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A Trade Deficit Is Not Necessarily Evidence of Domestic Consumption In Excess of Domestic Production

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Here’s a letter to the Wall Street Journal:

Greg Ip correctly criticizes the Trump administration for believing that bilateral trade deficits are a problem (“Deficits Are a Flawed Guide to Unfair Trade [2],” March 15).  Bilateral trade deficits indeed are utterly meaningless.  But Mr. Ip errs when he writes that “The U.S. has a trade deficit [with the rest of the world] because it consumes more than it produces.”

It’s untrue that a trade deficit necessarily signifies consumption in excess of production.  A simple example illustrates.

Suppose the Chinese use $1 million of the dollars they’ve earned through exporting to buy shares of stock on the NYSE.  Further suppose that the American who sold the shares immediately invests the full $1M to build a factory in Finland.  The result of these transactions is no change in America’s trade deficit (or, more accurately, current-account deficit).  Now amend the example by supposing that the American seller of the shares instead invests the full $1M to build a factory in Florida.  In this case, America’s trade deficit rises by $1M.  Yet American consumption and American investment are the same in both cases.  More significantly, American production in the second case – the one in which the U.S. trade deficit rises – is higher than it is in the first!

While a U.S. trade deficit might signify an excess of American consumption over American production, the only thing it unquestionably signifies is American imports over American exports.

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

Furthermore, as a recent example offered by Scott Sumner reveals [3], even the classification of what does and doesn’t count as an import and an export, being an accounting convention, is further reason to reject popular memes such as “a U.S. trade deficit means that Americans consume more than they produce.”

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