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A Deficit of Clarity

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Here’s a letter to an attorney friend of mine in St. Louis:


Thanks for reading my letter [2] in today’s Wall Street Journal – one in which I note that foreign investments in the United States promote American trade deficits. But naturally I regret that you, as you say, “don’t know what [I’m] talking about” on this front. I apologize for being unclear.

A U.S. trade deficit arises whenever, during some period – say, a month – we in America buy more goods and services as imports (measured in dollar value) than we sell as exports. So, if $Imports > $Exports, we run a trade deficit. If instead $Imports = $Exports, there’s neither a trade deficit nor a trade surplus. If $Imports < $Exports, we run a trade surplus.

For example, if in January Americans spend $100 on imports and foreigners in January immediately spend every cent of that $100 buying American exports, then we run in January neither a trade deficit nor surplus.

But suppose instead that foreigners are intrigued by an investment opportunity in St. Louis. To take advantage of this opportunity – that is, to invest in it – they need dollars. And so rather than spend the entire $100 on American exports, foreigners spend only some of the dollars on American exports. Foreigners use the remainder of the dollars to invest in America.

Foreigners might, for instance, want to invest $40 in America. If so, they can spend only $60 on American exports. America thus, during this period, runs a trade deficit of $40.

It’s really that simple.

Yes, the details of reality – especially the ability of past investments to be liquidated or to change form, the fact that the amount of capital in the world isn’t fixed, and the fact that investments abroad are also made by us Americans – add some steps to any complete explanation of real-world changes in a country’s trade deficit (or surplus). But these details do nothing to alter the fundamentals as revealed in the simple example above.

The bottom line is that foreigners are no different than us Americans: they can spend their dollars on consumption goods and services or they can invest these dollars. And so the more foreigners invest in America, the less they will be able to spend on American exports.

Put differently, the more foreigners invest in America, the higher will be – all other things held constant – America’s trade deficit. This fact is one reason why Trump trade guru Peter Navarro is comically inconsistent in applauding increased foreign investment in the U.S. given his and his boss’s (in)famous hostility to U.S. trade deficits.

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