At the same time, workers can be better prepared to compete in the world economy, and to use technological change to their advantage, if we invest in education. Educated workers make computers their assistants rather than their rivals. Good public infrastructure is another essential ingredient for making US workers productive. While some of these solutions take time to work, they are fundamentally important. In the meantime, workers who experience disruption can be supported by trade adjustment assistance (to help compensate workers for job loss caused by foreign competition), wage insurance (to support worker wages if they transition to lower paying jobs), and refundable tax credits (to boost worker wages at low incomes). Changes in labor laws and social norms also have roles to play in the ideal policy response to these important economic trends.
One key question remains. Absent the political will to help workers, are the gains from international trade still worth the losses? It is simple to show that the benefits from international trade exceed the losses overall, but it is also clear that some individuals will be harmed by trade. If the losers from trade are not compensated (because it is politically unpalatable to do so), is trade still worth the trouble?
While this question is more difficult to answer, there are some important insights to remember. First, we have the luxury of this debate in the United States, but for many countries, going without trade is not an option. They are simply too small to be self-sufficient. Second, there is no evidence that international trade is solely responsible, or even primarily responsible, for the labor market hardship of many workers. Many other factors, such as technological change, but also rents, market power, and evolving social norms and institutions, are all important. If we restrict trade in response, it is unlikely to make much of a dent in these larger labor market problems, but we will surely lose some of the gains from trade. Third, there is important evidence that trade produces many benefits—for export industries and their workers, for consumers (especially those of limited means), for international relations, and for the growth and stability of other nations. These are hardly inconsequential.
Trade agreements have been wrongly accused of creating worrisome labor market problems, but the fact is that such agreements can be part of the solution, offering policy responses to these developments. How? First, trade agreements should always take care to liberalize trade slowly, to slow the pace of economic disruption. (This, however, is not typically an issue for the United States, where trade barriers are already quite low.) Second, trade agreements can help promote workers’ interests by containing provisions that support core labor rights and encourage the bargaining power of labor, as TPP attempted to do. By undertaking joint agreements on such matters, countries reduce the competitive pressures on governments to provide lax regulatory environments to attract mobile businesses. Third, trade agreements can be used as levers to help solve other international collective action problems, such as those related to climate change and tax competition. Given all the ways that international agreements can be a force for good, it is ironic (if understandable) that they have been so vilified in the public discourse.
Increasing income inequality amidst wage stagnation is the defining economic problem of our era. Responding is a challenge, but it is important to avoid responding in a simplistic manner that would harm ourselves and others. Trade restrictions are the wrong answer.
III
International Capital and International Labor
The previous part of this book (Chapters 3 to 5) discussed the role of international trade in the American economy. While international trade can have serious downsides, trade provides great benefits to the American middle class, and therefore protectionist trade policies would harm the very workers they purport to help. There are much better ways to help American workers.
As Chapters 1 and 2 discussed, the economic success of the American middle class is of vital importance. The United States has experienced thirty-five years of middle-class economic stagnation, disappointed expectations, and increased income inequality. Chapters 9 to 12 of the book will discuss better ways to help American households, describing policy solutions that go directly to the problems of economic inequality and wage stagnation.
In this section of the book, Chapters 6 to 8 consider other aspects of globalization. While Chapters 3 to 5 focused on the movement of goods and services across borders in the form of international trade, Chapters 6 to 8 focus on the movement of capital and labor across borders. Chapters 6 discusses the international movement of financial capital (investments in stocks, bonds, and loans), Chapter 7 discusses the international movement of business activity by multinational corporations and offshoring, and Chapter 8 focuses on the movement of international labor through immigration.
Chapter 6 begins by considering international borrowing and lending. It turns out that international borrowing and lending are the root cause (and mirror image) of trade deficits and surpluses. Countries like the United States run trade deficits because they are spending more than they earn, borrowing the difference from abroad.
Six
Who’s Afraid of the Trade Deficit?
There is some confusion about the US trade deficit. Politicians and reporters often breathlessly announce changes in the trade deficit to the public as if these trends were the gauge of the country’s economic health. Yet in recent years, the trade deficit has shrunk when the economy did poorly, and increased when the economy did well. It turns out this is no mere coincidence. A country’s trade deficit is simply not a good measure of its success or “competitiveness” vis-à-vis other nations. It is a phenomenon that solely reflects a country’s savings tendencies, both private and public. This chapter will explain the origins of trade deficits and surpluses, and consider how they are influenced (and not influenced) by government policies. It will argue that reducing the trade deficit should not be a primary objective of US economic policy. At the same time, if we nonetheless insist on that goal, the most effective tools for trimming the trade deficit would be policies that address national savings, and in particular, steps that rein in budget deficits.
What Causes Trade Deficits?
