No. The U.S. Trade Deficit Is Not a Good Thing

In the world according to Senator James Lankford, America’s trade deficits are simply a sign of our economic strength. The United States sells fewer goods and services than it buys from the likes of China and Mexico, and this is somehow evidence that Americans are just very wealthy.

This is underlying premise in Lankford’s Washington Post op-ed celebrating our trade deficit. “For starters, a powerful economy such as our often runs a trade deficit because of the immense buying power of its people,” Lankford writes.

Tell that to Germany. It is a very wealthy country that runs a trade surplus of more than eight percent of its gross domestic product. Someone forgot to tell its people that they need to spend their immense buying power on foreign imports.

There is no principle known to any school of economics that says a wealthy country must “often” run a trade deficit. In fact, nearly all economists are in an agreement that a country cannot run a trade deficit forever. Most would tell you that when a country accumulates dollars by running a trade surplus with the U.S., those dollars must eventually be spent on goods on services from the U.S., reversing the trade balance. (Note: those economists are not quite right but more on that later.)

Lankford has a kind of dorm room, first three weeks of a freshman taking Economics 101 understanding on international trade and capital flows. He gets the idea that when the U.S. buys foreign goods, foreign countries accumulate dollars. These dollars often get re-invested in the U.S. in the form of Treasury bonds or buying the stocks and bonds of corporate America. But he mistakenly thinks this is making us wealthier.

“Foreign investment also tilts the trade-balance calculation … It should be an encouraging thing that we are by far the world’s largest receiver of foreign direct investment,” Lankford writes.

But there’s nothing “encouraging” about it. When a foreign country receives dollars from the sale of goods to the United States, it can do one of three things: 1) buy products made or services performed by American workers (which would mean balanced trade), 2) buy American real estate and stocks of American companies (creating a trade deficit), or 3) buy the debt of the U.S. government, banks, corporations, or municipalities (creating a trade deficit). So “foreign direct investment” isn’t some vote of confidence in the health of the American economy. It’s just a side-effect of the fact that our deficit leaves the world with excess dollars.

It’s also worth noting that this has distributional and political effects. The trade deficit means that income that would have gone to workers instead goes to investors and the U.S. government. The prices of stocks and bonds get bid up, but the income of American workers falls. Similarly, it becomes easier for the U.S. government to run up its debt, masking the effect that diminished worker income has on the tax base. The rich and the well-connected get richer, while the rest of America withers. Sound familiar?

Even at the aggregate level, there’s no evidence that the U.S. is either benefiting from or needs this level of foreign investment. Interest rates are very low (and are not dependent on foreign investment, in any case), and stock prices are at record highs. Price levels are not keeping up with production, causing inflation to fall short of the Federal Reserve’s target. We do not need more buyers of U.S. stocks or bonds. Certainly, their purchases aren’t boosting the economy in any serious way.

Lankford’s three-weeks into Economics 101 also shows up when he attacks a straw man. President Donald Trump’s plan to reduce our trade deficit is “rooted in the belief that when the United States buys more from foreign countries than those countries buy from us, jobs increase elsewhere and decrease here at home…Trade deficits are not always bad for U.S. workers and consumers,” he writes.

The primary reason this is an attack on a straw man rather than a serious attempt to engage with President Donald Trump is simple: no one claims that trade deficits are “always bad.” Everyone agrees that under the right circumstances, trade deficits can be just fine. When a trade deficit is a passing phenomenon, no big deal. When the economy is operating at its maximum potential, buying more from foreigners than we sell just means we get more stuff. If interest rates were set by the market forces of supply and demand of loanable funds, rather than by expectations of the path of future Fed targets, and rates were thought to be too high, foreign investment would help bring those rates down.

Since none of those things applies to us now, trade deficits are having negative effects. Again they are not “always bad.” They’re just bad for us, now.

