Why Worry About America’s Trade Deficit?

There is no evidence which suggests a trade deficit affects economic expansion.

Fog in the Houston Ship Channel, Texas, February 21, 2008
Fog in the Houston Ship Channel, Texas, February 21, 2008 (Louis Vest)

Republican presidential candidate Mitt Romney complained in his debate with Barack Obama last week that America’s trade deficit with China is “growing larger every year.” The president countered that exports to China have increased during his term in office — not doubled as he claimed, though — suggesting that he, too, would be concerned about a trade deficit.

Why?

The facts

The United States exported goods worth more than $100 billion to China in 2011, when their imports from the country were worth nearly $400 billion, resulting in a $295 billion trade deficit.

American exports to China grew fivefold in the preceding decade while imports grew by a factor of four. This suggests a convergence in the long term.

American exports include aircraft, machinery, plastics, power generation equipment and vehicles. The United States import clothing, furniture, games and toys as well as iron and steel from China.

Can’t have it both ways

If the trade deficit is a problem, the United States should either buy less Chinese products — which means more Americans should be making shoes and toys for their fellow citizens — or sell more to China — which means more Americans should be making airplanes and cars. It can’t do both.

Both presidential candidates proposed to reinvigorate American manufacturing, which suggests they would rather preserve existing industries than free up labor to build and expand new and more competitive ones.

At the same time, they recognize that Americans shouldn’t be making the sort of products they buy from China anymore but rather invest in the skills needed for the “industries of the future,” as Obama puts it.

Green energy is such an industry. Yet his government has set steep import duties on Chinese solar panel imports, because they are subsidized and therefore sell below “fair value” — all the while he is subsidizing domestic solar companies.

Supply and demand

The reason Americans buy Chinese solar panels and Chinese clothes and Chinese toys is simple. They are cheap.

If President Obama believes what he says — that consumer spending drives economic growth — he should be delighted that Americans are able to save money on their purchases and buy more stuff.

Yet he has slapped a tariff on Chinese tire imports to preserve “a thousand jobs” in the United States.

Those jobs may be saved, but tens of millions of Americans are now paying more for their tires.

America’s trade deficit with China is governed by the laws of supply and demand. Americans want cheap goods, the Chinese deliver.

The mistake politicians make is to think of imports as necessarily a drain on the economy and exports as necessarily advantageous. Hence Obama’s promise to “double exports.” The reality is more complex.

55 cents of every $1 dollar that is spent on a product made in China actually goes to Americans who design the products, The Wall Street Journal reported last month. That includes people who “manufacture components that are shipped to China for final assembly, transport the goods; market and retail them; finance their production and trade.”

The conservative Heritage Foundation estimates that Chinese imports in apparel and toys alone sustain up to 576,000 American jobs.

History lesson

If the United States were to reduce Chinese imports, those jobs would be at stake. History suggests that growth would be, too.

For most of the second half of the nineteenth century, the United States ran annual trade deficits, yet the period was marked by one of the greatest economic expansions in the country’s history.

Similarly, in the 1980s and 90s, the United Stated posted trade deficits almost every year, yet those decades saw fast growth and high economic diversification.

By contrast, America ran trade surpluses throughout the 1930s, a time of record-high unemployment.

That is not to say the trade balance affects growth, rather vice versa. If the economy expands and incomes increase, the demand for imports is likely to rise with it. If the economy contracts and real incomes decline, demand for foreign goods plummets.

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