The commentators’ flawed critique suffers from an overly narrow view of trade. A trade deficit doesn’t mean those dollars flowing abroad just disappear. They quickly return to the United States. If they are not used to buy our goods and services to export, they are used to buy American assets — Treasury bills, corporate stock and bonds, real estate and bank deposits.
In this way, America’s trade deficit is always and almost exactly offset by a foreign investment surplus. The net surplus of foreign investment into the U.S. each year keeps long‐term interest rates down, prevents the crowding out of private investment by government borrowing and promotes job creation through direct investment in U.S. factories and businesses.
In the broadest sense, our trade with the rest of the world is always balanced. In 2010, Americans bought $4 trillion worth of goods, services and assets from abroad, while foreigners bought $4 trillion worth of goods, services and assets from the U.S.
The union‐friendly Economy Policy Institute’s regular reports showing large job losses because of trade deficits are based on this faulty Keynesian understanding of trade. EPI models ignore jobs created by foreign investment inflows and by the cost savings to U.S. households and businesses from being able to buy goods and services in global markets at more competitive prices.
In a recent study for the Cato Institute, titled “The Trade‐Balance Creed,” I examined the past 30 years of U.S. economic performance to test the conventional wisdom on trade deficits and growth. The study compared how the U.S. economy actually performed during periods when the trade deficit in goods and services was rising as a share of gross domestic product (1982–84, 1992–95, 1997–00, 2001-06 and 2009-10) versus periods when it was contracting (1987–92, 2000-01 and 2006-09). The results show that the conventional wisdom is exactly wrong.
Since 1980, real U.S. GDP has grown at an annualized rate of 3.6 percent during those periods of rising trade deficits, compared to a sluggish 1.0 percent during periods of shrinking deficits. So much for trade deficits being a drag on growth.
Despite worries about the U.S. industrial base, manufacturing output during periods of expanding trade deficits rose a healthy 5.2 percent per year. During periods of declining (i.e. “improving”) trade deficits, manufacturing output contracted at an annualized rate of 2.0 percent.
Trade deficits were not a drag on the stock market, either. During periods of rising deficits, the Standard &Poor’s 500 index rose at an annualized rate of 11.3 percent. During periods of declining deficits, the stock market was stuck in neutral, advancing a paltry average of 0.3 percent per year.
As for the politically sensitive matter of jobs, during periods of rising trade deficits, employment has grown at an annualized average of 1.4 percent, compared to zero growth on average during periods of declining deficits. The unemployment rate dropped by an average of 0.4 percentage points a year during periods of rising deficits, compared to a painful 1.0 point per year when the deficit was declining — just the opposite result of what EPI’s flawed modeling would predict.
The bottom line: Our politicians should stop worrying about the trade deficit. Instead, they should turn their attention to cutting their own fiscal deficit down to size while maximizing the freedom of Main Street Americans to buy and sell goods, services and assets in global markets for mutual gain.