Time to Fix the Trade Deficit

The 2008 deficit on international trade in goods and services was $677.1 billion, down from $700.3 billion in 2007, but still 4.7% of GDP. The trade deficit was smaller in 2008 because economic growth and consumer spending began to decline during the second half of 2008.

Trade deficits and shoddy banking practices pushed the economy into recession, and until both trade and the banks are fixed, sustained economic growth cannot be accomplished. The trade deficit will rise again as the effects of the stimulus package are felt, but if its underlying causes are not addressed, the trade deficit will drag the economy back down into a double dip recession.

Pushed up by the surge in oil prices and the ballooning trade gap with China, the trade deficit is reducing U.S. GDP by $400 billion, annually, and significantly adding to the pain imposed by the unfolding recession. The negative effects of the trade deficit on GDP and employment overwhelm the potential positive effects of President Obama's proposed stimulus spending.

Anatomy of the Hemorrhaging Current Account

In 2008, the United States had a $144.1-billion surplus on trade in services. This was hardly enough to offset the massive $821.2-billion deficit on trade in goods.

The deficit on petroleum products was $386.3 billion, up from $293.2 billion in 2007. The average price for imported crude oil rose to $95.23 in 2008 from $64.28 in 2007, while the volume of petroleum imports fell 4.0%.

Also, the American appetite for inexpensive imported consumer goods and cars is a huge factor driving up the trade deficit. The trade deficit with China was $266.3 billion, a new record, and up from $256.2 billion in 2007.

The deficit on motor vehicle products was $107.1 billion. Ford (F) and GM continue to push their procurement offshore and cede market share to Japanese and Korean companies. However, the automotive trade deficit was down from $120.9 billion as Asian automakers continued to expand production in North America and demand for autos fell with the recession.

The trade deficit should ease in 2009 with lower oil prices and as the recession bears down on consumer spending. However, China is not permitting its currency to rise in value, despite its trade surplus, and has beefed up subsidies on its exports in an effort to export its unemployment to the United States and other industrialized countries. China's beggar-thy-neighbor protectionism threatens to ignite a global trade war of devastating proportions.

In 2010, as stimulus spending in the United States and elsewhere lifts economic activity, oil prices will surge and China's exports will rise above 2008 levels, thanks to an undervalued currency and larger export subsidies. That will push the trade deficit beyond its peak of 5.1% of GDP, and this may well pull the U.S. economy back into recession.

Dollars spent on imported oil and cars and consumer goods from China cannot be spent on U.S. goods and services, and every dollar that U.S. imports exceed exports negates at least one dollar of federal stimulus spending. Overall, the trade deficit overwhelms the positive effects of the Obama stimulus package on demand for U.S. goods and services, GDP and employment. Along with the banking crisis, the trade deficit is a primary cause of the U.S. recession.

The dollar remains at least 40% to 50% overvalued against the Chinese yuan and other Asian currencies. Although China adjusted the yuan from 8.28 per dollar to 8.11 in July 2005 and permitted it to rise gradually to 6.84 by July 2008, the value of the yuan has not changed since.

To sustain an undervalued currency in 2008, China purchased approximately $600 billion in U.S. and other foreign securities, creating a 40% subsidy on its exports of goods and services. Other Asian governments align their currency policies with China to avoid losing competitiveness to Chinese products in lucrative U.S. and EU markets.

Consequences for Economic Growth

High and rising trade deficits tax economic growth. Specifically, each dollar spent on imports that is not matched by a dollar of exports reduces domestic demand and employment and shifts workers into activities where productivity is lower.

Productivity is at least 50% higher in industries that export and compete with imports, and reducing the trade deficit and moving workers into trade-competing industries would increase GDP.

Were the trade deficit cut in half, GDP would increase by at least $400 billion, or about $2750 for every working American. Workers' wages would not be lagging inflation, and ordinary working Americans would more easily find jobs paying higher wages and offering decent benefits.

Manufacturers are particularly hard hit by this subsidized competition. Through the recent economic expansion and recession, the manufacturing sector has lost 4.6 million jobs since 2000. Following the patterns of past economic expansions, the manufacturing sector should have kept at least 2 million of those jobs, especially given the very strong productivity growth accomplished in durable goods and throughout manufacturing.

Longer term, persistent U.S. trade deficits are a substantial drag on growth. U.S. import-competing and export industries spend three times the national average on industrial R&D, and encourage more investments in skills and education than other sectors of the economy. By shifting employment away from trade-competing industries, the trade deficit reduces U.S. investments in new methods and products, and skilled labor.