A more subtle reason this is a straw man attack is that sophisticated critics of our trade deficit are not arguing that “jobs increase elsewhere and decrease here at home.” At least, not in the aggregate sense. After all, if it were just about how many jobs we were creating, deficit hawks could just hang up their hats and take a long vacation now that unemployment is down at 4.6 percent.

Trade deficits do not necessarily hurt the number of jobs in the U.S. They shift the geographic and occupational mix of jobs.  So even if overall we still have as many jobs as we would without a trade deficit, we have fewer manufacturing jobs and fewer jobs in places like Ohio, Michigan, Wisconsin, and Mississippi. There’s very strong evidence, pretty much undisputed by economists of any school, that deficits contributed to a decline in manufacturing jobs and that this decline was concentrated in Middle America. By the most reasonable estimates, unbalanced trade with China alone cost nearly one million jobs between 1999 and 2011.

More optimistic economists used to portray this–they call it a “sectoral shift” —  as benign. Americans would move out of those hard hat, calloused hands, blue-collar jobs and into sophisticated technology jobs. While some of that has happened, its been a much smaller story than was anticipated. A huge part of the sectoral shift has involved Americans shifting into lower-paid, less-productive jobs. Think of a guy who used to make machine parts making macchiatos.

In other words, the trade deficit is destroying good jobs in the U.S. economy by destroying demand for the things those jobs produce. Spending that would have employed Americans in manufacturing instead employs workers in Germany, China, and Mexico. Telling us that we can make up for it with jobs that pay less and are less productive is not comforting. In fact, most economists agree that declining U.S. productivity and sluggish wage growth are serious problems.

Even free-trade favoring economists no longer try to deny that the trade deficit has economic costs and results in financial fragility for millions of Americans. Instead, they say that lower prices on consumer goods means that we’re better off overall. But that’s not necessarily true. No law of economics says that 100 percent of the income lost when productive work is done abroad is recaptured by Americans in the form of lower prices. And even if it were true, it would ignore the “distributional effects,” a polite way of saying we’re wiping out the economic livelihoods of millions of Americans and devastating communities by destroying manufacturing jobs.

Earlier, I mentioned that the standard economics view of the fate of foreign dollar savings is “not quite right.” According to that view, dollars accumulated by foreigners must as a matter of logic eventually be spent on goods and services made in the U.S. Otherwise, foreigners would be selling us real things–cars, computers, call center operations–in exchange for nothing but paper: dollars, Treasuries, stocks. So unless foreigners are irrationally giving us stuff for free, they must really be accumulating dollars because they plan to buy stuff with dollars. Even if they plan to spend dollars on stuff made by other foreigners, then those folks must eventually want to buy stuff from us. Under this view, eventually our trade deficit will become a surplus as those dollars get used to buy stuff made in the U.S.

But this is too neat. It is a bit like financial economists who insist that stock prices reflect future dividends and then have to assume that stocks that pay no dividends eventually will. There’s no law of economics that says financial assets such as dollars and Treasuries cannot be accumulated without any plans to spend them on real goods. Dollars have an optionality, a call-value that is extinguished when they are spent. In the face of uncertainty about the future, it is rational for actors to preserve this optionality rather than extinguish it. And since the value of this optionality extends to subsequent generations–this of wealthy people who keep earning more than they can ever spend–that’s not necessarily the end to it. Which mean that so long as the future remains uncertain — until kingdom come — trade deficits can persist into eternity.

Or almost. Large and persistent trade deficits put a strain on our country by economically disenfranchising millions of Americans. The resulting destabilization eventually could threaten global demand for dollars, prompting large dollar holders like central banks to attempt to rid themselves of their dollar denominated holdings. That kind of capital flow driven financial crisis was once a prominent fear of many economists, although it has gone out of fashion ever since we had a very different kind of financial crisis. There’s no indication that anything like it is imminent, but crises often do not announce their arrival ahead of time.

Lankford says that American workers and consumers always win if there is “free and open” competition. That kind of patriotic optimism ring hollow after decades of trade deficits have hollowed out so many American factories and families. Hanging an American flag on the ruins of American industry won’t make America great again.