America’s chronic trade deficit continues to set new records, both for its sheer size in nominal terms and for its share of an expanding gross national product. The record deficit is fueling worry that it could hurt U.S. industry, destroy jobs, burden future generations, and cause the current economic expansion to end in a “hard landing.” But those worries rest on a fundamental misunderstanding of the causes and consequences of the U.S. trade deficit.
In November 2000 the congressionally appointed Trade Deficit Review Commission issued its final report, The U.S. Trade Deficit: Causes, Consequences and Recommendations for Action. The report reflected the views of a sharply divided commission, with Democratic appointed members warning of the dangers of the deficit while Republican appointed members emphasized its more benign nature.
Economic theory and experience demonstrate that trade deficits are driven primarily by macroeconomic factors, in particular investment flows, and not by allegedly unfair trade barriers or declining industrial competitiveness.
Because of the link between trade deficits and rising investment, larger trade deficits are typically accompanied by improving economic conditions. A survey of the U.S. economy since 1973 confirms that, by almost any measure—economic growth, employment, industrial production, poverty reduction—the economy has performed better in years in which the trade deficit rose than in years in which it shrank.
America’s annual trade deficits are sustainable as long as the United States remains a safe and profitable destination for the world’s savings. The accumulating net foreign ownership of U.S. assets, America’s socalled foreign debt, does not threaten our sovereignty, our ability to finance that investment, or continued economic expansion.
The best policy response for the new administration and Congress would be to ignore the U.S. trade deficit as a target of policy and concentrate instead on maintaining a strong and open domestic economy that welcomes foreign investment.