Cutting the trade deficit in half would boost U.S. GDP growth by 1 percentage point a year, and the trade deficits of the past two decades have reduced U.S. growth by 1 percentage point a year. Lost growth is cumulative. Thanks to the record trade deficits accumulated over the past 20 years, the U.S. economy is about $3 trillion smaller. This comes to about $20,000 per worker.

Had Washington acted responsibly to reduce the deficit, American workers would be much better off, tax revenues would be much larger, and the federal deficit would be much smaller. The recession would be much less severe.

If the Obama administration relies on stimulus and bank reform alone, the economy will fall back into recession once the spending has run its course. A pattern of false recoveries, much as occurred during the Great Depression, will likely emerge. Conditions will not be as bad, but unemployment will stay at unacceptable levels.

Comments

[Billy Gee:]

Thank you, Mr. Morci. It is so refreshing to see a reasoned analysis of our bizarre trade relationship with China. The usual "talking points" of protectionism and we need China to buy our Treasuries with their wealth to support our economy are having ruinous results for our standard of living. China has a gigantic soverign wealth fund of trillions of U.S. dollars that they must use to buy U.S. finished goods and services. This is a "Buy American" campaign to sustain a future trade relationship or else.

Feb 16 11:57 AM

[HaavBline:]

"In 2008, the United States had a $144.1-billion surplus on trade in services. This was hardly enough to offset the massive $821.2-billion deficit on trade in goods."

US exports 'security services' for free to the rest of the world. The value of such free security services can be estimated at about 70% of our annual defense spending. I derived this percentage based on the fact that US defense spending amounts to about half of all world defense spending, where all of our allies defense spending amounts to only 1/3 of that level, about 1/6 of world defense spending, according to Wikipedia.

"As of 2009, the United States government is spending about $1 trillion annually on defense-related purposes." (Again, from Wikipedia, "Military budget of the United States")

In other words, we give up annually around $700B of security services we exported to the world voluntarily. As a result, workers shifted into these global security activities has a productivity of ZERO because the US gets nothing in return.

IIf only half of such free service exports are converted to paid services to our allies, it will contribute 1% annually to our GDP growth and those all should be high paying jobs.

If we are able to push our allies to pay fully for the security services they received, the surplus on trade in services would be more than $800B, and this would reveal the true picture that our national trade has been balanced all along, that we have always exported services that should be valued the same as the good we exported all these years, if only we hadn't give them away for free to our allies.

Feb 16 11:58 AM

[Dave Wrixon:]

The biggest problem is the fixation with GDP.

The real problem is the ratio of the productive part of the economy to the total.

To get meaningful figures you have to cut down on things like Government Administration, Shopping, Wholesaling and Distribution, and Legal Costs. None of these things actually create wealth. These industries whilst important at best help to redistribute it, though not always more evenly. Even the entertainment Industry cannot be regarded as being wholly a wealth generating business.

What needs to happen is the creation of a measure by which we gauge the size of the wealth generating proportion of the economy and benchmark that against the wealth generating capacity of other countries. Only by measuring this accurately can we discover how to grow our real economic activity. It simply is not good enough to aggregate wealth generation, with leisure therapy and other forms of indulgence, and then lump on top all the human overhead and then top it off with a big dollop of waste.

Measure you wealth generating capacity and nurture it, and the balance of payments will right itself. Your industry will attract inward investors and you products will attract buyers. America has to get past the idea that any product will sell as long as you make the pricing structures sufficiently baffling and throw enough advertising spend at it.

Feb 16 01:31 PM

[iyamwutiam:]

I am not sure that there is no return on ' American security' services- as the person above puts it. Other's may call it colonialization. Take Japan for example where we have over 150K troops for over 50 years and also Korea. Japan in particular has gone out of its way to make sure the policies it implements will benefit the US at the cost to its own people. Germany as well, Saudi Arabia, Kuawait are also in the so-called subsidized services beneficiary line -with whom we wouldn't have two of OPECs producers helping to drive down the price of oil for the benefit of the consuming American public.

I am not sure why people thik that these 'services' are primarily there to benefit the US political and strategic missions (hegemony and using the military to support a move out of the US dollar's by many Asian/MidEast countries (Iraq/Iran). It has been well documented that the US military is used to support dollar hegemony -which is the real reason the US can sustain such mind-boggling deficits.

