The controversy over counting re-exports in the trade deficit derives from a common fallacy that I call factoid economics. You’ve heard people exclaim, “The real unemployment rate is ten percent!” Now people are saying, “The real trade deficit is $725 billion!”
Really, does anyone care what the exact figure is? Does anyone know what it should be?
Understanding economics does not come from throwing numbers around. It comes from understanding relationships, as when someone helps produce a product, and someone finds a buyer for the product, and someone invests in a business. No dollar amount is important in isolation from the entire set of relationships.
Here’s the background on the trade deficit calculation. The Trump administration wants to change the treatment of “re-exports.” Cars come from Japan into the Port of Portland (Oregon), a 30-minute drive from my office. Some of those cars head up to British Columbia by train. The new idea is to count all of the cars that come in as imports, but to not count the cars that head up to Canada as exports. This accounting method has a high bogusosity factor, to put it politely.
But what does it matter what the real number is? I have been forecasting the U.S. economy since 1980. There has never been a time when my forecast is better or worse for my knowledge of the trade deficit. I certainly have colleagues who agonize over it, but no one has shown me an example of where knowing the trade deficit helps provide an understanding of the future of the economy. Sometimes a rising high trade deficit leads to depreciation of the dollar on foreign exchange markets; sometimes it doesn’t.
For public policy purposes, it makes no difference how we count the numbers. The same number of people are working either way.
If the trade deficit were bad for the economy, then a higher number would seem worse. That would not be true if the high number were bogus, of course, though it might help motivate a change. But it is not true that a high deficit is bad for the economy. A country with strong growth needs investment. A trade deficit goes along with a foreign investment surplus. It’s an accounting identity.
Consider the period from 1870 through 1890. It was a good era for growth in the U.S., which averaged five percent a year inflation-adjusted. And in 13 of those 20 years, the country ran a trade deficit.
Here’s how I look at the factoid economists’ worries. First, I have a theory of how the economy works. A trade deficit is not necessarily bad. The unemployment rate shouldn’t be zero. The economy works best when prices reflect both scarcity and value.
Second, I try to put numbers in sort of perspective. When I look at unemployment rates, I tend to look at the trend over time. So when somebody grabs the U-6 measure and says the true unemployment rate is 9.4 percent, I shrug and say that’s down from a peak of 17.1 percent. All of the measures tend to go up and down together, and they all tell the same story about the movement of the economy.
Another approach to facts is to put them into some context. The U.S. trade deficit, for example, is easier to interpret relative to the size of the economy than in absolute dollars. The chart above shows the dramatic increase in the deficit (more negative in the chart) from 1990 through 2004 - during an era when overall U.S. growth was strong. The deficit fell for a few years before the 2008 recession.
Beware of the factoids that sound like they can speak for themselves. Understanding the economy requires that underlying relationships be clear, and numbers used only when they are in some kind of perspective.