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Pilkington Is Mistaken About Trade Deficits

Here’s a second letter in response to Philip Pilkington’s confused and confusing review of Samuel Gregg’s superb book, The Next American Economy.

Editor, Claremont Review of Books


Reviewing Samuel Gregg’s The Next American Economy, Philip Pilkington commits several errors when arguing that the American economy is imperiled by U.S. trade deficits (“Protecting the Free Market,” Spring 2023).

For example, Pilkington correctly recognizes that “[i]f financial markets decide that they are no longer willing” to hold dollar-denominated assets the American economy would be in big trouble. But to conclude, as he does, from this trivially true fact that U.S. trade deficits pose a problem for Americans is wildly unjustified. One can with equal correctness say that if financial markets decide that they are no longer willing to hold shares of Apple, Apple’s existing stockholders and employees would be in big trouble. Yet no one leaps from recognition of this mere possibility to the conclusion that current investors in, and employees of, Apple are in financial peril and should therefore divest their investments in Apple and quit their jobs with that company.

Investors don’t make decisions on whims. Investors put and keep resources in companies and countries that they believe have promising futures; they remove resources only from companies and countries that they believe are on paths economically destructive. As long as global investors believe that the American economy is fertile and safe soil for their funds they will continue to invest in America. And these investments will continue, despite the damage wreaked by the U.S. government’s fiscal incontinence, to help expand America’s stock of productive capital beyond the levels it would attain if foreigners consistently cashed out all of their dollars on purchases of American exports.

Pilkington will reply by pointing, as he does in his review, to the Asian financial crisis of 1997-1998. It’s true that the Asian countries that suffered this crisis had run current-account deficits. But contrary to Pilkington’s claim, the problem wasn’t these deficits; it was government interventions. As David Henderson wrote in 1999:

“Crony capitalism,” for example, has badly damaged South Korea, Indonesia, and Malaysia. The South Korean government has forced lenders to waste their money on its favored firms. Indonesia is mired in monopolies on imports and domestic production. Malaysia’s prime minister diverted a large part of Malaysians’ savings toward his political allies.*

Some of these countries’ economies were further weakened by involvement with the IMF, specifically from what Alan Reynolds described as “the moral hazard effect in which the sheer availability of loans at below-market interest rates encourages more national politicians and their foreign lenders to take imprudent and excessive risk.” Reynolds went on to note that “[i]n 1997–98, the Korean stock market fell very sharply shortly after the IMF program was revealed [and] Indonesia’s credit rating was downgraded after the IMF program was revealed….”**

Ironically, in calling for “a strong industrial policy” and “import substitution,” Pilkington proposes precisely the same sorts of interventions in America that were responsible in Asia for a financial crisis that he mistakenly blames on 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

* David R. Henderson, “Global Warning,” Red Herring Magazine, March 1, 1999.

** Alan Reynolds, “Crises and Recoveries: Multinational Failures and National Successes,” Cato Journal, Spring/Summer 2003, Vol. 23, page 101.