America’s Record Trade Deficit: A Symbol of Strength

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The U.S. Commerce Department announced today that America's trade deficit in2000 was the biggest in the history of the world. The difference betweenwhat Americans imported and exported last year should reach about $370billion -- more than $100 billion larger than the previous record deficit setin 1999 and double the 1998 deficit.

Many headlines and quotes from trade skeptics will sound a familiar refrain:"Worst Year Ever for American Trade." "Trade Deficit Costs Jobs." "Trade GapUndermines Dollar, Threatens Expansion." Should Americans worry about thetrade deficit? Or is it a sign of our nation's strong economy? A $2-millionfederal commission on the trade deficit issued a final report in Novemberthat answered yes to both questions.

Economic theory and experience show that trade deficits are driven by levelsof national saving and investment in the U.S. economy, not by allegedlyunfair trade barriers abroad or by declining industrial competitiveness athome. America's record trade deficit is a symbol of economic strength,reflecting a strong net inflow of foreign investment drawn to America'sdynamic economy.

Growing trade deficits signal improving economic conditions, while shrinkingdeficits often occur in times of economic trouble. During the last 25 years,the U.S. economy has on average grown about a percentage point faster, 3.5percent vs. 2.6 percent, in years when the trade deficit expanded comparedwith years when it shrank. The unemployment rate on average fell 0.4percentage points during years of rising deficits and rose 0.4 points whenthe deficit shrank. Manufacturing output rose much faster during years ofrising trade deficits than during years of shrinking deficits.

America's largest trade deficits in recent decades occurred during economicexpansions, its smallest deficits during recessions. It's no coincidencethat as the economy shows signs of slowing down, the monthly trade deficitnumbers have also begun to shrink with the economy's growth rate. (Thosecritics who demand that something be done to "fix" the trade deficit shouldbe concerned that they might get what they ask for.)

Critics of trade liberalization often point to the trade deficit as proofthat trade destroys jobs. If exports create jobs, they argue, then surelyimports mean less domestic production and fewer jobs. In fact, imports anddomestic production rise and fall together. Since 1987, manufacturing outputin the United States has risen the fastest during years when the volume ofimported goods has also risen the fastest. The two years of slowest importgrowth, 1990 and 1991, were the only two years in which manufacturing outputactually fell. The same economic expansion that spurs manufacturing growthalso attracts more imports and enlarges the trade deficit.

Another unfounded worry about the trade deficit is that it will saddlefuture generations with an unsustainable "foreign debt." It is true thatforeign investors own about $1.5 trillion more in U.S.-based assets thanAmericans own in foreign assets abroad. But about half of foreign-ownedassets in the United States are not debt but equity--direct investment infactories and real estate and portfolio investment in corporate stock. Andthe $1.5 trillion in net foreign investment in the United States is onlyabout 16 percent of Gross Domestic Product, and 4 percent of the net wealthof all U.S. households and non-profit organizations. Net payments to financeour foreign "debt" were less than $20 billion in 1999, about one-fifth ofone percent of GDP.

Yet another worry is that chronic trade deficits will spook foreigninvestors and undermine the foreign-exchange value of the U.S.dollar -- sending stock and bond markets and the real economy into a tailspin.The problem with that scenario is that it ignores the fact that tradedeficits are linked to a strong, not a weak, dollar. The trade deficitincreases the supply of dollars in the global economy, as foreign producersaccept more dollars in payment for imports. But in times of economicexpansion, the demand for those dollars by foreign investors seeking to buyU.S. assets is even greater. As long as foreign demand for U.S. assetsremains strong, the dollar will remain high, and so will the trade deficit.

The best policy is to ignore the trade deficit, however large it may nowseem, and concentrate on maintaining a strong and open domestic economy thatwelcomes foreign investment. As long as investors world-wide see the UnitedStates as a safe and profitable haven for their savings, the trade deficitwill persist, and Americans will be better off because of it.