Worrying About the ‘Trade Deficit’ Is Absurd to the Nth Degree

by Don Boudreaux on January 6, 2017

in Adam Smith, Balance of Payments, Myths and Fallacies, Trade

This post follows closely an earlier post from today.  (I likely have used in the past a very similar analogy as the one I use here.  Nevertheless, it works and is worth repeating.)

Suppose that we take all Americans whose last names start with the letter “N” and do an accurate accounting of this group’s spending and saving during some period (say, 2016).  Further suppose that our accounting reveals that these “N” Americans earned, collectively, in 2016 a total of $750 billion, and that of this $750 billion, these “N” Americans spent only $700 billion on consumption goods and services.  The remaining $50 billion was saved by these “N” Americans and invested in the non-“N” part of the American economy.  Some of this $50 billion was used to buy real estate from non-“N” Americans; some of it was used to build factories and retail stores in parts of America where no “N” Americans live; some of it was used to buy ownership shares of firms and of capital goods from non-“N” Americans; some of it was loaned to non-“N” Americans; and some of these dollars were simply held by these “N” people in their purses and wallets and piggybanks.)  Non-“N” Americans did no similar investing in the “N” part of the American economy.

The “N” Americans, in 2016, ran a trade surplus with non-“N” Americans, and we non-“N” Americans ran a trade deficit with the “N” Americans!  (Note that, inessential details aside, there is nothing at all implausible about this story.  It very well might be the case that “N” Americans ran in 2016 a trade deficit with non-“N” Americans.)

Should we non-“N” Americans worry about our trade deficit with “N” Americans?  Should we non-“N” Americans stop, or at least reduce, our trading with “N” Americans?  Should we worry that “N” Americans are harming us non-“N” Americans by investing more in the non-“N” part of the American economy than non-“N” Americans are investing in the “N” part of the American economy?  Should we conclude that “N” Americans are trading “unfairly” with non-“N” Americans?

Of course not.  It would obviously be absurd to harbor any such worries or to draw any such conclusions.  The “N” Americans’ net saving and investment not only do nothing to prevent us non-“N” Americans from saving and investing as much as we wish, but the “N” Americans’ saving and investing enrich us all – non-“N” and “N” alike – by making the economy of which we are all a part more productive.

And yet, when people fret about an American trade deficit, such worries and conclusions are drawn.  But these worries and conclusions make no more sense than they would in the context of “N” and non-“N” Americans.  Fretting over the trade balance is absurd.  Again, Adam Smith nailed it:

Nothing, however, can be more absurd than this whole doctrine of the balance of trade.

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