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Is Any Concept In Economics as Prodigious a Source of Misunderstanding and Mischief as is ‘the Trade Deficit’?

Here’s a letter to Barron’s:

Frank Berlage’s warning of the alleged dangers of U.S. trade deficits is a montage of misunderstanding (“Why Fixing Trade Deficits Is Essential,” Jan. 7).  For example, Mr. Berlage infers a decline in America’s “manufacturing base” from the decline in manufacturing employment.  This inference is mistaken.  As my Mercatus Center colleague Dan Griswold notes, “American factories and American workers are making a greater volume of stuff than ever – high-tech, high-value products that are competitive in markets around the world. In the last 20 years … real, inflation-adjusted U.S. manufacturing output has increased by almost 40%.”

Manufacturing employment is down because manufacturing productivity is up, and not just in America.  According to economist David Dollar, “job loss in manufacturing derives primarily from technological change, not from trade.  Manufacturing’s share of U.S. production is quite stable, but its share of employment has declined at a steady rate because productivity growth in manufacturing is higher than in services.  This trend can be observed in all of the advanced economies, including ones such as Germany that have large trade surpluses.”

An even more egregious misunderstanding is revealed in Mr. Berlage’s proposal to impose stiff taxes on American consumers who purchase imports from any country with which America runs persistent bilateral trade deficits.  Yet in a world of more than two countries, bilateral trade deficits are utterly without economic significance.

In this real world of ours with nearly 200 different countries, most of which are woven together into a single global economy, there is no more reason to expect that we Americans will over time sell as much to the Chinese as we buy from the Chinese than there is to expect that, say, General Motors will over time sell as much to Goodyear as General Motors buys from Goodyear.  And just as General Motors would be foolish to restrict its purchases from Goodyear on the grounds that Goodyear annually spends less on outputs sold by G.M. than G.M. spends on outputs sold by Goodyear, it would be foolish for us Americans to restrict our purchases of outputs sold by the Chinese on the grounds that the Chinese annually spend less on outputs sold by us than we spend on outputs sold by the Chinese.

Mr. Berlage’s poor understanding of both the reality and the economics of trade make him unfit to be taken seriously on this matter.

Donald J. Boudreaux
Professor of Economics
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA  22030

(I thank Steven Kaufman and Anthony Onofreo for alerting me to Berlage’s essay.)

One cannot repeat too often Adam Smith’s important insight: “Nothing, however, can be more absurd than this whole doctrine of the balance of trade.”