Harm: Trade deficit

High trade deficits coincide with high economic growth

February 27, 2005
Forget Trade Deficits: Go for Growth
by Daniel Griswold
Daniel Griswold is director of the Center for Trade Policy Studies at the Cato Institute.
This article originally appeared in the Financial Times, on February 25, 2005

”The UN study acknowledges what has long been true of the US economy: the trade
deficit tends to expand along with the economy and contract when the economy slows. In
fact, an analysis of economic data from the last quarter century shows that a growing
current account deficit (as a percentage of gross domestic product) is associated with
faster, not slower, economic growth, as well as rising manufacturing output and falling
unemployment.

Historical precedents prove that GDP grows when deficit grows

February 27, 2005
Forget Trade Deficits: Go for Growth
by Daniel Griswold
Daniel Griswold is director of the Center for Trade Policy Studies at the Cato Institute.

“Since 1980, the US current account deficit has shrunk as a share of GDP from the
previous year in eight different years, it has grown moderately (by half a percentage point
of GDP or less) in 10 years and has grown more rapidly in six years. How has the US
economy fared under each of those three current account scenarios?
By the most basic measures of economic performance - GDP, manufacturing output
and the unemployment rate - the US economy performs better in years when the current
account deficit is rising than in years when it is shrinking. And it performs especially well
in years when the current account deficit is rising most rapidly.
Consider the most fundamental measure of economic health, the growth of real
GDP. In those years since 1980 when the current account deficit declined, real GDP grew
a sluggish annual 1.9 per cent on average. When the current account deficit grew
moderately, real GDP grew at an annual average of 3 per cent. And when the deficit rose
the most rapidly, real GDP grew by a robust average of 4.4 per cent - a rate more than
double the growth in years when the deficit was "improving".

Domestic manufacturing is also helped by an increasing deficit

February 27, 2005
Forget Trade Deficits: Go for Growth
by Daniel Griswold
Daniel Griswold is director of the Center for Trade Policy Studies at the Cato Institute.

The same pattern emerges in the manufacturing sector. It has become the conventional
wisdom that a trade deficit hurts manufacturing because imports presumably displace
domestic production, but the plain evidence of the past quarter century contradicts that
presumption. Manufacturing output actually declined slightly on average in those years in
which the current account deficit shrank. In contrast, it grew by 4.1 per cent in years
when the current account deficit grew moderately, and by a brisk 5.3 per cent when the
deficit grew rapidly.

Unemployment also rises when the deficit rises

February 27, 2005
Forget Trade Deficits: Go for Growth
by Daniel Griswold
Daniel Griswold is director of the Center for Trade Policy Studies at the Cato Institute.

“The pattern also applies in the politically sensitive area of employment. Again, the
conventional wisdom holds that a trade deficit destroys jobs by supposedly shipping them
overseas. But again, the evidence suggests some thing quite different. In those years of an
"improving" current account deficit, the unemployment rate on average jumped by 0.8
percentage points. In years when the deficit moderately "worsened", the unemployment
rate fell by an average of 0.2 points, and in years when the deficit grew the most rapidly
the unemployment rate fell by an even larger average of 0.7 points.
If a rising trade deficit is responsible for "shipping jobs overseas", how do the
critics of trade explain the fact that unemployment rises when the trade deficit shrinks
and falls when it expands? The year 2004 fits the pattern comfortably. America's current
account deficit expanded by about 0.6 per cent of GDP last year, while economic
performance was also moderate to robust. Real GDP grew at an annual rate of 4 per cent
and manufacturing output by 5 per cent, while the unemployment rate fell by 0.3
percentage points. In 2004, as in previous years, a rising current account deficit may have
been bad news to headline writers, but it accompanied good news for the US economy, its
factories and workers.”

Germany got a huge surplus and its unemployment skyrocketed

February 27, 2005
Forget Trade Deficits: Go for Growth
by Daniel Griswold
Daniel Griswold is director of the Center for Trade Policy Studies at the Cato Institute.

Those who seek the Holy Grail of a trade surplus should be careful what they wish for.
Germany last year racked up a global surplus of almost Dollars 200bn. Not entirely
coincidentally, its unemployment rate reached 11.4 per cent in December and the number
of unemployed reached a post-unification high of 5m people. The last time America's
jobless rate was that high was 1982 - when its own current account deficit was a measly
Dollars 5bn.
America's trade deficit is essentially an accounting abstraction. Our attention should
focus on what really matters - economic growth, job creation, industrial output, and the
free and open markets that promote real growth.

The Causes and Consequences

 of the U.S. Trade Deficit
Testimony of
Daniel T. Griswold
Associate Director, Center for Trade Policy Studies
The Cato Institute
before the
Senate Finance Committee
Washington, DC June 11, 1998

Mr. Chairman and members of the Senate Finance Committee: Thank you for allowing
me to testify on the causes and consequences of the U.S. trade deficit.

