.g., DVDs and iPods) have transformed our everyday lives, both at work and at home; domestic and foreign travel is cheaper and available to more and more Americans; there has been an explosion in the variety of just about everything available to consumers; and on and on and on.  All this while we have been running annual multi-billion dollar "trade deficits."

In fact, our "trade deficits" are one of the sources of our prosperity.  Not only do they reflect the availability of cheaper and/or more desirable foreign products, which increases the quantity and quality of American consumption, but the competition from foreign firms (again, think Japanese auto makers) has spurred developments and improvements in our own firms beneficial to consumers.   

Furthermore, the term "trade deficit" itself is misleading, because it usually refers to the merchandise trade deficit (i.e., trade in such things as autos, steel, and textiles).  As Roberts points out, when capital accounts and services are added to the mix, our imports and our exports are almost perfectly in balance, as economic theory postulates.

So much for the notion that trade deficits undermine domestic prosperity.

But what about the idea that they undermine national security?  This was a common argument in the 1980s when a wave of fear about Japanese imports swept over the country.  The argument goes that American "dependence" on overseas suppliers (whatever this means in practice) could lead to shortages of vital products or raw materials in a time of war or other crisis.  While there is some hypothetical plausibility to this argument, that's about it.  The concern in the 1980s, for example, was that our military technology was too dependent on computer chips and other electronic components supplied by Japanese firms.  Supposedly Japan was going to use this "dependency" as leverage against us.  Needless to say, this concern was much ado about nothing.

Today the concern is mainly about oil.  Granted, there are many compelling reasons why we should reduce our use of oil from the Middle East.  (Query whether buying oil from Norway or England or Mexico is problematic.)  More generally, there may be moral or political reasons why we should limit our trade with certain totalitarian countries like Cuba or China -- although trade also can have a liberalizing effect.  In any event, a careful cost-benefit analysis should be done to evaluate the merits of such policies, which likely will require accepting certain economic costs (to us and to them) for the possibility of obtaining whatever moral or political benefits the policies hope to achieve.

But there is no support for the notion that American national security has suffered as a result of our "trade deficits" per se.  Arguably, the late 1970s, during the Carter Administration, represented the nadir of America's post-World War Two military and diplomatic strength.  Since then, the United States military has become far and away the most advanced and powerful fighting force on earth, and the United States today is the world's sole superpower.  There are many reasons for these developments, of course.  My point is simply that America has grown enormously in strength at the very same time that we have been running supposedly harmful (merchandise) trade deficits. 

In sum, there is no good reason to fear the trade deficit and many reasons to appreciate the considerable benefits of free trade, both at home and abroad.

Steven M. Warshawsky