Feb 16 01:45 PM

[Blackstone:]

It seems as if you are arguing that there is a major problem with the trade deficit, but you do not present a solution to amend this disaster. I agree that the trade imbalance should be righted and the United States needs to worry about getting their own economy in line before they begin to borrow foreign savings in order to patch the wound. However, just balancing the trade does not balance the trade deficit. There still remains the many billions of dollars that the economy has lost through foreign debt.

Thus, my question arises, how would you suggest on getting rid of the trade debt? At the same time, any plan that is enacted has to allow for the fact that the economy should not go back into a trade deficit, so how would you suggest to accomplish this as well?

!Blackstone!

Feb 16 05:15 PM

[scfranklin94:]

Keynesian fiscal policy in the government's hand guarantees that we'll spend too much money and inflation will return, when that happens the $1.7 trillion that the Chinese have invested with us will devalue and they'll see the idiocy of undervaluing their currency. When the yuan floats freely, the trade deficit will come back into balance as we become a somewhat poorer nation.

Feb 17 08:25 AM

[biomedlives:]

Amern - it is high time we fixed the trade deficit!

Feb 17 08:38 AM

[biomedlives:]

Amen, I meant.

Feb 17 08:38 AM

[Trane250:]

How do you propose to fix the trade deficit when we've forgotten how to make things? And even if we could restart the industries that we've lost, we would butt heads with the Japanese who design and produce better products more efficiently and with the Chinese who are masters at copying and mass producing things utilizing their unlimited supply of cheap labor.

Feb 17 09:53 AM

[kelm:]

This topic will get a lot more press i the next year or so I think. The author s certainly correct - we have both a massive fiscal deficit and trade deficit. Unfortunately, we, as a single nation, will find that he re-balancing of international trade is something we will need to work jointly with the rest of the world. exactly how or what needs to be done is unclear. Martin Wolf writing in the FT some weeks ago discussed the same problem but, again, there seem to be no god ideas yet on how to fix it. What is encouraging is that China has stated that the export model in Asia is dead. They, and other Asian nations do recognize that their economies are unbalanced as is ours (the difference is their banks and governments are not insolvent). So that provides some hope that other key nations in the world recognize that some joint solution needs to be developed.

Feb 17 09:54 AM

[svkoho:]

The Us has the highest current account deficit in the world. Your statement that our deficit declined in 2008 because of falling consumer demand and economic growth implies that those were the dominant factors. Do you think that having crude prices decline from $147 to $40 might be more important? I"m not sure about your figures either. IF you take an average price of $100/bl for the year(a little high but the math is easier) X the daily consumption per day of 13.5 million bbl/Day (our import average) X 365 days, I get almost $500 billion of our current account deficit due to petroleum products alone, a number almost sure to return after OPEC is done cutting exports. My point, like yours is that until we stop sending money abroad to buy oil, nothing else really matters. It's a Faustian choice to restrict imports by fiat or price or tax it to restrict it in the face of a looming depression, but it has to be done. I favor taxing it to generate money for infrastructure for grid and rail network build out rather than destroying what pitiful future my children now have.

Feb 17 11:40 AM

[HaavBline:]

If we are able to bring back low-end manufacturing to the US, we are going to bring back industrial pollution and energy consumption which we already conveniently exported to Asia.

People only remember that companies moved manufacturing to Asia to take advantage of low cost labor. They forget that the other major reason was to escape from higher environmental standards.

If we want those jobs back, we need to ready oursleves for a lower standard of living, more pollution, and more dependency on energy imports from OPEC.

Feb 17 01:52 PM

[Trane250:]

Could you define "low end manufacturing?" Would making brassieres be "low end?'" How about advanced integrated circuits"? Most of the world's semiconductors are manufactured in Taiwan.

On Feb 17 01:52 PM HaavBline wrote:

> If we are able to bring back low-end manufacturing to the US, we
> are going to bring back industrial pollution and energy consumption
> which we already conveniently exported to Asia.
>
> People only remember that companies moved manufacturing to Asia to
> take advantage of low cost labor. They forget that the other major
> reason was to escape from higher environmental standards.
>
> If we want those jobs back, we need to ready oursleves for a lower
> standard of living, more pollution, and more dependency on energy
> imports from OPEC.

