Seen from the other side, the countries who run trade surpluses are also helped by engaging in international lending. In China and Germany, for example, there are ample savings but fewer investment opportunities (relative to their savings). By loaning money to other countries, they can secure higher returns for savers than they would earn by keeping their money in the domestic economy. Much like trade in goods, trade in financial capital (borrowing and lending) allows both nations to gain by following their comparative advantage. Impatient countries like the United States borrow at lower interest rates than they would experience without world capital markets, while patient countries like Germany save, earning higher interest rates then they would experience without world capital markets. Both countries can benefit.
However, from a borrowing country’s perspective, there are still reasons to worry. Foremost among them is, of course, that the borrowed money must eventually be paid back; this will entail some subsequent period of lower spending relative to output in the future. Further, since financial markets can be abrupt in their determinations of whether assets are good investments, this can subject borrowing countries to excessively rapid swings from deficit to surplus. These rapid swings can create sudden changes in the exchange rate, even leading to deep recessions, with the associated misery of unemployment. Rapid reversals can also shift the allocation of the economy’s resources across sectors too abruptly, creating large transition problems.
There are also less obvious dangers associated with running trade deficits. They likely change the composition of jobs in the economy, even if they do not change the total number of jobs. Chapter 3 described how, when the economy is at full employment, international trade does not affect the total number of jobs, but it does affect their allocation, by adding jobs in export industries (such as airplanes, software, and soybeans) and taking jobs away from import industries (including shoes, clothing, and steel).
A Modern Greek Tragedy
In 2007, the current account deficit in Greece was an astonishing 14 percent of GDP. In part due to its adoption of the euro in 2001, investors had initially been eager to loan to the Greek economy by buying Greek bonds and other financial assets. With euro adoption, there was no longer exchange-rate risk associated with Greek loans, and the Greek economy was booming after twenty straight years of economic growth.
When that boom turned to bust, however, investors soured on the Greek economy, and refused to loan additional funds to the country. The absence of a Greek currency with its own exchange rate did not help; Greece could no longer adjust its currency (formerly the drachma) downward to make Greek assets more attractive to buyers. Instead, Greece faced a solvency crisis, defaulted on its debts, and turned to the international community for repeated bailouts. The outcome in Greece has been tragic. Unemployment rates, which had dipped below 8 percent before the crisis, shot up to over 27 percent by 2013, and have remained over 20 percent for more than six years, causing riots and political turmoil. And while the current account did improve—even turning to a surplus in 2015—the rapid changing of the tides made for anything but smooth sailing.
In a similar way, trade deficits affect job types. Economies running trade deficits produce less than they consume, borrowing the remainder from abroad. But there are some products (haircuts, restaurant meals, childcare, education, massages) that are difficult or impossible to replace with imports; these goods are nontraded goods. Goods are nontraded if there are prohibitively high transportation costs associated with moving them across borders. Few people would travel to India or Mexico for their haircuts, even if they are less expensive abroad! So, even if a country is borrowing from abroad to consume more than they produce, they cannot import the extra haircuts and restaurant meals. Therefore, in countries running persistent trade deficits, the nontraded goods sector must expand relative to the traded goods sector. This changes the types of jobs in the economy.
This also implies that transitions from trade deficits to trade surpluses will entail reallocations of workers and resources away from the nontraded goods sector toward the traded goods sector. This could cause temporary unemployment of barbers, waiters, construction workers, and others. Due to the serious pain associated with making such transitions quickly, it is ideal for countries to make more gradual changes in the size of their international imbalances. Sound financial regulation can help reduce the risk associated with rapid reversals, by making sure that capital inflows are directed toward productive investments rather than speculative ones.
All that said, there is no relationship between the trade deficit and the total number of jobs, or the unemployment rate. As seen in the figure at the beginning of the chapter, the trade deficit is typically the most negative when the economy is strong, and unemployment rates are low. The recessions that cause higher unemployment also improve the trade deficit through lower spending, and thus fewer imports.
Is the US Trade Deficit Sustainable?
International borrowing and lending can make both countries better off, and international borrowing benefits the United States by allowing us to borrow at lower interest rates, increasing capital investment, worker productivity, and standards of living. Yet countries that borrow do have to pay back their borrowed funds eventually, and rapid transitions from deficit to surplus can be quite painful. In the case of the United States, crucial questions arise. Is our trade deficit sustainable at current levels? Do we face an abrupt transition at some future time, and if so, how do we manage that risk?
