The Trade Deficit is an Overrated Measure
A country runs a trade deficit when the value of its imports exceeds the value of its exports. A trade deficit is also referred to as a negative balance of trade. There is a common misunderstanding as to the interpretation of a trade deficit. The Progressive Policy Institute, for example, describes the U.S. trade deficit as a necessary indication that, “The United States is currently consuming more than it is producing.” This line of reasoning suggests that consistent trade deficits lead a country into aggregate debt with other countries. However, a country’s gains from productive activities are not fully captured by a location-based measure of production, such as GDP. Many U.S. companies produce abroad and import a substantial proportion of their final product to U.S. markets (e.g., Nike). Such production logistics contribute dollar-for-dollar to our trade deficit. However, they are in no way an indication that we are consuming more than we are producing. Rather, the trade deficit fails to account for U.S. gains from U.S.-owned production overseas.
This is an important consideration, as the United States usually runs a substantial Foreign Direct Investment (FDI) surplus, whereby more U.S. owned production occurs overseas than non-U.S. owned production occurs within the United States. The current account provides a more complete measure as to whether our country is living within its current means. A country’s current account in a given time period is equal to its balance of trade plus its net factor income from abroad (i.e., income inflows from assets located abroad net of income outflows from foreign-owned assets located domestically) plus its net income from international transfer payments. Unfortunately, we have also run a consistent current account deficit in recent years. This is a much tighter indication that our purchases exceed our income and that we are borrowing to buy some of the current production of other countries. The resulting debt will have to be repaid through future current account surpluses. Though the current account is presently telling us the same thing about our spending levels as is the balance of trade, this may not always be the case. Given a sufficient amount of income from foreign assets, trade deficits are sustainable for a country. However, current account deficits must be repaid.
Judging the sustainability of a country’s spending levels by its balance of trade is like judging a basketball team’s success in a game by the number of points that the team scores. Though points scored is an argument in determining whether a team wins, it is not the final story.
-SS