Worries persist that the record U.S. trade deficit is weighingdown the nation's economy, depressing output, and sending jobsoverseas. Those worries have only increased in recent weeks asvarious measures of the deficit have reached new records. OnDecember 14, the Commerce Department announced that the monthlytrade deficit in goods and services for October had reached arecord $55.5 billion, and two days later the department announced thatthe U.S. current account deficit for the third quarter had reached$164.1 billion, also a record. The two related deficits arevirtually certain to set annual records approaching $600 billion bythe time the full year's trade accounts are tallied in early2005.
Concern about the impact of the trade deficit on growth isrooted in the assumption that rising imports displace domesticproduction in the U.S. economy, acting as a drag on the growth ofreal gross domestic product. As one wire service reported after therecent release of October's record trade deficit number, "such alarge trade deficit also threatened to be more of a drag on thedomestic economy than first thought and could see analysts trimback expectations for GDP growth this quarter."
How valid is the widespread assumption that a growing tradedeficit means slower economic growth? Hard evidence of such aconnection appears to be lacking. In fact, an analysis of economicdata from the last quarter century shows that a growing currentaccount deficit (as a percent of GDP) is actually associated withfaster, not slower, economic growth, as well as risingmanufacturing output and falling unemployment.
Testing the Conventional Wisdom
In 8 of the years since 1980, the U.S. current account balancehas moved in a positive direction (i.e., the deficit has shrunk or"improved") as a share of GDP from the previous year. In 16 ofthose years, it has moved in a negative direction (i.e., thedeficit has grown or "worsened"). Of those years in which thebalance moved in a negative direction, 10 have seen a moderatemovement of between 0.0 and 0.5 percentage points, and 6 have seena more rapid movement of 0.7 to 1.3 percentage points.
How has the U.S. economy fared under each of those three currentaccount scenarios? To address that question, Table 1 lists the sizeof the current account as a share of GDP for each year since 1980,along with the change in the current account percentage, realGDP,manufacturing output, and the unemployment rate from the previous year.(Changes in manufacturing output and the unemployment rate aremeasured from December to December to more fully capture the trendof that year.) The years are grouped in three categories, accordingto the magnitude of change in the current account balance as ashare of GDP.
As the table illustrates, by all three measures of economicperformance-GDP, manufacturing output, and the unemploymentrate-the U.S. economy performs better in years when the currentaccount deficit is rising as a share of GDP than in years when itis shrinking. And it performs especially well in years when thecurrent account deficit is rising most rapidly.
Trade Deficits, GDP, Manufacturing, andUnemployment
By the most basic measure of economic performance, the change inreal GDP, evidence points to a stronger economy in years in whichthe current account deficit is rising. In those years since 1980when the current account deficit declined as a share of GDP, theeconomy grew each year by an average of 1.9 percent. In those inwhich the current account deficit grew moderately, real GDP grew atan annual average of 3.0 percent. In those years in which thedeficit most rapidly "deteriorated," to borrow another popularcharacterization, real GDP grew by a robust annual average of 4.4percent-a rate more than double the growth in years when thedeficit was "improving." Four of the five best years for GDP growthsince 1980 have occurred in the same years when the current accountdeficit was growing most rapidly.
The same pattern emerges in the manufacturing sector. It hasbecome the conventional wisdom that a trade deficit hurtsmanufacturing because imports presumably displace domesticproduction, but the plain evidence of the past quarter centurycontradicts that presumption. Manufacturing output actuallydeclined slightly on average in those years in which the currentaccount deficit shrank. In contrast, it grew by 4.1 percent inyears when the current account deficit grew moderately and by abrisk 5.3 percent when the deficit grew rapidly. In fact, five ofthe six years that saw a decline in manufacturing output occurredin years in which the current account deficit was declining.
The pattern also applies in the politically sensitive area ofemployment. Again, the conventional wisdom holds that a tradedeficit destroys jobs by supposedly shipping them overseas. Butagain the evidence suggests something quite different. In thoseyears of an "improving" current account deficit, the unemploymentrate on average jumped by 0.8 percentage points. In years when thedeficit moderately "worsened," the unemployment rate fell by anaverage of 0.2 points, and in years when the deficit grew the mostrapidly, the unemployment rate fell by an even larger average of0.7 points. Indeed, in 7 of the 8 years in which the currentaccount deficit "improved," the unemployment rate went up; in 13 ofthe 16 years in which the current account deficit "worsened," theunemployment rate went down.
The year 2004 appears to fit the pattern comfortably. Throughthe first three quarters of the year, January through September,the current account deficit averaged 5.5 percent of GDP, a 0.6percentage point shift in the negative direction from 2003. That would place2004 somewhere between a moderate and rapid growth of the currentaccount deficit. Befitting the pattern, economic performancethrough the first three quarters of the year was also moderate torobust. Real GDP grew an average annual rate of 3.9 percent duringthe first three quarters. Manufacturing output grew during those samethree quarters at an annual rate of 5.4 percent from the previousyear,while the unemployment rate was on a pace to drop by 0.4 percentagepoints during the full year.