The economic turmoil in East Asia has thrust America's trade deficit back into the news.
Perhaps no aspect of American trade is talked about more and understood less than the
trade deficit. It has been cited as conclusive proof of unfair trade barriers abroad or a
lack of competitiveness among U.S. industries at home. It has been blamed for
destroying jobs and dragging down economic growth. I welcome the opportunity to
present a more charitable view of this much abused trade number.

The U.S. trade deficit is the result of a net inflow of capital to the United States from the
rest of the world. Because of our stable and relatively free domestic market, we remain
the world's most popular destination for foreign investment. We have become a net
importer of capital because Americans do not save enough to finance all the available
investment opportunities in our economy. This inflow of capital from abroad allows us to
pay for imports over and above what we export.

In other words, the trade deficit is simply a mirror reflection of the larger
macroeconomic reality that investment in the United States exceeds domestic savings. If
we want to change the U.S. trade deficit we must change the rate at which Americans
save and invest.

In a study published by the Cato Institute in April, I address four enduring myths about
the U.S. trade deficit. Two of them relate to causes, two to consequences.

The first myth is that the overall U.S. trade deficit is caused by unfair trade barriers
abroad. Foreign barriers are certainly a problem, just as our own barriers to imports
remain a problem. But trade restrictions do not determine the overall U.S. trade deficit,
nor do they fully account for the differences in bilateral trade balances. For example, the
United States runs a large trade surplus with Brazil, a country with relatively high trade
barriers, while we run deficits with Mexico and Canada, two countries virtually open to
U.S. exports.

The second myth is that trade deficits are caused by a lack of U.S. industrial
competitiveness. This myth has been refuted by the stellar performance of the American
economy, which today is the envy of the world. Since 1992, the U.S. trade deficit has
tripled. During that same time, U.S. industrial production has surged 24 percent and
manufacturing output 27 percent. The American people sell more goods and services in
the global marketplace than people of any other country.

A third myth is that trade deficits destroy jobs. Again, the performance of the U.S.
economy in the last decade should lay that myth to rest. While the trade deficit has
expanded, so have American payrolls. Indeed, there is a strong correlation between
rising trade deficits and falling rates of unemployment. The reason is simple: The same
expanding economy that stimulates demand for labor also raises demand for imported
goods and capital.

The final myth is that trade deficits are a drag on the U.S. economy. With the slowdown
in East Asia, this seems a reasonable claim. But the drag is not the trade deficit itself,
but falling demand for our exports in the Far East. A trade deficit that reflects both rising
exports and even more rapidly rising imports can be a sign of health. That has been the
case in the United States for most of past two decades. Since 1980, the U.S economy
has grown an average of 3.1 percent in years in which the current account deficit has
expanded from the previous year, and an average of only 2.0 percent in years in which
the deficit has shrunk. If trade deficits are bad for growth, why does the U.S. economy
grow more than 50 percent faster when the trade deficit expands?

Frankly, we would have more reason to worry if the U.S. were running a trade surplus.
In Mexico in 1995 and more recently in South Korea and other East Asian countries,
trade balances flipped overnight from deficit to surplus because of plunging domestic
demand and the flight of foreign capital. In Japan today, a soaring trade surplus has been
accompanied by record high unemployment. It's no coincidence that America's smallest
trade deficit in recent years occurred in 1991--in the trough of our last recession.

What does all this mean for policy? First, there is no emergency. The trade deficit is not
a sign of economic distress, but of rising domestic demand and investment. Second, the
trade deficit is largely immune to changes in trade policy. Imposing new trade barriers
will only make Americans worse off while leaving the trade deficit virtually unchanged.

Trade Deficit is a Myth

“New Voodoo Economics” from the American Spectator, by Brian S. Wesbury (The
American Spectator’s economics editor and chief economist at Grifin, Kubik, Stephen &
Thompson, Inc., a Chicago-based investment bank)

And many seem to forget that the stock market collapsed in 2000 and the recession began
in early 2001, despite a federal budget surplus and rising net national savings. If surpluses
truly are the Holy Grail, why did the economy have so many problems?

None of this evidence seems to dampen the dire warnings of the economic doomsayers.
They see a world that is about to spin out of control if U.S. saving does not rise. The
recipe to fix this problem is a devalued dollar to make imports more expensive and a tax
hike to reduce the deficit. In an honest moment, some of those who advocate these
positions might even let slip that they want tax hikes to slow consumption.
All of this smacks of the Keynesian notion that the economy is a machine that can be
managed by a few turns of the right screws. But the economy does not work this way.
Truth be told, all of this talk of doom is just a way to get the government more involved
in managing the economy, taking away freedom from individuals.

Trade deficits are the result of millions of individual decisions made by consumers and
businesses. Unless you own a grocery store, every reader of this magazine runs a trade
deficit with the local food purveyor. Chicago runs a trade deficit with the rest of Illinois.
Consumers buy goods made in China because they cost less. Trade increases our standard
of living. There is nothing wrong with buying goods that you, your city, or your country
do not produce.