The trade deficit is the difference between a country’s exports and its imports. This chapter will make use of the terms trade deficit and current account deficit interchangeably; the latter is a broader, but closely related, concept.1 In recent decades, the United States has run a trade deficit in almost every year. However, as is quickly apparent from Figure 6.1, the years when the trade deficit was the largest are not the “worst” years in terms of the economy; in fact, recessions are associated with improvements in the trade deficit. (US recessions occurred in 1981–1982, 1990–1991, 2001, and 2007–2009.) For example, note the sharp reduction in the trade deficit in the wake of the 2008 financial crisis that ushered in the Great Recession. If reducing the trade deficit were the only goal, it appears that a recession would be the quickest way to achieve it!
Why do trade deficits improve in such circumstances? It is not because our businesses suddenly become more competitive than their rivals abroad—even if we could define which businesses are truly “ours” in an era of multinational corporations (a point we explore in the next chapter). Instead, the trade deficit becomes smaller because our demand for imported goods falls when US incomes fall, and that affects our trade balance, which is the amount of US exports minus US imports. Yet, to understand the roots of this link between the trade deficit and the economy, we need to step back a bit and ask why some countries run trade deficits and others run trade surpluses.
The origin of a country’s trade balance is the imbalance between its savings and its investments, not the competitiveness of its goods or businesses. A country that invests more money than it saves, or whose government spends more money than it collects in taxes, must get the extra money for investment and government spending from somewhere, and it does this by borrowing from abroad. This borrowing is the mirror of the trade deficit; borrowing pays for the goods and serv
ices that are not produced at home.
Figure 6.1: Current Account Balances Do Not Indicate Economic Strength
Note: As noted in the text, the current account is a closely related measure to the trade deficit.
Data source: Bureau of Economic Analysis.
Figure 6.2: Global Capital Markets Add Funds to the US Economy
Some countries, including the United States, don’t save nearly as much as they invest, and they also tend to run government budget deficits, the public equivalent of spending more than you earn. Together, these factors explain why the United States persistently borrows from abroad. Doing so allows us to consume a bit more than we are producing—lately, about 2.5 percent of GDP more. In contrast, countries such as China and Germany have higher savings relative to their investment desires, and have government budgets that are more balanced. As a consequence, they more often run surpluses.
Simply put, international financial flows (in the form of borrowing and lending) and international goods flows (in the form of exports and imports) are mirror images of each other. Countries that borrow, spending more than they earn, also import more than they export by the same amount. Countries that lend, spending less than they earn, also export more than they import, symmetrically (fig. 6.3).
The Simple Truth about Trade Deficits: It’s All about Savings
Basic arithmetic, not abstract theory, explains why the trade deficit must be a straightforward result of two imbalances: that between private savings and investment and that between public taxation and government spending.
GDP (indicated here by the variable Y) measures the value added produced in a given economy in a given year; each year, government economists calculate this figure. It is the sum of expenditures by consumers (designated by C), companies investing (I, which includes new housing), the government’s consumption spending (G), and foreign consumers buying American products (exports, EX), removing US spending on foreign products (imports, IM).
Thus, Y = C + I + G + (EX–IM).
But consumption (C) is simply the amount of national income (Y) that is not saved (S) or paid to the government in taxes (T).
So C = Y–T–S.
If we plug the equation for C into the equation for Y, we find that:
Y = Y–T–S + I + G + (EX–IM).
Rearranging, we find that the trade deficit is simply the sum of two other imbalances: the imbalance of savings and investment and the imbalance between taxation and government spending.
(EX–IM) = (S–I) + (T–G).
This simple equation is an accounting fact, not a theory, so it must hold. These facts are insightful explanations of why some countries run deficits and other countries run surpluses. Simply put, countries that save a lot relative to their use of loanable funds (investment) run trade surpluses, and countries that save little relative to their use of loanable funds run trade deficits.
What Policies Affect the Trade Deficit?
One interesting feature of this arithmetic is that it shows that trade deficits are not an outcome of how competitive our firms are. Nor do trade deficits depend on subtle trade policies. Imagine, for example, that we implemented a prohibitive tariff on Chinese steel as part of a trade dispute, and Chinese steel imports stopped entirely.2 It is unlikely that the trade deficit would improve accordingly. First, we might simply import the steel from another country, perhaps at a higher price, which could worsen our trade deficit. Second, it is possible that our exports would fall, if foreign countries retaliated by pursuing similar trade policy actions of their own. Third, and crucially, the trade balance cannot improve unless there are associated changes in savings, investment, government spending, or tax revenue. It is not immediately clear that either private or public savings should increase. People and firms will not want to save more simply because Chinese steel has become inaccessible, and government policy-makers are unlikely to change budget balances in response. Even if investment fell as steel became more expensive, it is not clear that this would be a desirable outcome, since investment is the variable most positively associated with economic growth.3 More likely, though, investment decisions would be unchanged by the revision in trade policy.
