The Simple (If Painful) Way to Cut the Trade Deficit
Let's say you want to reduce the U.S. trade deficit. President-elect Donald Trump has said repeatedly that he does, and it's not just him.
Robert E. Scott of the left-leaning Economic Policy Institute argued in 2015 that big trade deficits were the main reason U.S. manufacturers had shed more than 5 million jobs since 2000. In a 2014 Journal of Economic Perspectives review of the state of U.S. manufacturing, Martin Neil Baily and Barry P. Bosworth of the centrist Brookings Institution wrote that "the macroeconomic factors creating the U.S. trade deficit" have been responsible for many of the sector's travails. This week Jared Bernstein, a former economic adviser to Vice President Joe Biden, opined that to improve the lot of working-class Americans, "we must start by lowering our economically large, persistent, and distortionary trade deficit." This is still not exactly the consensus view -- the standard economic argument is that more trade is good, and deficits neither good nor bad -- but I think it's fair to say that it has been getting more respectable lately.
So anyway, let's say you want to reduce the U.S. trade deficit. How do you do that? Well, if you're the president, or a member of Congress, the simplest, most straightforward way is to reduce the gap between federal spending and tax revenue. You know, the budget deficit.
Why is that? It's mainly just simple accounting. You can't run a current account deficit, a measure that incorporates the trade deficit and any deficit or surplus in cross-border income flows, without having a capital account surplus of equivalent size. A less-jargony way of putting this is that, as a country, you can't buy more than you sell unless you borrow money from other countries to cover the difference.
There are a lot of chicken-or-the-egg questions here. Does the U.S. run big trade deficits because it borrows so much, or does it borrow so much because it runs such big deficits? Or does it do both because the special status of the dollar as the world's reserve currency creates an unstoppable foreign demand for dollars that puts the U.S. in perpetual capital account surplus?
Whatever your answers, it is undeniably true that less borrowing and more saving by U.S. households, corporations and governments means a smaller capital account surplus and thus a lower current account deficit. And as Baily and Bosworth put it,
The government has few if any tools by which it can dramatically raise private saving; thus, the increment to national saving will be achieved most effectively by steps to reduce the federal budget deficit.
This observation is not by any means new or unique to them. "In any effort to reduce the current account," the Congressional Budget Office concluded in 1989, "the Congress and the Administration should emphasize reducing the budget deficit."
It is true that, since the 1980s, when there was frequent talk of the "twin deficits" and risks they posed, reality has gotten a bit more complicated. In the late 1990s, the budget deficit briefly disappeared, but the current account deficit ballooned as foreign investors piled into the hot U.S. market. And during and after the global financial crisis, the budget deficit ballooned but the current account shrank as U.S. households and corporations hunkered down and stopped borrowing.
It is also true that cutting the budget deficit can be a bad idea for short-term economic reasons. To go back to Baily and Bosworth (their article really is good; you should read it):
Fiscal consolidation in the very near-term could abort the recovery. Over the longer term, however, it is hard to see how the United States can significantly improve its trade balance without tackling the budget deficit.
The U.S. economy is stronger now than it was when they wrote that in 2014, but there are still lots of good reasons not to want to slash the budget deficit. For one thing, as the above chart shows, both the budget and current account deficits are already lot smaller than they were a few years ago. Interest rates, while rising, are probably still low enough to justify the debt-financed infrastructure spending binge that Trump has promised. And there are other things the U.S. government can do to decrease the trade deficit, which tend to involve either persuading foreign governments to change their policies -- by opening up markets to U.S. exports or allowing their currencies to rise in value -- or making long-term investments in education, research and infrastructure in the U.S.
Still, you've probably already sensed the looming conflict here. Federal budget deficits are expected to start rising soon as more and more baby boomers begin to avail themselves of Social Security and Medicare. The economic-policy proposals that Trump floated during the campaign would, if enacted, increase those deficits by a lot. That may well be the right thing to do. But it means the trade deficit is most likely to grow in the coming years, not shrink.
Bernstein is an Economic Policy Institute veteran who now works at the Center on Budget and Policy Priorities.
Which means there has to be a current account deficit.
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