Globalization and the Trumpaline
Inversions and Globalization
Outsourcing Common Sense and US Jobs


When did the U.S. begin to have large trade deficits?

Answer: The current account balance started going into deficit in 1982. After that there was a string of deficits interrupted by only one very small surplus in 1991.

Some take this deficit/debt performance as a sign of economic weakness. Others see it as the opposite. Which is it?

Answer: It could be either. If trade deficits result from importing goods or technology that make the economy more productive and stronger, then perhaps trade deficits aren’t so bad. Second, the answer to this question depends on what is causing what. It is well known that the large deficits of the 1990s were the result of a massive inflow of capital from abroad. What caused this desire by foreigners to invest in the U.S.? Surely a number of things but economists believe it was a combination of poor investment projects abroad and the thriving markets in the U.S. (resulting from the IT revolution and very strong economic growth in the latter 1990s). Why would this cause a trade deficit – isn’t this all about the financial account? There are two parts to this answer. The first is the accounting identity between current account deficits and financial account surpluses.

A more interesting answer is that the great interest in U.S. assets meant that many foreigners were buying dollars in foreign exchange markets – they were buying dollars as a prelude to buying U.S. bonds and stocks. This drove the value of the dollar up. When the dollar appreciated enough, it cut into U.S. exports and increased imports – causing a current account deficit.

Why is this story important? Because it shows how apparently “bad things” can be caused by good things. The U.S. had a strong economy. It sucked in the world’s capital. The dollar appreciated and the trade deficit widened. Do you want to get rid of this problem? I don’t think so – because one solution is to simply weaken the U. S. economy. That sounds a little like throwing the baby out with the dirty water.

Notwithstanding the above, trade deficits do lead to more international debt. If the international debt gets too large it could be a real problem. What happens if foreigners begin to believe that the U.S. is not such a good place to invest? What happens when investment opportunities in Europe, Asia, and elsewhere start to improve? The answer is that some of this money will move out of the U.S. If done in an orderly fashion this would not be a terrible thing. But if it is done in a chaotic panic, then it will be highly disruptive to people and companies in virtually every country. This is a good reason to pay attention to this problem.

Difference of Opinion

A common notion is that importing more than you export costs the country jobs. Is this common knowledge true?

Answer: There is a simple logic here. An export requires someone to produce it. So exports create jobs. An import is something that is produced elsewhere. It could have been produced at home with labor. So an import displaces labor. If imports are greater than exports, then the labor displacement must be greater than the labor increase. This seems pretty clear logic. Many economists disagree with this logic.

So do I.

Paul Krugman answered the question in his book, The Age of Diminished Expectations, page 41, “America’s trade deficit problem has nothing to do with jobs.” In 1990, US employment increased. A smaller trade deficit wouldn’t have caused more jobs to be created.” Why?

Because jobs are normally created by supply (expanding capacity); not by demand.

Exports minus imports reflect the net demand for goods and services caused by trade. A rise in net exports increases demand but does not translate into a permanent increase in output or jobs. More than likely the increase in demand will just cause inflation. A trade deficit just means a reduction in demand and less inflation ⎯ not a loss of jobs.  Suppose a high tariff caused imports to be lower in 1990? Would there really be more demand for people to work because of the net increase in demand for domestic production? Krugman says that the rise in demand would have simply increased wages and prices. If the FED reacted to the higher inflation with tight money, then employment might have actually declined. The result is much the same if the government had decreased the value of the dollar to promote exports. This would just lead to inflation ⎯ worse, the FED contracting the money supply.

Would the answer to the above problem change if the country was in a recession when a trade deficit improved?

Answer: Krugman admits that if we used a recession year for the example, with lots of unemployed workers, the story could be a little different. Demand is too low in recession years. But he says that you don’t need trade policy to raise demand and exit a recession. Domestic monetary and fiscal policies are better for that.

There is more to the issue.

For example, it is possible that the country is importing some things that it can’t or doesn’t want to produce.

Summing up, these imports clearly do not cause an employment problem.

