Deficit distortion

Most experts disagree with the Trump administration assertion that trade deficits are inherently negative

By: Eric Kulisch
Photo: SolarCat /
   President Donald Trump espouses a belief that trade deficits are at the root of all trade problems.
   At the end of March, Trump issued an executive order for agencies to compile a report on the causes of trade deficits and their impact on the U.S. economy.
   The question now is whether that view will take root in the administration going forward, given that most economists and trade analysts do not view trade deficits as a valid measure on which to base policy, and that key advisors who subscribe to the deficit bogeyman may be losing influence in the White House.
   In a Feb. 7 interview on MSNBC, former Obama administration U.S. Trade Representative Michael Froman, dismissed the notion that trade deficits are, by definition, bad.
   “Trade balances are the product of a lot of different factors,” he said. “If we’re growing faster than our neighbors, we tend to bring in more imports because we’re a very open economy. The trade deficit is one metric, but it may not be the overwhelming metric.
   “We had a wonderful trade surplus in the midst of the Great Depression and we had a growing trade deficit in the 1990s, when we added 20 million new jobs. So it’s a more complicated issue. If the trade deficit is an indication that there’s some unfair trade going on, or the other country is closing its market to our exports, well sure that’s an issue we ought to be focusing on through our enforcement efforts. But, if it’s an issue of we’re growing faster than the rest of the world, or because people want to buy U.S. assets, then it’s a different kind of question.”

   The Trump Worldview. During the presidential campaign and since, Trump has harped on the fact that the United States has trade deficits with China and Mexico, implying that the imbalance is directly tied to outsourcing, unfair trade practices and job losses. His rhetorical solution: slapping high, double-digit tariffs on countries that export more to the United States than they import.
   One of the people supplying Trump anti-trade ammunition is close advisor Peter Navarro, the director of the White House’s new National Trade Council. Navarro was a professor of business at the University of California at Irvine who spent the past decade blaming China as a grave threat to American prosperity, after several failed attempts to win public office. He seems to subscribe to the idea that for every $1 worth of goods imported there should be $1 exported.
   In a letter to the Wall Street Journal in February, Navarro questioned the accuracy of trade data, saying the Census Bureau overstates exports by counting re-exported imports without any domestic added value as exports, and that government import data is similarly skewed. The Trump administration says it is exploring how to correct these distorted accounting methods because they mask true trade flows and undermine the ability to properly negotiate trade deals.
   The problem with that approach, according to Caroline Freund at the Peterson Institute for International Economics, is that it cherry picks re-exports related to export data, but not from import data – as if the same practice doesn’t happen in other countries. The result is a “superficially, but misleadingly enlarged trade deficit.”
   In 2016, the United States exported $502.3 billion less of goods and services than it imported. When only goods are considered, the deficit is $746 billion. One reason that the negative balance of trade is greater than in 2013 is because the dollar has strengthened by 25 percent. The deficit is less than the record $762 billion in 2006.

Trade deficits often don’t tell us much about the overall health of our economy.

   For further context, 60 percent of the U.S. trade deficit is with China ($347 billion).
   Trump’s executive order called on the Commerce Department and the U.S. Trade Representative to lead an inter-agency review and submit a report within 90 days identifying trade partners with which the United States has a significant trade deficit and the reasons why. Officials say the review will examine deficits on a country-by-country and product-by-product basis. Causes to be examined include asymmetrical tariff rules, lax enforcement, non-tariff barriers, dumping, government subsidies, intellectual property theft, forced technology transfer, and denial of worker rights and labor standards.
   The report will also assess whether trading partners are using law, regulations or business practices to discriminate against U.S. commerce and how the trade balance is impacting the manufacturing sector, jobs and wage growth. The results will be used to develop ways to decrease trade deficits and increase exports.
   The administration announced Monday in the Federal Register that it will hold its first trade deficit hearing on May 18.

