Back in 1999, I wrote an article called “Untangling the Trade Deficit” for the Public Interest
magazine. I started this way:
The competition for most misunderstood economic statistic is hard-fought, but there is a clear winner: the trade deficit. No other number is interpreted so differently by professional economists and the general public. Common reactions to the U.S. trade deficit range from belligerence to dejectedness: It is thought that America’s trade deficit exists either because of the skullduggery and unfair trade practices of countries that shut out U.S. products, or because American companies are failing to compete against their global competitors. In either case, the preferred solution is often to get tough in trade negotiations for the sake of protecting U.S. jobs. But, according to most economists, cutting across partisan and ideological lines, such mainstream beliefs about cause, effect, and solution are wrong. Even more bothersome, these popular beliefs are wrong not simply because the evidence is against them—although it is—but because they reflect fundamental misunderstandings of what the trade deficit is and how it interacts with the rest of the economy.
For economists, that article didn’t didn’t offer any new lessons. It was just one more effort by to explain the intuition behind the economics of trade deficits–as taught in standard intro econ classes–to the general reader. The history of such explanations runs deep; indeed, back to Adam Smith and earlier. Apparently, the subject is difficult to exposit and economists aren’t very good at doing so.
Robert Z. Lawrence takes one more swing at the pinata in “Five ReasonsWhy the Focus onTrade Deficits Is Misleading,” published by the Peterson Institute of International Economics. (March 2018). I’ll start with some background, and then link it to Lawrence’s list of misconceptions.
It seems to be widely believed that a trade deficit shows the level of unfairness of import competition, and moreover that a trade deficit shows economic weakness, while a trade surplus shows economic strength. (For a vivid example, see the “Remarks by President Trump at Signing of a Presidential Memorandum Targeting China’s Economic Aggression” last week.) But even a casual look at actual US trade balances in recent decades shows the implausibility of such beliefs. Here’s a figure of US trade imbalances (as measured by the current account balance) since 1970, measured as a share of GDP.
In the 1970s, trade deficits were close to zero. But this did not mean when most people believed that international competition was fair: instead, it’s a time when foreign competitors from Japan and elsewhere were savaging US industries like cars and steel. It’s also not a time when the US looks especially strong, with a period of “stagflation” combining high unemployment and inflation, as well as a slowdown in productivity growth.
In the 1980s, trade deficits first boomed, and then diminished. But the mid-1980s was not a time of US economic weakness: instead, these were years of hearty economic growth after the recession of the early 1990s. The recession of 1990-91 is actually when the trade deficit declined. Moreover, no one seriously claims that US trading partners suddenly became much less fair for a few years in the mid-1980s, before then suddenly becoming much more fair by the early 1990s–which means that unfairness of trade isn’t what causes the US trade deficit to change.
Through the 1990s, this is a period when the US trade deficit becomes large, but at the same time, the US economy grows rapidly. Also, this is not a time a higher trade deficit can be linked to barriers to trade increased:instead, this is the decade when barriers to trade are reduced by the North American Free and by the completion of the “Uruguay round” of international trade talks leading to the creation of the World Trade Organization in 1995.
Since 2000, the trade deficit first falls when the economy is growing in the early 2000s, and then the steep recession of 2007-2009 is accompanied by a sharp decline in the trade deficit. If the trade deficit is a measure of unfair trade (which it isn’t!), the US should presumably be congratulating the rest of the world for how it dramatically improved its trade fairness since about 2006.
It is blindingly apparent from the most casual acquaintance with the actual trade balance statistics that trade deficits are often not associated with periods of weak economic performance, that declines in trade deficits are not associated with strong economic performance, and that fluctuations in foreign trade barriers are a deeply implausible explanation for changes in the trade balance.
One can walk through the same exercise with trade balances of other countries, as well. For example, here is China’s trade balance since its reforms started in the late 1970s, from the World Bank website.