Observers worried that the US economy was approaching an unsustainably large trade deficit in 2006, when the current account deficit approached 6 percent of GDP. As it turns out, the trade deficit came down rapidly in the years following, due to the Great Recession. But there are still reasons to suspect that a large deficit might be more sustainable for the United States than many countries. First, the United States is home to a disproportionate share of the world’s marketable securities and financial instruments. As such, it attracts a disproportionate share of global savings, in comparison to our share of world GDP. This makes it easier for the United States to finance our trade deficits by borrowing from abroad.
Second, when a country’s trade deficit becomes unsustainable, participants in international capital markets become more reluctant to loan money to the country. This reduced demand for the debtor country’s assets will reduce the demand for the debtor country’s currency, causing it to depreciate. (The depreciation prevents capital inflows from drying up, since it makes assets more attractive to foreign buyers.) This process can be destabilizing for countries that borrow in foreign currency since the value of their debt repayments increases as their currency depreciates. However, virtually all US borrowing is denominated in US dollars, so currency depreciation is less troublesome for the United States.
Third, the importance of the US dollar in world financial markets, and our floating (market-determined) exchange rate, make it more likely that future transitions from deficit to surplus, or to smaller deficits, will be relatively smooth. Since we are not intervening in currency markets to alter the value of the dollar, we do not need to worry about dramatic, sudden depreciations of our currency (which sometimes happen if countries can no longer “defend” their choice of exchange rate under managed currency systems). If investors decide US assets are less safe or rewarding then they were previously, dollar depreciation will follow, but not in a sudden, crashing way, assuming the fundamentals of the US economy are not dramatically altered. (A default on US debt, or a dramatic large-scale international conflict, could change that assessment.)
Finally, the net international investment position (which measures the difference between foreign-owned US assets and US-owned foreign assets) of the United States has not been deteriorating rapidly. The total amount that Americans owe foreigners is a relatively modest share of GDP, about 40 percent at present. Thus, the real burden of repayment should not be excessive.
All of that said, it is still important to rely on
sound financial regulation to ensure that our financial system is channeling funds toward productive investments.6 Making sure that financial institutions are adequately capitalized and not “too big to fail,” paying attention to risks associated with the parts of the financial system that are less subject to regulation (the “shadow” banking sector), and reducing the distortions that encourage excessive leverage in the economy are all important steps toward reducing financial frailty in times of economic stress.
In summary, the trade deficit is the flip side of international capital mobility; when a country imports more than they export, they also borrow to make up the difference. Countries with trade deficits borrow funds that are paid back in the future. While the benefits of international borrowing and lending are similar to the benefits of international trade, there are also dangers and vulnerabilities that result from international borrowing and lending.
There are different ways to view the US trade deficit. Spending more than we earn does not seem like a good thing, but our international borrowing also reflects the strength of US investment opportunities. Absent international borrowing, our economy would have fewer funds for productive investment. Further, the last several years have shown relatively modest US trade imbalances, so it is likely that the United States is on a sustainable path. Reducing trade deficits should not be an urgent policy priority at present. And, a focus on bilateral trade deficits is even more misguided.
Trump and the Trade Deficit
At numerous points in the 2016 presidential campaign, candidate Trump pledged to decrease the US trade deficit, and as president, Trump has continued to place trade deficit reduction at the center of US trade policy, often focusing in particular on bilateral trade deficits.1
Bilateral trade balances are a particularly silly target for U.S. trade policy, since they are shaped by comparative advantage in a way that is perfectly natural. Simply put, the countries that provide our desired imports (for example, oil) may not coincidentally happen to be the same countries that desire our exports (for example, aircraft). Moreover, bilateral trade data are inherently flawed, since internationally sourced components are not separately measured. For example, if China imports computer parts from Singapore, assembles a computer, and then sells it to the United States, the entire product will show up as a US import from China, even if most of the import’s value was supplied by Singapore.
Even if the focus is the overall trade deficit, as this chapter explains, trade policies are likely to have no effect. For example, bowing out of the Trans-Pacific Partnership may change the pattern of trade between different countries without changing the overall levels of US imports and exports. Similarly, tariffs on products from particular trading partners can lead to more expensive imports from other countries, as well as reduced exports due to retaliatory actions abroad. Importantly, none of these trade policies affect the fundamental macroeconomic factors (savings, investment, and the budget balance) that drive countries’ trade balances.
However, it is likely that the broader economic policies of the Trump administration and Congress affect the trade deficit in important ways, through the savings imbalance channels above. In particular, the Administration and the majority in Congress have enacted tax law changes that dramatically increase the size of the budget deficit. According to the Congressional Budget Office, these tax law changes add $1.8 trillion to deficits over the coming decade.2 These increasing budget deficits will worsen, rather than improve, the trade deficit.
In short, the Administration’s trade policies will likely have little effect on the trade deficit, and its budget policies are likely to make it worse. If Trump truly cares about the trade deficit, he should focus on fiscal discipline, lowering the budget deficit.
