Free Trade, the Trade Deficit, and Economic Growth

A couple of letters in the Washington Times over the past several days caught my eye. Both address the topic of international trade from widely different points of view.

The first letter appeared last Friday above the signature of Howard Richman, who identified himself as co-author of a book called Trading Away Our Future. (The book is published by a non-profit group called the Ideal Taxes Association, which seems to be a think-tank staffed by Mr. Richman and people sharing his surname.) His letter to the editor says, in part:

In his Tuesday Commentary column, "Economic Reality Check," Michael Barone cites many trees but misses the forest. He points out that the economy is not suffering from much unemployment (true), nor is there much inflation (true). Nor is the economy shrinking (true). He also points out that the growth rate is mighty slow, but he doesn't stop to analyze why. His conclusion: Barack Obama's "protectionism" would not help the United States economy.

What he misses is the reason U.S. growth is so slow despite the lack of unemployment. It is slow because businesses have not been investing in American production. They have not been investing because they know that if they do, the mercantilist countries that control our level of trade deficits through currency and other trade manipulations will simply drive them out of business. The key to fixing the problem is for the United States to insist on balanced trade.

Richman's letter prompted a response from Don Boudreaux, chairman of the economics department at George Mason University in Fairfax. Boudreaux's letter, which appeared in Monday's editions, deserves to be reproduced in full:

Howard Richman argues "Balanced trade is the key" (Letters, Friday/Saturday) to America's prosperity. He's confused, as evidenced by his claim that America's recent economic slowdown is linked to its trade deficit. The United States has run a trade deficit for each of the past 31 years, some of which (like the present) were periods of slow growth, but many of which were periods of high growth. Indeed, the evidence suggests that higher trade deficits are associated with higher, rather than lower, rates of economic growth.

This last point highlights another of Mr. Richman's confusions. He thinks trade deficits mean less domestic investment. Not so. Every trade deficit (more accurately, current-account deficit) is offset exactly by a capital-account surplus - meaning net inflows of capital into the domestic economy. More capital generally means more growth.

Boudreaux -- who has a knack for writing letters to the editor that he characterizes as "one-minute economics lessons -- has the better of this argument. His letter in the Times reminded me of an article I wrote on the same topic in the last century. It appears, below, as one of an irregular series of archival pieces that I think of as "history lessons."

The earliest version of this article appeared in the Chicago Tribune in August 1991. This revised version appeared in The Metro Herald in October 1993:

Free Trade and the Trade Deficit
Richard E. Sincere, Jr.

Virginia Governor L. Douglas Wilder's round-the-world trip to drum up business and investment for Virginia is a colorful reminder of how the globe is interconnected through commerce, finance, and industry. Virginia can only benefit when the Governor finds new markets for our agricultural and manufactured products. At the same time, the heated debate over the North American Free Trade Agreement (NAFTA) reminds us how international trade can be a political ping-pong ball.

One aspect of the trade issue is the so-called trade deficit. According to conventional wisdom, a trade deficit is bad while a trade surplus is good. In fact, the terms "trade deficit" and "trade surplus" are so much hot air—they are empty and meaningless. To focus on the trade deficit distracts us from more important economic tasks.

National trade figures are meaningless because nations are not economic units and therefore do not trade. The numbers gathered and released by the government merely summarize countless sales and purchases made by individuals and corporations. The "nation" does not trade; only units within it do.

Canadian economist Richard Grant, writing for the Johannesburg-based Financial Mail, explains: "The implication is that exports and trade surpluses are good is totally unfounded. They are simply numerical aggregates that emerge from the summation of millions of unrelated transactions by individuals. No one is responsible for it. To say that a surplus is ‘sound' or that the balance of payments is ‘in good shape' is meaningless babble."

Grant goes on to note this example: "When a miner sells gold, he doesn't care who buys it so long as it gets sold. And he should be under no illusion that he is in any way serving the ‘national interest' by selling it to foreigners instead of local buyers. If local buyers are the highest bidders, they will—and should—get the gold."

Put another way, it doesn't really matter whether an Arlington software company sells $1 million worth of its product within Virginia or if it "exports" the software to Hyattsville, Maryland, or Accra, Ghana. What matters is that the company earned $1 million, which can then be used to employ more workers and buy more raw materials or be invested in stocks, bonds, or bank accounts.

What has happened is that persistent trade deficits have embedded themselves in the national consciousness as bad things.

"Our balance of payments is sick," cry the economists who believe the balance of payments needs medicine from the Federal Reserve Board. They argue that a balance-of-payments deficit indicates that American business—particularly manufacturing industry—is in decline. This is not necessarily true; in fact, the opposite may be the case.

At a seminar sponsored by Hillsdale College, economists Marshall Loeb and George Gilder made precisely this point. Loeb, managing editor of Fortune magazine, noted that structural change is occurring in the U.S. economy.

"After years of stagnation," he said, "U.S. manufacturing productivity is rising sharply. In 1987, it went up about 3.5 percent, more than double the rate of the middle to late 1970s and faster than Japan's or Germany's." Despite a general slowdown in the economy, this trend has continued through the early 1990s.

Far from declining as a portion of the national economy, Loeb pointed out that U.S. manufacturing currently accounts for about one-fifth of the gross national product (GNP), "almost exactly the figure that existed 10 or 15 years ago."

How this affects international trade figures was explained by Gilder, a prolific author on economic themes. He suggested that the trade deficit is beneficial to the U.S. economy, not the threat that many perceive it to be, because a substantial amount of money earned by foreign exporters is reinvested in U.S. businesses, industries, and real estate.

"The other side of a trade gap is necessarily a capital surplus," Gilder said. "That's what it means when they say the United States is becoming a net debtor. People want to lend us money. During this period when our debts were increasing, our assets were increasing much more rapidly." Between 1980 and 1988, for instance, the value of assets owned by American companies grew from 180 percent of GNP to 240 percent.

How can importing be advantageous over exporting? Gilder thinks it signifies improving competitiveness. "What happened in the early 1980s is that the United States began growing much faster than it had in the '70s, and much faster, in fact, than its trading partners were growing."

What this means to American business is that "if you're an exporter from the United States, and you're exporting to a stagnant global market, clearly you won't be able to expand your exports as fast as an exporter from a country that faces a booming American market."

Richard Grant made much the same point in the Financial Mail: "It is not exporting that makes businessmen happy, but rather selling to a wider market. How much business sells—and where—will be determined in the marketplace." And the marketplace, we know—the "invisible hand" exposed by Adam Smith—is a remarkable instrument for creating wealth.

Let's remember that the next time politicians start calling for a "national industrial policy" (that is, more central planning), or propose subsidies, quotas, and tariffs to "protect" American industries (that is, to keep obsolescent factories going despite their uselessness) or simply bash Japanese or Mexican workers to please their more bigoted constituents. The "trade deficit" is nonsense. All that matters is expanding wealth and wider opportunities for buying and selling. That's why Governor Wilder deserves our applause for traveling to Africa, Asia, and Europe to open up more markets for Virginia.

While the specific numbers for the first decade of the 21st century may be different from the last two decades of the 20th century, the principles remain the same. A trade deficit does not portend bad economic news; in fact, the opposite is often the case, since it means that Americans have money to spend on goods and services from whatever source they choose, whether here or abroad.