U.S. Records Huge Trade Deficit

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by: Peter Morici

Today, the Commerce Department reported the November trade deficit was $40.4 billion. This was down from $56.7 billion in October, largely because oil prices fell and the recession is curbing demand for imported consumer goods and petroleum.

To the extent stimulus packages expected to be enacted in the United States, Europe and China lift the global economy, the reduction in the trade deficit will reverse. Oil prices will rise again, and with China increasing subsidies on exports, U.S. imports of consumer goods will soar. The trade deficit will emerge as a major drag on the demand for U.S. made goods and services, and pull the U.S. economy back into recession as the effects of stimulus spending wear off.

At 3.4 percent of GDP, the huge trade deficit indicates Americans continue to consume much more than they produce and borrow too much from the rest of the world, especially China and the Middle East oil exporters.

The huge trade deficit is nearly entirely by trade with China, imports and automobiles and parts. These are caused by a combination of an overvalued dollar against the Chinese yuan and Chinese protectionism, a dysfunctional national energy policy that increases U.S. dependence on foreign oil, and the competitive woes of the three domestic automakers. Together, the trade deficit with China and on petroleum and automotive products account for virtually the entire deficit on trade in goods and services.

To finance the trade deficit, Americans are borrowing and selling assets at a pace of about $400 billion a year. U.S. foreign debt exceeds $6.5 trillion, and the debt service comes to nearly $2,000 a year for every working American.

The trade deficit will make the recession longer and deeper, and lessen the positive benefits of President-elect Obama’s proposed stimulus package. If Obama does not fix the banks and significantly reduce the trade deficit, stimulus spending will not permanently pull the economy out of recession, and the economy will slip into a prolonged malaise or depression.

Simply, money spent on Middle East oil, Chinese televisions and coffee markers, Japanese and Korean cars can’t be spent on U.S. made goods and services, unless offset by a comparable amount of exports. Since U.S. imports exceed exports by 3.4 percent of GDP, the trade deficit creates an enormous drag on demand for U.S.-made goods and services. Along with the credit crisis and resulting slowdown in new housing and commercial construction, the banking crisis and trade deficit could push unemployment above 10 percent for a long time.

The trade deficit imposes a significant tax on GDP growth by moving workers from export and import-competing industries to other sectors of the economy. This reduces labor productivity, research and development (R&D) spending, and important investments in human capital. In 2009 the trade deficit is slicing $400 billion to $600 billion off GDP, and longer term, it reduces potential annual GDP growth to 3 percent from 4 percent.

Cutting the trade deficit in half would pull the country out of recession and get the economy on a stable growth path. A fiscal stimulus package, increasing the federal budget deficit by two or three percent of GDP, will make things much better for a period of time; however, successive stimulus spending and permanently larger federal budget deficits will be needed to sustain the GDP and employment gains. Whereas, cutting the trade deficit in half would yield lasting benefits for U.S. GDP and employment growth, far transcending any fiscal stimulus in its permanent effects. Cutting the trade deficit would substantially increase tax revenues and reduce the federal budget deficit.

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 percent higher in industries that export and compete with imports, and reducing the trade deficit and moving workers into these industries would increase GDP.

Were the trade deficit cut in half, the movement of workers and capital into more productive export and import-competing industries would increase by at least $400 billion or about $2500 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 recession and recovery, the manufacturing sector has lost more than 4 million jobs since 2000. Following the pattern of past economic recoveries, the manufacturing sector should have regained 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 productivity 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 one percentage point a year, and the trade deficits of the last two decades have reduced U.S. growth by one percentage point a year.

Lost growth is cumulative. Thanks to the record trade deficits accumulated over the last 10 years, the U.S. economy is about $1.5 trillion smaller. This comes to about $10000 per worker.

Had the Administration and the Congress acted responsibly to reduce the deficit, American workers would be much better off, tax revenues would be much larger, and the federal deficit could be eliminated without cutting spending.

The damage grows larger each month, as the Administration and Congress dally and ignore the corrosive consequences of the trade deficit.