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Greg Ip’s Understanding of Trade Deficits is Fundamentally Flawed

Here’s a letter to the Wall Street Journal:

Greg Ip writes that “The U.S. runs a trade deficit because it consumes more than it produces while its trading partners, collectively, do the opposite” (“How the Tax Cut President Trump Loves Will Deepen Trade Deficits He Hates,” April 19).

Not so.  A U.S. trade deficit does not imply that the U.S. consumes more than it produces (although the unfortunate conventional description of trade deficits as resulting from shortfalls of domestic savings over domestic investment fuels this fallacy).  What a U.S. trade deficit does imply is that global investors find the U.S. to be an especially attractive place to invest.  With the U.S. receiving a net inflow of global capital, the size of the U.S. capital stock grows.  In turn, production in the U.S. rises to heights that it would otherwise not reach.

An example will expose the fallacy of Mr. Ip’s claim.  When BMW built its automobile factory in Greer, SC, in the 1990s the U.S. trade deficit rose as a result of Germans not spending on American exports the dollars that they invested in the factory.  But this investment was neither evidence of, nor a cause of, the U.S. producing less than it consumes.  This German investment caused more cars to be produced in the U.S.

At the very least, this increased production of cars in the U.S. offset the decreased production of particular American exports caused by the higher U.S. trade deficit.  But in the long run this foreign investment in the U.S. raised total production here by increasing the amount of productive capital in operation on our shores.

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