Commentary

A Rising Trade Deficit Signals Good Times for U.S. Economy

By Daniel Griswold
September 1, 1999
The August 19 Commerce Department report of another record monthly trade deficit, this one reaching $24.6 billion in June, will probably spur the usual round of complaints that the trade deficit has become “a drag on growth.” In fact, the trade deficit has been blamed for a host of economic ills, from unemployment and deindustrialization to a rising gap between rich and poor.

Beyond dispute is the fact that, in nominal terms, America’s trade deficit is soaring into record territory. The annual deficit on the current account, the broadest measure of America’s international transactions, could top $300 billion this year. What is fraught with misunderstanding is the trade deficit’s impact, if any, on the U.S. economy. Those who agonize about the trade gap have confused cause and effect and compounded their mistake by turning the empirical evidence on its head.

The trade deficit is not the cause of bad things, but the result of good things in our economy. It reflects an economy ripe with investment opportunities and flush with consumer confidence.

For this reason, trade deficits tend to be pro-cyclical, growing along with the economy, and shrinking during times of recession. It is no coincidence that America’s smallest current account deficit in the last 17 years occurred in the midst of the 1990-91 recession.

A survey of the U.S. economy since 1973, when the era of floating exchange rates and free capital flows began, only confirms that rising trade deficits generally signal good times for the U.S. economy. In the 26 years surveyed, America’s current account deficit as a percentage of GDP grew larger (or, in the parlance of the typical news report, “worsened”) in 15 of them and shrank (or “improved”) in 11.

By almost any measure, America’s economy has performed better in years in which the trade deficit rose compared to years in which it shrank. During years of rising deficits, the growth of real gross domestic product averaged 3.2 percent per year, compared to 2.3 percent during years of shrinking deficits. If trade deficits really are a drag on growth, why does the economy grow so much faster when the trade deficit is getting bigger?

On the issue of jobs, the story is much the same. During those dark and troubling years of rising trade deficits, the unemployment rate has, on average fallen by 0.4 percentage points. During those bright and happy years of “improving” trade deficits, the unemployment rate has, on average, jumped 0.4 percentage points.

In the politically sensitive sector of manufacturing, the trade deficit again proves to be a companion of better times. During years of rising deficits, manufacturing output grew an average of 4.5 percent a year. During years of shrinking deficits the average growth rate of manufacturing output fell to 1.4 percent—less than one-third the rate of growth during years of rising deficits.

As to manufacturing employment, those years in which the trade deficit grew saw factory employment rise by an average of 13,100 workers per year. Those years of shrinking deficits were accompanied by an average annual loss of manufacturing jobs of 116,700. If the leadership of the AFL-CIO truly cares about manufacturing jobs, it should tolerate if not welcome a rising trade deficit, rather than exploit it as a whipping boy in its ongoing campaign against more open trade.

Yes, but what about the poor? In turns out that poor Americans also fare better under bigger trade deficits. In years when the deficit grew, the poverty rate in America fell an average of 0.1 percentage points a year. In years when it shrank, the poverty rate rose by an average of 0.3 points. In terms of real people, those supposedly blessed years of “improving” trade deficits saw the number of Americans living below the poverty line increase by an average of 907,000 people a year, compared an 81,000 increase during years of rising deficits.

The only major economic indicator out of sync was the stock market. On average, the New York Stock Exchange Composite Index rose 8.7 percent during years of rising deficits, lagging behind the 12.3 percent rise in years of shrinking deficits. One plausible explanation, of course, is that the stock market tends to reflect expectations of future growth, not merely current conditions. (Maybe the real gripe of labor unions against the trade deficit is the drag it seems to impose on the growth of their pension funds.)

Without a trade deficit, Americans could not import the capital we need to finance our rising level of investment in plants and new equipment, including the latest computer technology. The strong dollar helps keep a lid on inflation while lower import prices raise the real wages of the vast majority of American workers.

Of course, none of this evidence argues that the trade deficit is the cause of economic blessing. But it should punch a $300 billion hole in the argument that the trade deficit drags down growth, destroys jobs, undermines industry, and impoverishes Americans.

The biggest threat to our prosperity is not the trade deficit, but what politicians might do in a misguided mission to shrink it.

Daniel T. Griswold is associate director of the Cato Institute’s Center for Trade Policy Studies and author of a recent Cato study on the U.S. trade deficit. He is the co-editor of the Cato book, Economic Casualties: How U.S. Foreign Policy Undermines Trade, Growth, and Liberty.