For example, critics claim that many U.S. jobs are moving to Mexico. But many of those jobs are moving to Mexico instead of China or Brazil. These are jobs that can no longer be done profitably in a rich nation like the U.S. Such changes in industrial structure have been a constant in employment dynamics for 200 years. First jobs moved away from agriculture. Then they moved away from low-skilled manufacturing toward services. Throughout U.S. history these kinds of job losses have been dwarfed by new kinds of jobs at home.

If you are the one losing the job, it is personal and might be tragic. But if you are conducting national or business policy, what matters is what is best for your company or for the whole nation. Continued attention to such things as saving, competition, knowledge acquisition and application are the best ways to improve employment in the nation. As Krugman said, this is an aggregate supply issue, not a trade issue.

In what other ways might large, continuous trade deficits cause major problems?

Answer: There are two “psychological” reasons to pay attention to trade deficits. If your child thinks there is a ghost hiding in a closet, then it is hard to dislodge them of this notion. You have to deal with this “unrealistic” fear anyway. People think a lot of things about deficits. For one thing, many people are very nationalistic and simply don’t like the thought that foreign persons or institutions are buying symbolic assets. They also don’t like the idea that these entities may be controlling more and more of their economy. Anti-globalization protesters, for example, declare that the U.S. controls too many coffee plantations in South America. The U.S. wouldn’t want French control over the Statue of Liberty and the French would resist a U.S. takeover of Air France.

These nationalistic feelings swell up whenever a country starts to have a larger trade deficit. They could, under the right conditions, lead to political trends that promote protectionist policies. One way to defend against extreme and unproductive policies is to find better ways to address the problems before they get out of hand.

How is the US trade deficit distributed?

Answer: Not very evenly. The chart below comes from the US Census at:

Notice that as of December 2010, the annual trade deficit with China was almost $273 billion. The next largest US deficits were with Japan ($59 billion) and Mexico ($66 billion). These bilateral deficits focus our attention on country-specific factors but as we see below, the macroeconomic answers to national trade deficit problems generally focus on macroeconomic solutions.

Top Ten Countries with which the U.S. has a Trade Deficit

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What causes trade deficits?

Answer: Suppose an increase in government spending (or a reduction in income taxes) causes national spending to rise at the expense of saving. If the pool of saving is insufficient for the needs of domestic borrowers (investment demand), then this usually drives interest rates higher. Higher interest rates in one country (assuming no increase in financial risk) cause foreigners to want to invest their savings in the US ⎯ a capital inflow. Since foreigners have to buy US currency to buy US assets, this capital inflow pushes the value of the dollar higher. A higher value of the dollar leads to more US imports and less exports of goods and services. Thus a government deficit causes a trade deficit.

This scenario explains how the balance between national saving and national investment impacts trade imbalances. In general, anything that leads to a reduction in national saving relative to national investment will lead to a trade deficit. When a country wants to invest more than it saves, it ends up bringing savings from abroad. That makes saving an important cause of trade problems. Recall that national saving is composed of household savings, business saving and government saving.

Industry application

The late 1990s offers a good example of how a good idea can be misunderstood. Many people prior to the late 1990s associated trade deficits with low government savings. Thus they talked about the twin deficits – government deficits caused trade deficits. But a strange thing happened during the later 1990s – government deficits disappeared. A good business person would have concluded that this reduction of the national budget deficit would increase national saving and lead to smaller trade deficits. But guess what – trade deficits got even larger. What happened?

The answer is that trade deficits depends on national saving – not just on government saving.

In the late 1990s, it turned out that households reduced their saving considerably (apparently all the unrealized stock market gains were not counted as saving and the wealthier folks went on a spending spree). Despite public saving increasing, national saving did not increase and the trade deficits stayed with us.