Feb 17 03:17 PM

[misiosnechacz:]

Firs thing that US has to do is to force china to put juan on free market. Right now Chinese goverment decide of value of juan so they are pushing export. I don't think that You should be scared of bonds that chinese got that's their problem. If Iremember correctly they've got somthing like 650 bln $. But if they are going to change for gold and euros they will just lose the money. dolar will hit bottom and will be even more difficult to export goods for them to US. And changing it for something else that would create another bubble on Euro, gold and whatever they would choose.
Someone stupid said that US forgot how to produce3 things because chinese and japanese are better. Anyone can make money on anything if You really want it You will get it.
Change the trade deficit I think that some US companys are just intrested in USA and few big countries. You have to try to be everywhere I think that is really worth it. I can see Made in China or Japan everywhere I can't say the same about US. All I can see from US is $.

Feb 18 05:52 AM

[User 365748:]

Thank goodness someone is helping to connect the dots between our massive trade deficit and the overall economy. Mr. Morici's analysis should be alarming to all Americans when he states that our trade deficits have retarded GDP growth by 1% over the past few years. That is a very sobering statistic.

I wish to comment on those who quite appropriately raise the question of what can be done about the trade deficit. As one blogger pointed out, most of the options involve working with our allies and trading partners, a slow and tedious process.

There is one option which is 100% within our control and that is reforming our highly dysfunctional tax system. One of the most damaging aspects of our tax system is the manner in which we tax production at each and every level of the supply chain, and then provide no mechanism for relieving the burden of these costs on the exports we ship out. We also do not add taxes (in most cases) to imports arriving on our shores. Of course, import tariffs are discriminatory and would create problems with our trading partners and the WTO. However, a National Retail Sales Tax (NRST) would not present those problems, since it would not be seen as discriminatory. This is precisely what the FairTax bill (HR25) does.

To those who say that tax structure is not a significant factor in our trade deficit, I would point out that (1) only one country in the OECD has no border adjustment element in its tax system. The other 29 do. (2) Also, only one country has a massive trade deficit; the other 29 actually have a net trade surplus, or at least they did a couple of years ago. Would it surprise you to find out that the 1 country in #1 is the same as the 1 country in #2? Calling that a coincidence is quite a stretch, isn't it?

This isn't to say that addressing the tax bias will bring our trade in balance. However, unlike most of the other factors, addressing the bias which our current tax system provides is totally within our control - no need to collaborate with other countries is necessary. As such, it should be seen as "low hanging fruit".

Feb 27 03:06 PM

[Rick W Johnson:]

Amen, Brother. The FairTax is a help for several of our economic woes.

On Feb 27 03:06 PM User 365748 wrote:

> Thank goodness someone is helping to connect the dots between our
> massive trade deficit and the overall economy. Mr. Morici's analysis
> should be alarming to all Americans when he states that our trade
> deficits have retarded GDP growth by 1% over the past few years.
> That is a very sobering statistic.
>
> I wish to comment on those who quite appropriately raise the question
> of what can be done about the trade deficit. As one blogger pointed
> out, most of the options involve working with our allies and trading
> partners, a slow and tedious process.
>
> There is one option which is 100% within our control and that is
> reforming our highly dysfunctional tax system. One of the most damaging
> aspects of our tax system is the manner in which we tax production
> at each and every level of the supply chain, and then provide no
> mechanism for relieving the burden of these costs on the exports
> we ship out. We also do not add taxes (in most cases) to imports
> arriving on our shores. Of course, import tariffs are discriminatory
> and would create problems with our trading partners and the WTO.
> However, a National Retail Sales Tax (seekingalpha.com/symbo...)
> would not present those problems, since it would not be seen as discriminatory.
> This is precisely what the FairTax bill (HR25) does.
>
> To those who say that tax structure is not a significant factor in
> our trade deficit, I would point out that (1) only one country in
> the OECD has no border adjustment element in its tax system. The
> other 29 do. (2) Also, only one country has a massive trade deficit;
> the other 29 actually have a net trade surplus, or at least they
> did a couple of years ago. Would it surprise you to find out that
> the 1 country in #1 is the same as the 1 country in #2? Calling that
> a coincidence is quite a stretch, isn't it?
>
> This isn't to say that addressing the tax bias will bring our trade
> in balance. However, unlike most of the other factors, addressing
> the bias which our current tax system provides is totally within
> our control - no need to collaborate with other countries is necessary.
> As such, it should be seen as "low hanging fruit".

Feb 27 09:02 PM