It’s been a tough week for President Trump – and it’s only Tuesday. Just when Trump nearly had the country acknowledging his omnipotence, the stock market took a record one-day plunge on Monday and then, this morning, we learned that the president’s first year in office coincided with the largest U.S. trade deficit in nine years. Lest Mr. Trump concludes that he hasn’t been protectionist enough, there is another way for him to explain (without need of contrition or humility, of course) how he presided over a bigger trade deficit in his first year than was experienced in any of President Obama’s eight.
Trade deficits are pro-cyclical and have nothing to do with trade policy. Imports rise when the economy grows. When the economy grows—and it has been growing relatively strongly this past year—households, businesses, and governments consume more. They purchase more domestic and imported goods and services. Stronger growth tends toward larger trade deficits. Maybe Trump can try that slogan on for size.
But as sure as the sun rises in the east, business writers at most of the major newspapers, magazines, and online news venues will conclude that the trade deficit is a drag on growth. Here’s Bloomberg Markets (randomly selected):
The [December deficit of $52.1 billion] add[s] to details for the fourth quarter, when trade was a substantial drag on the economy, and show[s] how a widening deficit may mitigate any gains in the pace of expansion in 2018. Net exports subtracted 1.13 percentage points from gross domestic product growth…
These writers rely on—and then misinterpret the meaning of—the so-called National Income Identify. The identity tells us how we dispose of our national income. It is not a “growth formula,” as some of the president’s advisers suggest. In an op-ed last year, Commerce Secretary Wilbur Ross and trade adviser Peter Navarro wrote:
When net exports are negative, that is, when a country runs a trade deficit by importing more than it exports, this subtracts from growth… The structural problems driving the slow growth in the US economy over the last 15 years have primarily been the investment and net exports drivers in the GDP growth equation.
The reference was to the national income identity, Y = C + I + G + X - M, which says that national output is either (C)onsumed by households; consumed by businesses as (I)nvestment; consumed by (G)overnment as public expenditures; or e(X)ported. Those are the only four channels through which national output is disposed.
But the identity is not a GDP growth equation. Imports have nothing to do with GDP—except that they tend to increase when the economy is growing and decrease when the economy is contracting. But we subtract M in the identity because i(M)ports comprise a portion of C, I, and G. They are part of the aggregate spending of households, businesses, and governments. If we didn’t subtract M, then GDP would be overstated by the value of imports. But there is no inverse relationship between imports and GDP. In fact, there is a strong positive relationship between changes in the trade deficit and changes in GDP.
Although trade deficits are not meaningless, the meaning of trade deficits is aggrandized and misappropriated. It is aggrandized because we tend to look at it in isolation. By looking at the trade account (or the slightly broader current account), which is in deficit (and has been for 42 straight years), while ignoring the capital account, which is in surplus (and has been for the same period), we focus minds on the word “deficit” instead of “balance.”
The U.S. trade deficit means only that Americans buy more goods and services from foreigners than foreigners buy goods and services from Americans. But why should that be especially relevant when that formulation excludes a third, and very important, set of transactions between Americans and foreigners: the purchases and sales of assets? Instead of saying that the United States runs a trade deficit because Americans purchase more goods and services from foreigners than foreigners purchase from Americans, we should be saying that U.S. transactions with the world are in balance because the value of Americans’ purchases of foreign goods, services, and assets equals (almost to the dollar) the value of foreigners’ purchases of U.S. goods, services, and assets.
It’s misappropriated because too many commentators tend to describe the trade account as a function of trade policy—a scoreboard to indicate whether we are winning or losing at trade. Exports are Team America’s points; imports are the foreign team’s points; the trade account is the scoreboard; the deficit means we’re losing; and we’re losing because the foreign team cheats. But that’s just not right. The trade account is a function of disparate macroeconomic policies channeled through disparate patterns of savings and consumption among countries.
Some people who understand that the term deficit is loaded, and that our transactions (goods, services, assets) with foreigners are in balance still worry that selling assets to foreigners (“selling off assets” as it’s often put) to finance current consumption is shortsighted. They worry that we are chipping away at our principle or slowly killing the golden goose. That’s a reasonable concern, but I suspect more a theoretical problem than a real one because U.S. assets are not finite and their values are not constant. Their values rise and fall according to supply and demand and the factors affecting supply and demand. New assets are created all of the time, through ingenuity and the combining of factors of production that creates value.
When foreigners buy U.S.-owned assets, such as physical factories, research centers, land, patents, etc., they do so with the intention of increasing the value of those assets and/or the returns to those assets. A U.S. owned factory that was operating at 60 percent capacity that is purchased by a foreign company, which injects new capital and fresh ideas and uses more capacity to generate more production, revenue, and profits is improving that asset to create more value-added, more jobs, a bigger tax base, and demand for locally produced parts and local services.
In other words, just because a U.S. asset is purchased by a company that may have a foreign headquarters or just because some of the profits are repatriated to that foreign country doesn’t mean Americans are selling off the principle or are otherwise worse off. If the operation has promise in the United States, profits will be reinvested in that operation, which will continue to provide benefits for Americans.
Moreover, a lot of foreign investment in the United States is so-called “greenfield” investment—turning undeveloped land into factories, service centers, and other working assets. American owners sell their land to a foreign interest, which turns that land into a productive asset with tons of local benefits. Why should it matter whether the company is headquartered abroad, as long as it’s creating value in the United States?
However, it does seem important to draw distinctions among foreign purchases of debt, equities, and property and other physical assets. When we say a $500 billion current account deficit is balanced by a $500 billion capital account surplus, we haven’t yet focused on the types of assets foreigners are buying. Foreign purchases of government debt, while contributing in a more circuitous way to U.S. value added, do represent debt that has to be repaid. So, when people say running trade deficits represents a burden on future generations, it is this portion of the trade deficit that they are considering. Corporate debt must be paid back, as well, but it is not a public burden. It is a burden on the executives, employees, and shareholders of those corporations. Purchases of factories, property, equipment, patents and other real assets are not debt. They don’t have to be paid back.
In these two pieces (1 and 2), I go into greater depth about how the meaning of trade deficit has been aggrandized and misappropriated. Meanwhile, with a year of experience under his belt, maybe President Trump can begin to realize that a rising trade deficit reflects a growing economy and that government profligacy (really, the unwillingness of politicians to tax now for what they spend now or to reduce spending) is the basis for any legitimate concerns about the trade deficit.