More Nonsense about the Trade Deficit

It has become conventional wisdom that a rising trade deficit is bad news for the economy. This week’s announcement of an expanding deficit in June prompted such headlines today as this one in the news pages of the Wall Street Journal: “Wider Trade Gap Signals Weak Growth.” As my colleague David Boaz blogged earlier today, the trade deficit is even blamed for daily swings in the stock market.

I’ve been studying and writing about the trade deficit for years, and devoted a whole chapter of my 2009 Cato book Mad about Trade to the subject, and I keep coming back to a basic question: If the trade deficit signals weak growth, why does the U.S. economy seem to perform so much better during periods when the trade deficit is growing, and so much worse when the trade deficit is shrinking?

Think back to the 1990s, the “goldilocks economy” when growth was strong, jobs plentiful, and inflation low. That was also a time of rising trade deficits. In fact, the trade gap grew for eight years in a row, rising from $77 billion in 1991 to $455 billion in 2000. In that same period, the unemployment rate dropped from 7.3 to 3.9 percent.

Again, in the middle of the George W. Bush presidency, the trade gap grew for five straight years, during a period when the economy expanded and the unemployment rate fell from 5.7 to 4.4 percent.

In contrast, the trade deficit invariably shrinks during periods of recession. The trade deficit fell by more than half from 2007 to 2009 as domestic demand and imports plunged and unemployment soared. Sagging domestic demand means fewer imports.

Of course, I’m not arguing that a bigger trade deficit stimulates the economy. I am arguing, contrary to the conventional wisdom reflected in this morning’s headlines, that an expanding trade deficit does not appear to be a drag on growth. In fact, the plain evidence is that an expanding trade deficit is more often than not a signal of stronger growth.