Manhattan's Trade 'Deficit' Explains Its Prosperity
Next week, the Census Bureau will issue their monthly national trade in goods and services report which is better known as our trade deficit report. My forecast for the report is that it will be irrelevant. There will be plenty of articles written about it, the stock market may move a few points based on the number, and it will affect the GDP calculation, but the reported number for the trade deficit will not be meaningful.
I once heard the story of a make believe island where the people grew no food and manufactured no products. The people on the island had a high standard of living by importing all of their food and goods. The island seemed to show no downside from their permanent trade deficit. As strange as this sounds, the island had an even stranger name: Manhattan.
Manhattan is able to achieve the permanent trade deficit because people on the island have the wealth they need to support their standard of living. Collectively, they own assets off the island that produce enough income to fund their needs. People are also free to move to and from the island.
The larger question is whether this "island effect" would also apply to countries, and more specifically to the United States. According to the Census Bureau, the United States has run a cumulative trade deficit in excess of $9.5 trillion since it began keeping records in 1960. The question that should be answered is whether this cumulative trade deficit (if real) represents America's overseas assets generating income, or whether it represents the United States spiraling in debt to foreign countries.
If the trade deficit figure is real and the people of the United States continue to go deeper in debt, then over time, we should be paying more money to these overseas owners of our debt. While the Census Bureau tracks the balance of trade, a separate government agency - U.S. Bureau of Economic Analysis - tracks national income including transfer payments to and from the United States. These transfer payments include interest, dividends, and reinvested earnings on assets. In 2013, these payments from the United States residents to foreign individuals totaled $569.5 billion. Payments from outside the United States to U.S. residents totaled $827.3 billion. This means that payments to the United States residents exceeded payment to foreign resident by over a quarter of a trillion dollars. This is a strong sign that the trade deficit number is not accurate. If one looks at the chart below containing both annual trade deficits and net income payments, the net income payments into the United States have been positive every year since 1960 and continue to grow. This is the opposite of what should occur from a real persistent trade deficit.
There are several reasons the trade deficit data is suspect. Since the United States has the highest corporate tax rate in the world at 35% plus state and local taxes, there are financial incentives to minimizing U.S. based profits. For a multinational company with manufacturing assets around the world, this can occur several ways: transfer pricing on imports and exports, contract pricing differences in raw materials, profit shifting to a low tax nations like Ireland or Singapore and moving corporate headquarters (now called "tax inversion").
The real danger from the trade deficit report is from politicians who attempt to restrict freedom in order to solve our trade deficit "problem." Individuals and companies respond to the rules they live under. Currently, the United States has the highest corporate tax rate and is one of the few countries that tax overseas earnings (this occurs when the earnings are brought back to the U.S.). This has provided the incentive to maximize overseas profits and to keep those foreign profits overseas. The trade deficit report is a better measure of U.S. corporate tax laws than any actual trade deficit. Real freedom to trade with others should not be sacrificed because of poor corporate tax laws.
Charlie Musick (email@example.com) is a chemical engineer in research & development.