Homers Nod

by Don Boudreaux on May 6, 2017

in Balance of Payments, Budget Issues, Debt and Deficits, Myths and Fallacies, Trade

Here’s a letter to the Washington Post:

George Shultz and Martin Feldstein are correct that “If we manage to negotiate a reduction in the Chinese trade surplus with the United States, we will have an increased trade deficit with some other country” (“Everything you need to know about trade economics, in 70 words,” May 6).  They are also correct that Uncle Sam’s deficit spending is a regrettable, massive act of American dissaving that does indeed affect America’s trade deficit.

But they overstate their case to the point of confusion.  It’s simply untrue that if the government’s budget deficit is controlled we “will control trade deficits.”  Uncle Sam last ran budget surpluses in 1998, 1999, 2000, and 2001.  In each of those four years the U.S. ran large trade deficits.  More significantly, in the first three of those four years the size of the trade deficit increased not only absolutely but also as a percentage of (a rising) GDP.  (And in the fourth year it fell as a percentage of GDP only very slightly.)*

This reality is neither mysterious nor lamentable.  Foreign investment goes not only into government bonds but also into private enterprises.  If America is an attractive place to invest relative to other countries, America will run a trade deficit even if Uncle Sam no longer runs budget deficits.  Under such happy circumstances, America will continue to attract a net positive inflow of foreign capital to fund innovation and increase productivity.  Indeed, if – as Messrs. Shultz and Feldstein undoubtedly and correctly believe – greater fiscal prudence by Uncle Sam would improve America’s investment climate, the result will likely be, as it was during most of Bill Clinton’s final term in office, a rising rather than a falling trade deficit.

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

* Calculated from the following: here, here, and here.

According to my calculations, the U.S “deficit” on trade in goods and services was:
1.3 percent of GDP in 1997
1.8 percent of GDP in 1998
2.7 percent of GDP in 1999
3.6 percent of GDP in 2000
3.4 percent of GDP in 2001

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