   The Pushback. Trade advocates and experts say stepped up enforcement to stop cheating on trade agreements can be justified, but it’s dangerous to read too much into a trade deficit -- especially a bilateral deficit with a specific partner. Trade deficits arise from a country’s saving, investment and consumption behavior and not from the trade policies of other countries, they argue.
   Businesses “focus on fairness, access to markets, the rules, barriers we face. That’s what ought to be the ultimate determinant,” Rufus Yerxa, president of the National Foreign Trade Council and a former U.S. trade negotiator, told the Adam Smith Project. “We don’t think just focusing on balancing trade makes sense at all. It will probably result in the erection of more barriers.”
   Responding to the executive order, the U.S. Chamber of Commerce said it favored strong enforcement of trade rules as long as they were based on fact and not politics, noting that “trade deficits often don’t tell us much about the overall health of our economy.”
   At a Senate Finance Committee hearing last month on the nomination of Robert Lighthizer to be the U.S. Trade Representative, Sen. Patrick Toomey, R-Pa., lectured the administration about using trade deficits as a measuring stick for fair trade.
   “I think that would be a big mistake for several reasons,” he said. “One, it would invite retaliation that would almost certainly diminish American exports. Second, whatever mechanism we use – quotas, tariffs, bureaucratic hurdles – the net result is fewer choices and higher costs for American consumers. And finally, I would just stress that the fact is, historically trade deficits do not harm manufacturing broadly speaking and they don’t cause unemployment.”
   “The United States of America is manufacturing more today than we ever have in the history of the republic. We’ve done it with fewer people, which is mostly a function of automation. What’s even more stunning, though, is that there’s no correlation between a reduction in manufacturing and increase in trade deficit. In fact it’s the opposite. Trade deficits are more when manufacturing output is going up. And when the deficit reverses and gets smaller, manufacturing output goes down probably because when the economy is strong we are manufacturing more and buying more products,” Toomey added.

Rising living standards depend on rising productivity, which in turn depends on innovation, workers skills, and capital investment. Trade deficits had no adverse effects on these dynamics.

   The same inverse relationship exists between unemployment and trade deficits, the senator added. From 1992 to 2001, as the trade deficit grew, unemployment declined. And when the deficit diminished in 2009, unemployment skyrocketed. Since then, Toomey said, unemployment has declined while the trade deficit has leveled off.
   Robert Shapiro, founder of the economic advisory firm Sonecon and a former undersecretary of commerce for economic affairs, put some figures behind those assertions during a recent panel discussion hosted by the Washington International Trade Association.
   He cited a prominent study that showed between 1991 and 2011, the U.S. trade imbalance with China cost 2 million jobs, 1 million of them in manufacturing.
   Today, 12.4 million Americans are employed in manufacturing, or 10 percent of all private employment. Another 1 million workers would increase the percentage to 10.8 percent, compared to the 1960s when manufacturing represented a quarter of all employment or the 1970s, when 20 percent of the workforce was in manufacturing. Manufacturing’s large decline in the share of employment 40 years ago happened while the United States ran trade surpluses.
   “Similarly,” Shapiro said, “there is no direct relationship between trade deficits and incomes or living standards. From 1965 to 2000, manufacturing share of GDP fell from 25 percent to 15 percent, while real per capita income nearly doubled to $43,900. Rising living standards depend on rising productivity, which in turn depends on innovation, workers skills, and capital investment. Trade deficits had no adverse effects on these dynamics.”

