Free Trade Doesn't Cause Trade 'Deficits,' But Growth Does

Free Trade Doesn't Cause Trade 'Deficits,' But Growth Does
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Once again this week President Trump blamed a free trade deal for a trade deficit. This time the alleged culprit was the South Korea-U.S trade agreement (KORUS). Last week it was NAFTA. But trade deficits do not stem from “bad” or “unfair” trade deals. Trade deficits aren’t even necessarily a bad thing.

Trade deficits do not equal a sluggish economy, and trade surpluses do not necessarily indicate a robust one. Over the past two years, more than half of the 35 nations belonging to OECD, the rich countries’ club, have run trade deficits. More than half of the G7 have also run trade deficits for the past two years. But Mongolia, Kazakhstan, and Angola all ran trade surpluses. Which economy would you rather have?

A trade deficit simply means a country imports more than it exports. But high imports to not indicate a troubled economy, they indicate a buoyant one. Consumers are spending a lot of money because they have a lot of money to spend, and/or the confidence to spend it. The U.S. saw its highest trade deficit in history in 2006, in the midst of an economic surge. The country’s smallest trade deficit in recent years occurred in 2009, when the U.S economy was in the midst of a recession.

In fact, the last time the United States had a trade surplus was in 1975, another year when the U.S. economy was in recession, in the middle of a decade characterized by stagflation. On the other hand, economic booms in the late 1980s and late 1990s were accompanied by steep increases in trade deficits. The more money people have, the more they are going to spend. The more people spend, the higher the total of imports.

To get a sense of how implausible is the notion that trade surpluses or trade deficits stem from “good” or “bad” trade deals, just look at the United States’ trade balances with Germany and the Netherlands. Both countries are members of the EU, trading under the same set of WTO rules. Neither is part of a bilateral or regional trade agreement with the United States. But U.S. trade balances with the two countries couldn’t be more different. The U.S has a big trade deficit with Germany, and a trade surplus with the Netherlands. They both trade with the United States under the exact same regulations, but the results are starkly different. Clearly, the differences don’t stem from a trade agreement, well or badly negotiated.

The biggest difference is that Germany produces a lot of goods that Americans want, so Americans buy more than they sell, and the United States produces a lot of goods that the Dutch want, so Americans sell more than they buy. Trade among countries is no different in that respect from trade among individuals. I buy more from my grocer because he can offer something I want – food. I don’t sell anything to him because he does not require position papers or speeches. That is why the United States has a quarter-billion-dollar trade surplus in services. Americans aren’t racking up that surplus because they are trading unfairly. And it isn’t because of “smart” trade deals. The same trade agreements that generate deficits in manufacturing trade produce surpluses in trade in services. The difference isn’t the trade deals; it is the fact that American companies have built expertise in services.

Moreover, in a global economy characterized by extensive supply chains, it is sometimes hard to distinguish what is an export and what is an import. Trade deficits sometimes disguise production, rather than illuminate it. A product can count as an export for a country if it is where value was last added, even if the value that is added is relatively small. China adds far less of the value to an iPhone than the United States does, yet the phone counts as a Chinese export to the United States – even though it was created through R&D conducted in the U.S. What one sees as a trade deficit is indeed more jobs in manufacturing plants in China – and more jobs in research hubs in the United States. Essentially, longstanding jobs that leave the Rust Belt are making possible new, more lucrative jobs in the Sun Belt.

Trade balances are determined by levels of spending and saving, areas of comparative advantage, and supply chains that make production more efficient – not by how clever one is at writing a trade agreement.

Allan Golombek is a Senior Director at the White House Writers Group. 

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