Griswold and Freytag On the So-Called “Trade Deficit”

by Don Boudreaux on April 25, 2023

in Balance of Payments, Trade

This new paper by my friend and former Mercatus Center colleague Dan Griswold, co-written with Andreas Freytag, is not to be missed. In it, Dan and Prof. Freytag brilliantly bust many myths about the trade deficits. This paper should silence the incessant false alarms that the U.S. trade deficit both reflects and promotes America’s economic decline. The truth is quite the opposite. Here are some slices:

Concerns about the trade deficit are myopic and do not fully account for the benefits of expanding trade. In particular, both the causes and supposed consequences of the trade deficit are misunderstood, leading to wrong and self‐​damaging policy conclusions. We explain the causes and consequences of the trade deficit, contrasting the U.S. case with trade surplus countries such as Germany, including the impact on manufacturing output and employment. We also explain how the balance of trade, in fact, points to the nation’s strength as a haven for global investment, to robust trade in goods and services, and to a strong dollar that remains at the center of the global economy. And finally, we briefly recommend policy steps to build on the nation’s underlying commercial and geopolitical strengths.

The U.S. balance of trade in goods and, more broadly, the current account, have been in deficit for decades. Year after year, Americans buy more goods in global markets than they sell. This is not a problem to be solved with tariffs or other trade measures, but the result of deeper economic realities in the economy that could reasonably be seen as signs of strength. The United States can only run a persistent deficit in its current account because it runs an equally persistent surplus in the financial account, which measures the flow of capital across the border. More investment flows into the United States each year than flows out, on net, in large part because the United States remains a safe and profitable haven for the world’s savings. The investment, in turn, fuels growth and job creation.


When critics are not focusing on the overall trade deficit, they call attention to persistent bilateral trade deficits with key trading partners such as China and the European Union. But bilateral imbalances are even less meaningful than the general balance in trade. American citizens and firms deal with partners all over the world. There is no rational economic reason why Americans should be expected to sell exactly the same value of goods and services to people in a particular foreign nation than they buy from them.

To illustrate this point, let us conduct a thought experiment: imagine the world consists of three countries with limited but generally balanced trade. Germany is only buying oil from Saudi Arabia and only selling machines to the United States, which itself is only selling telecommunications equipment to Saudi Arabia. Germany runs a bilateral trade deficit with Saudi Arabia, Saudi Arabia with the United States, and the United States with Germany. Each country has balanced trade with the world, but deficits and surpluses with individual trading partners. The bilateral deficits can reflect perfectly normal comparative advantages and preferences.


In reality, manufacturing output, as measured by domestic value‐​added, has expanded in the past two decades along with persistent annual deficits in merchandise trade. In 2021, as the merchandise trade deficit continued to exceed 4 percent of GDP, manufacturing value reached a record high of $2.563 trillion. As Figure 4 shows, real U.S. manufacturing value‐​added rose in the past two decades by more than a third, from $1.84 trillion in 2000 to $2.5 trillion in 2021. Meanwhile, the merchandise trade deficit as a share of GDP has fluctuated within a range of 3.5 to 6.1 percent of GDP. While certain regions of the country have seen a decline in their traditional manufacturing sectors, a persistent trade deficit is no barrier to expanding manufacturing output in the United States overall.


Beneath the headline number of the trade deficit lies evidence of America’s continued economic strength and influence in the world, including a projection of soft power in its growing competition with Russia and China. The U.S. trade balance is not a source or symptom of weakness, but a reflection of underlying strengths of America’s still relatively open economic system. A more comprehensive look at America’s commercial accounts with the world shows the economic sophistication of the economy, the importance of the freedom to import, its enduring attraction as a safe and profitable haven for the world’s capital, and the continued dominance of the U.S. dollar—all of which enhance America’s influence in the world.


Another sign of strength in the U.S. balance of payments is the nation’s openness to imports. The United States is the world’s largest market for the rest of the world’s exports of goods and services. Since the end of World War II, this status has enhanced America’s influence over global trade rules and alliances. Access to globally priced imports also benefits consumers and domestic producers who depend on imports and global supply chains to produce competitively priced products. The economy is stronger and more resilient because of the ability of American companies to source semiconductors and other critical components from a broad range of global suppliers. This is true of the defense sector as well as private industry.


A more open economy would both stimulate economic performance while strengthening our ties to allies and increasing our influence in the world. This had been a consensus in Washington in the decades after World War II, but it is worth renewing our national commitment as tensions continue to rise with rivals such as China and Russia. A commitment to openness would strengthen channels of influence such as robust U.S. exports and imports, the continued attractiveness of the United States as a home for foreign investment, and the strength and appeal of the U.S. dollar as the world’s most important currency.

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