Why Trade Deficits Matter

Why Trade Deficits Matter


The reason for so much controversy over Free Trade Agreements like TPP and Trade Deficits is that economists, and for that matter legislators and their advisors, have lost perspective since the many changes that have taken place since the 2001 recession.

Explaining the trade deficit:

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When trade deficits occur during periods when we are below full employment and at the lower band of short term interest rates, they are a drag on economic growth. That is the situation we are in today, but a reversal of “trading partners” and their unacceptable currency management would boost growth and jobs.

The explanation is simple: exports increase demand for U.S. output and imports reduce demand for output. If net exports (exports minus imports) fall, aggregate demand is reduced. Trade deficits are a mirror image of capital inflows into the U.S. economy and there are times when these capital inflows will reduce domestic interest rates and boost economic activity, providing an offset to the demand-drag caused by trade flows. That is not the case in today’s world as further pressure on already very low interest rates (since most of these inflows go into U.S. Treasuries) do little to increase domestic investment which would normally counteract the demand drag from trade flows.

During times when the economy is at or close to full employment, or when the Fed has latitude to counteract the demand-drag from trade deficits (effectively adjust interest rates), one can see trade deficits that would not harm overall job growth although these would absolutely change the composition of jobs in the U.S. economy. By the same token there is two way causality between trade deficits and overall GDP growth, rising trade deficits can drag on growth and faster GDP growth can lead to higher trade deficits. Imports will grow faster as we grow domestically and with all other things being equal will increase trade deficits. This does not change the fact that if the trade deficits were to be reduced in coming years and there was an end to wide spread currency management with our trading partners, the U.S. would see a pick-up in output and employment growth.

Why have we lost so many manufacturing jobs?

Most of the U.S. trade deficit is centered in manufactured goods, so even when the U.S. is at full employment, U.S. manufacturing employment will be lower than normal absent trade deficits as jobs rise in non-manufacturing sectors. Put simply, the change in manufacturing employment should equal the change in domestic demand for manufactured goods plus the change in net manufacturing exports which is essentially a measure of foreign demand for U.S. manufactured goods minus productivity growth. If U.S. consumers demand 4% more manufacturing output in a given year and net exports are flat and productivity growth is 4%, manufacturing employment will not change as the increased productivity allows the current manufacturing workforce to satisfy the rise in demand for manufactured goods.

On the other hand, if U.S. consumers demand 4% more manufacturing output, but net exports (measured as a share of manufacturing output) fall by 2% while productivity rises by 4%, the employment in U.S. manufacturing will fall by 2% as overall demand for manufactured goods is depressed by falling foreign demand or exports, keeping domestic production lagging behind productivity growth. Trade has had an impact on manufacturing’s employment decline since 2001. All you have to do is to look at the level of manufacturing employment instead of its share of the total. Manufacturing employment was relatively stable between 17 and 19.5 million for 35 years between 1965 and 2000. The initial huge losses started during the 2001 recession and led to a fall of 12 million jobs at its trough. Unfortunately employment levels never recovered in the following expansion because of rising trade deficits. The 2008/9 recession further increased unemployment levels and even higher trade deficits in manufacturing which is a key reason for our non-recovery so far.

Trade deficit reductions engineered by ending currency management would boost U.S. output and employment and trade deficit reductions would boost manufacturing employment.

How our trade deficit harms U.S. industry and the country.

The trade deficit is the means by which foreign countries are permitted to amass the funds necessary to buy out American companies and industries. In normal times when the U.S. buys more than it sells from other countries, these countries accept our dollars which must eventually return to the U.S. and be exchanged for something of value. Since we are producing less, it is more likely that those dollars will return by way of the purchase of U.S. assets and wealth producing companies. This is why many of our core industries are not controlled or managed for the benefit of foreign entities. These large deficits we have continued to produce have put us at a distinct disadvantage by allowing control of many of our key assets such as technology and natural resources. Just look at our inability to offset China’s currency manipulation that is making it nearly impossible for American exporters to compete.

We are seeing the looting of America because of policy decisions made by Washington. Decisions like WTO, NAFTA, CAFTA, KORUS and not TPP in many cases have turned out to be one way free trade with agreements eliminating laws regulating what other countries can ship into the U.S. You can look at free trade as simply as the looting of a store. If there were no laws to protect the merchant from robbery he would be out of business in no time.

Foreign countries produce goods paying ultra-low wages in protected home markets with government subsidies and do not have the same regulations we have here in the U.S. like environmental or labor laws. While a worker in China would make $1 an hour, a U.S. manufacturer would be paying $12 per hour. U.S. goods are no longer competitive and therefore must produce their goods in other countries with cheaper labor. We took the bait when foreign countries lobbied for the U.S. to reduce its protections with their cheap goods. We have now lost our ability to produce what we consume and find ourselves destitute because the laws no longer protect us from being robbed.

Trump wants to stop these inequities that are crippling our country.

This is why Donald Trump is screaming at the top of his lungs that we need to reverse these trade deals that were made by politicians who were more interested in appeasing lobbyists than growing our country. Today we are in an extremely vulnerable position not being able to produce what we need for everyday consumption. Between government and consumer debt we borrow $2.8 billion more each day from other countries. What would happen if we were engaged in a major military conflict, and these foreign countries were not willing to supply us with what we needed to defend ourselves? There would not be a good outcome.

(Much of the material contained in this article was taken from “How the Trade Deficit Affects You” Thomas Heffner Nov. 4, 2015, “Trade deficits: Bad or Good? ” and “Yes, Trade Deficits Do Indeed Matter for Jobs” Josh Bivens May 28, 2015)

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