A trade deficit sure sounds like a bad thing. Isn’t it always better to sell more than you buy? Who wants a deficit of anything?
But if trade surpluses are great for the American economy we would remember the 1930s as the Roaring ’30s, a decade of broadly shared prosperity.
The value of what Americans sold abroad exceeded imports almost every year of that decade, and the gap wasn’t even close. But, of course, an economic boom isn’t what anyone remembers. The 1930s economic bust was so devastating that at one point a quarter of American workers were out of a job.
Admittedly the Great Depression was an unusual period in our history, but the same kind of thing has happened far more recently. The last time the U.S. trade deficit sharply declined was from the summer of 2008 to spring 2009, during the worst of the Great Recession.
No one should conclude that big trade surpluses or a shrinking trade deficit actually are what cause economic slowdowns. They aren’t.
But cutting the trade deficit with Mexico won’t by itself stimulate economic growth either, no matter what White House trade official Peter Navarro thinks. A commentary he wrote last week in the Wall Street Journal was so outside the bounds of what economists usually write that it would have earned him an F in an introductory economics class.
With so much talk about trade in the past year it’s important to try to understand the balance of trade, and admittedly it isn’t easy. Navarro has a Ph.D. in economics, from Harvard no less, and should know better. Yet his essay had such basic misunderstandings that he didn’t even accurately describe what drives economic growth, commonly expressed as gross domestic product, or GDP.
This is one of his key points: “The economic argument that trade deficits matter begins with the observation that growth in real GDP depends on only four factors: consumption, government spending, business investment and net exports (the difference between exports and imports).”
What Navarro has confused here is the idea of “depends.” He’s basically misapplying a simple equation of addition and subtraction that gets put up on a whiteboard the first week of an introductory class in economics. More consumption, more business investment, more government spending and more net exports all add up to a bigger GDP number.
But the drivers of economic growth can’t be shown using that equation. It’s not an economic growth equation. It adds up to GDP all right, but that C + I + G + (Exports - Imports) formula won’t show how we get more economic output. This is absolutely critical to understand. All it shows is what we actually do with the economic output we get.
Households do consume plenty of output — that’s called consumption. Businesses invest and governments spend, too. If nobody here consumes what is produced, it’s because it’s been consumed by somebody outside of the country. That’s an export.
Why are imports subtracted? Remember, it’s a measure of what we do with what our economy produces. We shouldn’t include stuff that’s consumed here but produced somewhere else.
Navarro insisted that when a consumer buys a Ford Focus assembled in Mexico it penalizes GDP growth. Well, no, not quite. He’s forgotten about “C.” That car gets consumed here.
So what would happen to the economy if imports declined by a lot? Provided no one’s tried some sort of protectionist idea, like slapping a quota on Mexican imports, a decline in imports likely means consumption is slipping. That’s the “C” part of that well-known GDP formula.
Looking past the data and into the lives of real people, that means consumers are increasingly worried about getting laid off, and they have slashed household spending. The new Volkswagen car, new Samsung TV, back-to-school clothes for the kids, all of it gets put on hold. Of course, when enough consumers are doing that the economy starts to shrink. Say hello to a new recession.
That kind of explanation fits with trade surpluses back during the Great Depression. It’s also why the same thing is true in reverse, as the U.S. trade deficit usually widens when the economy is booming. When employment is up, wages are up and confidence is up; the appetite of Americans to buy things of all kinds goes up, too, including products made or grown across the border.
Back in the height of the dot-com boom of 1999, the trade deficit ballooned by nearly 60 percent. Yet there wasn’t much fretting in that era about the country going broke, maybe because inflation-adjusted economic growth hit 4.7 percent — the best year of economic growth since 1984.
Rather than publish nonsense, it would have been helpful to say what does drive economic growth. Big national economies are complex organisms. In general, though, growth comes from an increase in the amount of productive things in an economy, meaning everything from land and equipment to the labor of workers, plus getting more products and services from the workers and equipment we already have.
Producing a lot more stuff within the same hour of work, for example, can be great. If American exports increased, that could be a good thing. It might mean American land and equipment and American workers have all gotten more productive. But what to do about a trade deficit, particularly fixating on trade between us and a single country like Mexico, is the wrong question.
A far better question, for anyone working across the street from the president and advising on trade policy, is what could enhance the competitiveness of American businesses and workers. Maybe as the new administration matures it will find such a savvy adviser.