Figure 6.3: Countries with Trade Surpluses Save a Lot; Those with Deficits Don’t
China Has a Current Account Surplus.
And So Does Germany.
The United States Has a Current Account Deficit.
And So Does the United Kingdom
Data source: World Bank.
Indeed, countries with more trade barriers do not have smaller trade deficits than countries with fewer trade barriers. If anything, countries with higher tariffs have larger trade (current account) deficits (fig. 6.4).
Some suggest that, if the United States wants to reduce its trade deficit, it should pay more attention to the value of the US dollar in international markets. However, most major economies—the Eurozone (as a whole), Japan, the United Kingdom, Australia, Canada, and the United States—have floating exchange rates. In other words, the sellers and buyers of currency determine the value of exchange rates in the foreign currency markets, leaving little room for the Federal Reserve and other central banks to affect exchange rates in these countries. This is likely for the best, since monetary policy (the actions of the central bank) can then be devoted to more useful ends, like working to counter recessions.
The fact that other countries, including China and Switzerland, have managed exchange rate systems causes some observers to suggest that the US government take more active measures to deter foreign currency manipulation. To be sure, there are arguments for discouraging foreign currency manipulation. Interestingly, however, China’s latest currency interventions have actually been aimed at keeping the Chinese currency’s value higher, not lower—and have thus reduced the competitiveness of Chinese exports!4
Figure 6.4: Protection Doesn’t Help the Trade Balance
Note: The correlation between the two variables is –0.34. Data source: World Bank.
If US government actors really want to improve the country’s trade deficit, a more direct route would be to address the government’s budget shortfalls. Any improvements in the matching of annual tax revenues to government expenditures should also improve the trade balance, assuming that private savings and investment decisions remain unchanged. When the government borrows less money, our national borrowing is less, and the United States as a whole comes closer to spending what we earn, shrinking both international borrowing, and the mirrored trade deficit, accordingly.
Other options for improving the trade deficit are far less appealing. We could take various policy actions to curtail investment (or plunge into recession), but this would be very bad for economic growth. We could attempt to boost private savings with tax incentives, as with today’s 529 plans for tax-preferred college savings or 401(k) plans for tax-preferred retirement savings.5 But doing this has had little overall effect in the past; savings tend to shift toward the tax-advantaged investment choices, but the level of private savings does not rise in aggregate. Further, any increase in private savings caused by tax breaks is likely offset by reductions in public savings, since tax incentives decrease tax revenues—and therefore drive up the budget deficit.
Is China a Currency Manipulator?
China frequently intervenes in their exchange rate market, and in past years, especially the period leading up to 2007, the Chinese currency was artificially undervalued as a result. While the undervalued Chinese currency fueled an export boom that helped lift hundreds of millions of Chinese out of poverty, their currency policy also fueled very large Chinese current account surpluses in the mid 2000s, adding to the US current account deficit in the process. Yet while these actions were important in the past, since 2014, China has often intervened to increase the value of their currency, thus reducing Chinese surpluses and other countries’ deficits. China’s current account surplus is far more modest than it was a decade ago.
Often, other countries intervene
to increase, rather than lower, the value of their currencies. At several times in the past, the Mexican peso was overvalued, and Mexico tends to run a trade deficit with the rest of the world. (Although Mexico has a bilateral surplus with the United States at present.)
While currency manipulation might become a subject of future trade agreements, most countries target other goals (aside from the trade balance) when they set their monetary (and currency) policies, aiming for low unemployment, low inflation, and foreign debt sustainability. And at present, currency policy is small potatoes (and may even be helpful) when it comes to United States international balances.
Should We Even Care About the Trade Deficit?
So far we’ve seen that trade deficits are caused by imbalances in private and public savings and investment, and that the countries running trade deficits do so because their savings and tax revenues fall short of their investment and government spending, causing international borrowing, which is the mirror of the trade deficit. As a society, we are simply spending more than we earn, so our imports must exceed our exports accordingly. Therefore, protectionist trade policies are futile when it comes to affecting trade imbalances, since they do not affect their underlying causes. Government budget balances, meanwhile, have a direct effect on international borrowing and the trade deficit.
But one question remains unanswered. Should we even care about the size of the trade deficit and, therefore, aim to correct it with policy?
There are several reasons why running a trade deficit may actually be a wise thing to do. In the case of the United States, we have many investment opportunities due to our vibrant and entrepreneurial economy. Yet our citizens have notoriously low savings rates and are known instead for being world-class consumers. If the United States did not borrow on worldwide capital markets, interest rates would be higher, and fewer US investment opportunities would be possible. The US capital stock (plant and equipment) would be lower, and economic growth and living standards would also suffer, since investment is an important ingredient in raising worker productivity. Thus, international borrowing plays a vital role in the US economy.
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