A good article about U.S. saving, capital inflows, and trade deficits is “The Great American Savings Grab” From Stephen Roach, Chief Economist at Morgan Stanley. A copy of this short article can be found at

Difference of Opinion: Saving and Employment

In the Financial Times (“American Savings Shortfall is Hurting Workers”, October 21, 2004, page 15), Ronald McKinnon argues that U.S. government budget deficits are a primary contributor to a long-term savings shortfall and reduction in manufacturing employment. He argues that without persistent government budget deficits,  national saving would have been higher and manufacturing employment would have been 4.7 million higher in 2003. He ends this article with the following words, “The proper way of reducing protectionism pressure and relieving anxiety about U.S. manufacturing is for the government to consolidate its finances and move deliberately towards running surpluses – in short, to eliminate the U.S. economy’s saving deficiency.” While McKinnon does clearly explain why domestic manufacturing employment suffers because of insufficient saving over a time period of considerable years, he does not offer any specific suggestions in this article for how to raise government revenues or reduce spending.

An earlier Financial Times article (“U.S. Election, October 13, 2004, page 13) took up the policy question and concluded that neither presidential candidate had adequate long-term solutions. The article quotes Peter Peterson, “The melancholy truth is that there is no solution to the fiscal deficit and the current account deficit that does not involve an increase in national saving.” The article concludes that pensions and elderly heath care are the two forces that will rob the U.S. and other countries of their future national savings, yet neither U.S. candidate has adequately spelled out how he will handle these issues. Candidates are wont to deal with difficult problems but even less likely to want to risk their political fortunes on issues whose solutions raise costs today only to create benefits at some time far off into the future.”

Difference of Opinion

Solving the trade deficit with policy. Okay – so increasing national saving is the main way to reduce trade deficits. Why don’t we do it? Consider what it takes to get a nation to save more.

First, one has to induce people to spend less. It may be that people have good reasons for wanting to spend more. It might not be easy to change their minds about spending. C. Alan Garner (“Should the Decline in the Personal Savings Rate be a Cause of Concern?” Federal Reserve bank of Kansas City Economic Review, Second Quarter 2006, pages 5-28. ) concluded that saving is not measured well and may not be as deficient as the published data suggests, “There are reasons to think that the NIPA estimate of personal saving might be revised upward in the future….to the extent that American households have correctly anticipated future gains in productivity and labor income and incorporated these expectations into their spending plans, any future adjustments in consumption spending need not be wrenching.”

Second, policies to increase saving might also be unpopular. Policies that discourage spending might not be appreciated by voters. A new sales tax on consumption was suggested by George W. Bush in 2004. It was not universally hailed. Why? This gets back to issues between the rich and poor. This changes from year to year, but something like 20% of the people do about 80% of the saving in the U.S. If you want a policy that is going to substantially induce more saving, then it will have to be aimed at the richest people in the country. Giving big tax breaks to rich people for any purpose is like a politician putting a ban on kissing babies!

So if it is so difficult to change spending and saving habits with policy, is there a second-best solution to trade deficits?

If a high value of the currency causes a trade deficit, why not focus policy directly on lowering the exchange rate? Or directly on the trade deficit (by prohibiting or taxing imports)?

Answer:  The problem with the first idea is that the exchange rate is a symptom, not a cause of trade deficits. Trade imbalances are caused by the interactions between saving and investment; not by exchange rates. Sometimes if no other remedy is available, we don’t mind our physicians attending to our symptoms. They may not know what is really wrong with us, but finding ways to reduce our pain or temperature is always appreciated. So treating symptoms isn’t always a terrible thing. But it is a bad thing if it detracts attention from looking for the true causes of the problems. Why? Because we know that if the cause of the disease is not eliminated, then the pain and temperature will just come back. We can try to push down exchange rates, but if saving continues to be deficient relative to investment, then the exchange rate will soon rise again.  

Furthermore, government restriction of trade won’t work either if the true problem is one of deficient savings. Consider what happens if you directly reduce imports through restrictions (like tariffs or quotas), yet national saving is too low. The restriction tends to raise the value of the dollar. This is not the way to create a lasting improvement in the trade deficit.

Result – the trade deficit problem comes back to saving and investment. It is hard to escape this macro fact.