   Trade barriers. Toomey urged Lighthizer to consider “making the higher of the priorities not the reduction in the trade deficit, but the mutual elimination of trade barriers, the expansion of trade and certainly opening up foreign markets for our products.”
   The nominee said trade deficits can indicate rules of trade with a specific country are not working well, but that the goal should be to increase efficiency in allocating resources not simply to get the deficit down.
   In an interview, Scott Miller, a senior advisor on international business at the Center for Strategic and International Studies, echoed the point that trade deficits are misguided benchmarks for judging commercial relations between nations.
   “If you worry about trade deficits then you must assume that when imports are purchased, the dollars never come back,” he said. “But they do come back as investments in the United States, so that’s the folly about worrying about trade deficits. People are confusing an economic goal with an accounting identity.”
   China, for example, uses the foreign currency it gains from selling goods in the United States to buy U.S. bonds. The trade balance with any nation is the largest portion of the current account, which also includes investment income such as dividends and interest, and unilateral transfers such as remittances from migrants and international aid. Against the current account is the capital account, which records transactions relating to purchases and sales of foreign assets and liabilities. In other words, the flow of goods and services is tabulated in one ledger and payment of debts and claims in another.
   Over the past 41 years, the size of the U.S. economy has tripled, per capita income has doubled and at times when unemployment has been the lowest, the trade deficit was the highest, Miller said. The trade deficit, he noted, has more to do with the low rate of savings in the United States.
   “All a trade deficit says is you have a lot of dollars flowing out of the U.S. to purchase imports, less returning to buy exports and more returning in the form of investments,” Miller, a former executive at Procter & Gamble, said.

If you worry about trade deficits then you must assume that when imports are purchased, the dollars never come back. But they do come back as investments in the United States, so that’s the folly about worrying about trade deficits.

   The analogy is an individual has a wage surplus with his/her employer, but doesn’t buy anything from the employer. The same person has a trade deficit with the grocery store, but doesn’t sell anything to the store to balance the relationship.
   “Does any of this matter for my personal economy?” Miller said. “The bilateral trade deficit should be one of the least economically interesting numbers you can make up. It tells you nothing,”
   The downside of financing imports by selling dollars is that foreign investors in stocks, real estate or other financial assets take home any resulting dividends, interest and capital gains, Shapiro said.
   “But those foreign investments also increase our supply of capital, which in turn tends to lower our interest rates,” he said. “The capital flows stimulate demand and jobs, especially when our saving rate is low. Certainly it would be better if U.S. savings financed those additional investments, but we would be worse off if those investments by foreigners didn’t happen at all.”
   Shapiro also noted that half of U.S. imports are inter-company transfers – parts or goods procured from a foreign subsidiary – and 30 percent of exports also go from U.S. entities to their foreign parent company.
   Peter Morici, a professor of business at the University of Maryland, countered that trade deficits have negative consequences, including on manufacturing jobs and growth of the national debt from borrowing to pay for imports.
   “Our meltdown will come when central banks and the American public don’t want to hold our debt; when people demand such high interest rates that it throws us into some kind of black hole,” he said.
   Freund, a former World Bank economist, said one solution to trade deficits would be a consumption tax (value-added tax) as part of a tax reform package because it would force people to save more. The House Republican proposal for a border adjustment tax, which essentially would target imports for a higher tax liability and spare exports from any corporate taxes, will not achieve its intended goal and would have negative economic consequences, she said.
   How far the Trump administration pursues the notion of trade deficit adjustment is an open question because Navarro’s status may have taken a hit in the ongoing palace intrigue at the White House. Navarro is said to be close to Chief Strategist Steve Bannon, who helped Trump articulate a nationalist message that carried him to the presidency.
   Bannon was seen as Trump’s key advisor in the early days of his administration, but he recently was ousted from the principle’s committee on the National Security Council and has clashed with Trump’s son-in-law, Jared Kushner, who has tried to steer the president to take some more mainstream positions, according to recent media reports. Gary Cohen, the former Goldman Sachs executive who heads the National Economic Council, is also said to be in the ascendancy within Trump’s inner circle.
   Advisers like Cohen do not share the same populist ideology as Bannon and Navarro.
   But Navarro has an ally on trade matters in Commerce Secretary Wilbur Ross, who co-authored a paper with Navarro last summer that argued Trump could impose tariffs and encourage changes in consumer buying habits to erase the trade deficit. Ross is a wealthy businessman who has Trump’s ear, so how trade policy shakes out remains anyone’s guess at this point.
   Another factor influencing trade policy is the new honeymoon between President Trump and Chinese President Xi after their summit at in Palm Beach, Fla., last week. Trump has backed off his harsh rhetoric of Chinese currency manipulation and suggested that he is willing to offer China better terms in trade talks if China helps contain the North Korean nuclear threat.