Unlike the descriptions used by President Trump , a trade deficit is not an account. Nor is it a debt that one country owes to another. This is an inaccurate description. A trade deficit can be very good for an economy.
This makes everyone wealthier, by giving consumers in both countries more buying power than they would have otherwise. By manufacturing its phones in China, then, Apple can put nearly three phones into the market for every one it could sell if it produced devices domestically.
This is a net wealth creation. Consumers have three times as many cell phones for the same amount of money. The Chinese economy gets wealthier because it has wealthier workers. If Apple had made its phones domestically, a similar number of workers would have gained income for one-third as many phones in the market. This is not, however, to say that a trade deficit is unambiguously good. Economies need to beware of wealth extraction when running a large trade deficit.
This happens, in particular, if an economy allows trade deficits to create a zero-sum game in labor. For instance US dollars are paid to Chinese exporters for their goods. In turn, the Chinese exporters can either exchange the money or keep it in reserve. Ultimately, as Milton Friedman once said, the money comes back again. It either comes back through lower exchange rates, which make the domestic nations exporters more competitive. Or, through Foreign Direct Investment. However, the main issue with such is that foreign nations may be able to collect a significant amount of currency.
In turn, this may be used to buy and control large parts of the economy. From a geopolitical point of view, this can present a security risk. For instance, China may well be able to buy large parts of the US economy with its stock of US reserve currency.
When a country has a trade deficit, it is essentially sending its currency abroad. This means that the domestic money supply is actually shrinking.
In turn, it is possible to see some level of deflationary pressure. However, it will depend on monetary policy, the demand for debt, and the extent of the trade deficit. To explain, the decline in the monetary supply may very well be counter-acted by an increase by the central bank, which may very well stave off some level of deflation.
Furthermore, foreign direct investment into the country may also help fight off any deflationary pressures. However, it may occur under certain circumstances. This could either mean a reallocation within the workforce, or the outsourcing of jobs. In goes without saying that when more goods are demanded from abroad instead of domestically, jobs also shift abroad.
This is because demand for the domestic goods falls. So in the short term, this could cause some minor job losses. In terms of how the market reacts will depend on the exchange rates. Nevertheless, it is likely that new employment opportunities will arise.
As consumers benefit from lower-priced goods from abroad, they have more money to spend elsewhere. In turn, this opens up new opportunities for other domestic firms. However, the issue with such is that the new jobs will not necessarily be suitable for the previously displaced workers.
Furthermore, not all the expenditure will translate into an equal amount of lost jobs. Nevertheless, in the long-term, the currency will work its way back. Either through the exchange rate mechanism, or, alternatively, through foreign direct investment. American policymakers should certainly be paying attention to those cases where a pattern of extensive and sustained current account deficits and foreign borrowing has gone badly—if only as a cautionary tale.
Perhaps no economy around the world is better known for its trade surpluses than Japan. Clearly, a whopping trade surplus is no guarantee of economic good health.
In , Japan ran a trade deficit due to the high cost of imported oil. Trade surpluses are no guarantee of economic health, and trade deficits are no guarantee of economic weakness. Either trade deficits or trade surpluses can work out well or poorly, depending on whether the corresponding flows of financial capital are wisely invested.
Tabuchi, Hiroko. World Bank. Skip to content Chapter The International Trade and Capital Flows. Learning Objectives By the end of this section, you will be able to: Identify three ways in which borrowing money or running a trade deficit can result in a healthy economy Identify three ways in which borrowing money or running a trade deficit can result in a weaker economy. Are trade deficits always harmful? Are trade surpluses always beneficial? Considering Japan since the s.
Exercises For each of the following, indicate which type of government spending would justify a budget deficit and which would not. Recall that trade deficits are equivalent to inflows of financial capital from abroad.
Describe a scenario in which a trade surplus benefits an economy and one in which a trade surplus is occurring in an economy that performs poorly. What key factor or factors are making the difference in the outcome that results from a trade surplus? Our trade deficit and foreign debt have yet to reach critical levels.
However, the U. A deficit of this size could trigger concern among foreign investors about our ability to borrow sufficient funds to finance this level of spending. A sharp outflow of short-term capital would result, causing the dollar to collapse, at a minimum.
Short-term interest rates could also increase dramatically, as they have throughout Asia, pushing the economy into a deep recession, or worse. However, structural changes in the not-to-distant future such as the successful creation of the euro could weaken dollar demand and lead to a crisis, if our trade problems persist and deepen in the future.
Persistent trade current account deficits are a fundamental risk factor in this potential shock to our economy. Lester Thurow has referred to the U. In the long run, the only way to avoid such a collapse is to reduce the trade deficit to at least sustainable levels through some other means, such as more effective trade policies. The causes of structural trade deficits Many economists have emphasized the importance of fundamental accounting identities in explaining trade flows. For example, the Economic Report of the President notes that, by definition, any excess of national investment over national savings must be financed through an inflow of foreign capital, which must, in turn be matched by an offsetting deficit in our current account, the broadest measure of our trade balance.
In this view, a low level of national savings must necessarily result in a trade deficit. However, just because trade is influenced by macroeconomic forces such as savings rates and currency values, it does not follow that trade policy cannot influence the level of the trade deficit. There are at least two key issues that must be considered. First, what determines the macroeconomic flows that affect trade, and second, how can public policies at home and abroad affect our trade balances?
Accounting identities do not, and cannot, explain the causal relationships between savings, investment, and trade flows. Do low savings rates cause trade deficits, or does causation run in the other direction? A trade deficit reduces the incomes of domestic workers, pushing many into lower income brackets. Families with lower incomes generally find it much harder to save. Therefore, increasing trade deficits can and do reduce national savings.
The CEA report also notes that, since , the size of our trade deficit has been closely correlated with movements in the exchange value of the U.
As the dollar appreciated in the early s, the trade deficit expanded, and the deficit shrank as the dollar fell later in the decade. The CEA emphasizes the influence of macroeconomic factors, such as U. Japan has also intervened heavily in foreign exchange markets, with similar consequences. Exchange rate intervention is not our only trade problem, by any means. Japan maintains numerous structural barriers to U. For example, Japan condones restrictive practices that have limited U.
China maintains even heavier import restrictions than Japan. China also uses discriminatory offset and technology transfer policies to capture market share and move rapidly upscale into high-tech products such as automobiles, computer products, and aircraft.
Over , jobs in aerospace and related industries alone could be lost over the next two decades because of offsets policies and other types of outsourcing.
Many other countries in Europe, Asia, Africa, and Latin America use protected home markets as a base to support industries that dump excess output in the U. Government subsidies also distort trade flows, especially in high-tech industries. For the past 18 months, the dollar has also been appreciating because of significant private capital inflows into the U.
These private flows have also contributed to the growth of our trade deficit, while also pushing asset prices such as the stock market to unsustainable levels.
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