________________________
1. For example, in the administration’s July 2017 articulation of objections for the renegotiation of NAFTA, the paramount objective with respect to trade was to “improve the US trade balance and reduce the trade deficit with NAFTA countries.” See Office of the US Trade Representative, “Summary of Objectives for the NAFTA Renegotiation,” Report, July 17, 2017.
2. $300 billion of this total is due to additional debt service because of the additional borrowing due to lower tax revenues. See Congressional Budget Office, “Estimated Deficits and Debt under the Conference Agreement of H.R. 1,” January 2, 2018, https://www.cbo.gov/publication/53437.
If policy-makers insist on making the overall trade deficit a goal, however, one thing is clear. To reduce the trade deficit, trade policy interventions do more harm than good, both in terms of reducing the gains from trade and in terms of their ineffectiveness in addressing the trade deficit. A more straightforward policy to reduce the trade deficit would be to focus on the budget deficit. The budget deficit is within the control of the federal government, and it has an important causal effect on the trade deficit.
Seven
Multinational Corporations
Globalization is not just about the cross-border flows of goods, services, and financial capital discussed in Chapters 3 through 6. It is also about international business, and the wide reach, large size, and market power of the world’s global companies. Of course, multinational corporations are hardly a new phenomenon. Important international companies with market power have been around at least since the days of the Hudson Bay and East India trading companies.1 But in recent decades, the scale and sweep of the world’s largest corporations have increased dramatically.
This chapter first describes the phenomenon of multinational corporations. Multinational companies are (typically) headquartered in one country, but their operations span many countries. Parent companies, and their affiliate children throughout the world, are both big players in the world economy, undertaking the vast majority of all international trade. Global companies are typically the most successful and innovative companies in the world, and their global production processes achieve staggering efficiencies.
The international mobility of global corporations creates important challenges for government policy-makers, workers, and citizens. How can national governments tax and regulate companies that span international borders? How do laborers retain bargaining power in negotiations with employers that are more agile than they are? How do consumers make sure that the market power of these global corporations does not work against their interests? This chapter ends by discussing how economic policy can be modernized to address these concerns regarding global businesses, while still fostering a strong and successful business environment.
The Growing Importance of International Business
The scale and importance of international business activity has increased over recent decades. Global foreign direct investment—a measure of multinational company business investment—slowed during the Great Recession and its aftermath, but the importance of global firms is as great as it has been at any point in recent history (fig. 7.1).
The difference between foreign direct investment and the international capital mobility discussed in Chapter 6 is captured by the word direct. The purpose of such investment is to maintain direct control over a foreign asset, rather than just earn returns from it. If Apple invests in an Irish subsidiary, for example, the American “parent” company owns and controls the Irish affiliate, Apple Ireland—whereas if I buy a share of Diageo, the UK-based multinational corporation that produces Guinness beer, I do not control this company; I only receive dividends (and capital gains) from its profits.
In the United States, multinational corporations contribute mightily to the national economy as sources of both outward and inward foreign direct investment. The country is home to some of the world’s largest and most important global companies, whose affiliates operate throughout the globe, and it also hosts many affiliates of foreign-headquartered multinational companies. Currently, stocks of foreign direct investment (the market value of all foreign investments) are quite large, equivalent in size to about one-third of US GDP.
&n
bsp; Figure 7.1: Stocks of Foreign Direct Investment (In or Out) Are Growing
Note: The comparison to US GDP is made to provide a sense of scale for these stocks. Data source: UN Committee on Trade and Development.
For the United States, the scale of operations of foreign affiliates is far larger than the scale of international trade. Sales of goods and services by the affiliate “children” of US parent companies abroad were $7.4 trillion in 2014, an amount 43 percent of the size of US GDP, and much higher than US exports, which were $2.4 trillion in 2014. In the opposite direction, sales of US affiliates of foreign parent multinational companies were $4.4 trillion in 2014, an amount 25 percent the size of US GDP; in comparison, US imports were $2.9 trillion in 2014.2
Multinational Firms Control Most International Trade
Multinational companies play a prominent role in the broader globalization story. The scale of their operations is much larger than the size of international trade, and beyond that, multinational companies themselves conduct the vast majority of international trade. In 2014, US parent multinational companies exported $314 billion to their affiliates abroad and $488 billion to unaffiliated entities, accounting for 49 percent of that year’s goods exports; the same companies also accounted for 39 percent of US goods imports. Foreign multinational companies are also big traders. In 2014, the US affiliates of foreign-headquartered multinational companies accounted for 30 percent of all US imports and 26 percent of all US exports.3
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