In 2004, as in previous years, a rising current account deficitmay have been bad news to headline writers, but it appears to haveaccompanied good news for the U.S. economy, its factories, and itsworkers.
A Growing Economy, a Growing Trade Deficit
Evidence from the past 25 years directly contradicts theassumption that trade deficits impose a drag on the U.S. economy.Contrary to prevailing assumptions, "worsening" trade deficits areassociated with faster GDP and manufacturing growth and morerapidly declining unemployment, while "improving" trade deficitsare associated with slower GDP and manufacturing growth and risingunemployment.
The evidence does not suggest that expanding trade deficitscause the superior economic performance. More plausibly, causationruns the other direction. An expanding economy fuels demand byAmerican consumers and producers to buy more imports as well asdomestically produced goods and services while rising domesticoutput attracts the foreign investment that finances an expandingcurrent account deficit. In contrast, slowing domestic demand notonly depresses output and employment growth but also demand forimports and the inflow of foreign investment.
Nor does the evidence address the question of how persistent andrising current account deficits may affect the U.S. economy in thelong run. The "sustainability" of the U.S. current account deficithas been addressed elsewhere in Cato studies. But whatever negativeimpact the deficit may have in the long run, there is no evidencethat it poses a drag on the economy in the short run.
Misperceptions about the trade deficit and the economy can temptpolicymakers to "do something" about the deficit that would onlyhurt economic growth. The most obvious example would be raisingbarriers to imports in the mistaken belief that protectionism wouldcut the trade deficit and spur the economy. Even if higher tradebarriers could somehow trim the trade deficit, there is simply noevidence that such a policy goal would deliver faster growth inGDP, manufacturing, and employment.
 The tradedeficit is a subset of the current account deficit. It includesimports and exports of goods and services. The current account isthe broadest measure of U.S. international transac-tions, includinggoods, services, income on foreign investment, and unilateraltransfers such as foreign aid. The two measures are closely relatedand can be used interchangeably for the pur-pose of thisanalysis.
 Reuters,"Trade Gap Widens, Industrial Output Up," December 14, 2004.
 For thecurrent account balance and nominal GDP for the years 1980 through2002, see Council of Economic Advisers, The Economic Report ofthe President 2004 (Washington: U.S. Government PrintingOffice, February 2004), Tables B-1 and B- 103. For 2003, see JointEconomic Committee of Congress, Economic Indicators, pp. 1 and 36,www.gpoaccess.gov/indica-tors/ 04novbro.html. The current accountbalance for 1991 was adjusted by - $41 billion to remove theone-time payments to the U.S. government that year by Gulf Warallies.
 Forchanges in real GDP through 2002, see Council of Economic Advisers,Table B4, p. 289. For changes in 2003 and the first three quartersof 2004, see U.S. Commerce Department, Bureau of Economic Analysis,"National Economic Accounts: Gross Domestic Product," Table 1,www.bea.doc.gov/bea/dn/home/gdp.htm.
 For theindex of manufacturing output (seasonally adjusted) in December ofeach year, see U.S. Federal Reserve Board, "Statistics: Releasesand Historical Data," G.17 Supplement, Table B00004, www.federalreserve.gov/releases/g17/ipdisk/ip.sa.
 For theunemployment rate in December of each year, see U.S. Bureau ofLabor Statistics, "Labor Force Statistics from Current PopulationSurvey," Unemployment Rate: Civilian Labor Force, TableLNS14000000, data.bls.gov/cgi-bin/surveymost?ln.
 Fornominal GDP through the first three quarters of 2004, see U.S.Commerce Department, Bureau of Economic Analysis, "NationalEconomic Accounts: Gross Domestic Product," December 22, 2004,Table 3, www.bea.doc.gov/bea/dn/home/gdp.htm.For the current account balance through the first three quarters of2004, see U.S. Commerce Department, "U.S. InternationalTransactions: Third Quarter 2004."
 SeeU.S. Commerce Department, Bureau of Economic Analysis, "NationalEconomic Accounts: Gross Domestic Product," December 22, 2004,Table 1. According to the BEA, real GDP grew 4.5 percent in thefirst quarter of 2004, 3.3 per-cent in the second, and 4.0 in thethird, for an average growth of 3.9 percent.
 SeeU.S. Federal Reserve Board.
 SeeU.S. Bureau of Labor Statistics.
Daniel T. Griswold, "America's Record TradeDeficit: A Symbol of Economic Strength," Cato Trade PolicyAnalysis no. 12, February 9, 2001, pp. 10-14.